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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 005-57091
FIRST MUTUAL BANCSHARES, INC.
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(Exact name of registrant as specified in its charter)
State of Washington 91-2005970
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
400 108th Avenue N.E., Bellevue, Washington 98004
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (425) 455-7300
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Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $1.00 per share
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K(229.405 of this chapter) is not contained herein, and
will not be contained, to the best of the registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X]
Indicate by a check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). YES [_] NO [X]
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As of June 30, 2002, there were issued and outstanding 5,210,144 shares
of the registrant's common stock. The aggregate market value of the voting stock
held by non-affiliates 3,300,744 shares of the registrant was $53,802,127
based on the closing sales price of the registrant's common stock as quoted on
the Nasdaq National Market System which on June 30, 2002 was $16.30.
As of March 7, 2003, there were issued and outstanding 4,273,561 shares
of the registrant's common stock.
DOCUMENTS INCORPORATED BY REFERENCE
1. Annual Report to Shareholders for the fiscal year ended December 31,
2002.
2. Proxy Statement dated March 7, 2003 for the 2003 Annual Meeting of
Shareholders.
PART I
ITEM 1. BUSINESS
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(a) General
First Mutual Bancshares, Inc. (the "Company") is a Washington
corporation, which was formed for the purpose of becoming the bank holding
company for First Mutual Bank ("First Mutual" or the "Bank"). The Bank's
reorganization was completed on October 26, 1999, on which date the Bank became
the wholly-owned subsidiary of the Company, and the stockholders of the Bank
became stockholders of the Company. The Company's only significant activity is
holding the stock of the Bank and engaging in certain passive investment
activities. This discussion refers to the consolidated statements of the Company
and the Bank and therefore the references to "Bank" in this discussion refers to
both entities.
First Mutual Bank was incorporated as a Washington state-chartered
mutual savings bank in 1968 known as First Mutual Savings Bank and was the
successor to Eastside Savings and Loan Association, which was organized in 1952
and commenced operations in 1953. The Bank converted from mutual to stock form
through the sale and issuance of 966,000 shares of Common Stock in December
1985. In connection with the holding company reorganization, the Bank changed
its name to First Mutual Bank. Effective June 2000, the Federal Reserve Bank
approved the election for the Company to become a financial holding company. The
Bank is subject to regulation by the State of Washington Department of Financial
Institutions and the Federal Deposit Insurance Corporation ("FDIC"). The Company
is subject to regulation by the Federal Reserve Board.
Our business consists of attracting deposits from the general public as
well as wholesale funding sources and investing those funds primarily in
commercial and residential real estate loans, business loans, construction
loans, and consumer loans. We also invest in federal government and agency
obligations, structured notes, real estate mortgage investment conduits
("REMICs"), mortgage-backed securities, and municipal securities. In addition to
portfolio lending, we participate in mortgage banking activities that encompass
the selling of primarily fixed-rate loans into the secondary mortgage market. We
generally sell the right to service the loans sold (I.E., collection of
principal and interest payments) for which we receive a fee.
The principal sources of funds for lending and investment activities
are deposits, repayment of loans, loan sales and Federal Home Loan Bank ("FHLB")
of Seattle advances. The primary sources of income are interest on loans, gains
on sales of loans, investments, and loan servicing rights, servicing fees on
loans, service-charge income on deposit accounts and interest and dividends on
investment securities. Principal expenses are interest paid on deposits and
borrowings, and general and administrative costs.
The savings and lending operations are conducted through ten
full-service facilities located in Bellevue (3), Kirkland (2), Redmond, Seattle
(2), Issaquah, and Monroe. We also have income property loan production offices
located in Bellingham and Tacoma, Washington, and a consumer loan office located
in Jacksonville, Florida. Our main office is located at 400 108th Avenue N.E.,
Bellevue, Washington. See "Item 2. - Properties" herein for additional
information regarding our facilities.
2
Our Securities and Exchange Commission filings may be accessed through
our website: "www.firstmutual.com" free of charge, as soon as reasonably
practicable after those reports are electronically filed with or furnished to
the Commission.
FORWARD-LOOKING STATEMENTS
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This Form 10-K Report contains statements concerning future operations,
trends, expectations, plans, capabilities, and prospects of the Bank that are
forward-looking statements for purposes of the safe harbor provisions under the
Private Securities Litigation Reform Act of 1995. Statements containing words
such as "anticipate," "believe," "estimate," "expect," "plan," "should," or
similar words may constitute forward-looking statements. Although the Bank
believes that the expectations expressed in these forward-looking statements are
based on reasonable assumptions within the bounds of its knowledge of its
business and operations, actual events, results, or developments may differ
materially from those expressed or implied in forward-looking statements due to
a number of risks and uncertainties. Factors which could affect actual results
include economic conditions in the Bank's market area, interest rate
fluctuations, the impact of competitive products, services and pricing, loan
delinquency rates, and the legislative and regulatory changes affecting the
banking industry. There are other risks and uncertainties which could affect the
Bank which are discussed from time to time in the filings made by the Bank with
the Securities and Exchange Commission. These risks and uncertainties should be
considered in evaluating the forward-looking statements, and undue reliance
should not be placed on such statements. The Bank shall not be responsible to
update any such forward-looking statements.
SELECTED FINANCIAL DATA
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The information under the section captioned "Selected Financial Data"
in the 2002 Annual Report to Shareholders ("Annual Report") is incorporated
herein by reference.
YIELDS EARNED AND RATES PAID
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Pretax earnings depend significantly upon net interest income, which is
the difference between the income we receive on our loan portfolio and other
investments and our cost of money, consisting primarily of interest paid on
savings deposits and FHLB advances. Net interest income is affected by: (i) the
difference between rates of interest earned on our interest-earning assets and
rates paid on our interest-bearing liabilities ("interest rate spread") and (ii)
the relative amounts of our interest-earning assets and interest-bearing
liabilities. When interest-earning assets approximate or exceed interest-bearing
liabilities, any positive interest rate spread will generate net interest
income.
At December 31, 2002, our portfolio of loans consisted of 92%
adjustable-rate and 8% fixed-rate loans. We have employed various measures
designed to make yields on our loan portfolio and investments interest-rate
sensitive. They have included: (i) adoption of a policy under which we generally
originate and sell long-term, fixed-rate mortgage loans which have been written
to specifications promulgated by the Federal Home Loan Mortgage Corporation
("Freddie Mac") and Federal National Mortgage Association ("Fannie Mae") and
qualify for sale in the secondary market, (ii) emphasis on origination of
adjustable-rate mortgage loans on residential and commercial properties, (iii)
origination of construction loans secured by residential and commercial
properties, at interest rates subject to periodic adjustment based upon the
prevailing market rates, (iv) origination of business loans at interest rates
subject to periodic adjustment based on prevailing market rates, and (v)
origination of direct consumer loans at interest rates subject to periodic
adjustment based upon the prevailing rates. See "Lending Activities" and
"Interest Rate Risk Management."
3
AVERAGE BALANCE SHEET
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The following table presents for the periods indicated, information
regarding average balances of assets and liabilities as well as the total dollar
amounts of interest income from average interest-earning assets and interest
expense on average interest-bearing liabilities, resulting interest rate spread,
and ratio of interest-earning assets to interest-bearing liabilities. Averages
are calculated using monthly averages. We follow the practice of stopping
interest accruals on loans past due 90 days and over unless it is reasonably
believed that all principal and interest due on the loan will be fully
recovered. The interest income on loans for all years presented below excludes
the interest beyond the 90 day period. These amounts were immaterial for all
periods presented. Interest income on tax-free municipal bonds are not shown on
a tax-equivalent basis.
At December 31, Years Ended December 31,
--------------- -------------------------------------------------------------------------------
2002 2002 2001 2000
--------------- ------------------------- ------------------------ ------------------------
Average Average Average Average
Yield/ Average Yield/ Average Yield/ Average Yield/
Balance Cost Balance Interest Cost Balance Interest Cost Balance Interest Cost
-------- ----- -------- -------- ----- -------- ------- ----- -------- ------- -----
(Dollars in Thousands)
Interest-earning assets:
Loans receivable............... $627,319 6.62% $588,213 $ 42,925 7.30% $535,229 $46,453 8.68% $474,144 $43,682 9.21%
Mortgage-backed securities..... 60,402 5.48 80,523 4,514 5.61 62,369 3,818 6.12 65,503 4,232 6.46
Corporate and municipal bonds.. 1,337 6.03 1,342 80 5.96 2,796 161 5.76 3,485 193 5.54
Short-term investments......... 6,203 1.09 4,673 50 1.07 8,261 259 3.14 1,931 71 3.68
U.S. securities................ 13,000 4.27 1,666 49 2.94 21,501 1,480 6.88 47,660 2,768 5.81
Other equity investments....... 10,443 6.75 10,095 707 7.00 8,252 558 6.76 7,484 483 6.45
-------- -------- -------- -------- ------- -------- -------
Total interest-earning assets.. 718,704 6.44 686,512 48,325 7.04 638,407 52,729 8.26 600,207 51,429 8.57
Non-interest earning assets..... 26,591 25,310 22,383 11,967
-------- -------- -------- --------
Total assets.................... $745,295 $711,822 $660,790 $612,174
======== ======== ======== ========
Interest-bearing liabilities:
Deposits....................... $497,268 2.50% $467,702 $13,995 2.99% $441,483 $22,708 6.79% $433,601 $22,987 5.30%
FHLB advances and other
borrowed money............... 184,394 4.11 176,954 7,692 4.35 149,500 8,694 5.82 127,239 7,932 6.23
-------- -------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities................... 681,662 2.94 644,656 21,687 3.36 590,983 31,402 6.49 560,840 30,919 5.51
Non-interest-bearing
liabilities - deposits
and other...................... 19,349 19,038 20,863 8,707
-------- -------- -------- --------
Total liabilities.............. 701,011 663,694 611,846 569,547
Shareholders' equity............ 44,284 48,128 48,944 42,627
-------- -------- -------- --------
Total liabilities and
shareholders' equity........... $745,295 $711,822 $660,790 $612,174
======== ======== ======== ========
Net interest income............. $ 26,638 $21,327 $20,510
======== ======= =======
Ratio of average interest-
earning assets to average
interest-bearing liabilities... 1.17x 1.19x 1.07x
Interest rate spread............ 3.68% 2.95% 3.06%
Net yield (net interest income
as a percentage of average
interest-earning assets)....... 3.88% 3.34% 3.42%
Amortized loan fees included in
loan receivable interest income. $ 474 $ 981 $ 1,165
4
RATE VOLUME ANALYSIS
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The "Rate Volume Analysis" table is contained in the section captioned
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in the Annual Report, which is incorporated herein by reference.
