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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended.......September 30, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to ___________
Commission File Number 005-57091
FIRST MUTUAL BANCSHARES, INC.
--------------------------------------------
(Exact name of registrant as specified in its charter)
WASHINGTON 91-2005970
---------- ----------
(State of incorporation) (I.R.S. Employer Identification Number)
400 108th Avenue N.E., Bellevue, WA 98004
---------------------------------------- ----------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (425) 453-5301
--------------
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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. November 14, 2002 4,236,436
----------------- ---------
================================================================================
FIRST MUTUAL BANCSHARES, INC.
QUARTERLY REPORT ON FORM 10-Q
SEPTEMBER 30, 2002
TABLE OF CONTENTS
PAGE
----
PART I: FINANCIAL INFORMATION...........................................
Forward-Looking Statements Disclaimer....................
Item 1. Financial Statements............................................
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................
General..................................................
Results of Operations....................................
Net Income.........................................
Net Interest Income................................
Other Operating Income.............................
Operating Expenses.................................
Financial Condition......................................
Asset Quality............................................
Portfolio Information....................................
Deposit Information......................................
Business Segments........................................
Consumer Lending...................................
Commercial Lending.................................
Investment Securities..............................
Liquidity and Capital Reserves...........................
Branch Expansion.........................................
Trust Preferred Securities Issuance......................
Item 3. Quantitative and Qualitative Disclosures About Market Risk......
Gap Analysis.............................................
Simulation Model.........................................
Securities...............................................
Item 4. Controls and Procedures.........................................
PART II: OTHER INFORMATION...............................................
Item 1. Legal Proceedings...............................................
Item 2. Changes in Securities and Use of Proceeds.......................
Item 3. Defaults Upon Senior Securities.................................
Item 4. Submission of Matters to a Vote of Security-Holders.............
Item 5. Other Information...............................................
Item 6. Exhibits and Reports on Form 8-K................................
SIGNATURES.................................................................
CERTIFICATION..............................................................
1
PART I: FINANCIAL INFORMATION
FORWARD-LOOKING STATEMENTS DISCLAIMER
- -------------------------------------
This Form 10-Q, First Mutual Bancshares, Inc. contains statements concerning
future operations, trends, expectations, plans, capabilities, and prospects of
First Mutual Bancshares, Inc. and First Mutual Bank (together, the "Company")
that are forward-looking statements for the purposes of the safe harbor
provisions under the private securities litigation reform act of 1995.
Statements containing words such as "expect", "anticipate", "indicate",
"possible", "likely", and "forecast" generally constitute forward-looking
statements. Although the company believes that the expectations expressed in
these forward-looking statements are based on reasonable assumptions within the
bounds of its knowledge of its business, operations, and prospects, these
forward-looking statements are subject to numerous uncertainties and risks, and
actual events, results, and developments will ultimately differ from the
expectations and may differ materially from those expressed or implied in such
forward-looking statements. Factors which could affect actual results include
economic conditions in the company's market area and the nation as a whole,
interest rate fluctuations, the impact of competitive products, services, and
pricing, credit risk management, the ability of the company to control its costs
and expenses, loan delinquency rates in one or more of its segments, and the
legislative and regulatory changes affecting the banking industry. These risks
and uncertainties should be considered in evaluating the forward-looking
statements, and undue reliance should not be placed on such statements. The
Company shall not be responsible to update any such forward-looking statements.
ITEM 1. FINANCIAL STATEMENTS
In the opinion of management, the accompanying consolidated statements of
financial condition and related interim consolidated statements of income,
comprehensive income, stockholders' equity and cash flows reflect all
adjustments (which include reclassifications and normal recurring adjustments)
that are necessary for a fair presentation in conformity with accounting
principles generally accepted in the United States of America ("GAAP"). The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect amounts reported in the financial
statements. Changes in these estimates and assumptions are considered reasonably
possible and may have a material impact on the financial statements.
Certain reclassifications have been made to the 2001 financial statements to
conform to the 2002 presentation. All significant intercompany transactions and
balances have been eliminated.
The information included in this Form 10-Q should be read in conjunction with
First Mutual Bancshares, Inc. Year 2001 Annual Report on Form 10-K to the
Securities and Exchange Commission. Interim results are not necessarily
indicative of results for a full year.
Consolidated Financial Statements of the Company begin on page 2.
2
Item 1. Financial Statements
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, December 31,
2002 2001
------------- -------------
(Unaudited)
ASSETS:
CASH AND CASH EQUIVALENTS:
Interest-earning deposits $ 8,537,931 $ 5,761,548
Noninterest-earning demand deposits
and cash on hand 5,061,107 8,853,755
------------- -------------
13,599,038 14,615,303
MORTGAGE-BACKED AND OTHER SECURITIES
AVAILABLE-FOR-SALE 55,984,502 45,961,301
LOANS RECEIVABLE, HELD-FOR-SALE 6,031,083 4,475,792
MORTGAGE-BACKED AND OTHER SECURITIES
HELD-TO-MATURITY 19,227,078 26,385,652
LOANS RECEIVABLE 593,290,328 570,109,616
RESERVE FOR LOAN LOSSES (7,666,431) (7,032,062)
------------- -------------
LOANS RECEIVABLE, net 585,623,897 563,077,554
ACCRUED INTEREST RECEIVABLE 3,418,413 3,556,110
LAND, BUILDINGS AND EQUIPMENT, net 10,427,454 8,831,022
FEDERAL HOME LOAN BANK (FHLB) STOCK, 10,268,500 9,759,300
at cost
MORTGAGE SERVICING RIGHTS 44,826 47,810
OTHER ASSETS 3,088,111 1,638,707
------------- -------------
TOTAL $ 707,712,902 $ 678,348,551
============= =============
3
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Continued)
September 30, December 31,
2002 2001
------------- -------------
(Unaudited)
LIABILITIES:
Deposits:
Money market deposit and
checking accounts $ 121,476,688 $ 109,055,274
Regular savings 8,616,671 7,855,528
Time deposits 353,784,184 311,986,860
------------- -------------
Total deposits 483,877,543 428,897,662
Drafts payable 493,434 1,015,927
Accounts payable and other liabilities 4,492,862 3,446,997
Advance payments by borrowers for
taxes and insurance 3,154,864 1,662,530
FHLB advances 161,380,581 191,104,138
Other advances 250,000 250,000
Current tax liability 2,740,751 --
Trust Preferred Securities 9,000,000 --
------------- -------------
Total liabilities 665,390,035 626,377,254
STOCKHOLDERS' EQUITY:
Common stock, $1 par value-
Authorized, 10,000,000 shares
Issued and outstanding, 4,217,828
and 4,725,966 shares, respectively 4,217,828 4,725,966
Additional paid-in capital 23,732,024 31,411,296
Retained earnings 13,704,293 16,025,853
Accumulated other comprehensive income:
Unrealized income/(loss) on securities
available-for-sale and interest rate
swap, net of federal income tax 668,722 (191,818)
------------- -------------
Total stockholders' equity 42,322,867 51,971,297
------------- -------------
TOTAL $ 707,712,902 $ 678,348,551
============= =============
4
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
Quarters ended September 30, Nine Months ended September 30,
---------------------------- -------------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
(Unaudited)
INTEREST INCOME:
Loans Receivable $10,868,309 $11,787,341 $32,259,697 $35,157,638
Interest on AFS Securities 823,104 401,184 2,683,591 1,463,723
Interest on HTM Securities 291,523 713,804 988,659 3,031,487
Interest Other 223,934 300,736 532,211 602,545
----------- ----------- ----------- -----------
12,206,870 13,203,065 36,464,158 40,255,393
INTEREST EXPENSE:
Deposits 3,482,694 5,740,381 10,637,202 18,037,256
FHLB advances and other 1,912,267 2,269,545 5,808,397 6,582,087
----------- ----------- ----------- -----------
5,394,961 8,009,926 16,445,599 24,619,343
----------- ----------- ----------- -----------
Net interest income 6,811,909 5,193,139 20,018,559 15,636,050
PROVISION FOR LOAN LOSSES 650,000 50,000 785,000 315,000
----------- ----------- ----------- -----------
Net interest income, after provision
for loan losses 6,161,909 5,143,139 19,233,559 15,321,050
OTHER OPERATING INCOME:
Gain on sales of loans 522,670 100,105 980,194 1,263,786
Servicing fees, net of amortization 34,064 25,080 86,405 91,908
Gain on sales of investments 129,383 417,545 286,826 1,046,208
Fees on deposits 118,478 76,500 348,370 243,653
Other 274,615 257,745 789,750 671,122
----------- ----------- ----------- -----------
Total other operating income 1,079,210 876,975 2,491,545 3,316,677
BALANCE, carried forward 7,241,119 6,020,114 21,725,104 18,637,727
5
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Continued)
Quarters ended September 30, Nine Months ended September 30,
---------------------------- -------------------------------
2002 2001 2002 2001
---- ---- ---- ----
(Unaudited)
BALANCE, brought forward $ 7,241,119 $ 6,020,114 $21,725,104 $18,637,727
OPERATING EXPENSES:
Salaries and employee benefits 2,400,765 1,751,438 7,588,177 6,063,816
Occupancy 590,131 531,390 1,727,371 1,568,609
Other 1,072,649 1,062,903 3,359,005 2,876,961
----------- ----------- ----------- -----------
Total other operating expenses 4,063,545 3,345,731 12,674,553 10,509,386
----------- ----------- ----------- -----------
Income before Federal Income Tax and
Cumulative Effect of Adoption of
New Accounting Principle 3,177,574 2,674,383 9,050,551 8,128,341
FEDERAL INCOME TAX 1,074,639 904,886 3,060,410 2,750,393
----------- ----------- ----------- -----------
Income before Cumulative Effect of
Adoption of New Accounting Principle 2,102,935 1,769,497 5,990,141 5,377,948
Cumulative effect of Adoption of New
Accounting Principle, net of federal
income tax -- -- -- (155,247)
----------- ----------- ----------- -----------
NET INCOME $ 2,102,935 $ 1,769,497 $ 5,990,141 $ 5,222,701
=========== =========== =========== ===========
PER SHARE DATA:
Basic earnings per common share before
Cumulative Effect of Adoption of New
Accounting Principle $ 0.46 $ 0.34 $ 1.21 $ 1.04
Cumulative Effect of Adoption of New
Accounting Principle, net of federal
income tax -- -- -- (0.03)
----------- ----------- ----------- -----------
Basic earnings per common share $ 0.46 $ 0.34 $ 1.21 $ 1.01
=========== =========== =========== ===========
Earnings per common share before
cumulative effect of Adoption of New
Accounting Principle, Assuming Dilution $ 0.45 $ 0.34 $ 1.18 $ 1.03
Cumulative Effect of Adoption of New
Accounting Principle, net of federal
income tax -- -- -- (0.03)
----------- ----------- ----------- -----------
Earnings Per Common Share Assuming
Dilution $ 0.45 $ 0.34 $ 1.18 $ 1.00
=========== =========== =========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING 4,527,841 5,183,158 4,975,848 5,170,831
=========== =========== =========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING
INCLUDING DILUTIVE STOCK OPTIONS 4,639,084 5,266,074 5,066,706 5,260,501
=========== =========== =========== ===========
6
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
Common stock Additional Employee Stock Accumulated
------------------------ Paid-In Retained Ownership Comprehensive
Shares Amount Capital Earnings Plan Debt Income(Loss) Total
----------- ----------- ----------- ----------- ----------- ----------- -----------
BALANCE, December 31, 1999 4,672,636 $ 4,672,636 $31,116,359 $ 4,527,356 $ (310,739) $ (668,953) $39,336,659
Options exercised, including tax
benefit of $6,431 8,650 8,650 42,186 50,836
Retirement of shares repurchased (10,000) (10,000) (40,000) (51,874) (101,874)
Repayment of ESOP debt 212,918 212,918
Cash dividends declared ($.20 per
share) (933,913) (933,913)
Comprehensive income:
Net income 6,599,000 6,599,000
Other comprehensive income(loss)--
Change in unrealized gain on
securities available-for-sale, net
of federal income tax 753,645 753,645
----------- ----------- -----------
Total Comprehensive income 6,599,000 753,645 7,352,645
----------- ----------- ----------- ----------- ----------- ----------- -----------
BALANCE, December 31, 2000 4,671,286 $ 4,671,286 $31,118,545 $10,140,569 $ (97,821) $ 84,692 $45,917,271
=========== =========== =========== =========== =========== =========== ===========
Options exercised, including tax
benefit of $117,015 54,680 54,680 292,751 347,431
Repayment of ESOP debt 97,821 97,821