KEY OPERATING RATIOS
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The following table provides certain performance ratios for the periods
indicated.
Years Ended December 31,
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2002 2001 2000 1999 1998
------ ------ ------ ------ ------
Return on average assets (net income divided
by average total assets) .................... 1.10% 1.05% 1.08% 1.12% 1.11%
Return on average equity (net income divided
by average equity) .......................... 16.20% 14.14% 15.48% 16.22% 15.95%
Average equity to average assets ratio (average
equity divided by average total assets) ..... 6.76% 7.41% 6.96% 6.91% 6.99%
Dividend payout ratio (cash dividend divided by
diluted EPS) ................................ 16.60% 14.94% 14.18% 15.30% 49.00%
LENDING ACTIVITIES
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GENERAL. Our loan portfolio totaled $627.3 million at December 31, 2002
(loans held-for-sale totaled $12.7 million of this amount). On that date before
deductions, $93.2 million, or 14%, of total outstanding loans, including loans
held-for-sale, consisted of loans secured by one-to-four-unit residential
properties; $177.6 million, or 26%, consisted of loans secured by mortgages on
over-four-unit residential properties; construction loans constituted $107.3
million, or 16%; $219.3 million, or 33%, consisted of commercial real estate
loans; $57.6 million, or 9% consisted of consumer loans; and $14.7 million, or
2% consisted of business loans. (See table on next page.)
Our principal lending activities have focused on the origination of
residential, commercial real estate, business banking, and consumer loans. Total
loans originated were $211.1 million and $323.1 million for the years ended
December 31, 2000 and 2001, respectively, and $342.1 million for the year ended
December 31, 2002.
In order to maintain the interest rate sensitivity of our loan
portfolio and investments, we place an emphasis on the origination of
adjustable-rate mortgage loans on residential and commercial properties, and
construction, business, and consumer loans at interest rates subject to periodic
adjustment based upon the prevailing market rates. At December 31, 2002, $577.5
million, or 92% of net loans receivable, including loans held-for-sale, were
comprised of loans that were other than long-term, fixed-rate mortgage loans.
This amount consists of $83.3 million in residential mortgage loans with rates
adjustable at periods ranging from one to five years, $400.5 million in business
loans and loans secured by income-producing and multifamily residential
properties, $69.5 million in net construction loans, and $24.2 million in
consumer loans.
5
The following tables provide selected data relating to the composition
of our loan portfolio by type of loan and type of security on the dates
indicated.
At December 31,
------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
---------------- ---------------- ---------------- ---------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
(Dollars in Thousands)
TYPE OF LOAN:
Real Estate Loans:
Interim construction loans.. $107,266 17.10% $ 84,245 14.84% $103,727 21.19% $ 72,906 16.05% $ 60,641 15.67%
Loans on existing property.. 270,947 43.18 250,038 44.05 198,240 40.49 186,632 41.07 160,068 41.37
Loans refinanced............ 219,125 34.93 208,383 36.72 196,089 40.05 204,630 45.03 174,691 45.15
Insured or guaranteed real
estate loans................ 103 0.02 244 0.04 257 0.05 275 0.06 320 0.08
Consumer loans & other......... 57,627 9.19 42,488 7.49 34,219 6.99 24,435 5.38 17,465 4.52
Business lines of credit....... 14,683 2.34 11,995 2.11 5,033 1.03 3,347 0.74 2,629 0.68
Less -
Loans in process............ (34,528) (5.50) (22,270) (3.92) (40,087) (8.19) (29,959) (6.59) (21,765) (5.63)
Reserve for loan losses..... (7,754) (1.24) (7,032) (1.24) (6,729) (1.37) (6,309) (1.39) (5,569) (1.44)
Deferred loan fees and
other discounts............ (150) (0.02) (537) (0.09) (1,198) (0.24) (1,576) (0.35) (1,574) (0.40)
TOTAL.......................... $627,319 100.00% $567,554 100.00% $489,551 100.00% $454,381 100.00% $386,906 100.00%
At December 31,
------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
---------------- ---------------- ---------------- ---------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
(Dollars in Thousands)
TYPE OF SECURITY:
Residential:
One-to-four-family...........$ 93,208 14.86% $ 83,887 14.78% $ 74,359 15.19% $ 96,418 21.22% $ 95,807 24.76%
Multifamily.................. 177,621 28.30 174,062 30.66 160,297 32.74 148,354 32.65 118,015 30.50
Construction.................... 107,266 17.10 84,245 14.84 103,727 21.19 72,906 16.04 60,641 15.67
Commercial real estate.......... 219,346 34.97 200,716 35.37 159,930 32.66 146,765 32.30 121,257 31.34
Consumer loans & other.......... 57,627 9.19 42,488 7.49 34,219 6.99 24,435 5.38 17,465 4.52
Business lines of credit........ 14,683 2.34 11,995 2.11 5,033 1.03 3,347 0.74 2,629 0.68
Less -
Loans in process............. (34,528) (5.50) (22,270) (3.92) (40,087) (8.19) (29,959) (6.59) (21,765) (5.63)
Reserve for loan losses...... (7,754) (1.24) (7,032) (1.24) (6,729) (1.37) (6,309) (1.39) (5,569) (1.44)
Deferred loan fees and
other discounts............ (150) (0.02) (537) (0.09) (1,198) (0.24) (1,576) (0.35) (1,574) (0.40)
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
TOTAL. . .......................$627,319 100.00% $567,554 100.00% $489,551 100.00% $454,381 100.00% $386,906 100.00%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======
6
LOAN MATURITY. The following table sets forth certain information at
December 31, 2002, regarding the dollar amount of loans maturing based on their
contractual terms to maturity or repricing. Demand loans, loans having no stated
schedule of repayments and no stated maturity are reported as due in one year or
less. Loan balances exclude unearned discounts, deferred loan origination fees,
and allowance for loan losses.
Due 2 Years 3 Years
Within Through Through
One Year 3 Years 5 Years After 5
From After After Years
December December December Through Beyond
31, 2002 31, 2002 31, 2002 10 Years 10 Years Total
-------- -------- -------- -------- -------- --------
(In Thousands)
Real Estate Loans:
Interim construction loans $ 72,738 $ -- $ -- $ -- $ -- $ 72,738
Loans on existing property 228,820 32,123 9,232 -- 772 270,947
Loans refinanced ......... 185,289 25,801 7,415 -- 620 219,125
Insured or guaranteed real
estate loans ............. -- -- -- -- 103 103
Consumer loans & other ..... 25,915 1,479 4,170 16,137 9,926 57,627
Business lines of credit ... 12,133 2,016 304 230 -- 14,683
-------- -------- -------- -------- -------- --------
Total Loans ................ $524,895 $ 61,419 $ 21,121 $ 16,367 $ 11,421 $635,223
======== ======== ======== ======== ======== ========
The following table sets forth the dollar amount of all loans,
categorized by fixed interest rates and floating or adjustable interest rates.
Loan balances exclude unearned discounts, deferred loan origination fees, and
allowance for loan losses.
Due Within
One Year From December 31, 2002 Due After December 31, 2003
---------------------------------- ----------------------------------
Fixed Adjustable Fixed Adjustable
Rates Rates Total Rates Rates Total
-------- -------- -------- -------- -------- --------
(In Thousands)
Mortgage loans.............. $ 12,498 $474,349 $486,847 $ 3,704 $ 74,362 $ 76,066
Consumer loans ............. 387 25,528 25,915 31,712 -- 31,712
Business lines of credit ... 15 12,118 12,133 -- 2,550 2,550
-------- -------- -------- -------- -------- --------
Total ................. $ 12,900 $511,995 $524,895 $ 35,416 $ 74,912 $110,328
======== ======== ======== ======== ======== ========
RESIDENTIAL LOANS. At December 31, 2002, approximately 14% of the total
loan portfolio, including loans held-for-sale, consisted of loans secured by
one-to-four-unit family dwellings located within the States of Washington,
Oregon, and Idaho.
Our lending policies generally limit the maximum loan-to-value ratio on
residential mortgage loans to 97% of the appraised value as determined by an
independent appraiser, with the condition that private mortgage insurance is
required on home loans with loan-to-value ratios in excess of 80%.
The loan-to-value ratio, maturity, and other provisions of the loans
originated generally have reflected the policy of making less than the maximum
loan permissible in accordance with sound lending practices, market conditions,
and underwriting standards established by management. Mortgage loan originations
are generally long-term loans, amortized on a monthly basis, with principal and
interest due each month. The initial contractual loan payment period for
residential loans typically ranges from five to 30 years. Our past experience
indicates that real estate loans remain outstanding for significantly shorter
periods than their contractual terms. Borrowers may refinance or prepay loans at
their option, subject to prepayment penalty provisions when included in the
note.
7
We offer adjustable rate loans, with a rate adjustment after a period
of one-year, two-year, three-year, five-year, seven-year, or ten-years, with
subsequent adjustments every one, two or three years. These loans have a maximum
rate adjustment of two percent in any one year with a maximum lifetime interest
rate adjustment of between four and six percent. We also offer fixed-rate 15-
and 30-year loans that we sell into the secondary market. At times, we may
choose to portfolio some of these loans that are underwritten to certain
criteria.
All improved real estate which serves as security for a loan must be
insured by companies we have approved against fire, extended coverage,
vandalism, malicious mischief, and other hazards. Such insurance must be
maintained throughout the term of the loan and in an amount not less than that
amount necessary to meet the replacement cost of the property structures,
subject to insurance carrier limits.
CONSTRUCTION AND COMMERCIAL REAL ESTATE LOANS. Our real estate loan
portfolio also includes loans on multifamily housing (over four units),
construction loans (residential, commercial, and multifamily), and commercial
loans.
Multifamily loans are generally made in amounts between $500,000 and
$2.0 million and at December 31, 2002, the largest multifamily loan was for $3.9
million. As of December 31, 2002, multifamily loans were $177.6 million, or 26%,
of the loan portfolio as compared to $174.1 million, or 29%, in 2001.
Interim (construction) financing is available for residential and
commercial property development. At December 31, 2002, we had $107.3 million in
construction loans of which $34.5 million was disbursed. These loans constituted
17% of the loan portfolio.
Single-family construction loans are further designated into two
categories -- speculative and custom. Speculative (spec) construction loans are
approved for builder-developers who generally first build the residence and then
sell the property to the end buyer. Those loans typically are made for a
12-month period, which may be extended subject to negotiation and the payment of
an extension fee. Interest rates on spec loans are tied to the prime rate and
are adjusted when the prime rate changes. At the present time, rates quoted
range from 1.0% to 2.0% above the prevailing prime rate and are dependent upon
the type of loan and its terms.
Custom construction loans are originated directly to the borrower. The
builder, which the borrower has contracted with to build the residence, must be
approved by the Bank. We oversee the disbursement of construction funds to the
borrower and builder. These loans generally have 30- or 15-year terms with the
construction period ranging from six to 12 months, with interest collected
monthly based upon the disbursed balance of the loan. At the end of the
construction period the terms of payment are modified to fully amortize the loan
balance over the subsequent 30- or 15-year term.
The loan programs and interest rates offered for custom construction
loans are typically the same as those offered for other one-to-four family
residential loans. The fee structure for custom construction loans is 1% - 2%
higher than that assessed other single-family loans with similar terms and
conditions. The additional loan fee compensates us for the extra cost and
interest rate risk associated with this type of lending.
At December 31, 2002, commercial real estate loans (excluding
multifamily and construction loans) constituted $219.3 million, or approximately
35% of the loan portfolio. These loans are typically secured by office
buildings, warehouse, commercial and retail centers located in our primary
lending area in the Greater Puget Sound area and Western Oregon. Permanent
commercial real estate loans are normally made up to 75% of the appraised value
of the property and generally have interest rates which are adjusted annually
based on the short-term FHLB of Seattle's advance rate plus a spread ranging
from 3.00% to 4.00%.
Income property loans, consisting of multifamily, construction, and
commercial real estate loans, totaled $424.8 million at December 31, 2002. That
figure compares to $406.6 million at year-end 2001 and $369.0 million at
year-end 2000.
8
Income property real estate financing is generally considered to
involve a somewhat higher degree of credit risk than financing of residential
properties. The risk of loss on an income property construction loan is
dependent largely upon the accuracy of the initial estimate of the property's
value at completion of construction or development and the estimated cost
(including interest) of construction. If the estimate of the construction cost
of the property upon completion of the project proves to be inaccurate, we may
be required to advance funds beyond the amount originally committed to permit
completion of the development. If the estimate of value proves to be inaccurate,
we may be confronted, at or prior to the maturity of the loan, with collateral
which is insufficient to assure full repayment. On permanent income property
real estate loans, the risk is primarily attributable to the cash flow from the
property being financed. If the cash flow from the property is reduced (E.G., if
leases are not obtained or renewed), the borrower's ability to repay the loan
may be impaired.
Our underwriting criteria is designed to evaluate and minimize the risk
of income property real estate lending. Among other things, we consider the
credit history and reputation of the borrower, the borrower's net worth and
liquidity, the amount of the borrower's equity in the project, independent
appraisal and review of cost estimates, pre-construction sale and leasing
information, and cash flow projections of the borrower. To manage and control
the risk inherent in this type of lending, we have adopted a concentration of
credit policy which, among other things, generally limits the amount we can lend
to any one borrower to $6.75 million unless this requirement is waived by the
Investment Committee of the Board of Directors.
BUSINESS BANKING. The Business Banking Department makes loans for
"owner-occupied" commercial real estate properties, construction loans and
non-real-estate-based business loans. At year-end 2002, total business banking
loans grew to $73.6 million compared to $59.6 million the previous year. Non
real estate business loans included in those totals were $13.1 million and $12.0
million at December 31, 2002 and 2001, respectively.
Business banking commercial real estate loans are typically made on
"owner-occupied" properties. The Business Banking Department analyzes the
owner's business that occupies the property and looks at the business's cash
flow as the primary source of repayment. The real estate collateral provides
secondary security to the loan. Non real estate business loans are typically
extended to medium-sized businesses for the purpose of financing inventory,
accounts receivable, equipment, facilities, etc.
Interest rates on business loans are generally tied to the prime rate,
plus a spread ranging from 0% to 3% or to the short-term FHLB of Seattle's
advance rate, plus a spread ranging from 3% to 4%. The rates are adjusted when
the index rate changes. Most prime-based loans reprice immediately while the
rest reprice based on set schedules, generally annually and after a fixed period
of time. Annual fees are also usually assessed to line-of-credit business loans.
Commercial business lending generally involves greater risk than
residential mortgage lending and involves risks that are different from those
associated with residential, commercial, and multifamily real estate lending.
Real estate lending is generally considered to be collateral-based lending with
loan amounts based on predetermined loan to collateral values, and liquidation
of the underlying real estate collateral is viewed as the primary source of
repayment in the event of borrower default. Although commercial business loans
are often collateralized by equipment, inventory, accounts receivable or other
business assets, the liquidation of collateral in the event of a borrower
default is often not a sufficient source of repayment because accounts
receivable may be uncollectible and inventories and equipment may be obsolete or
of limited use, among other things. Accordingly, the repayment of a commercial
business loan depends primarily on the creditworthiness and cash flow of the
borrower (and any guarantors), while liquidation of collateral is a secondary
source of repayment.
9
CONSUMER LOANS. We originate consumer loans through two principal
methods: sales finance lending (indirect lending), and direct consumer lending
(consumer and home equity loans). Consumer loans totaled $57.6 million at
December 31, 2002 compared to $42.5 million the previous year. The increase is
due to a combination of growth in both departments. The direct consumer lending
area, which includes home equity lines of credit (HELOC), portfolio balance
December 31, 2002 totaled $24.2 million as compared to $16.1 million in 2001.
Sales finance loans totaled $33.4 million and $26.4 million, at year-end 2002
and 2001, respectively.
The Sales Finance Department began operations during the third quarter
of 1997. This department purchases non-recourse consumer financing contracts
from approved dealers in many states. Typical collateral for these contracts
include retrofitted windows, siding, roofs, and spas. Dealers must be approved
with the Bank prior to the purchase of contracts. Before a contract is
purchased, Bank personnel make independent credit decisions on the borrowers by
checking the creditworthiness of the borrower, calculating debt-to-income
ratios, and evaluating the value of the collateral purchased.
In July of 2001, we opened a satellite office of our Sales Finance
Department in Jacksonville, Florida. Our employees based out of this office work
with contractors in the eastern portion of the United States to generate home
improvement contracts for assignment to First Mutual.
The Sales Finance Department originates loans both for portfolio and
for sale on the secondary market. Loans originated for portfolio can either be
unsecured or secured by the use of a Financing Statement filed against the real
property where the goods were installed. The terms of the contracts are fixed
rate and vary in term from two to 12 years. Loans originated for sale on the
secondary market are unsecured. The loans are sold non-recourse to various
institutional purchasers for a fee.
Beginning late 2002, we underwent a change in direction and going
forward will portfolio many of the loans that previously were sold. To mitigate
future losses, we have entered into an agreement with a national insurance
company to provide credit default insurance on a portion of the sales finance
loans. The default insurance pays 100% of the loss on any given loan up to an
overall liability cap as defined in the insurance policy. The insurance
coverage, when applicable, is typically purchased for loans that fall below a
cutoff credit score. That cutoff score is generally set in a range between 680 &
740. The Sales Finance Department's portfolio, which was $33.4 million at
year-end 2002, should grow at a much stronger pace as a result of these changes.
We anticipate that the portfolio will approach $60 million by year-end 2003.
The Direct Consumer Lending Department processes and closes consumer
loan requests generated within the deposit branches and from lending officers.
The lending products offered fall into two categories: collateral-based loans
(automobiles, boats, recreational vehicles, home improvement, etc.), and
unsecured lines-of-credit. The underwriting criteria for collateral-based loans
are similar to that of the sales finance loans noted above. Primary
consideration is given to the borrower's capacity to repay the obligation. A
secondary consideration on secured consumer loans is the value of the loan
collateral as a source of repayment. The underwriting criteria on the unsecured
lines-of-credit call for a higher level of borrower creditworthiness because of
the unsecured nature of these loans. The terms on the collateral-based loans are
fixed rates with terms of up to 10 years. The unsecured lines-of-credit are
variable and tied to the prime rate plus a margin. Direct consumer loans totaled
$24.2 million at December 31, 2002 as compared to $16.1 million at year-end
2001.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of loans that are unsecured or secured by rapidly
depreciating assets such as automobiles. In such cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation. The remaining deficiency often does not warrant
further substantial collection efforts against the borrower beyond obtaining a
deficiency judgment. In addition, consumer loan collections are dependent on the
borrower's continuing financial stability and thus are more likely to be
adversely affected by job loss, divorce, illness or personal bankruptcy.
Furthermore, the application of various federal and state laws, including
federal and state bankruptcy and insolvency laws, may limit the amount which can
be recovered on such loans. Such loans may also give rise to claims and defenses
by a consumer loan borrower against an assignee of such loans such as the Bank,
and a borrower may be able to assert against such assignee claims and defenses
that it has against the seller of the underlying collateral. At December 31,
2002, consumer loans past due 90 days or more totaled $44,000 as compared to
$5,000 at year-end 2001.
10
LOAN SOLICITATION AND PROCESSING. We rely upon our employees to solicit
and/or originate business, consumer, income property, and residential loans. We
also utilize the services of mortgage brokers. Residential mortgage brokers take
applications from borrowers, process the credit information, obtain property
appraisals, and then submit the loan to us for approval. If approved, the loan
is funded by and closed in the name of the Bank. Income property brokers are
generally limited to taking the initial application from borrowers. Mortgage
brokers provide us with a cost-effective method of originating loans in a
broader geographic area than our customer base. Approximately 79% of all
residential loans closed during the year ended December 31, 2002, were obtained
through mortgage brokers as compared to 75% during 2001.
Our lending policy is reviewed annually and approved by the Board of
Directors. Residential loans up to specified limits may be approved by a
designated underwriter or member of the Consumer Loan Committee, which is
comprised of officers Boudreau, Boyd, Harlan, Stroup, and Young. Commercial real
estate loans can be approved by the chief credit officer up to $750,000 or by a
designated member of the Commercial Loan Committee up to $300,000. The entire
Commercial Loan Committee can approve these loans up to $2 million. This
committee can also approve other secured or unsecured business loans up to
$750,000; its members are officers Valaas, Collette, Mandery, Boudreau, Davis,
Everett, Harlan, Werth, and Young. Larger loans are further reviewed and
approved by the Investment Committee of the Board, which is comprised of
Directors Parker, Valaas, Wallace, Florence, Doud, and Rowley. Except for small
consumer or community business loans, the Investment Committee must also approve
loans where the cumulative debt exceeds $2.5 million. Subsequent to year-end,
officer Zavaglia joined the Bank and was named to both the Consumer and
Commercial Loan Committees.