Cash dividends declared ($.22 per
share) (1,036,847) (1,036,847)
Comprehensive income:
Net income 6,922,131 6,922,131
Other comprehensive income(loss)--
Change in unrealized gain on
securities available-for-sale, net
of federal income tax (276,510) (276,510)
----------- ----------- -----------
Total Comprehensive income 6,922,131 (276,510) 6,645,621
----------- ----------- ----------- ----------- ----------- ----------- -----------
BALANCE, December 31, 2001 4,725,966 $ 4,725,966 $31,411,296 $16,025,853 $ -- $ (191,818) $51,971,297
=========== =========== =========== =========== =========== =========== ===========
Options exercised, including tax
benefit of $99,579 38,235 38,235 255,262 293,497
Retirement of shares repurchased (1,019,256) (1,019,256) (13,963,793) (815,419) (15,798,468)
10% stock dividend 472,883 472,883 6,029,259 (6,502,142) --
Cash dividends declared ($.07 per
share) (994,140) (994,140)
Comprehensive income:
Net income 5,990,141 5,990,141
Other comprehensive income(loss)--
Change in unrealized gain on
securities available-for-sale, and
interest rate swap net of federal
income tax 860,540 860,540
----------- ----------- -----------
Total Comprehensive income 5,990,141 860,540 6,850,681
----------- ----------- ----------- ----------- ----------- ----------- -----------
BALANCE, September 30, 2002 4,217,828 $ 4,217,828 $23,732,024 $13,704,293 $ -- $ 668,722 $42,322,867
=========== =========== =========== =========== =========== =========== ===========
7
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended September 30,
--------------------------------
2002 2001
------------- -------------
(Unaudited)
OPERATING ACTIVITIES:
Net income $ 5,990,141 $ 5,222,701
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Provision for loan losses 785,000 315,000
Depreciation and amortization 576,275 999,968
Deferred loan origination fees, net of accretion (601,023) (435,448)
Amortization of mortgage servicing rights 35,589 9,832
Gain on sales of loans (980,194) (1,100,127)
Gain on sale of repossessed real estate -- (9,296)
Gain on sale of securities available-for-sale (286,826) (581,996)
Gain on sale of other investments -- (464,212)
FHLB stock dividends (446,600) (408,800)
Changes in operating assets & liabilities:
Loans receivable held-for-sale (1,555,291) 10,787,223
Accrued interest receivable 137,697 1,055,257
Other assets (1,449,404) (336,595)
Drafts payable (522,493) 180,676
Accounts payable and other liabilities 1,078,234 (897,124)
Federal income taxes 2,740,751 484,727
Advance payments by borrowers for taxes and insurance 1,492,334 1,394,933
------------- -------------
Net cash provided by operating activities 6,994,190 16,216,719
INVESTING ACTIVITIES:
Loan originations (170,589,494) (182,341,853)
Loan principal repayments 140,517,563 125,970,510
Increase/decrease in undisbursed loan proceeds 7,164,336 (9,699,454)
Principal repayments & redemptions on
mortgage-backed and other securities 13,204,561 50,422,704
Purchase of mortgage-backed securities available-for-sale (39,526,461) (14,434,698)
Purchase of mortgage-backed and other securities (250,000) (2,996,250)
Purchases of premises and equipment (2,236,384) (1,737,517)
Purchase of FHLB stock (62,600) (233,100)
Proceeds from sale of loans 306,104 1,146,155
Proceeds from other investments -- 472,769
Proceeds from sale of securities 25,836,655 34,767,959
Proceeds from sale of real estate held-for-sale -- 1,433,584
------------- -------------
Net cash provided (used) by investing activities (25,635,720) 2,770,809
8
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
Nine months ended September 30,
--------------------------------
2002 2001
------------- -------------
(Unaudited)
FINANCING ACTIVITIES:
Net increase (decrease) in deposit accounts 44,621,347 (14,205,956)
Interest credited to deposit accounts 10,358,534 18,076,756
Proceeds from Trust Preferred Securities 9,000,000 --
Repurchase/Retirement of Common Stock (15,798,468) --
Proceeds from advances 134,198,892 173,941,000
Repayment of advances (163,922,449) (159,834,500)
Dividends paid (1,026,509) (703,795)
Proceeds from exercise of stock options 193,918 186,590
Repayment of employee stock ownership plan debt -- 97,821
------------- -------------
Net cash provided by financing activities 17,625,265 17,557,916
------------- -------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS (1,016,265) 36,545,444
CASH & CASH EQUIVALENTS:
Beginning of year 14,615,303 6,998,992
------------- -------------
End of quarter $ 13,599,038 $ 43,544,436
============= =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Loans originated for mortgage banking activities $ 53,797,048 $ 70,987,505
============= =============
Loans originated for investment activities $ 170,589,494 $ 182,341,853
============= =============
Proceeds from sales of loans held-for-sale $ 52,241,757 $ 81,774,728
============= =============
Cash paid during the Nine months ended September 30 for:
Interest $ 16,541,852 $ 25,501,389
============= =============
Income taxes $ 2,490,000 $ 2,202,500
============= =============
SUPPLEMENTAL DISCLOSURES OF NONCASH
INVESTING ACTIVITIES:
Loans securitized into securities available for sale $ 14,485,309 $ --
Loans transferred (from) real estate
held-for-sale, net $ -- $ (1,352,611)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1.
The results of operations for the interim periods shown in this report are not
necessarily indicative of results to be expected for the fiscal year. In the
opinion of management, the information contained herein reflects all adjustments
necessary to make the results of operations for the interim periods a fair
statement of such operations.
NOTE 2.
MORTGAGE-BACKED AND OTHER SECURITIES AVAILABLE-FOR-SALE
The amortized cost and estimated fair value of securities available-for-sale at
September 30, 2002, and December 31, 2001 are summarized as follows:
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
------------ ------------ ------------ ------------
SEPTEMBER 30,2002:
Freddie Mac securities $ 4,737,657 $ 164,269 $ -- $ 4,901,926
Fannie Mae securities 49,636,495 1,446,081 -- 51,082,576
------------ ------------ ------------ ------------
$ 54,374,152 $ 1,610,350 $ -- $ 55,984,502
============ ============ ============ ============
DECEMBER 31, 2001:
Freddie Mac securities $ 5,276,304 $ 13,813 $ 5,779 $ 5,284,338
Fannie Mae securities 40,975,631 59,065 357,733 40,676,963
------------ ------------ ------------ ------------
$ 46,251,935 $ 72,878 $ 363,512 $ 45,961,301
============ ============ ============ ============
NOTE 3.
MORTGAGE-BACKED AND OTHER SECURITIES HELD-TO-MATURITY
The amortized cost and estimated fair value of mortgage-backed and other
securities are summarized as follows:
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
------------ ------------ ------------ ------------
SEPTEMBER 30, 2002:
Fannie Mae securities $ 16,903,708 $ 555,571 $ -- $ 17,459,279
Freddie Mac securities 948,461 11,468 -- 959,929
Municipal bonds 1,340,014 3,549 -- 1,343,563
REMICS 34,895 827 -- 35,722
------------ ------------ ------------ ------------
$ 19,227,078 $ 571,415 $ -- $ 19,798,493
============ ============ ============ ============
DECEMBER 31, 2001:
Fannie Mae securities $ 24,068,746 $ 497,926 $ -- $ 24,566,672
Freddie Mac securities 1,103,892 7,459 -- 1,111,351
Municipal bonds 1,112,852 -- 1,580 1,111,272
REMICs 100,162 999 17 101,144
------------ ------------ ------------ ------------
$ 26,385,652 $ 506,384 $ 1,597 $ 26,890,439
============ ============ ============ ============
9
NOTE 4.
NONPERFORMING ASSETS
The Bank had nonperforming assets as follows:
September 30, December 31,
2002 2001
------------ ------------
Nonperforming loans $ 837,123 $ 498,033
Real Estate and Repossessed assets held-for-sale 33,688 22,587
------------ ------------
Total Nonperforming Assets $ 870,811 $ 520,620
============ ============
At September 30, 2002, and December 31, 2001, the Bank had no material impaired
loans as defined under Statement of Financial Accounting Standards (SFAS) No.
114, "Accounting by Creditors for Impairment of a Loan."
NOTE 5.
EARNINGS PER SHARE
Basic Earnings Per Share is computed by dividing net income by the
weighted-average number of shares outstanding during the year. Diluted EPS
reflects the potential dilutive effect of stock options and is computed by
dividing net income by the weighted-average number of shares outstanding during
the year, plus the dilutive common shares that would have been outstanding had
the stock options been exercised.
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations for quarters ending September
30, 2002, and September 30, 2001:
Income Shares Per share
(numerator) (denominator) amount
------------------------------------------
Quarter ended September 30, 2002
- --------------------------------
Basic EPS:
Income available to common shareholders $ 2,102,935 4,527,841 $ 0.46
============
Effect of dilutive stock options -- 111,243
------------ ------------
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised $ 2,102,935 4,639,084 $ 0.45
============ ============ ============
Nine months ended September 30, 2002
- ------------------------------------
Basic EPS:
Income available to common shareholders $ 5,990,141 4,975,848 $ 1.21
============
Effect of dilutive stock options -- 90,858
------------ ------------
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised $ 5,990,141 5,066,706 $ 1.18
============ ============ ============
Quarter ended September 30, 2001
- --------------------------------
Basic EPS:
Income available to common shareholders $ 1,769,497 5,183,158 $ 0.34
============
Effect of dilutive stock options -- 82,916
------------ ------------
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised $ 1,769,497 5,266,074 $ 0.34
============ ============ ============
Nine months ended September 30, 2001
- ------------------------------------
Basic EPS:
Income available to common shareholders $ 5,222,701 5,170,831 $ 1.01
============
Effect of dilutive stock options -- 89,670
------------ ------------
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised $ 5,222,701 5,260,501 $ 1.00
============ ============ ============
10
NOTE 6.
RATE VOLUME ANALYSIS THIRD QUARTER 2002 NINE MONTHS ENDED SEPTEMBER 30, 2002
(Dollars in thousands) VS VS
THIRD QUARTER 2001 NINE MONTHS ENDED SEPTEMBER 30, 2001
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
TOTAL TOTAL
VOLUME RATE CHANGE VOLUME RATE CHANGE
- -------------------------------------------------------------------------------- ------------------------------------
INTEREST INCOME
Investments:
Available-for-sale securities $ 537 $ (115) $ 422 $ 1,417 $ (197) $ 1,220
Held-to-maturity securities (393) (29) (422) (1,553) (490) (2,043)
Other equity investments (71) (50) (121) (4) (110) (114)
---------- ---------- ---------- ---------- ---------- ----------
Total investments 73 (194) (121) (140) (797) (937)
Loans:
Residential 26 (241) (215) (72) (757) (829)
Residential construction 154 (113) 41 255 (493) (238)
Multifamily 196 (513) (317) 892 (1,710) (818)
Multifamily construction (154) (74) (228) (578) (348) (926)
Commercial real estate and Business 482 (748) (266) 2,157 (2,417) (260)
Commercial real estate construction 23 (35) (12) 95 (122) (27)
Consumer & Other 257 (136) 121 698 (456) 242
---------- ---------- ---------- ---------- ---------- ----------
Total loans 984 (1,860) (876) 3,447 (6,303) (2,856)
---------- ---------- ---------- ---------- ---------- ----------
Total interest income 1,057 (2,054) (997) 3,307 (7,100) (3,793)
INTEREST EXPENSE
Deposits:
Money market deposit and checking 116 (216) (100) 288 (1,057) (769)
Regular savings 1 (12) (11) -- (42) (42)
Time deposits (52) (2,095) (2,147) (642) (5,948) (6,590)
---------- ---------- ---------- ---------- ---------- ----------
Total deposits 65 (2,323) (2,258) (354) (7,047) (7,401)
FHLB advances and other 367 (725) (358) 1,731 (2,505) (774)
---------- ---------- ---------- ---------- ---------- ----------
Total interest expense 432 (3,048) (2,616) 1,377 (9,552) (8,175)
Net interest income $ 625 $ 994 $ 1,619 $ 1,930 $ 2,452 $ 4,382
========== ========== ========== ========== ========== ==========
11
NOTE 7.
SEGMENTS
Effective January 1, 2002 management implemented a fundamental change in the way
that it views the segments within the Bank. Previously management had identified
three segments of business: consumer banking, residential lending, and
commercial lending. Management has re-evaluated the composition of the segments
and combined the consumer and residential segments as well as added an
additional segment: Investment Securities. Unlike financial accounting, there is
no comprehensive, authoritative guidance for management accounting. The
management reporting process measures the performance of the operating segments
based on the management structure of the Bank and is not necessarily comparable
with similar information for any other financial institution. The Bank's
operating segments are defined by product type and customer segments. The Bank
continues to enhance its segment reporting process methodologies. These
methodologies are based on the Bank's management reporting process, which
assigns certain balance sheet and income statement items to the responsible
operating segment. New methodologies that are now applied to the measurement of
segment profitability include:
A new funds transfer pricing system, which allocates actual net interest
income between funds users, is based upon the funding needs and the
relative duration of the loans or securities within each segment.
The retail deposit gathering branch network income and expenses are now
allocated to the business segments based on their asset size.
In previous reports, the calculation for the provision for loan and lease
losses was not allocated to the business segments.