LOAN ORIGINATIONS AND SALE OF LOANS INTO THE SECONDARY MARKET. Loan
originations increased in 2002 to $342 million from $319 million in 2001 and
the comparable figure for 2000 was $211 million. The increase in originations
came largely from sales finance and residential loan closings. Sales finance
loan closings increased from $24.3 million in 2001 to $39.7 million in 2002. In
addition, residential loan closings increased $12.4 million from $135.5 million
last year to $147.9 million in 2002.
Selling loans in the secondary mortgage market reduces the risk that
interest rates will escalate while holding long-term, fixed-rate loans in the
portfolio. The sale of loans into the secondary market also allows us to
continue to make loans during periods when savings flows decline or funds are
not otherwise available for lending purposes. In connection with such sales, we
generally sell the servicing rights (I.E., collection of principal and interest
payments).
As of December 31, 2002, we serviced loans for others aggregating
approximately $46 million as compared to $47 million in 2001. Loan servicing
fees, net, totaled $103,000 for the year ended December 31, 2002 and $106,000
for the year ended December 31, 2001.
Currently, long-term mortgage loans are being originated for sale in
the secondary mortgage market to Fannie Mae, and other investors. During the
year ended December 31, 2002, we securitized $14.5 million in loans and sold
$72.5 million in residential loans as compared to $4.9 million and $90.9 million
respectively during 2001.
Set forth below is a table showing our loan origination and sales
activity for the periods indicated.
Years Ended December 31,
----------------------------------------
2002 2001 2000
---------- ---------- ----------
(In Thousands)
Total loans at beginning of period
(net of undisbursed loan proceeds) $ 575,123 $ 497,478 $ 462,266
Loans originated:
Real estate loans:
Construction loans ............. 85,059 54,330 78,207
Loans on existing property ..... 118,345 169,214 77,843
Loans refinanced ............... 78,301 59,408 28,745
Insured and guaranteed loans ... 10,203 3,282 2,022
Consumer and other loans ......... 50,293 36,824 24,248
---------- ---------- ----------
Total loans originated .. 342,201 323,058 211,065
Principal reductions ............... (192,698) (154,513) (133,082)
Loans sold:
Whole loans ...................... (72,197) (76,619) (36,972)
Participation loans .............. (17,206) (14,281) (5,799)
---------- ---------- ----------
Total loans sold ........ (89,403) (90,900) (42,771)
---------- ---------- ----------
Total gross loans at end of period
(net of undisbursed loan proceeds) $ 635,223 $ 575,123 $ 497,478
========== ========== ==========
11
LOAN COMMITMENTS. Our commitments to make conventional mortgage loans
on existing residential dwellings are generally made for periods of 30 to 60
days. The borrower may reserve ("lock-in") an interest rate and loan fee for a
period of 10 to 60 days from the date of application. This reservation is
conditioned upon loan approval and closing within this time frame. Interest
rates and loan fees committed at the time of the lock-in are based upon the
prevailing market rate at the time of approval. Outstanding commitments to
borrowers for loans, including commitments for income property loans, totaled
$185.7 million at December 31, 2002, and $106.4 million at year-end 2001.
LOAN ORIGINATION FEES AND OTHER FEES. In addition to interest earned on
loans and servicing fees on loans sold and securitized, we receive loan
origination fees for originating mortgage loans. See Note 1 of "Notes to
Consolidated Financial Statements" in the Annual Report for information as to
the recognition of loan fee income.
Loan origination fees vary with the volume and type of loans made and
with competitive conditions in mortgage markets. Loan demand and availability of
money affect these market conditions. Recent trends have kept loan origination
fees in the 1% to 2% range for permanent real estate loans. Construction loan
fees at the present time range from 2% to 3% of the loan amount.
We also receive other fees and charges relating to existing loans,
which include late charges, prepayment fees, and fees collected in connection
with a change in borrower or other loan modifications, including construction
loan extensions. In connection with loan origination activities, we also realize
closing fees.
REAL ESTATE HELD-FOR-SALE AND NON-PERFORMING LOANS. Loans are defined
as non-performing when any payment of principal and/or interest is 90 days past
due unless the loan is well secured and is in process of collection. Generally
we are able to work out a satisfactory repayment schedule with a delinquent
borrower; however, the Bank will undertake foreclosure proceedings if the
delinquency is not otherwise resolved. Property we acquire as a result of
foreclosure or by deed in lieu of foreclosure is classified as "held-for-sale"
until such time as it is sold or otherwise disposed. At December 31, 2002, the
total of non-performing loans, repossessed assets, and real estate acquired
through foreclosure was $2.1 million as compared to $521,000 at year-end 2001.
The following table sets forth information regarding non-performing
assets at the dates indicated.
At December 31,
----------------------------------
2002 2001 2000
-------- -------- --------
(Dollars in Thousands)
Loans greater than 90 days
delinquent and still accruing ...... $ -- $ -- $ --
Restructured troubled loans .......... -- -- --
Nonaccrual loans ..................... 2,074 498 1,111
Other assets and real estate
acquired through foreclosure ....... 45 23 1,353
-------- -------- --------
Total .............................. $ 2,119 $ 521 $ 2,464
======== ======== ========
As a percentage of net loans ......... 0.34% 0.09% 0.50%
As a percentage of total assets....... 0.28% 0.08% 0.38%
Gross interest income that would
have been recorded in the period
if loans had been current with
original terms ..................... $ 156 $ 40 $ 100
Interest income on loans included
in net income for the period ....... $ 117 $ 30 $ 53
12
Non-performing assets for 2002 were composed of loans collateralized by
single-family residences, consumer goods, and commercial real estate.
RESERVE FOR LOAN LOSSES
The reserve for loan losses is maintained at a level sufficient to
provide for estimated losses based on known and inherent risks in the loan
portfolio. This reserve is based upon management's continuing analysis of the
factors underlying the quality of the loan portfolio. These factors include
changes in the size and composition of the loan portfolio; actual loan loss
experience; current and anticipated economic conditions; detailed analysis of
individual loans for which full collectibility may not be assured and for which
impairment may be present; and determination of the existence and fair value of
the collateral and guarantees securing the loans. The reserve is based upon
factors and trends identified by management at the time the financial statements
are prepared. The ultimate recovery of loans is susceptible to future market
factors beyond our control, which may result in losses or recoveries differing
significantly from those provided in the financial statements. At December 31,
2002, the reserve for loan losses totaled $7.8 million which compares to $7.0
million at December 31, 2001.
While we believe we have established our existing reserve for loan
losses in accordance with generally accepted accounting principles as of
December 31, 2002, there can be no assurance that regulators, when reviewing our
loan portfolio in the future, will not request us to change our reserve for loan
losses, thereby adversely affecting our financial condition and earnings. See
the Consolidated Financial Statements contained in the Annual Report.
The following table sets forth an analysis of the allowance for loan
losses for the periods indicated.
Years Ended December 31,
---------------------------------------------------
2002 2001 2000 1999 1998
------- ------- ------- ------- -------
(In Thousands)
Balance at beginning of period................... $ 7,032 $ 6,729 $ 6,309 $ 5,569 $ 4,858
Charge-offs.................................... (271) (144) (112) (68) (39)
Residential real estate and other loans..... (265) (144) (112) (45) (39)
Commercial real estate...................... (6) -- -- (23) --
Construction................................ - -- -- -- --
Recoveries..................................... 83 82 2 3 --
Residential real estate and other loans..... 83 82 2 3 --
Commercial real estate...................... - -- -- -- --
Construction................................ - -- -- -- --
Provision...................................... 910 365 530 805 750
------- ------- ------- ------- -------
Balance at end of period......................... $ 7,754 $ 7,032 $ 6,729 $ 6,309 $ 5,569
======= ======= ======= ======= =======
Ratio of net charge-offs during the period to
average loans outstanding during the period.... 0% 0% 0% 0% 0%
13
INTEREST RATE RISK MANAGEMENT
- -----------------------------
Market risk is defined as the sensitivity of income and capital to
changes in interest rates, foreign currency exchange rates, commodity prices,
and other relevant market rates or prices. The primary market risk to which we
are exposed is interest rate risk. Our profitability is dependent to a large
extent on our net interest income, which is the difference between the interest
received from our interest-earning assets and the interest expense incurred on
our interest-bearing liabilities. Our objectives in asset/liability management
are to utilize our capital effectively, to provide adequate liquidity, and to
enhance net interest income, without taking unreasonable risks subjecting us
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. We monitor interest rate
sensitivity by examining our 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, we utilize the gap report as a complement to
our income simulation model.
Income Simulation Model
- -----------------------
Our simulation model calculates the change to net interest income and
the net market value of equity based upon increases and decreases of 100 and 200
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. We run 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. We believe that data and assumptions are realistic representations
of our portfolio and possible outcomes under the various interest rate
scenarios. Nonetheless, the interest rate sensitivity of our 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.
We have discontinued the use of the rate shock model to measure
simulated changes in 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 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.
14
Our income simulation model and gap analysis results for the periods
ending December 31, 2002, and December 31, 2001, are presented below.
SIMULATION MODEL RESULTS
Net Interest Income and Net Market Value
December 31, 2002 December 31, 2001
Percentage Change Percentage Change
- --------------------------------------------------------------------------------
Net Net Net Net
Change in Interest Market Interest Market
Interest Rates Income Value Income Value
- --------------------------------------------------------------------------------
+200 2% (11)% (1)% (12)%
-100 (1) 0 (1) (2)
-200 n/a n/a (3) (7)
- --------------------------------------------------------------------------------
GAP MODEL
(In Thousands)
December 31, 2002 December 31, 2001
----------------- -----------------
One-year repricing assets $ 600,577 $ 506,137
One-year repricing liabilities 477,932 413,029
--------- ---------
One-year gap 122,645 93,108
--------- ---------
Total assets $ 745,295 $ 678,349
========= =========
One Year Interest Rate Sensitive
Gap as a Percent of Assets 16.5% 13.7%
The interest rate scenarios reflected above represent the results of
possible near-term interest rate movements. Approximately 75% of the loan
portfolio is tied to rate indices that are one year or less in duration. These
indices include prime, Federal Home Loan Bank of Seattle (FHLB) Advance Rate,
London Interbank Offering Rate (LIBOR), and Constant Maturity Treasury (CMT),
most of which as of December 31, 2002, were below 2%. Therefore, given the
current interest rate levels, we believe that a scenario simulating a decline of
200 basis points is unlikely, as this would place the absolute rate of these
indices below zero.
The percentages shown represent changes over a 12-month period in net
interest income and net portfolio value under the various rate scenarios. Net
portfolio value is defined as the net market value of our assets and
liabilities, which have been estimated by calculating the present value of their
cash flows. The cash flows have been adjusted to account for projected
amortization, prepayments, core deposit decay rates, and other factors.
The sensitivity analysis does not 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, we cannot make any assurances as to the outcome of these analyses.
Our primary objective in managing interest rate risk is to minimize the
adverse impact of changes in interest rates on our net interest income and
capital, while structuring the asset and liability components to obtain the
maximum net interest margin. We rely on our asset and liability structure to
control interest rate risk.
15
Market Value Analysis
- ---------------------
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. Prepayment behavior in different interest rate scenarios can then be
modeled. Loan caps can be simulated. Loans tied to different indices can be
distinguished. The effect of forecasted loan and deposit growth can both be
included and excluded. Different forecast assumptions can also be used.
SECURITIES
- ----------
The following table sets forth certain information regarding carrying
values and percentage of total carrying values of the consolidated portfolio of
securities classified as available-for-sale and held-to-maturity (in thousands).
-----------------------------------------------
At December 31,
-----------------------------------------------
2002 2001
------------------- -------------------
Carrying Percent Carrying Percent
AVAILABLE-FOR-SALE: Value of Total Value of Total
- ------------------- ------------------- -------------------
US Government Treasury and agency obligations $ 13,081 22% $ -- 0%
Mortgage backed securities:
Freddie Mac 4,260 8% 5,284 11%
Fannie Mae (includes FNMA stock) 41,039 70% 40,677 89%
------------------- -------------------
Total mortgage-backed securities 45,299 78% 45,961 100%
------------------- -------------------
=====================================================================================================
Total securities available-for-sale $ 58,380 100% $ 45,961 100%
=====================================================================================================
-----------------------------------------------
At December 31,
-----------------------------------------------
2002 2001
------------------- -------------------
Carrying Percent Carrying Percent
HELD-TO-MATURITY: Value of Total Value of Total
- ----------------- ------------------- -------------------
Municipal Bonds $ 1,337 8% $ 1,113 4%
Mortgage backed securities:
Freddie Mac 729 4% 1,104 4%
Fannie Mae 14,266 87% 24,069 91%
------------------- -------------------
Total mortgage-backed securities 14,995 92% 25,173 95%
CMO's 26 0% 100 0%
------------------- -------------------
=====================================================================================================
Total securities held-to-maturity $ 16,358 100% $ 26,386 100%
=====================================================================================================
=====================================================================================================
Estimated Market Value $ 16,926 $ 26,890
=====================================================================================================
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 December 31, 2002
----------------------------------------------------------------------------------------
Over One to Over Three Over Five
One Year or Less Three Years to Five Years to Ten Years
------------------- ------------------- ------------------- -------------------
Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
-------- -------- -------- -------- -------- -------- -------- --------
AVAILABLE-FOR-SALE:
- -------------------
US Government Treasury and agency
obligations $ -- 0.00% $ -- 0.00% $ -- 0.00% $ 6,064 4.08%
Mortgage backed securities:
Freddie Mac 360 4.46% -- 0.00% -- 0.00% 3,900 5.50%
Fannie Mae 665 6.11% -- 0.00% -- 0.00% 27,863 5.50%
-------- -------- -------- -------- -------- -------- -------- --------
Total mortgage-backed securities 1,025 5.53% -- 0.00% -- 0.00% 31,763 5.50%
========================================================================================
Total securities available-for-sale --
Carrying Value $ 1,025 5.53% $ -- 0.00% $ -- 0.00% $ 37,827 5.27%
========================================================================================
========================================================================================
Total securities available-for-sale --
Amortized Cost $ 997 5.53% $ -- 0.00% $ -- 0.00% $ 36,488 5.27%
========================================================================================
-----------------------------------------------------------------
Available-for-sale at December 31, 2002
-----------------------------------------------------------------
Over Ten to
Twenty Years Over Twenty Years Total
------------------- ------------------- -------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
-------- -------- -------- -------- -------- --------
AVAILABLE-FOR-SALE:
- -------------------
US Government Treasury and agency
obligations $ 7,018 4.43% $ -- 0.00% $ 13,082 4.27%
Mortgage backed securities:
Freddie Mac -- 0.00% -- 0.00% 4,260 5.41%
Fannie Mae 10,049 4.95% 2,462 5.00% 41,039 5.34%
-------- -------- -------- -------- -------- --------
Total mortgage-backed securities 10,049 4.95% 2,462 5.00% 45,299 5.35%
=================================================================
Total securities available-for-sale --
Carrying Value $ 17,067 4.74% $ 2,462 5.00% 58,381 5.11%
=================================================================
=================================================================
Total securities available-for-sale --
Amortized Cost $ 16,678 4.73% $ 2,371 5.00% 56,534 5.10%
=================================================================
----------------------------------------------------------------------------------------
Held-to-Maturity at December 31, 2002
----------------------------------------------------------------------------------------
Over One to Over Three Over Five
One Year or Less Three Years to Five Years to Ten Years
------------------- ------------------- ------------------- -------------------
Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
-------- -------- -------- -------- -------- -------- -------- --------
HELD-TO-MATURITY:
- -----------------
Municipal Bonds $ -- 0.00% $ -- 0.00% $ -- 0.00% $ -- 0.00%
Mortgage backed securities:
Freddie Mac 729 5.01% -- 0.00% -- 0.00% -- 0.00%
Fannie Mae 3,326 5.77% 1,890 5.53% 6,777 5.65% 2,159 5.50%
-------- -------- -------- -------- -------- -------- -------- --------
Total mortgage-backed securities 4,055 5.63% 1,890 5.53% 6,777 5.65% 2,159 5.50%
CMO's -- 0.00% -- 0.00% -- 0.00% -- 0.00%
========================================================================================
Total securities held-to-maturity --
Carrying Value $ 4,055 5.63% $ 1,890 5.53% $ 6,777 5.65% $ 2,159 5.50%
========================================================================================
========================================================================================
Total securities held-to-maturity --
Fair Market Value $ 4,215 5.64% $ 1,946 5.53% $ 7,043 5.65% $ 2,281 5.50%
========================================================================================
-----------------------------------------------------------------
Held-to-Maturity at December 31, 2002
-----------------------------------------------------------------
Over Ten to
Twenty Years Over Twenty Years Total
------------------- ------------------- -------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
-------- -------- -------- -------- -------- --------
HELD-TO-MATURITY:
- -----------------
Municipal Bonds $ 220 5.38% $ 1,117 6.16% $ 1,337 6.03%
Mortgage backed securities:
Freddie Mac -- 0.00% -- 0.00% 729 5.01%
Fannie Mae -- 0.00% 114 7.50% 14,266 5.66%
-------- -------- -------- -------- -------- --------
Total mortgage-backed securities -- 0.00% 114 7.50% 14,995 5.75%
CMO's 26 6.50% -- 0.00% 26 6.50%
=================================================================
Total securities held-to-maturity --
Carrying Value $ 246 5.49% $ 1,231 6.28% 16,358 5.66%
=================================================================
=================================================================
Total securities held-to-maturity --
Fair Market Value $ 243 5.50% $ 1,198 6.33% $ 16,926 5.66%
=================================================================
INVESTMENT ACTIVITIES
- ---------------------
Under Washington law, savings banks are permitted to own government and
government agency obligations, commercial paper, corporate bonds, mutual fund
shares, debt and equity obligations issued by creditworthy entities, whether
traded on public securities exchanges or placed privately for investment
purposes. We retain a portfolio of mortgage-backed securities, real estate
mortgage investment conduits (REMICS), and municipal bonds. Subject to certain
exceptions, we are prohibited by FDIC regulations from making equity investments
of a type, or in an amount, that is not permissible for national banks.
The Chief Financial Officer determines appropriate investments in
accordance with approved policies of the Investment Committee of the Board of
Directors. The policy generally limits investments to US Government and agency
securities, and mortgage-backed securities issued and guaranteed by Freddie Mac,
Fannie Mae, and Ginnie Mae. Investments are made based on certain
considerations, which include the interest rate, yield, settlement date and
maturity of the investment, our liquidity position, and anticipated cash needs
and sources. In addition, the effect on our credit and interest rate risk and
risk-based capital is also included in the evaluation.
At December 31, 2002, the book value of the investment securities
portfolio totaled $72.9 million, while the estimated fair market value amounted
to $75.3 million as compared to $72.6 million and $72.9 million, respectively,
for 2001. Securities with stated maturities greater than ten years comprised
35.1% of the investment portfolio in 2002. Mortgage-backed securities guaranteed
by Fannie Mae, Freddie Mac, and Ginnie Mae totaled $60.3 million including those
available-for-sale. From time to time, investment levels may be increased or
decreased depending upon a number of factors. These factors include the yields
on investment alternatives and upon management's judgement as to the
attractiveness of the yields then available in relation to other opportunities
and its expectations of the level of yield that will be available in the future.
In addition, management's projections as to the short-term demand for funds to
be used in origination of loans and other activities, are also a consideration.
As a result of these factors, during the past year the investment portfolio has
remained relatively flat, increasing a mere 3%.
MORTGAGE BACKED SECURITIES. We purchase mortgage-backed securities to:
(i) generate positive interest rate spreads on large principal balances with
minimal administrative expense, (ii) lower our credit risk as a result of the
guarantees provided by Freddie Mac, Fannie Mae, and Ginnie Mae, (iii) enable the
use of mortgage-backed securities as collateral for financing, and (iv) invest
excess funds during periods of reduced loan demand. Included in the
mortgage-backed securities portfolio are Fannie Mae and Freddie Mac
mortgage-backed obligations with a book value of $58.6 million and a market
16
value totaling $60.9 million. In comparison, the related figures for 2001
totaled a book value of $71.4 million and a market value of $71.6 million. Also
included in the mortgage-backed security portfolio are Real Estate Mortgage
Investment Conduit Securities (REMICS) with a book value of $25,600 and a
maturity date of 2022.