Operating income and expenses are allocated to segments whenever they can
be directly attributed to their activities. Indirect income and overhead
costs are credited or charged to the segments whenever they are
specifically identified as providers or users of the ancillary internal
service, or are allocated based on some common denominator.
Historical periods have been restated to conform to this new presentation. Under
the new structure, the reportable segments include the following:
CONSUMER LENDING - Consumer lending includes residential and home equity
lending, direct consumer loans, and consumer dealer financing contracts.
Residential lending offers loans to borrowers to purchase, refinance, or
build homes secured by one-to-four-unit family dwellings. Consumer loans
include lines of credit and loans for purposes other than home ownership.
Included within the consumer lending segment is a mortgage banking
operation, which sells loans in the secondary mortgage market. The mortgage
banking operation may choose to retain or sell the right to service the
loans sold (i.e., collection of principal and interest payments) depending
upon market conditions.
COMMERCIAL LENDING - Commercial lending offers permanent and interim
construction loans for multifamily housing (over four units) and commercial
real estate properties, and loans to small- and medium-sized businesses for
financing inventory, accounts receivable, and equipment, among other
things. The underlying real estate collateral or business asset being
financed typically secures these loans.
INVESTMENT SECURITIES - The investment securities segment includes the
investment securities portfolio. Although management does not consider this
to be an operating business line, security investments are a necessary part
of liquidity management for the Bank.
These segments are managed separately because each business unit requires
different processes and different marketing strategies to reach the customer
base that purchases those products and services. All three segments derive a
majority of their revenue from interest, and management relies primarily on net
interest revenue in managing these segments. No single customer provides more
than 10% of the Company's revenues.
Financial information for the Company's segments is shown below for September
30, 2002, 2001 and 2000:
CONSUMER COMMERCIAL SECURITY
QUARTER ENDED SEPTEMBER 30: LENDING LENDING INVESTMENTS TOTALS
- -------------------------- ------- ------- ----------- ------
Interest income 2002 $ 3,155,948 $ 7,712,257 $ 1,338,665 $12,206,870
2001 3,131,627 8,654,362 1,417,076 13,203,065
2000 2,579,777 8,474,717 2,160,662 13,215,156
Interest Expense 2002 1,347,044 2,988,975 1,058,942 5,394,961
2001 1,754,520 4,539,101 1,716,305 8,009,926
2000 1,520,992 4,682,277 1,819,944 8,023,213
Net Interest Income 2002 1,808,904 4,723,282 279,723 6,811,909
2001 1,377,107 4,115,261 (299,229) 5,193,139
2000 1,058,785 3,792,440 340,718 5,191,943
Provision for loan losses 2002 197,867 452,133 -- 650,000
2001 15,455 34,545 -- 50,000
2000 15,455 34,545 -- 50,000
Net interest income, after provision
for loan losses 2002 1,611,037 4,271,149 279,723 6,161,909
2001 1,361,652 4,080,716 (299,229) 5,143,139
2000 1,043,330 3,757,895 340,718 5,141,943
Noninterest income 2002 600,482 325,138 153,590 1,079,210
2001 163,879 263,297 449,799 876,975
2000 58,961 161,334 36,366 256,661
Noninterest expense 2002 1,488,742 2,415,842 158,961 4,063,545
2001 1,124,503 1,811,287 409,941 3,345,731
2000 866,858 1,633,855 359,440 2,860,153
Income before federal income taxes 2002 722,777 2,180,445 274,352 3,177,574
and cumulative effect of 2001 401,028 2,532,726 (259,371) 2,674,383
adoption of New Accounting principle 2000 235,433 2,285,374 17,644 2,538,451
Federal income taxes 2002 245,744 741,351 87,544 1,074,639
2001 136,418 861,126 (92,658) 904,886
2000 80,047 777,027 1,763 858,837
Income before Cumulative Effect of 2002 477,033 1,439,094 186,808 2,102,935
Adoption of New Accounting Principle 2001 264,610 1,671,600 (166,678) 1,769,497
2000 155,386 1,508,347 15,881 1,679,614
Net income 2002 477,033 1,439,094 186,808 2,102,935
2001 264,610 1,671,600 (166,678) 1,769,497
2000 155,386 1,508,347 15,881 1,679,614
Total Interest Earning assets (Ending 2002 178,564,252 420,559,806 94,018,011 693,142,069
period balances) 2001 140,385,812 411,784,692 103,975,891 656,146,395
2000 120,387,328 370,173,907 132,335,196 622,896,431
12
NOTE 7.
SEGMENTS (CONTINUED)
YEAR-TO-DATE ENDED SEPTEMBER 30:
CONSUMER COMMERCIAL SECURITY
QUARTER ENDED SEPTEMBER 30: LENDING LENDING INVESTMENTS TOTALS
- -------------------------- ------- ------- ----------- ------
Interest income 2002 $ 8,919,520 $23,339,671 $ 4,204,967 $36,464,158
2001 9,217,289 25,936,731 5,101,373 40,255,393
2000 7,956,315 24,052,257 5,649,328 37,657,900
Interest Expense 2002 3,875,485 9,105,918 3,464,196 16,445,599
2001 5,530,072 14,049,100 5,040,171 24,619,343
2000 4,740,935 12,998,745 4,593,413 22,333,093
Net Interest Income 2002 5,044,035 14,233,753 740,771 20,018,559
2001 3,687,217 11,887,631 61,202 15,636,050
2000 3,215,380 11,053,512 1,055,915 15,324,807
Provision for loan losses 2002 239,315 545,685 -- 785,000
2001 97,368 217,632 -- 315,000
2000 86,548 193,452 -- 280,000
Net interest income, after provision 2002 4,804,720 13,688,068 740,771 19,233,559
for loan losses 2001 3,589,849 11,669,999 61,202 15,321,050
2000 3,128,832 10,860,060 1,055,915 15,044,807
Noninterest income 2002 1,183,925 942,850 364,770 2,491,545
2001 1,518,108 677,254 1,121,315 3,316,677
2000 681,904 448,268 88,451 1,218,623
Noninterest expense 2002 4,445,199 7,428,205 801,149 12,674,553
2001 3,631,703 5,936,528 941,155 10,509,386
2000 3,029,908 4,862,825 895,554 8,788,287
Income before federal income taxes 2002 1,543,446 7,202,713 304,392 9,050,551
and cumulative effect of adoption 2001 1,476,254 6,410,725 241,362 8,128,341
of New Accounting principle 2000 780,828 6,445,503 248,812 7,475,143
Federal income taxes 2002 524,772 2,448,922 86,716 3,060,410
2001 501,927 2,179,646 68,820 2,750,393
2000 265,482 2,191,471 75,552 2,532,505
Income before Cumulative Effect of 2002 1,018,674 4,753,791 217,676 5,990,141
Adoption of New Accounting 2001 974,327 4,231,079 172,542 5,377,948
Principle 2000 515,346 4,254,032 173,260 4,942,638
Cumulative effect of Adoption of New 2002 -- -- -- --
Accounting Principle, net of 2001 (155,247) -- -- (155,247)
federal income tax 2000 -- -- -- --
Net income 2002 1,018,674 4,753,791 217,676 5,990,141
2001 819,080 4,231,079 172,542 5,222,701
2000 515,346 4,254,032 173,260 4,942,638
Total Interest Earning assets (Averages) 2002 164,526,006 424,519,312 100,003,843 689,049,161
2001 146,427,757 400,357,693 107,896,235 654,681,685
2000 130,807,050 357,532,778 122,055,080 610,394,908
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
- -------
First Mutual Bancshares, Inc. (the "Company"), a Washington corporation, is a
financial holding company owning all of the equity of its wholly owned
subsidiary, First Mutual Bank. The Company is subject to regulation by the
Federal Reserve Bank of San Francisco. This discussion refers to the
consolidated statements of the Company and the Bank and therefore the references
to "Bank" in this discussion refer to both entities.
First Mutual Bank (the "Bank") is a Washington-chartered savings bank subject to
regulation by the State of Washington Department of Financial Institutions and
the Federal Deposit Insurance Corporation ("FDIC"). The Bank conducts business
from its headquarters in Bellevue, Washington, and has ten full-service
facilities located in Bellevue (3), Kirkland (2), Redmond, Seattle (2),
Issaquah, and Monroe. The Bank also has income property loan production offices
located in Bellingham and Tacoma, Washington, and a consumer loan office located
in Jacksonville, Florida. The Bank's business consists mainly of attracting
deposits from the general public as well as wholesale funding sources, and
investing those funds primarily in real estate loans, small and mid-sized
business loans, and consumer loans. In addition to portfolio lending, the Bank
conducts a mortgage banking operation.
On June 20, 2002 the Company formed a new subsidiary, First Mutual Capital Trust
I, for the sole purpose of issuing $9,000,000 in Trust Preferred Securities
through a pool sponsored by Bear Stearns & Co. Inc., Regional Advisor's
Alliance, and other brokers. The Company owns 100% or 279 common shares
($279,000) in the trust subsidiary. The transaction was completed on June 27,
2002. The proceeds of the offering have been used to fund a stock repurchase of
1,019,256 shares in a private transaction.
RESULTS OF OPERATIONS
- ---------------------
NET INCOME
----------
Net income for the third quarter and the nine months ended September 30, 2002
was $2.1 million and $6.0 million, compared with $1.8 million and $5.2 million
for the same periods in 2001. Diluted earnings per share totaled $0.45 and $1.18
for the quarter and nine months ended September 30, 2002. The comparable figures
for the quarter and nine months ended September 30, 2001, were $0.34 and $1.00.
NET INTEREST INCOME
-------------------
Net interest income increased $1.6 million, or 31%, in the third quarter of 2002
as contrasted with the same quarter in 2001. Year-to-date net interest income
has increased $4.4 million, or 28%, rising from $15.6 million for the first nine
months of 2001 to $20.0 million for the same period this year. Net interest
income improved as a result of both a decrease in the rates paid on
interest-bearing liabilities and an increase in earning-assets. The net positive
impact from the decrease in interest rates totaled $994,000 for the third
quarter of this year. Additionally the continued increase in interest-earning
assets contributed $625,000 for the quarter. Year-to-date the change in interest
rates provided $2.5 million to net income and the rise in interest-earning
assets amounted to $1.9 million, for a total change of $4.4 million.
The net interest margin (as illustrated below) increased over the prior year as
a result of the cost of funds dropping faster than the yield on earning assets.
The cost of funds has declined from 5.01% at September 30, 2001, to its current
rate of 3.11% -- a drop of 1.90%. The yield on earning assets also fell, but at
a slower pace, from 7.92% a year ago to 6.81%, a decrease of
14
1.11%. While the funding costs have declined 38% over the last year, the yield
on loans and investments has only dropped 14%.
The net interest margin continues to remain steady on a sequential quarterly
basis:
--------------------------- ---------------------------
Quarter Ended Net Interest Margin
=========================== ===========================
September 30, 2001 3.23%
--------------------------- ---------------------------
December 31, 2001 3.50%
--------------------------- ---------------------------
March 31, 2002 3.94%
--------------------------- ---------------------------
June 30, 2002 3.94%
--------------------------- ---------------------------
September 30, 2002 3.95%
--------------------------- ---------------------------
The Bank is currently positively gapped (more one-year assets than liabilities)
by 21%, which means that rising rates would improve the net interest margin,
while falling rates would be adverse. The Bank's simulation model also indicates
that the Bank would benefit from a rise in interest rates. The simulation model,
however, suggests that the improvement from an increase in rates, or the
negative impact from a drop in rates, is not as dramatic as the Gap Report might
indicate. The latest simulation model report shows a 1.84% improvement in net
interest income if interest rates should rise 200 basis points, and a 3.13%
decline if rates should fall by the same amount. (Please see "Item 3.
Quantitative and Qualitative Disclosures About Market Risk" for more
information.)
One area of the portfolio that has provided support to the net interest margin
is commercial real estate. Approximately 47% of the portfolio, or $177 million,
has interest rate floors of 7.5%. That figure compares to 61%, or $227 million
at year-end 2001. The current rate for loans of comparable collateral and
quality is 5.375%, and there are typically no prepayment penalties associated
with the early repayment of these loans. If 50% of these loans were to
immediately reprice, net interest income would be adversely impacted by an
estimated 7.5%.
The provision for loan losses increased from $50,000 in the third quarter of
2001 to $650,000 in the like period in 2002. Year-to-date the provision for loan
losses totaled $785,000 as compared to $315,000 for the first nine months of
2001. The provision for loan losses reflects the amount deemed appropriate to
produce an adequate reserve for possible losses inherent in the risk
characteristics of the Bank's loan portfolio. In determining the appropriate
reserve balance, the Bank takes into consideration the local and national
economic outlook and the historical performance of the loan portfolio. (Please
see the section titled "Asset Quality" under "Results of Operations" for a
complete discussion of this subject.)