Mortgage-backed securities typically represent a participation interest
in a pool of single-family or multifamily mortgages. The principal and interest
payments on these mortgages are passed from the mortgage originators, through
intermediaries (generally US Government agencies and government-sponsored
enterprises) that pool and resell the participation interests in the form of
securities, to investors such as the Bank. Such US Government agencies and
government-sponsored enterprises, which guarantee the payment of principal and
interest to investors, primarily include Freddie Mac, Fannie Mae, and Ginnie
Mae. Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that fall within a specified range and have varying
maturities. Mortgage-backed securities generally yield less than loans that
underlie such securities because of the cost of payment guarantees and credit
enhancements. In addition, mortgage-backed securities are usually more liquid
than individual mortgage loans and may be used to collateralize certain
liabilities and obligations of the Bank. These types of securities also permit
us to optimize our regulatory capital because they have a low risk weighting.
The actual maturity of a mortgage-backed security may be less than its
stated maturity due to prepayments of the underlying mortgages. Prepayments that
are faster than anticipated may shorten the life of the security and may result
in a loss of any premiums paid and thereby reduce the net yield on such
securities. Although prepayments of underlying mortgages depend on many factors,
including the type of mortgages, the coupon rate, the age of mortgages, the
geographical location of the underlying real estate collateralizing the
mortgages and general levels of market interest rates, the difference between
the interest rates on the underlying mortgages and the prevailing mortgage
interest rates generally is the most significant determinant of the rate of
prepayments. During periods of declining mortgage interest rates, if the coupon
rate of the underlying mortgages exceeds the prevailing market interest rates
offered for mortgage loans, refinancing generally increases and accelerates the
prepayment of the underlying mortgages and the related security. Under such
circumstances, we may be subject to reinvestment risk because, to the extent
that the mortgage-backed securities amortize or prepay faster than anticipated,
we may not be able to reinvest the proceeds of such repayments and prepayments
at a comparable rate.
At December 31, 2002, municipal bonds included seven Washington State
municipal bonds that are rated AA or better.
For further information concerning the investment portfolio, reference
is made to Note 3 and 4 of the "Notes to Consolidated Financial Statements" in
the Annual Report.
17
The following table sets forth information regarding the mortgage-backed
securities (including REMICs) activity for the periods indicated.
Years Ended December 31,
----------------------------------
2002 2001 2000
-------- -------- --------
(In Thousands)
Beginning balance ......................... $ 71,234 $ 73,345 $ 59,595
Mortgage-backed securities purchased ...... 39,477 39,413 22,038
Amortization of premiums and discounts..... 2,093 8 654
Principal repayments ...................... (52,484) (41,532) (8,942)
-------- -------- --------
Ending balance ....................... $ 60,320 $ 71,234 $ 73,345
======== ======== ========
The following table sets forth the composition of the mortgage-backed
securities portfolio at the dates indicated.
Years Ended December 31,
---------------------------------------------------
2002 2001 2000
--------------- --------------- ---------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
------- ------ ------- ------ ------- ------
(Dollars in Thousands)
Mortgage-backed securities:
Freddie Mac............... $ 4,989 8.27% $ 6,388 8.97% $ 1,958 2.67%
Fannie Mae ............... 55,305 91.69 64,746 90.89 69,347 94.55
Ginnie Mae ............... -- -- -- -- 1,694 2.31
REMICs ................... 26 0.04 100 0.14 346 0.47
------- ------ ------- ------ ------- ------
Total .................. $60,320 100.00% $71,234 100.00% $73,345 100.00%
======= ====== ======= ====== ======= ======
The following table presents the carrying value of the investment
securities portfolio. The market value of the investments in the table at
December 31, 2002, was approximately $75.3 million.
At December 31,
----------------------------------
2002 2001 2000
-------- -------- --------
(In Thousands)
Investment securities:
US Government and agency obligations..... $ 13,081 $ -- $ 46,666
Corporate and municipals ................ 1,337 1,113 3,644
Mortgage-backed certificates ............ 60,320 71,234 73,345
Fannie Mae stock ........................ -- -- 35
-------- -------- --------
Total ..................................... $ 74,738 $ 72,347 $123,690
======== ======== ========
18
The following table provides the scheduled maturities, carrying
values, market values, and average yields for the investment securities at
December 31, 2002.
One to Five to More than
One Year Five Years Ten Years Ten Years Total Total
Book Yield Book Yield Book Yield Book Yield Book Market Yield
------ ------ ------ ------ ------- ------ ------- ------ ------- ------- ------
(Dollars in Thousands)
Municipals*................ $ -- --% $ -- --% $ -- --% $ 1,337 6.03% $ 1,337 $ 1,296 6.03%
US Agencies................ -- -- -- -- 5,978 4.08 6,986 4.43 12,964 13,081 4.27
Freddie Mac Certificates... -- -- -- -- 3,733 5.50 1,081 4.83 4,814 5,004 5.35
Fannie Mae Certificates.... -- -- 8,666 5.63 28,937 5.42 16,148 5.53 53,751 55,899 5.49
REMICs-Fannie Mae.......... -- -- -- -- -- -- 26 6.50 26 26 6.50
------ ------ ------ ------ ------- ------ ------- ------ ------- ------- ------
Total...................... $ -- --% $8,666 5.63% $38,648 5.22% $25,578 5.23% $72,892 $75,306 5.27%
====================================================================================================
* Municipal bond yields are not shown on a tax equivalent basis.
19
DEPOSIT ACTIVITIES AND OTHER SOURCES OF FUNDS
- ---------------------------------------------
GENERAL. Savings accounts and other deposits are an important source of
our funds for use in lending, security investments, and for other general
business purposes. In addition to deposit accounts, we derive funds from loan
repayments, interest payments, loan sales, FHLB advances and other borrowings,
and operations. The availability of funds from loan sales is influenced by
general interest rates and other market conditions. Loan repayments and interest
payments are a relatively stable source of funds, while deposit inflows and
outflows vary widely and are influenced by prevailing interest rates and money
market conditions. Borrowings are used to complement deposit inflows. Although
the use of borrowed funds changes from year to year, we target a funding range
of 20-30% of assets. At year-end 2002, borrowings represented 24.7% of assets.
That figure compares to 28.2% in 2001.
DEPOSITS. We offer a number of deposit accounts, including savings
accounts, NOW checking, business checking accounts, money market accounts, and
time deposit accounts, ranging in maturity from 30 days to ten years. Deposit
account terms vary with the principal differences being the minimum balance
required, the time period the funds must remain on deposit and the interest
rate.
JUMBO TIME DEPOSITS. We offer jumbo, mini-jumbo and public funds
mini-jumbo time deposits. These accounts are offered for minimum terms of 30
days and in minimum amounts of $100,000, $50,000, and $20,000, respectively.
The following table indicates the amount of the jumbo time deposits by
time remaining until maturity as of December 31, 2002. Rates paid on jumbo time
deposits are negotiable.
Jumbo
Maturity Period Time Deposits
--------------- -------------
(In Thousands)
Three months or less........................ $ 11,931
Four through six months ................... 3,420
Over six through twelve months.............. 63,477
Over twelve months.......................... 45,780
---------
Total...................................... $ 124,608
=========
IRA ACCOUNTS. We offer tax-deferred individual retirement accounts
(IRA). IRA accounts are offered on the same terms as the time deposits. In
addition, we offer a money market account to IRA customers. The money market IRA
requires a minimum balance of $100.
20
DEPOSIT FLOWS. The following table sets forth the balance of savings
deposits in the various types of savings accounts that we offered at the dates
indicated.
Balance at Balance at Balance at
December 31, % of Increase December 31, % of Increase December 31, % of
2002 Deposits (Decrease) 2001 Deposits (Decrease) 2000 Deposits
-------- -------- -------- -------- -------- -------- -------- --------
(Dollars in Thousands)
NOW and Business
Checking Accounts................... $ 38,234 7.7% $ 9,952 $ 28,282 6.6% $ 801) $ 29,083 6.4%
Jumbo Time Deposits................. 124,608 25.0 11,923 112,685 26.3 7,282 119,967 26.2
Extreme Checking Accounts........... 5,842 1.2 1,910 3,932 0.9 1,733 2,199 0.5
Savings Accounts.................... 8,387 1.7 531 7,856 1.9 (494) 8,350 1.8
Money Market Deposit Accounts....... 90,171 18.1 13,330 76,841 17.9 11,193 65,648 14.4
3 Months or less Time Deposits...... 1,900 0.4 (2,369) 4,269 1.0 3,341 928 0.2
4-6 Month Time Deposits............. 8,005 1.6 (3,752) 11,757 2.7 662 11,095 2.4
7 Month - One Year Time Deposits.... 127,265 25.6 16,685 110,580 25.7 3,474 107,106 23.4
13 Month - Five Year Time Deposits.. 92,163 18.5 20,322 71,841 16.8 (40,386) 112,227 24.5
6-10 Year Time Deposits............. 794 0.2 (61) 855 0.2 (34) 889 0.2
-------- -------- -------- -------- -------- -------- -------- --------
Total Deposits................. $497,370 100.0% $ 68,472 $428,898 100.0% $(28,594) $457,492 100.0%
======== ======== ======== ======== ======== ======== ======== ========
IRA/Keogh Accounts.................. $ 25,699 5.2% $ 2,078 $ 23,621 5.5% $ (935) $ 24,556 5.4%
======== ======== ======== ======== ======== ======== ======== ========
21
The following table represents an analysis of the deposit accounts by
interest rate and maturity ranges at December 31, 2002.
1 Year to 2 Years to
Less Than Less Less 5 Years
One Year Than 2 Years Than 5 Years or more Total
-------- -------- -------- -------- --------
(In Thousands)
Less than 4.01%.......... $400,969 $ 48,596 $ 4,099 $ 38 $453,702
4.01 - 5.00%............. 634 1,929 27,665 4 30,232
5.01 - 6.00% ............ 4,735 981 2,343 168 8,227
6.01 - 8.00%............. 526 1,086 3,597 -- 5,209
-------- -------- -------- -------- --------
Total.................... $404,864 $ 54,592 $ 37,704 $ 210 $497,370
======== ======== ======== ======== ========
The following table provides the savings activity for the periods
indicated.
Years Ended December 31,
--------------------------------------
2002 2001 2000
---------- ---------- ----------
(In Thousands)
Deposits............................... $1,170,547 $ 944,371 $ 919,230
Withdrawals ........................... 1,115,618 995,770 884,666
---------- ---------- ----------
Net Deposits (Withdrawals)
Before Interest Credited .............. 54,928 (51,399) 34,564
Interest Credited ..................... 13,544 22,805 22,754
---------- ---------- ----------
Net Increase (Decrease) in Deposits.... $ 68,472 $ (28,594) $ 57,318
========== ========== ==========
For further information concerning deposits, reference is made to Note
9 of the "Notes to Consolidated Financial Statements" in the Annual Report.
BORROWINGS. The FHLB serves as our primary borrowing source. Advances
from the FHLB are typically secured by a portion of our first mortgage loans and
multifamily permanent loans. At December 31, 2002, First Mutual had advances
totaling $184.1 million from the FHLB, which mature in 2003 through 2011 at
interest rates ranging from 1.35% to 7.48%.
At the Holding Company level we borrow from other banks. Those
borrowings totaled $250,000 at the end of 2002. For further information on
borrowings, see Note 10 of the "Notes to Consolidated Financial Statements" in
the Annual Report.
22
Years Ended December 31,
--------------------------------------
2002 2001 2000
---------- ---------- ----------
(In Thousands)
FHLB advances.......................... $ 184,144 $ 191,104 $ 133,035
========== ========== ==========
FHLB advances:
Maximum outstanding at any month end. $ 196,437 $ 191,104 $ 135,979
Average outstanding.................. 175,573 145,329 125,639
Weighted average interest rates:
Annual............................ 4.111% 5.962% 6.297%
End of Year....................... 3.520% 4.321% 6.387%
Other advances......................... $ 250 $ 250 $ 250
The FHLB functions as a central reserve bank providing credit for
commercial banks, savings banks, savings and loan associations and certain other
member financial institutions. As a member, First Mutual is required to own
capital stock in the FHLB and is authorized to apply for advances on the
security of its home mortgages and other assets such as securities which are
obligations of, or guaranteed by, the United States Government, commercial real
estate loans, etc., provided certain standards related to creditworthiness have
been met. Advances are made pursuant to several different programs. Each credit
program has its own interest rate and range of maturities. Limitations on the
amount of advances are based on the FHLB's assessment of the institution's
creditworthiness. Under its current credit policies, the FHLB has limited
advances to First Mutual to 40% of our assets. At December 31, 2002, the
percentage of assets represented by FHLB borrowings was 25%. See "Regulation and
Supervision - Federal Home Loan Bank System" below.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare our Consolidated Financial Statements in conformity with
accounting principles generally accepted in the United States of America
("GAAP"). Certain of our accounting policies, including the estimated lives
assigned to our assets, the determination of bad debt reserves, asset
impairment, amortization of deferred loan costs and fees, and the calculation of
our income tax liabilities, require that we apply significant judgment in
defining the appropriate assumptions for calculating financial estimates. By
their nature, these judgments are subject to an inherent degree of uncertainty.
Our judgments are based upon our historical experience, economic conditions, our
observance of trends in the industry, and information available from other
outside sources, as appropriate. There can be no assurance that actual results
will not differ from our estimates. To provide an understanding of the
methodology we apply, our significant accounting policies are discussed where
appropriate in this discussion and analysis and in the "Notes to the
Consolidated Financial Statements."
RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2002, the FASB issued Statement No. 148, Accounting for
Stock-Based Compensation - Transition and Disclosure, which amends Statement No.
123. This Statement provides alternative methods of transitioning, on a
voluntary basis, from the intrinsic value-based method of accounting prescribed
by Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock
Issued to Employees, to the fair value-based method of accounting for
stock-based employee compensation. We have elected to continue to use the
intrinsic value method of accounting and, as a result, the provisions of this
statement are not expected to have a material effect on our financial position
or results of operations.
23
REGULATION AND SUPERVISION
GENERAL. As a state-chartered, federally-insured financial institution,
the Bank is subject to extensive federal and state regulation. Lending
activities and other investments must comply with various statutory and
regulatory requirements, including prescribed minimum capital standards. The
Bank is regularly examined by the Federal Deposit Insurance Corporation (FDIC)
and the Department of Financial Institutions of the State of Washington and
files periodic reports concerning the Bank's activities and financial condition
with its federal and state regulators. Our relationship with depositors and
borrowers also is regulated to a great extent by both federal and state law,
especially in such matters as the ownership of savings accounts and the form and
content of mortgage documents.
Federal and state banking laws and regulations govern all areas of the
operation of banks, including reserves, loans, mortgages, capital, issuance of
securities, payment of dividends and establishment of branches. Federal and
state bank regulatory agencies also have the general authority to limit the
dividends paid by insured banks and bank holding companies if such payments
should be deemed to constitute an unsafe and unsound practice. The respective
primary federal regulators of the Company and the Bank have authority to impose
penalties, initiate civil and administrative actions and take other steps
intended to prevent banks from engaging in unsafe or unsound practices.
DEPOSIT INSURANCE. The FDIC is an independent federal agency that
insures the deposits, up to prescribed statutory limits, of depository
institutions. The FDIC administers two separate deposit insurance funds: the
Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF). The
BIF is a deposit insurance fund for commercial banks and some state-chartered
savings banks, such as First Mutual. The SAIF is a deposit insurance fund for
most savings associations. As an insurer of our deposits, the FDIC has
examination, supervisory and enforcement authority over us.
The FDIC has established a risk-based system for setting deposit
insurance assessments. Under the risk-based assessment system, an institution's
insurance assessment varies according to the level of capital the institution
holds and the degree to which it is the subject of supervisory concern. In
addition, regardless of the potential risk to the insurance fund, federal law
requires the ratio of reserves to insured deposits at $1.25 per $100. Both funds
currently meet this reserve ratio. During 2002, the assessment rate for both
SAIF and BIF deposits ranged from zero to 0.27% of covered deposits. As a
well-capitalized bank, we qualified for the lowest rate on our deposits for
2002.
In addition to deposit insurance assessments, the FDIC is authorized to
collect assessments against insured deposits to be paid to the Finance
Corporation (FICO) to service FICO debt incurred in the 1980's to help fund the
thrift industry cleanup. The FICO assessment rate is adjusted quarterly.
Prior to 2000, the FICO assessment rate for BIF-insured deposits was
one-fifth the rate applicable to deposits insured by the SAIF. Beginning in
2000, SAIF- and BIF-insured deposits were assessed at the same rate by FICO. As
a result, BIF FICO assessments are higher than in previous periods while SAIF
FICO assessments are lower. During 2002, BIF FICO assessment rates ranged from
1.70 cents to 1.82 cents per $100 of insured deposits.
Any insured bank, which does not operate in accordance with or conform
to FDIC-regulations, policies and directives may be sanctioned for
non-compliance. For example, proceedings may be instituted against any insured
bank or any director, officer, or employee of such bank who engages in unsafe
and unsound practices, including the violation of applicable laws and
regulations. The FDIC has the authority to terminate deposit insurance pursuant
to procedures established for that purpose. Management is not aware of any
existing circumstances that could result in termination of the deposit insurance
or any sanctions for the Bank.
CAPITAL REQUIREMENTS. FDIC regulations recognize two types or tiers of
capital: core ("Tier 1") capital and supplementary ("Tier 2") capital. Tier 1
capital generally includes common stockholders' equity and non-cumulative
24
perpetual preferred stock, less most intangible assets. Tier 2 capital, which is
limited to 100 percent of Tier 1 capital, includes such items as qualifying
general loan loss reserves, cumulative perpetual preferred stock, mandatory
convertible debt, term subordinated debt and limited life preferred stock;
however, the amount of term subordinated debt and intermediate term preferred
stock (original maturity of at least five years but less than 20 years) that may
be included in Tier 2 capital is limited to 50 percent of Tier 1 capital.
The FDIC currently measures an institution's capital using a leverage
limit together with certain risk-based ratios. The FDIC's minimum leverage
capital requirement specifies a minimum ratio of Tier 1 capital to average total
assets. Most banks are required to maintain a minimum leverage ratio of at least
4% to 5% of total assets.
FDIC regulations also establish a measure of capital adequacy based on
ratios of qualifying capital to risk-weighted assets. Assets are placed in one
of four categories and given a percentage weight -- 0%, 20%, 50% or 100% --
based on the relative risk of that category. In addition, certain
off-balance-sheet items are converted to balance sheet credit equivalent
amounts, and each amount is then assigned to one of the four categories. Under
the guidelines, the ratio of total capital (Tier 1 capital plus Tier 2 capital)
to risk-weighted assets must be at least 8%, and the ratio of Tier 1 capital to
risk-weighted assets must be at least 4%. We have calculated our total
risk-based capital ratio to be 10.7% as of December 31, 2002, and our Tier 1
risk-based capital ratio to be 9.4%.
Federal statutes establish a supervisory framework based on five
capital categories: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized. An institution's
category depends upon where its capital levels are in relation to relevant
capital measures, which include a risk-based capital measure, a leverage ratio
capital measure, and certain other factors. The federal banking agencies have
adopted regulations that implement this statutory framework. Under these
regulations, an institution is treated as well capitalized if its ratio of total
capital to risk-weighted assets is 10% or more, its ratio of Tier I capital to
risk-weighted assets is 6% or more, its ratio of Tier I capital to adjusted
total assets is 5% or more, and it is not subject to any federal supervisory
order or directive to meet a specific capital level.
In 2002, in addition to capital provided through retained earnings, we
have augmented our regulatory capital with trust preferred securities (TPS).
These securities have a maturity of 30 years and are redeemable at par after
five years, with certain exceptions. The TPS securities are treated on our
financial statements as a liability, but qualify as capital for regulatory
capital limits. They are eligible for Tier I leverage capital treatment up to
25% of shareholder equity, and for risk-weighted capital up to 50% of
shareholder equity. We have issued $13 million in securities ($9 million in 2002
and $4 million in 2003), which is 29% of our December 31, 2002, shareholder
equity. There are no present plans to issue additional TPS securities, and we
believe that our current capital, plus retained earnings for year 2003, will
meet our budgeted growth in assets for the forthcoming year.
25
Management believes that, under the current regulations, we will
continue to meet our minimum capital requirements as a well capitalized
institution in the foreseeable future. However, events beyond our control, such
as a downturn in the economy in areas where we have most of our loans, could
adversely affect future earnings and, consequently, the ability to meet our
capital requirements.