OTHER OPERATING INCOME
----------------------
Other operating income consisted of the following:
Three Months Nine Months
Ended September 30 Ended September 30
------------------ ------------------
2002 2001 2002 2001
---- ---- ---- ----
Secondary Market Fees $ 251,000 $ 48,000 $ 635,000 $ (33,000)
Sale of Servicing Rights 189,000 (2,000) 189,000 858,000
SFAS 133 Gain 62,000 35,000 92,000 307,000
Mortgage Servicing Rights 21,000 19,000 64,000 132,000
-------------------- ---------------------- --------------------- ----------------------
GAIN ON SALE OF LOANS: $ 523,000 $ 100,000 $ 980,000 $ 1,264,000
==================== ====================== ===================== ======================
15
-------------------- ---------------------- --------------------- ----------------------
SERVICING FEES: $ 34,000 $ 25,000 $ 86,000 $ 92,000
==================== ====================== ===================== ======================
-------------------- ---------------------- --------------------- ----------------------
GAIN ON SALE OF INVESTMENTS: $ 129,000 $ 418,000 $ 287,000 $ 1,046,000
==================== ====================== ===================== ======================
-------------------- ---------------------- --------------------- ----------------------
FEES ON DEPOSITS: $ 118,000 $ 77,000 $ 348,000 $ 244,000
==================== ====================== ===================== ======================
OTHER INCOME:
Prepayment/Brokered
Loan/Extension Fees $ 174,000 $ 153,000 $ 458,000 $ 347,000
Rental Income 25,000 21,000 75,000 77,000
Miscellaneous and
Official Check Income 18,000 31,000 83,000 87,000
Other Income 58,000 52,000 174,000 160,000
-------------------- ---------------------- --------------------- ----------------------
SUBTOTAL: $ 275,000 $ 257,000 $ 790,000 $ 671,000
==================== ====================== ===================== ======================
-------------------- ---------------------- --------------------- ----------------------
TOTAL OTHER INCOME $ 1,079,000 $ 877,000 $ 2,491,000 $ 3,317,000
==================== ====================== ===================== ======================
Total other income increased to $1.1 million in the third quarter of 2002 as
compared to $877,000 in the same quarter in 2001. Other income declined from
$3.3 million for the first nine months of 2001 to $2.5 million for the like
period in 2002. The increase for the third quarter was mainly attributable to
the rise in gain on sale of loans and the decline for the first nine months of
2002 was mainly due to the significant drop in gain on sale of investments.
GAIN ON SALE OF LOANS is composed of four elements: secondary market fees, the
sale of servicing rights, the mark-to-market of all interest rate locks on loans
pending sale and forward commitments into the secondary market (pursuant to SFAS
No. 133), and the capitalization of mortgage servicing rights.
The gain on sale of loans jumped from $100,000 in the third quarter of 2001 to
$523,000 this year. Year-to-date, the gain on sale of loans declined from $1.3
million to $980,000 this year. The increase for the quarter is mainly due to
secondary marketing fees, whereas the majority of the decrease year-to-date is
attributable to the sale of servicing rights.
Secondary Market Fees. Secondary market fees are the cash gains or losses from
the sale of loans into the secondary market and the resulting gain or loss from
forward commitments (pair-offs). The gain/loss from the sale of loans into the
secondary market includes both loans sold servicing released and loans sold
servicing retained. Loans sold "servicing released" simply means that the Bank
has given up its right and entitlement to future income associated with the
collection of future loan payments. Therefore, loans sold "servicing retained"
are those loans that the Bank has chosen to sell but retain the right to the fee
income associated with the activity of collecting future loan payments. The
distinction is made here due to the fact that depending upon various factors,
the Bank may decide to sell loans "servicing released" or "servicing retained"
or a combination thereof. The fees from these activities are all captured under
the heading "secondary market fees". What is not included in this line item, are
any gains or losses as a result of the sale of the servicing rights that are
sold separate from that of the sale of the actual loan. These gains/losses are
included in the line item titled "sale of servicing rights". As a result,
significant changes may occur from period to period in regards to these two
accounts depending upon the manner in which the Bank is selling loans and/or
servicing rights.
16
Secondary market fees totaled $251,000 in the third quarter of 2002 as compared
to $48,000 in the same quarter last year. The increase for the quarter is
largely the result of fee income generated from the sale of consumer loans and a
significant drop in pair-off losses.
Three Months Ending Three Months Ending Nine Months Ending Nine Months Ending
September 30, 2002 September 30, 2001 September 30, 2002 September 30, 2001
- -------------------------------- --------------------- --------------------- -------------------- --------------------
Fees from Sales of:
- --------------------------------
Residential Loans:
- --------------------------------
Servicing
Released Fees $ 109,000 $ 161,000 $ 297,000 $ 280,000
- -------------------------------- --------------------- --------------------- -------------------- --------------------
Pair-off Fees 2,000 (180,000) (66,000) (500,000)
- -------------------------------- --------------------- --------------------- -------------------- --------------------
Total Residential
Loans $ 111,000 $ (19,000) $ 231,000 $ (220,000)
- -------------------------------- --------------------- --------------------- -------------------- --------------------
Consumer Loans 140,000 67,000 404,000 187,000
- -------------------------------- --------------------- --------------------- -------------------- --------------------
Total $ 251,000 $ 48,000 $ 635,000 $ (33,000)
- -------------------------------- ===================== ===================== ==================== ====================
Sales of:
- --------------------------------
Residential Loans
Servicing Released $ 7.1 million $ 25.8 million $ 20.0 million $ 62.7 million
- -------------------------------- --------------------- --------------------- -------------------- --------------------
Sale of All
Residential Loans
(incl. Servicing
Released) $ 8.4 million $ 25.8 million $ 26.7 million $ 69.7 million
- -------------------------------- --------------------- --------------------- -------------------- --------------------
Consumer Loans $ 5.1 million $ 1.4 million $ 12.6 million $ 3.7 million
- -------------------------------- --------------------- --------------------- -------------------- --------------------
Fees from the sale of residential loans amounted to a loss of $19,000 in the
third quarter last year and a gain of $111,000 in the like quarter of 2002.
Year-to-date the fees from the sales of residential loans amounted to $231,000
as compared to a loss of $220,000 for the same period last year. The gains and
losses from the sale of residential loans are broken down into two areas,
servicing released fees and pair-off fees. Servicing released fees totaled
$109,000 for the third quarter this year as compared to $161,000 for the same
period last year. The decline in income in this area is due to the decrease of
residential loans sold servicing released. During the third quarter of 2001
$25.8 million of residential loans were sold servicing released as compared to
$7.1 for the like period this year. For the first nine months of 2001, fees from
this source totaled $280,000 as compared to $297,000 this year. Although the
amount of loans sales related to these fees declined from $62.7 million for the
period ending September 30, 2001 to $20.0 million this year the fees from these
sales were nearly identical due to the improved execution of loans sales.
The increase in fee income for residential loans for the quarter and the first
nine months of the year is mainly attributable to the significant decline in
pair-off losses. Pair-off fees, which are a routine secondary marketing
activity, are the resulting gain or loss incurred when a forward loan commitment
position is settled. The resulting gain or loss is largely dependent upon the
movement of interest rates. Pair-off losses tied to the hedging activities of
residential loans being held-for-sale for the third quarter of 2001 totaled
$180,000 as compared to a gain of $2,000 for the
17
same period this year. For the first nine months of 2001, pair-off losses
amounted to $500,000 compared to $66,000 for 2002. In 2001, during a period when
the Bank was more active in its mortgage banking activities, rates fell
throughout the year making the hedging of interest rates more difficult. Over
the past year the Bank has changed its strategy and deemphasized its salable
residential loan products in relation to its overall product menu. Competitive
pressure in the conforming loan market (which are the loans typically sold by
the Bank) has focused the Bank on its more profitable portfolio and construction
products.
Gains from the sale of consumer loans totaled $140,000 in the third quarter of
2002 as compared to $67,000 last year. Consumer loan fee income for the fourth
quarter is expected to drop to between $90,000 and $120,000. The Bank is
implementing a change in direction that, going forward, will result in the
adding to the loan portfolio, many consumer loans that had previously been sold.
It has been the practice to portfolio home improvement loans originated in
Washington and Oregon and sell all loans originated elsewhere. In the third
quarter sold loans accounted for 50% of all home improvement loans funded in
that period. The Bank is transitioning to the new policy in the fourth quarter
and intends to have fully implemented the new strategy by year-end 2003. The
reason for the change is that the Bank has been pleased with the performance to
date of the home improvement loan portfolio. The portfolio currently totals $27
million and has a 0.14% non-performing loans ratio, which compares to the
national average of 1.02%. The yield on the portfolio is at 10.43% and is the
highest of the Bank's loan categories. Year-to-date fee income from this source
has totaled $404,000 as compared to $187,000 last year.
Sale of Servicing Rights. The sale of servicing rights amounted to a loss of
$2,000 in the third quarter of last year, as compared to a gain of $189,000 in
2002. The principal reason for the increase was a sale during the third quarter
of 2002 of $18.9 million in residential servicing rights. There were no
comparable sales in the third quarter of 2001. The Bank does not anticipate any
further bulk sales of servicing in 2002. The remaining servicing portfolio,
which totals $45 million, is largely made up of commercial real estate loans
that are not readily saleable. Year-to-date, the gain from the sale of servicing
rights totaled $189,000, as contrasted with $858,000 last year. The sale of
loans with servicing rights totaled $18.9 million through September 30, 2002 as
compared to $84.4 million for the like period last year. Last year's servicing
sale includes a bulk sale of $78 million. The decrease year-to-date, as compared
to the same period last year is largely the result of the Bank's decision to
liquidate its residential servicing portfolio during the first quarter of 2001.
Mark-to-Market of Financial Derivatives. The third piece of the Gain on Sale of
Loans is the gain or loss resulting from financial derivatives. Financial
Accounting Standard No. 133, Accounting for Derivative Instruments and Hedging
Activities, is the accounting guidance applicable to derivative financial
instruments. This standard requires that all interest rate locks (IRL's) on
loans pending sale and forward sale commitments, which are considered to be
derivatives, be marked-to-market. The net gain realized from these two
activities totaled $62,000 for the third quarter of 2002 and $92,000
year-to-date as compared to $35,000 and $307,000 respectively for 2001. The Bank
did not have any forward commitments outstanding at the end of the third
quarter; however subsequent to that time, the Bank has taken down approximately
$10 million in forward commitments as a result of an increase in the residential
loan pipeline and the inherent interest rate risk embedded within this activity.
It is unknown at this time what the impact to net income will be during the
fourth quarter when these positions are marked-to-market per SFAS 133.
Conditions that affect the potential gain or loss include the amount of IRL's
and forward commitments outstanding and the movement of mortgage rates. As of
October 31, 2002, $10 million in forward commitments and $9 million of IRL's
are outstanding. Forward commitments are bought to hedge loans held for sale.
How much of the forward commitments is held at any given point in time depends
on the percentage of loans originated that are held for sale, and the amount of
market risk the Bank is willing to assume on those loans. That process is highly
fluid and can change significantly on any given day. IRL's are more predictable
in that all rate locks in residential loans held for sale are marked-to-market,
except those that are effectively hedged.
18
The movement of interest rates affects forward commitments and IRL's
differently. Falling interest rates result in a SFAS 133 mark-to-market loss for
forward commitments, but a gain for IRL's. Just the opposite is true for rising
rates.
Mortgage Servicing Rights. The fourth and final piece of the calculation of Gain
on Sales of Loans is the capitalization of mortgage servicing rights (MSR's).
MSR's are recognized only on loan sales with "servicing retained", (see earlier
discussion). The gains recorded for mortgage servicing rights are pursuant to
Statement of Financial Accounting Standard (SFAS) No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,
which requires the capitalization of internally generated servicing rights. The
amount of MSR's capitalized and recognized in income totaled $21,000 for the
third quarter of 2002 as compared to $19,000 for the like quarter in 2001. The
amount of loan sales, related to the capitalization of the MSR's in the third
quarter of 2002 amounted to $4.0 million as compared to $4.8 million in the
third quarter of 2001. The amount of loan sale activity, the underlying loan
types (i.e. residential, income property or business banking), and the yearly
analysis of the capitalization value all contribute to the calculation of the
amount of gain recognized when loans are sold with the servicing rights
retained. Year-to-date the amount of MSR's capitalized totaled $64,000 as
compared to $132,000 for the first nine months of 2001. The related loan sale
activity for the same time periods totaled $19.7 million and $19.0 million,
respectively.
SERVICING FEES have increased $9,000, or 36%, for the third quarter of 2002 as
compared to the like quarter last year, due to an increase in the mortgage
servicing portfolio. The servicing portfolio totaled $44.5 million at September
30, 2002, as compared to $39.8 million a year ago. Year-to-date servicing fee
income amounted to $86,000 for the first nine months of 2002 and $92,000 for the
like period last year. The year-to-date servicing fee income last year benefited
from sub-servicing fees on the $78 million bulk sale. That arrangement was
concluded in March 2001. The Bank has sold the servicing rights underlying $18.9
million in loans during the third quarter of 2002. As a result, the amount of
income from this source is anticipated to decline for the fourth quarter.
GAIN ON SALE OF INVESTMENTS fell from $418,000 in the third quarter of last year
and $1.0 million year-to-date to $129,000 for the third quarter of 2002 and
$287,000 year-to-date. Security sales during the third quarter of 2002 totaled
$15.2 million compared to $30.8 million in the like quarter last year.
Year-to-date security sales totaled $25.9 million as compared to $39.0 million
last year. The year-to-date gains on sales of investments also include gains
realized from the sale of a limited partnership interest, of which $26,000 was
recognized this year and $464,000 was recognized through September 30, 2001.
There are no more anticipated distributions from the sale of the limited
partnership investment in the future.
DEPOSIT FEES have risen in 2002, $41,000 on a quarter-to-quarter comparison, and
$104,000 on a year-to-date basis. Virtually all of that increase came from
improved fee income on checking accounts. The Bank expects fee income from this
source to continue to show an increase, although not at the rate experienced in
the last two years.
OTHER INCOME increased slightly from $257,000 in the third quarter of 2001 to
$275,000 for the same period this year. Year-to-date other income rose from
$671,000 to $790,000 this year.
19
On a quarterly and year-to-date basis prepayment and extension fees contributed
to the increase as did rental income and income from the Bank's official check
program.
Prepayment, brokered loan and extension fees have increased $21,000 from
$153,000 in the third quarter of 2001 to $174,000 for the like period this year.
The year-to-date results are similar to the third quarter. For the nine months
ended September 30, 2001 these fees totaled $347,000 as compared to $458,000, in
2002, an increase of $111,000. Over the past year the Bank has experienced an
increase in this area due to the unusually low interest rates as well as a rise
in the amount of brokered loans closed this year.
Rental income on the Bank owned property was up $4,000 as compared to the third
quarter of last year. Year-to-date rental income declined slightly from $77,000
last year to $75,000. The Bank's income from miscellaneous fees and the issuance
of official checks has decreased on a quarterly and year-to-date basis. For the
third quarter, income from this source totaled $18,000, as compared to $31,000,
for the like quarter last year. For the nine months ending September 30, 2002,
income from this source amounted to $83,000 as contrasted with $87,000 last
year. The reason for the decline is due to the drop in income from the issuance
of official checks. The low interest rate environment and the reduction, during
the second quarter, of the deposit that the Bank was initially required to keep
with the program administrator have contributed to the decline. As a result, the
Bank now earns a lower interest rate on a smaller outstanding balance. This
trend is expected to continue through the fourth quarter unless rates and/or
volumes rise substantially.
20
OPERATING EXPENSES
------------------
Operating expense consisted of the following:
Three Months Nine Months
Ended September 30 Ended September 30
------------------ ------------------
2002 2001 2002 2001
---- ---- ---- ----
---------------------- ---------------------- --------------------- ----------------------
Salaries and Benefits: $ 2,401,000 $ 1,752,000 $ 7,588,000 $ 6,064,000
====================== ====================== ===================== ======================
---------------------- ---------------------- --------------------- ----------------------
Occupancy: $ 590,000 $ 531,000 $ 1,727,000 $ 1,568,000
====================== ====================== ===================== ======================
Other Expenses:
Marketing/Investor Rel. $ 199,000 $ 156,000 $ 565,000 $ 408,000
Data Processing 137,000 122,000 406,000 360,000
Other 737,000 785,000 2,388,000 2,109,000
---------------------- ---------------------- --------------------- ----------------------
Total Other Expenses: $ 1,073,000 $ 1,063,000 $ 3,359,000 $ 2,877,000
====================== ====================== ===================== ======================
---------------------- ---------------------- --------------------- ----------------------
TOTAL OPERATING EXPENSE $ 4,064,000 $ 3,346,000 $ 12,674,000 $ 10,509,000
====================== ====================== ===================== ======================
SALARIES AND EMPLOYEE BENEFITS increased $649,000, or 37%, from $1,752,000 in
third quarter of 2001 to $2,401,000 in the like quarter this year. A number of
factors contributed to that increase to include a reversal of a bonus accrual
last year, an annual salary increase of 4%, and a 15% increase in staff.
In the third quarter of 2001 a $250,000 accrual for a staff performance bonus
was reversed. That accrual had been established in the first quarter, when
financial results were more favorable and it appeared that a bonus would be paid
at year end. There were no comparable bonus accruals this year.
On a quarter-to-quarter comparison the Bank's staffing levels rose 15%, with
approximately one-half of that increase occurring in the loan production areas.
The staff additions were fairly evenly spread among the Business Banking, Sales
Finance and Residential Lending departments. Back-office personnel increases
occurred in the Information Systems, Auditing and lending support areas.
Year-to-date salaries and employee benefits costs have also increased over last
year by $1.5 million, or 25%. Like the results for the third quarter, the
reversal of the staff bonus last year, increases in staffing over the past year
coupled with increases in loan officer commissions have contributed to the rise.
Current forecasts for year 2003 include a continued rise in staffing levels.
Projections include increased personnel in the lending support and
administrative departments to sustain the production loan officers that were
added to staff this year.
OCCUPANCY EXPENSE is up $59,000, or 11%, on a quarter-to-quarter basis;
year-to-date the increase totaled $159,000, or 10%. Adding to occupancy expense
was the opening of the Juanita Branch last summer and the expansion of leased
space at the Bellevue Headquarters.
Other operating expenses increased $10,000, or 0.9%, from $1,063,000 in the
third quarter of 2001 to $1,073,000 in the same period of this year.
Year-to-date other expenses have increased $482,000, or 17% as compared to the
first nine months of 2001. The largest elements were marketing/investor
relations and data processing expenses.
21
Marketing/investor relations expenses increased $43,000 quarter-over-quarter and
$157,000 on a year-to-date comparison. A marketing director joined the Bank late
last year, and more emphasis is now being placed on brand and product
development.
Data processing expense rose $15,000, or 13% for the third quarter as compared
to the same quarter last year. Year-to-date the increase was $46,000, or 13%.
The rise for both periods is due to the growth in staff and growth in the number
of loan and deposit accounts.
FINANCIAL CONDITION
- -------------------
ASSETS At September 30, 2002, the Bank's assets totaled $707.7 million, an
increase of 4% from $678.3 million at December 31, 2001. The change in assets is
principally the result of growth in the loan portfolio, including loans
held-for-sale and a slight increase in the securities portfolio since year-end.
LOANS Net loans receivable, including loans held-for-sale, rose from $567.6
million at year-end 2001 to $591.7 million, an increase of $24.1 million, or 4%
in the first nine months of this year. The growth in the portfolio came mainly
from residential loans, residential custom construction loans, and the business
banking areas which were somewhat offset by the decline in the commercial
construction portion of the portfolio. The residential loan portfolio increased
$13 million, or 13%, the residential custom construction sector of the portfolio
increased $13 million, or 54% and the business banking area grew $7.1 million,
or 12%. On the decline was the commercial construction portion of the loan
portfolio which decreased $11 million, or 29%. The residential portfolio and
custom construction loan origination areas benefited from increased marketing,
the hiring of loan representatives more experienced in selling portfolio and
custom construction products, and through an expanded product menu. The addition
of production staff in the business banking areas since year-end have also
contributed to the increase in the loan portfolio. Offsetting the increase in
the loan portfolio was the decline in the commercial construction area. Over the
past year the Bank has scaled back this type of lending due to lower demand for
this type of lending.
SECURITIES The Bank classifies investment securities in one of the following
categories: 1) trading, 2) available for sale (AFS), or 3) held to maturity.
Securities classified as available for sale are reviewed regularly, and any
unrealized gains or losses are recorded in the shareholders' equity account. The
balance of the unrealized gain, net of federal income taxes, was $669,000 at
September 30, 2002, and a loss of $192,000 at year-end 2001. The $669,000 is
comprised of a gain of $1,063,000 related to the AFS securities and a loss of
$394,000 related to the interest rate swap purchased in connection with the
issuance of the trust preferred securities at the end of the second quarter this
year. Pursuant to SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, the Bank is required to include the market value of the
interest rate swap under the comprehensive income/loss heading within the equity
section on the balance sheet. The fluctuation of interest rates normally has the
opposite effect on AFS securities as compared to the interest rate swap. For the
AFS securities, generally, rising interest rates will decrease the amount
recorded as unrealized gain, and falling rates will increase any unrealized
gains, as the market value of securities inversely adjusts to the change in
interest rates. The opposite effect occurs with the interest rate swap. As rates
increase, the value of the swap will generally increase and vise versa with
falling rates. Another difference between these two instruments is that it is
management's general intent to sell some or all of the AFS securities when it is
prudent to do so.
22
In contrast, the interest rate swap is an instrument that the Bank has purchased
for a five year period for the purpose of fixing the rate of interest that is
paid to the trust preferred security holders. It is the intent of management to
hold onto this financial instrument to its maturity date. As a result, the
unrealized gains or losses resulting from the interest rate swap are less likely
to even be recognized in the income statement.
Security investments increased $2.9 million, or 3.8%, from year-end 2001. The
rise in securities is a result of more securities being purchased or securitized
in the first nine months of the year than sold or matured. Year-to-date, the
Bank has experienced the following activity in the securities portfolio:
purchased $25.3 million in securities; securitized $14.5 million; sold $25.9
million; and slightly over $1.0 million in securities matured or were called by
the issuer. In addition, normal principal reductions and prepayment activity
have also occurred in regard to the mortgage-backed securities. At year-end 2001
it was management's intent to increase the security investment portfolio by
$50-$60 million. Since that point in time, interest rates have fallen
significantly and are at 40-plus year lows. Because of the historically low
rates, the Bank has been reluctant to materially increase the portfolio. Since
the end of the quarter, the Bank has purchased $7 million in structured notes
that will settle in November 2002.
LIABILITIES Deposits increased $55.0 million, or 12.8%, in the first nine months
of 2002, totaling $483.9 million as compared to $428.9 million at year-end 2001.
This increase in deposits was used to fund the asset growth in the loan and
securities portfolio as well as to pay down the Federal Home Loan Bank of
Seattle (FHLB) borrowings.
The FHLB advances decreased from $191.0 million at year-end 2001 to $161.4
million as of the end of the third quarter 2002. As of September 30, 2002, the
Bank had the capacity to borrow up to $283.1 million in FHLB advances, subject
to sufficient collateral to support those advances.
ASSET QUALITY
- -------------
Provision and Reserve for Loan Losses. The Bank analyzes a number of factors in
determining the provision for loan losses, such as current and historical
economic conditions, non-accrual asset trends, and historical loan loss
experience. The results of that analysis indicated the need for a provision of
$650,000 in the third quarter of 2002, bringing the total loan loss reserve
balance to $7.7 million. Year-to-date the reserve balance has increased
$785,000.
The key considerations that led to the increase in the reserves for loan losses
included the growth in the loan portfolio, concern about the local economy, and
the Bank's relatively low capital levels as compared to financial institutions
of similar size.
Since year-end 2001 the net loan portfolio (excluding loans held-for-sale) has
increased $22.5 million. Most of that growth has been in the residential loan
area, which is generally considered lower risk than the commercial real estate
or business banking loans although the economy in the Northwest can have a
significant affect on all loan types.
The national and local economic environments are of concern to the Bank.
Negative economic news has continued to accumulate throughout the third quarter.
The stock market, which has been roiled by corporate accounting scandals earlier
in the year, has been hitting new lows in recent weeks in part because of
concerns about what a possible war with Iraq will do to the oil prices and the
overall economy.
23
This quarter has been the worst for the Dow Jones Industrial Average since 1987.
It has made investors feel less wealthy.
Consumers may be slowing down their spending. Large retailers have reported that
sales in August were lower than expected, and numerous corporations have been
reporting weak results or lowering their forecasts. The manufacturing sector
shrank for the first time in eight months. This activity suggests that the
economic recovery has stalled, and concerns about a double-dip recession have
increased.
The local economy has already been underperforming the nation as a whole. The
state's unemployment rate, at 7.4%, is the second highest in the nation next to
Alaska, with Oregon following closely behind Washington State. The Seattle area
has lost 104,000 jobs since January 2001, including 25,000 dot.com jobs, and
continues to lose an additional 3,000 per month. Economists now predict that it
may be 2005 before Seattle creates enough new jobs to rehire all the people that
have been laid off in the past two years.
The rapidity with which the recession has hit the State has surprised even the
experts. Chang Mook Sohn, Washington State's Chief Economist, said that he
underestimated the State's economic condition. "The recession is much deeper and
more severe than we originally thought."
The State's budget shortfall is now estimated at $2 billion - up substantially
from the last forecast. In addition, further Boeing layoffs are now expected.
The airplane production target for 2003 has been lowered to 275-300 planes from
380 in 2002. The impact on the economy from the current labor dispute at west
coast ports is unknown but projected to be large if it persists very long.
This economic activity, or lack thereof, has had further effects on the real
estate market. Office vacancy has increased. The Seattle Times newspaper
recently published the following local statistics:
- ---------------------- --------------------------------------------- -----------------------------------------------
Office Vacancy Rental Rates
- ---------------------- --------------------------------------------- -----------------------------------------------
March 2001 March 2002 March 2001 March 2002
- ---------------------- ------------------------ -------------------- ------------------------- ---------------------
Downtown Seattle 11.9% 14.6% $36.12 $30.38
- ---------------------- ------------------------ -------------------- ------------------------- ---------------------
Downtown Bellevue 20.7% 29.0% $32.39 $27.19
- ---------------------- ------------------------ -------------------- ------------------------- ---------------------
Eastside suburban 10.7% 16.7% $28.73 $26.08
- ---------------------- ------------------------ -------------------- ------------------------- ---------------------
North end 15.8% 19.9% $23.93 $23.87
- ---------------------- ------------------------ -------------------- ------------------------- ---------------------
South end 12.7% 18.9% $23.63 $20.84
- ---------------------- ------------------------ -------------------- ------------------------- ---------------------
All of this points toward significant increases in the inherent risks within the
loan portfolio. This deterioration in the economy will have an effect on the
performance of the investor-owned rental properties as well as the ability of
individuals to pay their loans.
Another factor that has been taken into consideration in regards to the
provision this quarter is the relatively low capital levels that the Bank
maintains vis-a-vis the national average ratios for Banks with $300 million-$1
billion in assets. In July the Bank's holding company repurchased a little over
1 million of its shares of stock. As part of that transaction, it had the
Banking Subsidiary pay
24
an $8 million dividend to the parent. That reduced the amount of capital
available to cushion the effects of an economic downturn on the Bank's loan
portfolio.
The present level of non-performing assets is within the Bank's normal range and
well below the regional and national peer levels. The Bank is not aware of any
pending delinquent conditions that would be out of the norm. However, because of
the economic environment the Bank, as well as other banks in the Puget Sound
area, can reasonably expect increased stress on the loan portfolio.
As of quarter-end September 30, 2002, the Bank's ratio of non-performing assets
to total assets was 0.12%, which compares to 0.32% as of September 30, 2001.
Those numbers compare to the national ratios of 0.65% for savings institutions
and 0.96% for commercial banks as of June 30, 2002.
The composition of those non-performing assets is as follows:
Amount
--------
Office building in the Puget Sound area with no loss anticipated $344,000
Single-family residence in the Puget Sound area - the loan
has subsequently been paid in full 221,000
Single-family residence in the Puget Sound area with no loss
anticipated 175,000
Single-family residence in Eastern WA with no loss anticipated 48,000
Two consumer loans with an anticipated loss of $20,000 22,000
Four consumer loans with no loss anticipated 16,000
Consumer loan reinstated in October 11,000
--------
Total Non-Performing Loans $837,000
========
The Bank has 11 pieces of property that it has repossessed, which include items
such as motorcycles, spas, and a gazebo. The properties are held-for-sale on
consignment, typically with a dealer that specializes in that type of property.
Total Repossessed Assets $ 34,000
========
Total Non-Performing and Repossessed Assets $871,000
========
25
PORTFOLIO INFORMATION
- ---------------------
The average loan size (excluding construction loans) in the commercial real
estate portfolio was $666,000 as of September 30, 2002, with an average
loan-to-value ratio of 64%. At quarter-end, only one of these commercial loans
was delinquent for 30 days or more (0.09%). Small individual investors or their
limited liability companies as well as business owners typically own the
properties securing these loans. The commercial real estate portfolio is split
between residential use (multifamily or mobile home parks) and commercial use.
At quarter-end, the breakdown was 45% residential and 55% commercial.
Adjustable-rate loans account for 91% of First Mutual's total portfolio.
The loans in the commercial real estate portfolio are well diversified, secured
by small retail shopping centers, office buildings, warehouses, mini-storage
facilities, restaurants and gas stations, as well as other properties classified
as general commercial use.
To diversify its risk and to continue serving customers, the Bank sells
participation interests in some loans to other financial institutions. About 8%
of commercial real estate loan balances originated by the Bank have been sold in
this manner. The Bank continues to service the customer's loan and is paid a
servicing fee by the participant. Likewise, the Bank occasionally buys an
interest in loans originated by other lenders. About $17 million of the
portfolio (5%) has been purchased in this manner.
The loan portfolio distribution at the end of the third quarter was as follows:
Single Family (includes loans held-for-sale) 15%
Income Property 54%
Business Banking 11%
Commercial Construction 3%
Single Family Construction:
Spec 2%
Custom 6%
Consumer 9%
DEPOSIT INFORMATION
- -------------------
The number of business checking accounts increased from 673 at September 30,
2001, to 862 at September 30, 2002, a gain of 189 accounts, or 28%. Consumer
checking accounts also increased from 3,927 in the third quarter of 2001 to
4,439 this year, a growth in the number of accounts of 512, or 13%.
DEPOSIT MIX
-----------
Time Deposits 73%
Checking 8%
Money Market Accounts 17%
Statement Savings 2%
BUSINESS SEGMENTS
- -----------------
Effective January 1, 2002, management implemented a fundamental change in the
way that it views the segments within the Bank. Previously management had
identified three segments of
26
business: consumer banking, residential lending, and commercial lending.
Management has re-evaluated the composition of the segments and combined the
consumer and residential segments as well as added an additional segment -
Investment Securities. Unlike financial accounting, there is no comprehensive,
authoritative guidance for management accounting. The management reporting
process measures the performance of the operating segments based on the
management structure of the Bank and is not necessarily comparable with similar
information for any other financial institution. The Bank's operating segments
are defined by product type and customer segments. The Bank continues to enhance
its segment reporting process methodologies. These methodologies are based on
the Bank's management reporting process, which assigns certain balance sheet and
income statement items to the responsible operating segment. New methodologies
that are now applied to the measurement of segment profitability include:
o A new funds transfer pricing system, which allocates actual net interest
income between funds users, and is based upon the funding needs and the
relative duration of the loans or securities within each segment.
o The retail deposit-gathering branch network income and expenses are now
allocated to the business segments based on their asset size.
o In previous reports, the calculation for the provision for loan and lease
losses was not allocated to the business segments.
o Operating income and expenses are allocated to segments whenever they can
be directly attributed to their activities. Indirect income and overhead
costs are credited or charged to the segments whenever they are
specifically identified as providers or users of the ancillary internal
service, or are allocated based on some common denominator.
Historical periods have been restated to conform to this new presentation. Under
the new structure, the reportable segments include the following:
CONSUMER LENDING - Consumer lending includes residential and home equity
lending, direct consumer loans, and consumer dealer financing contracts.
Residential lending offers loans to borrowers to purchase, refinance, or build
homes secured by one-to-four-unit family dwellings. Consumer loans include lines
of credit and loans for purposes other than home ownership. Included within the
consumer lending segment is a mortgage banking operation, which sells loans in
the secondary mortgage market. The mortgage banking operation may choose to
retain or sell the right to service the loans sold (i.e., collection of
principal and interest payments) depending upon market conditions.
COMMERCIAL LENDING - Commercial lending offers permanent and interim
construction loans for multifamily housing (over four units) and commercial real
estate properties, and loans to small- and medium-sized businesses for financing
inventory, accounts receivable, and equipment, among other things. The
underlying real estate collateral or business asset being financed typically
secures these loans.
INVESTMENT SECURITIES - The investment securities segment includes the
investment securities portfolio. Although management does not consider this to
be an operating business line, security investments are a necessary part of
liquidity management for the Bank.
27
These segments are managed separately because each business unit requires
different processes and different marketing strategies to reach the customer
base that purchases those products and services. All three segments derive a
majority of their revenue from interest, and management relies primarily on net
interest revenue in managing these segments. No single customer provides more
than 10% of the Bank's revenues.
CONSUMER LENDING
- ----------------
Net income for the consumer lending segment increased from $265,000 in the third
quarter of 2001 to $477,000 in the same quarter in 2002. The rise in net income
was the result of a decrease in interest expense coupled with an increase in
non-interest income, both of which were partially offset by a rise in
non-interest expense.
Net interest income, before provision for loan losses, was up $432,000,
increasing from $1.4 million in the third quarter of 2001 to $1.8 million this
year. Most of this amelioration was due to the drop in interest expense, which
decreased $407,000 as compared to the third quarter of 2001. The Bank's cost of
funds overall has decreased at a much faster pace than that of the yield on
interest earning assets.
The provision for loan loss increased significantly for the quarter as did the
provision for the Bank as a whole. For the third quarter of 2001 the provision
for loan losses totaled $15,000 as compared to $198,000 for the same quarter
this year. Please see the discussion regarding this subject under the Asset
Quality section.
Non-interest income jumped from $164,000 in the three months ending September
30, 2001, to $600,000 in the same quarter this year. The increase was mainly
attributable to the improvement in secondary marketing fees. Gains from the sale
of consumer loans totaled $140,000 in the third quarter of 2002 as compared to
$67,000 last year. Fee income for the fourth quarter is expected to drop to
between $90,000 and $120,000. The Bank is implementing a change in direction
that, going forward, will result in the adding to the loan portfolio, many
consumer loans that had previously been sold. It has been the practice to
portfolio home improvement loans originated in Washington and Oregon and sell
all loans originated elsewhere. The reason for the change is that the Bank has
been pleased with the performance to date of the home improvement loan
portfolio. Additionally the Bank has experienced a significant decrease in
pair-off fee losses related to the sale of residential loans into the secondary
market. Pair-off losses amounted to a loss of $180,000 in the third quarter of
2001 as compared to a gain of $2,000 this year. Please see the discussion under
Other Operating Income relating to the Gain on Sale of Loans and Secondary
Market Fees.
Non-interest expense increased $364,000, or 32%, for the quarter as compared to
the third quarter of 2001. A number of factors that affected both the consumer
and commercial lending segments included a reversal of a bonus accrual last
year, an annual salary increase of 4%, and a 15% increase in staff bank-wide. In
the third quarter of 2001, a $250,000 accrual for a staff performance bonus was
reversed. That accrual had been established in the first quarter, when financial
results were more favorable and it appeared that a bonus would be paid at year
end. There were no comparable bonus accruals this year. On a quarter-to-quarter
comparison the Bank's staffing levels rose 15%, with approximately one-half of
that increase occurring in the loan production areas. The loan production staff
additions were fairly evenly spread among the Business Banking, Sales Finance
and Residential Lending departments.
28
Year-to-date net income increased $200,000, from $819,000 in the nine months
ending September 30, 2001, to $1.0 million in 2002. The rise is mainly
attributable to a decline in interest expense which was somewhat offset by a
decline in non-interest income and an increase in non-interest expense.
Net interest income, before provision for loan losses, increased $1.4 million,
or 37% for the first nine months of the year as compared to the same period last
year. Both interest income and interest expense dropped, but interest expense
declined at a much faster pace. Interest income declined $298,000, or 3%, while
interest expense decreased $1.7 million, or 30% over the past year.
The provision for loan loss increased from $97,000 for the first nine months of
2001 as compared to $239,000 for the same period this year. Due to the current
economic uncertainty, management and the Board of Directors felt it necessary to
increase the provision this year.
Non-interest income declined $334,000, from $1.5 million for the first nine
months of 2001 to $1.2 million in 2002. The change in non-interest income is
largely attributable to a $78 million bulk sale of servicing rights in the first
quarter of last year. The pre-tax gain from that sale totaled $891,000.
Non-interest expense, year-to-date, increased to $4.4 million for the first
three quarters of 2002 as compared to $3.6 million for the like period last
year. Like the third quarter results, the $813,000 rise was associated with a
reversal of a bank-wide $250,000 bonus accrual last year in the third quarter
coupled with a 4% increase in compensation and an increase in staffing in this
area.
COMMERCIAL LENDING
- ------------------
Net income for this business segment declined $233,000, or 14%, from $1.7
million in the third quarter of 2001 to $1.4 million in the same quarter of
2002. Net interest revenue before provision for loan loss grew $608,000 due to a
substantial decrease in interest expense. Offsetting the net interest revenue
increase was a rise in provision for loan loss and an increase in non-interest
expense.
Net interest income, before provision, benefited from a dramatic decline in
interest rates over the past year. Interest income declined 11.0% while interest
expense for this segment dropped by 34%, or $1.6 million. At the same time,
assets continued to increase. Interest-earning assets totaled $421 million at
September 30, 2002, as compared to $412 million a year ago.
The provision for loan loss allocated to this segment increased substantially
for the third quarter as compared to the same quarter last year. During the
three months ended September 30, 2001, the provision for loan losses amounted to
$35,000, up $418,000 to $452,000 for the like quarter this year. As was true for
the Bank as a whole, the provision was increased due to the current economic
conditions. Please see the discussion regarding this subject under the Asset
Quality section.
Other operating income rose $62,000, or 24%, as contrasted with the third
quarter last year. This increase was mainly due to the rise in miscellaneous
loan fees such as loan prepayment, extension, and broker fees and the allocation
of branch fee income to this segment.
29
Operating expenses increased 33%, or $605,000, in the third quarter of 2002 as
compared to the like quarter in 2001. Non-interest expense rose primarily
because of the growth in compensation costs resulting from the Bank's focus on
expansion of the Business Banking and Community Business Banking departments
over the past year. In addition, the reversal of the bank-wide $250,000 bonus
last year also contributed to the increase in expense quarter-over-quarter.
Net income for the first nine months of the year rose to $523,000, or 12%, as
compared to last year. Like the quarterly results, interest expense decreased
substantially, non-interest income rose slightly, and operating expenses
increased.
Net interest income before provision for loan losses rose from $11.9 million to
$14.2 million, or $2.3 million. The decline in interest expense had the largest
impact, decreasing $4.9 million, or 35%. Declining interest rates again
benefited this segment.
The provision for loan loss increased from $218,000 for the first nine months of
2001 as compared to $546,000 for the same period this year. Due to the current
economic uncertainty, management and the Board of Directors found it necessary
to increase the provision this year.
Non-interest income grew $266,000 to $943,000 from $677,000 for the nine months
ended September 30, 2001. The increase is mainly attributable to the rise in
miscellaneous loan fees.
Operating expenses increased $1.5 million, or 25%, during the nine-month period
ended September 30, 2002, as compared to the same period last year. Escalating
compensation costs associated with the expansion of the Business Banking and
Community Business Banking areas contributed significantly to the increase as
did the reversal of the bank-wide $250,000 bonus recorded last year.
INVESTMENT SECURITIES
- ---------------------
Net income increased for the investment securities segment, from a loss of
$167,000 in the third quarter of 2001 to a gain of $187,000 in 2002. This
segment was affected by a rise in net interest income, which was partially
offset by a decline in non-interest income.
Net interest income jumped for this business segment, from a loss of $299,000 in
the third quarter of 2001 to a gain of $280,000 for the like quarter this year.
The reason for the increase is due to a significant decline in interest expense.
Interest expense totaled $1.7 million in the third quarter of 2001, declining
$657,000, or 38% as compared to the same quarter this year. During the year
interest rates have decreased thus resulting in a reduction in the Bank's
overall funding costs.
Non-interest income decreased from $450,000 in the three months ending September
30, 2001, to $154,000 in the same period this year. During the third quarter of
2001 the Bank sold $30.8 million in securities which resulted in a gain of
$375,000 and realized a gain of $42,000 related to the sale of a limited
partnership investment. In the third quarter of 2002, sales of securities
totaled $15.2 million resulting in a gain of $129,000. There were no comparable
gains from other investments during the quarter.
Operating expenses dropped by $251,000 to $159,000 in the third quarter this
year. This decrease is largely due to the manner in which the branch operating
expenses and the holding company expenses are allocated to each segment. Branch
operating expense allocated to this
30
segment amounted to $393,000 for the third quarter of 2001 as compared to
$249,000 for the same period this year. The amount of branch operating expense
allocated to each segment is based on the balance of the earning assets. At
September 30, 2001, the earning assets balance for the investment securities
segment totaled $104 million as compared to $94 million at the end of the third
quarter of 2002.
The year-to-date results for 2002 show an increase of $45,000, or 26%, in net
income over the comparable period last year. Although net interest income
increased $680,000, benefiting from a drop in interest expense of $1.6 million,
it was somewhat offset by a decline in non-interest income.
Non-interest income for the first nine months of 2002 totaled $365,000 as
compared to $1 million last year. In the first quarter of 2001 the Bank, along
with other limited partners, sold its interest in an ATM network. The pre-tax
gain amounted to $422,000. The final gain from this investment was recoded in
the second quarter of this year adding an additional $26,000. In addition, gains
from security sales in the first nine months of 2001 totaled $582,000 as
compared to $261,000 this year.
Operating expense dropped $140,000, or 15%, on a year-over-year basis, due to
the allocation of increased overhead costs to the other two segments.
LIQUIDITY AND CAPITAL RESERVES
- ------------------------------
The net change in cash, as reported in the Statement of Cash Flows, has
decreased by $1.0 million in the first nine months of 2002. Some of the more
significant inflows were from principal repayments on loans and securities, the
net increase in deposits, and the issuance of Trust Preferred Securities. Those
cash inflows were offset by cash outflows for loan originations, purchases of
securities, repayments on FHLB advances, and the repurchase of the Company's
common stock.
Loan and security principal repayments contributed to the cash inflows. During
the first nine months of 2002, loan principal repayments totaled $141 million
while principal repayments and redemptions on mortgage-backed securities and
other securities amounted to $13 million. In addition, net deposits rose $55
million. Included in the increase in deposits is the acquisition of
approximately $17 million in brokered deposits during the first quarter of 2002.
During the second quarter, $9 million of Trust Preferred Securities were sold
contributing to the cash inflows.
Cash inflows were used mainly to fund loan originations, which amounted to $171
million during the first nine months of 2002, and purchase mortgage-backed
securities AFS, totaling $40 million. In addition repayments on FHLB advances
totaled $30 million, and the repurchase of the Bank's common stock decreased
cash by $16 million.
The Bank's long term liquidity objective is to fund 60-80% of its growth through
consumer deposits. The remaining 20-40% of growth is funded through wholesale
sources that include FHLB advances, broker deposits, and reverse repurchase
agreements. The single largest source of wholesale funds is the FHLB, where the
Bank currently has a credit limit of 40% of assets. At September 30, 2002, the
Bank's ratio of FHLB advances to assets was 23%. The Bank also has reverse
repurchase agreement credit lines of $50 million, but has to date not used any
of those
31
lines. Other sources of liquidity include the sale of loans into the secondary
market and net income after the payment of dividends.
The Bank has made preliminary plans for year 2003 to purchase land, building,
and equipment totaling $12 - $16 million. Management believes that the Bank has
adequate liquidity and capital to support those transactions. Funding would come
from the traditional sources of retail and wholesale funds, and capital would be
provided from earnings in 2003.
The FDIC's statutory framework for capital requirements establishes five
categories of capital strength, ranging from a high of well capitalized to a low
of critically under-capitalized. An institution's category depends upon its
capital level in relation to relevant capital measures, including a risk-based
capital measure, a leverage capital measure, and certain other factors. At
September 30, 2002, the Bank exceeded the capital levels required to meet the
definition of a well-capitalized institution:
To be categorized as well
For capital capitalized under prompt
Actual adequacy minimum corrective action provisions
------ ---------------- ----------------------------
Total capital (to risk-weighted assets):
First Mutual Bancshares, Inc. 11.00% 8.00% N/A
First Mutual Bank 10.81 8.00 10.00%
Tier I capital (to risk-weighted assets):
First Mutual Bancshares, Inc. 9.75 4.00 N/A
First Mutual Bank 9.55 4.00 6.00
Tier I capital (to average assets):
First Mutual Bancshares, Inc. 6.92 4.00 N/A
First Mutual Bank 6.88 4.00 5.00
BRANCH EXPANSION
- ----------------
The Bank opened a new location for its Ballard Branch on September 30, 2002.
This branch had previously been a leased store-front location, and the Bank made
the decision to build its own free-standing branch. A branch site has also been
acquired for a location in Woodinville and construction began in November 2002.
The Bank continues to seek opportunities to expand its branch franchise in its
primary market area east of Lake Washington, and north from Renton to the
Bothell/Kenmore area. This particular market area has the highest household
income and household net worth of any area in the state. This expansion will
continue to have an impact on expenses as branches are opened. Income from
branch operations often requires a number of years before it equals operating
expenses.
TRUST PREFERRED SECURITIES ISSUANCE
- -----------------------------------
During the second quarter of 2002, the Financial Holding Company formed a
subsidiary whose sole purpose was to issue $9.0 million in Trust Preferred
Securities through a pool sponsored by Bear Stearns & Co. Inc., Regional
Advisor's Alliance and other brokers. Under the terms of the transaction, the
Trust Preferred Securities have a maturity of 30 years and are redeemable after
five years with certain exceptions. The floating-rate securities have an initial
rate of 5.52%, which resets quarterly at the three-month LIBOR rate plus 3.65%.
The Trust Preferred Securities are recorded as a liability on the Statement of
Financial Condition, but qualify as Tier 1 capital for regulatory capital
purposes. The proceeds from the offering have been used to fund the stock
repurchase of approximately 20% of the shares outstanding.
32
In connection with the Trust Preferred Securities issuance, the Bank entered
into a swap agreement with the Federal Home Loan Bank of Seattle (FHLB) in order
to fix the interest rate on the issuance. Under the terms of the swap agreement,
the Bank receives the equivalent of three-month LIBOR and pays the FHLB a fixed
rate of interest equal to the five-year swap curve, as of the trade date, based
upon the notional value of the contract. This transaction is intended to be a
highly effective cash flow hedge as defined by FAS No. 133, Accounting for
Derivative Instruments and Hedging Activities.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is defined as the sensitivity of income and capital from changes in
interest rates, foreign currency exchange rates, commodity prices, and other
relevant market rates or prices. The primary market risk to which the Bank is
exposed is interest rate risk. The Bank's profitability is dependent to a large
extent on its net interest income, which is the difference between the interest
received from its interest-earning assets and the interest expense incurred on
its interest-bearing liabilities. The Bank's objectives in its asset/liability
management are to utilize its capital effectively, to provide adequate
liquidity, and to enhance net interest income, without taking unreasonable risks
and subjecting the Bank unduly to interest rate fluctuations.
Assumptions regarding interest rate risk are inherent in all financial
institutions. Interest rate risk is the risk to earnings or capital resulting
from adverse movements in interest rates. Interest rate sensitivity is the
relationship between market interest rates and net interest income due to the
repricing characteristics of assets and liabilities. The Bank monitors interest
rate sensitivity by examining its one-year and longer gap positions on a regular
basis. Gap analysis and an income simulation model are used to manage interest
rate risk.
GAP ANALYSIS
- ------------
The interest rate sensitive gap is defined as the difference between
interest-earning assets and interest-bearing liabilities anticipated to mature
or reprice during the same period. The gap analysis quantifies the mismatch
between these assets and liabilities in like time periods. Certain shortcomings
are inherent in gap analysis. For example, some assets and liabilities may have
similar maturities or repricing characteristics, but they may react differently
to changes in interest rates. Assets such as adjustable-rate mortgage loans may
have features that limit the effect that changes in interest rates have on the
asset in the short term and/or over the life of the loan. Due to the limitations
of the gap analysis, these features are not taken into consideration.
Additionally, in the event of a change in interest rates, prepayment and early
withdrawal penalties would likely deviate significantly from those assumed in
the gap calculation. As a result, the Bank utilizes the gap report as a
complement to its simulation model.
SIMULATION MODEL
- ----------------
The Bank's simulation model calculates the change to net interest income and the
net market value of equity based upon increases and decreases of 100-, 200-, and
300-basis point movements in interest rates. The model is based on a number of
assumptions such as the maturity, repricing, amortization, and prepayment
characteristics of loans and other interest-earning assets and the repricing of
deposits and other interest-bearing liabilities. The Bank runs the rate ramp (a
monthly pro rata increase/decrease over a one year period) simulation model
monthly for review by the ALCO (Asset Liability Committee), senior management,
and the Board of Directors. The Bank believes that the data and assumptions are
33
realistic representations of its portfolio and possible outcomes under the
various interest rate scenarios. Nonetheless, the interest rate sensitivity of
the Bank's net interest income and net market value of equity could vary
substantially if different assumptions were used or if actual experience differs
from the assumptions used.
The Bank has discontinued the use of the rate shock model to measure simulated
changes in its net interest income and the market value of equity. Management
believes that the rate ramp model produces more meaningful results that more
closely track actual Bank performance. The difference between the two models is
the assumption regarding the timing of the interest rate increases or decreases.
The rate shock model assumes rates immediately rise or fall 100-, 200-, or
300-basis points, whereas the rate ramp assumes a steady increase over a
12-month period. All numbers presented reflect the results of the rate ramp
model.
The Bank's simulation model and its gap analysis results for the periods ending
September 30, 2002, and December 31, 2001, are presented below.
One-Year Interest Rate Sensitive GAP
------------------------------------
(in thousands)
September 30, 2002 December 31, 2001
------------------ -----------------
One-year repricing assets $ 564,913 $ 506,458
One-year repricing liabilities 413,693 413,279
---------- ----------
One-year gap $ 151,220 $ 93,179
---------- ----------
Total assets $ 707,712 $ 678,349
========== ==========
One year interest rate sensitive
gap as a percent of assets 21.4% 13.7%
FIRST MUTUAL BANCSHARES, INC.
RATE RAMP ESTIMATES
Net Interest Income and Net Market Value
September 30, 2002 December 31, 2001
Percentage Change Percentage Change
- ----------------- ---------- -------------------- ---------- -------------------
Gradual Net Net Net Net
Change in Interest Market Interest Market
Interest Rates Income Value Income Value
- ----------------- ---------- -------------------- ---------- -------------------
+300 4% (9)% (1)% (15)%
+200 2 (8) (1) (12)
+100 1 (3) 0 (5)
-100 (2) (1) (1) (2)
-200 (3) 0 (3) (7)
-300 (7) (3) (7) (13)
- ----------------- ---------- -------------------- ---------- -------------------
34
Gap results indicate that the Bank is asset sensitive - that is more assets will
mature and/or reprice than liabilities within the next year. Model simulation
results for the period further indicate results typically associated with an
asset-sensitive institution in that the Bank's net interest income is projected
to increase by a greater magnitude in a rising rate environment. Market value
analysis goes beyond simulating earnings for a specified time period to
generating principal and interest cash flows for the entire life of all assets
and liabilities. These cash flows are then discounted back to the present.
Significant factors contributing to the market value simulation results are the
Bank's fixed-rate loans and securities. These assets comprise approximately
12.2% of the Bank's total rate-sensitive assets. In a simulated shift in the
yield curve, both rising and declining, the market values associated with these
assets typically tend to decline. This is also referred to as negative
convexity. As interest rates rise, the cash flows on these assets will typically
decline, as borrowers are less likely to refinance or prepay their loans. The
result of this is that there is less cash reinvested at current (higher) market
rates. The opposite effect occurs as rates decline, cash flows tend to increase
as borrowers refinance their existing mortgage to a lower rate and the cash
received must be reinvested at current (lower) market interest rates.
The sensitivity analysis does not necessarily represent a forecast for the Bank.
There are numerous assumptions inherent in the simulation model as well as in
the gap report. Some of these assumptions include the nature and timing of
interest rate levels, including yield curve shape, prepayments on loans and
securities, deposit decay rates, pricing decisions on loans and deposits, and
reinvestment/replacement of asset and liability cash flows. Customer preferences
and competitor and economic influences are impossible to predict; therefore, the
Bank cannot make any assurances as to the outcome of these analyses.
SECURITIES
The following table sets forth certain information regarding carrying values and
percentage of total carrying values of the Company's consolidated portfolio of
securities classified as available-for-sale and held-to-maturity (in thousands).
At September 30,
------------------------------------------------------------------------
2002 2001
---------------------------------- ----------------------------------
AVAILABLE-FOR-SALE: Carrying Value Percent of Total Carrying Value Percent of Total
- ------------------- ---------------------------------- ----------------------------------
Mortgage backed securities:
Freddie Mac $ 4,902 9% $ 5,424 23%
Fannie Mae (includes FNMA stock) 51,083 91% 17,783 77%
---------------------------------- ----------------------------------
Total mortgage-backed securities 55,985 100% 23,207 100%
---------------------------------- ----------------------------------
Total securities available-for-sale $ 55,985 100% $ 23,207 100%
---------------------------------------------------------------------------------- ----------------------------------
At September 30,
------------------------------------------------------------------------
2002 2001
---------------------------------- ----------------------------------
HELD-TO-MATURITY: Carrying Value Percent of Total Carrying Value Percent of Total
- ----------------- ---------------------------------- ----------------------------------
US Government Treasury and agency obligations $ -- 0% $ 3,999 12%
Municipal Bonds 1,340 7% 1,115 4%
Mortgage backed securities:
Freddie Mac 948 5% 1,155 3%
Fannie Mae 16,904 88% 27,166 81%
---------------------------------- ----------------------------------
Total mortgage-backed securities 17,852 93% 28,321 84%
CMO's 35 0% 164 0%
---------------------------------- ----------------------------------
Total securities held-to-maturity $ 19,227 100% $ 33,599 100%
---------------------------------------------------------------------------------- ----------------------------------
Estimated Market Value $ 19,798 $ 34,569
----------------------------------------------------------- -----------
35
The following table shows the maturity or period to repricing of the Company's
consolidated portfolio of securities available-for-sale and held-to-maturity
(dollars in thousands):
Available-for-sale at September 30, 2002
- -------------------------------------------------------------------------------------------------------------------------------
Over One to Over Three to
One Year or Less Three Years Five Years
- -------------------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
- -------------------------------------------------------------------------------------------------------------------------------
AVAILABLE-FOR-SALE:
- -------------------
Mortgage backed securities:
Freddie Mac $ 363 4.46% $ -- 0.00% $ -- 0.00%
Fannie Mae 666 6.11% -- 0.00% -- 0.00%
----- ----- ----- ----- ----- -----
Total mortgage-backed securities 1,029 5.53% -- 0.00% -- 0.00%
----------------------------------------------------------------------
Total securities available-for-sale -- Carrying Value $ 1,029 5.53% $ -- 0.00% $ -- 0.00%
======================================================================
Total securities available-for-sale -- Amortized Cost $ 1,004 5.53% $ -- 0.00% $ -- 0.00%
=====================================================================
Available-for-sale at September 30, 2002
- -------------------------------------------------------------------------------------------------------------------------------
Over Five to Over Ten to
Ten Years Twenty Years Over Twenty Years
- -------------------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
- -------------------------------------------------------------------------------------------------------------------------------
AVAILABLE-FOR-SALE:
- -------------------
Mortgage backed securities:
Freddie Mac $ 4,539 5.50% $ -- 0.00% $ -- 0.00%
Fannie Mae 31,938 5.50% 10,670 4.96% 7,808 5.85%
------- ----- ------- ----- ------- -----
Total mortgage-backed securities 36,477 5.50% 10,670 4.96% 7,808 5.85%
----------------------------------------------------------------------
Total securities available-for-sale -- Carrying Value $36,477 5.50% $10,670 4.96% $ 7,808 5.85%
======================================================================
Total securities available-for-sale -- Amortized Cost $35,499 5.50% $10,379 4.96% $ 7,492 5.85%
======================================================================
Available-for-sale at September 30, 2002
- -------------------------------------------------------------------------------
Total
- -------------------------------------------------------------------------------
Weighted
Carrying Average
Value Yield
- -------------------------------------------------------------------------------
AVAILABLE-FOR-SALE:
Mortgage backed securities:
Freddie Mac $ 4,902 5.42%
Fannie Mae 51,082 5.45%
------- -----
Total mortgage-backed securities 55,984 5.45%
----------------------
Total securities available-for-sale -- Carrying Value $ 55,984 5.45%
======================
Total securities available-for-sale -- Amortized Cost $ 54,374 5.44%
======================
Held-to-Maturity at September 30, 2002
- -------------------------------------------------------------------------------------------------------------------------------
Over One to Over Three to
One Year or Less Three Years Five Years
- -------------------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
- -------------------------------------------------------------------------------------------------------------------------------
HELD-TO-MATURITY:
Municipal Bonds $ -- 0.00% $ -- 0.00% $ -- 0.00%
Mortgage backed securities:
Freddie Mac 949 4.98% -- 0.00% -- 0.00%
Fannie Mae 3,497 6.20% 61 6.50% 10,751 5.61%
------ ----- --- ----- ------- -----
Total mortgage-backed securities 4,446 6.33% 61 6.50% 10,751 5.63%
CMO's -- 0.00% -- 0.00% -- 0.00%
----------------------------------------------------------------------
Total securities held-to-maturity -- Carrying Value $ 4,446 5.94% $ 61 6.50% $ 10,751 5.61%
======================================================================
Total securities held-to-maturity -- Fair Market Value $ 4,602 5.95% $ 62 6.50% $ 11,028 5.61%
======================================================================
Held-to-Maturity at September 30, 2002
- -------------------------------------------------------------------------------------------------------------------------------
Over Five to Over Ten to
Ten Years Twenty Years Over Twenty Years
- -------------------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
- -------------------------------------------------------------------------------------------------------------------------------
HELD-TO-MATURITY:
Municipal Bonds $ -- 0.00% $ 220 5.38% $ 1,120 6.16%
Mortgage backed securities:
Freddie Mac -- 0.00% -- 0.00% -- 0.00%
Fannie Mae 2,417 5.50% -- 0.00% 177 7.50%
------ ----- ---- ----- ---- -----
Total mortgage-backed securities 2,417 5.50% -- 0.00% 177 7.50%
CMO's -- 0.00% 35 6.50% -- 0.00%
----------------------------------------------------------------------
Total securities held-to-maturity -- Carrying Value $ 2,417 5.50% $ 255 5.53% $ 1,297 6.34%
======================================================================
Total securities held-to-maturity -- Fair Market Value $ 2,542 5.50% $ 259 5.53% $ 1,305 6.35%
======================================================================
Held-to-Maturity at September 30, 2002
- -------------------------------------------------------------------------------
Total
- -------------------------------------------------------------------------------
Weighted
Carrying Average
Value Yield
- -------------------------------------------------------------------------------
HELD-TO-MATURITY:
Municipal Bonds $ 1,340 6.03%
Mortgage backed securities:
Freddie Mac 949 4.98%
Fannie Mae 16,903 5.74%
------- -----
Total mortgage-backed securities 17,852 5.81%
CMO's 35 6.50%
----------------------
Total securities held-to-maturity -- Carrying Value $ 19,227 5.72%
======================
Total securities held-to-maturity -- Fair Market Value $ 19,798 5.73%
======================
ITEM 4. CONTROLS AND PROCEDURES
The Company's chief executive officer and chief financial officer and other
appropriate officers have evaluated the Company's disclosure controls and
procedures designed to ensure that information required to be disclosed in our
filings under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's rules and forms, and have concluded that, although there
are inherent limitations in all control systems and although we apply certain
reasonable cost/benefit considerations to the design of our disclosure controls
and procedures, as of September 30, 2002 those disclosure controls and
procedures are effective.
There have been no changes in the Company's internal controls or in other
factors known to the Company that could significantly affect these controls
subsequent to their evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
While the Company believes that its existing disclosure controls and procedures
have been effective to accomplish these objectives, the Company intends to
continue to examine, refine and formalize its disclosure controls and procedures
and to monitor ongoing developments in this area.
36
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
At September 30, 2002, the Bank was not engaged in any legal proceedings, which
in the opinion of management, after consultation with our legal counsel, would
be material to our financial condition either individually or in the aggregate.
ITEM 2. CHANGES IN SECURITIES
(a) On July 12, 2002, the Company issued a $9 million Floating Rate Junior
Subordinated Deferrable Interest Debenture due June 30, 2032, to a
business trust subsidiary which issued $9 million in Trust Preferred
Securities based upon this Debenture and a guarantee from the Company.
Interest is payable quarterly at a rate of 3.65% above the three-month
LIBOR rate. The Debenture matures on June 30, 2032, and may be
redeemed on or after June 30, 2007, or if certain conditions are met.
The Debenture and Trust Preferred Securities provide that we have the
right to elect to defer the payment of interest on the Debenture and
Trust Preferred Securities for up to an aggregate of 20 quarterly
periods; however, if the Company should defer the payment of interest
or default on the payment of interest on the Debenture, we may not
declare or pay any dividends on our common stock during any such
period. We paid a placement fee of $270,000 plus certain expenses to
SAMCO Capital Markets in
37
connection with the placement of the Trust Preferred Securities. The
issuance of the Debenture and the Trust Preferred Securities were
exempt from registration under the Securities Act pursuant to Section
4(2) there under. We utilized the proceeds of the Debenture in
connection with our repurchase of 1,019,256 shares of our common stock
from MGN Group LLC, as described in our 8-K filed June 3, 2002.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(3.1) Articles of Incorporation, incorporated by reference to the
Report on Form 8-K filed with the SEC on November 10, 1999.
(3.2) Amendment to Articles of Incorporation effective May 16, 2001,
incorporated by reference to the Report on Form 10-Q filed with
the SEC on May 13, 2002.
(3.3) Bylaws, incorporated by reference to the Report on Form 8-K
filed with the SEC on November 10, 1999.
(11) Statement regarding computation of per share earnings. Reference
is made to the Company's Consolidated Statements of Income
attached hereto as part of Item I Financial Statements, which
are incorporated herein by reference.
(99.1) Certification of the Chief Executive Officer Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
(99.2) Certification of the Principal Financial Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
38
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 14, 2002 FIRST MUTUAL BANCSHARES, INC.
/s/ John R. Valaas
--------------------------------------
John R. Valaas
President and Chief Executive Officer
/s/ Roger A. Mandery
--------------------------------------
Roger A. Mandery
Executive Vice President
(Principal Financial Officer)
39
CERTIFICATION
I, John R. Valaas, President and Chief Executive Officer of the Company certify
that:
1. I have reviewed this quarterly report on Form 10-Q of First Mutual
Bancshares, Incorporated;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002 By: /s/ John R. Valaas
-------------------------------------
John R. Valaas
President and Chief Executive Officer
40
CERTIFICATION
I, Roger A. Mandery, Principal Financial Officer of the Company certify that:
1. I have reviewed this quarterly report on Form 10-Q of First Mutual
Bancshares, Incorporated;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002 By: /s/ Roger A. Mandery
-------------------------------------
Roger A. Mandery
Principal Financial Officer
41