FEDERAL DEPOSIT INSURANCE IMPROVEMENT ACT (FDICIA). The Bank has
surpassed the $500 million asset threshold, and as such, is required to be
compliant with the FDICIA originally enacted in 1991 and with enhanced
provisions adopted in 1993. In general, FDICIA requires us to conduct an annual
independent audit of our financial statements, appoint an independent audit
committee of outside directors, report on and assess management's
responsibilities for preparing financial statements, and establish an internal
control structure.
An independent accountant must attest to and report on the assertions
in management's report concerning these internal controls, with the desired
outcome of efficient and effective operations; the safeguarding of assets;
reliable financial reporting and compliance with applicable laws and
regulations.
The FDIC, our primary regulator, has outlined, in general, the
requirements for compliance with FDICIA but does not provide specific guidance
on the internal control structure, documentation, or procedures to test the
effectiveness. It is up to each bank to establish, document and design
procedures to evaluate and test the internal control structure over financial
reporting and compliance with designated laws and regulations that minimally
include loans to insiders and dividend restrictions.
We have identified and documented existing controls with consideration
given to the control environment, risk assessment, control activities,
information and communication systems, and monitoring activities to ensure
compliance with the regulatory requirements. These systems and controls are
reviewed, at a minimum, on a yearly basis to comply with the FDICIA
requirements.
Under FDICIA, the Audit Committee of the Board of Directors, has
several responsibilities that include but are not limited to overseeing the
internal audit function; conducting periodic meetings with management, the
independent public accountants, and the internal auditors; review of significant
accounting policies, and audit conclusions regarding significant accounting
estimates; review of the assessments prepared by management and independent
auditor on the adequacy of internal controls and the resolution of identified
material weaknesses and reportable conditions in internal controls; and the
review of compliance with laws and regulations.
FEDERAL HOME LOAN BANK SYSTEM. The FHLB of Seattle serves as a reserve
or central bank for the member institutions within its assigned region. It is
funded primarily from proceeds derived from the sale of consolidated obligations
of the FHLBs. It makes loans (I.E., advances) to members in accordance with
policies and procedures established by the Federal Housing Finance Board and the
Board of Directors of the FHLB of Seattle. As a member, we are required to
purchase and hold Class B(1) stock in the FHLB of Seattle. The amount of stock a
member institution is required to hold is based on the cumulative value of three
criteria:
o Advance Stock Purchase - Under this requirement, a member must currently
hold stock with a par value equal to 3.5% of the outstanding principal
balance of advances extended to the member.
o Mortgage Purchase Program - Under this requirement, a member must currently
hold stock with a par value equal to 5.0% of the outstanding principal
balance of the loans sold to the FHLB, by the member, under the Mortgage
Purchase Program, minus the Membership Stock Purchase requirement.
o Membership Stock Purchase - Under this requirement, a member must currently
hold stock with a par value equal to the greater of 0.75% or $500 of the
member's home mortgage loans outstanding as of the most recent calendar
year end.
26
As of December 31, 2002, we held stock in the FHLB of Seattle in the
amount of $10.4 million. See "Business -- Deposit Activities and Other Sources
of Funds -- Borrowings."
FEDERAL RESERVE SYSTEM. The Federal Reserve Board requires (under
"Regulation D") that all depository institutions, including savings banks,
maintain reserves on transaction accounts or non-personal time deposits. These
reserves may be in the form of cash or non-interest bearing deposits with the
regional Federal Reserve Bank. NOW accounts and other types of accounts that
permit payments or transfers to third parties fall within the definition of
transaction accounts and are subject to Regulation D reserve requirements, as
are any non-personal time deposits at a savings bank. Under Regulation D, we
must maintain reserves against net transaction accounts in the amount of 3% on
amounts of $42.1 million or less, plus 10% on amounts in excess of $42.1
million. We may designate and exempt $6.0 million of certain reservable
liabilities from these reserve requirements. These amounts and percentages are
subject to adjustment by the Federal Reserve Board. The reserve requirement on
non-personal time deposits with original maturities of less than 1.5 years is
0%. As of December 31, 2002, our deposit with the Federal Reserve Bank and vault
cash exceeded the reserve requirements.
THE COMPANY
GENERAL. The Company, as the sole shareholder of the Bank is a
financial holding company and is registered as such with the Federal Reserve.
Financial holding companies are subject to comprehensive regulation by the
Federal Reserve under the Bank Holding Company Act of 1956, as amended ("BHCA"),
and the regulations of the Federal Reserve. As a financial holding company, the
Company is required to file with the Federal Reserve annual reports and such
additional information as the Federal Reserve may require and will be subject to
regular examinations by the Federal Reserve.
NEW LEGISLATION.
SARBANES - OXLEY ACT OF 2002 - The Sarbanes-Oxley Act of 2002 and
related rulemaking by the SEC, which effect sweeping corporate disclosure and
financial reporting reform, generally require public companies to focus on their
disclosure controls and procedures. As a result, public companies such as The
Bank now must have disclosure controls and procedures in place and make certain
disclosures about them in their periodic SEC reports (i.e., Forms 10-K and 10-Q)
and their chief executive and financial officers must certify in these filings
that they are responsible for developing and evaluating disclosure controls and
procedures and disclose the results of an evaluation conducted by them within
the 90-day period preceding the filing of the relevant report, among other
things.
USA PATRIOT ACT OF 2001 - In October 2001, the USA Patriot Act of 2001
was enacted in response to the terrorist attacks in New York, Pennsylvania, and
Washington D.C. which occurred on September 11, 2001. The Patriot Act is
intended to strengthen U.S. law enforcement's and the intelligence communities'
abilities to work cohesively to combat terrorism on a variety of fronts. The
potential impact of the Patriot Act on financial institutions of all kinds is
significant and wide ranging. The Patriot Act contains sweeping anti-money
laundering and financial transparency laws and imposes various regulations,
including standards for verifying client identification at account opening, and
rules to promote cooperation among financial institutions, regulators and law
enforcement entities in identifying parties that may be involved in terrorism or
money laundering.
27
DIVIDENDS. The Federal Reserve has issued a policy statement on the
payment of cash dividends by bank holding companies, which expresses the Federal
Reserve's view that a bank holding company should pay cash dividends only to the
extent that the company's net income for the past year is sufficient to cover
both the cash dividends and a rate of earnings retention that is consistent with
the company's capital needs, asset quality and overall financial condition. The
Federal Reserve also indicated that it would be inappropriate for a company
experiencing serious financial problems to borrow funds to pay dividends.
Furthermore, under the prompt corrective action regulations adopted by the
Federal Reserve, the Federal Reserve may prohibit a bank holding company from
paying any dividends if the holding company's bank subsidiary is classified as
"undercapitalized" under the prompt corrective action regulations.
STOCK REPURCHASES. Bank holding companies, except for certain
"well-capitalized" and highly rated bank holding companies, such as the Company,
are required to give the Federal Reserve prior written notice of any purchase or
redemption of its outstanding equity securities if the gross consideration for
the purchase or redemption, when combined with the net consideration paid for
all such purchases or redemptions during the preceding 12 months, is equal to
10% or more of their consolidated net worth. The Federal Reserve may disapprove
such a purchase or redemption if it determines that the proposal would
constitute an unsafe or unsound practice or would violate any law, regulation,
Federal Reserve order, or any condition imposed by, or written agreement with,
the Federal Reserve.
On July 30, 2002 the holding company for the Bank repurchased and
retired 1,019,256 shares, approximately 20% of the shares outstanding, from MGN
Group LLC, a private investment firm in Seattle. The funds received from the $9
million issuance of trust preferred securities on June 27, 2002 was used to fund
a portion of the repurchase of the shares. The remainder of the funds came from
routine funding sources.
CAPITAL REQUIREMENTS. The Federal Reserve has established capital
adequacy guidelines for bank holding companies that generally parallel the
capital requirements of the FDIC for the Bank.
The Company's total risk-based capital must equal 10% of risk-weighted
assets and one half of the 10%, or 5%, must consist of Tier 1 capital to
constitute a well capitalized Bank. As of December 31, 2002, the Company's total
risk-based capital was 10.9% of risk-weighted assets and its risk-based capital
of Tier 1 capital was 9.6% of risk-weighted assets.
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
GENERAL. The Company and its subsidiaries report their income on a
fiscal year basis using the accrual method of accounting and are subject to
federal income taxation in the same manner as other corporations with some
exceptions, including particularly the Bank's reserve for bad debts discussed
below. The following discussion of tax matters is intended only as a summary and
does not purport to be a comprehensive description of the tax rules applicable
to the Bank.
28
The current thrift bad debt rules were passed by Congress as part of
"The Small Business Job Protection Act of 1996." The rules adopted a method for
deducting additions to the tax bad debt reserves for all financial institutions
for tax years beginning after December 31, 1995. These rules also require that
all institutions recapture all or a portion of their bad debt reserves added
since the base year (last taxable year beginning before January 1, 1988). We
have previously recorded a deferred tax liability equal to the bad debt
recapture and as such the rules will have no effect on the net income or federal
income tax expense. For taxable years 1996-1998, the Bank's bad debt deduction
was determined under the experience method using a formula based on actual bad
debt experience over a period of years. Beginning in 1999 the deduction has been
calculated on the basis of net charge-offs during the taxable year.
MINIMUM TAX. In addition to regular corporate income tax, corporations
are subject to an alternative minimum tax which generally is equal to 20% of
alternative minimum taxable income (taxable income, increased by tax preference
items and adjusted for certain regular tax items). The preference items which
are generally applicable include an amount equal to 75% of the amount by which a
financial institution's adjusted current earnings (generally alternative minimum
taxable income computed without regard to this preference and prior to reduction
for net operating losses) exceed its alternative minimum taxable income without
regard to this preference and the excess of the institution's bad debt deduction
over the amount deductible under the experience method, as discussed below.
Alternative minimum tax paid can be credited against regular tax due in later
years.
29
Our federal income tax returns have been audited through 1991, and no
additional taxes have been assessed.
STATE TAXATION
We are subject to a business and occupation tax, which is imposed under
Washington law at the rate of 1.5% of gross receipts. However, interest received
on loans secured by first lien mortgages or deeds of trust on residential
properties is not subject to such tax.
Reference is made to Note 12, of the "Notes to Consolidated Financial
Statements" in the Annual Report for additional information regarding income
taxes payable by the Bank.
COMPETITION
Competition for deposits comes from securities brokerage firms and
other financial institutions, many of which have greater resources than we do.
In addition, during times of low interest rates we experience significant
competition for investors' funds from bond mutual funds.
We compete for deposits principally by offering depositors a wide
variety of savings programs, convenient branch locations, pre-authorized payment
and withdrawal systems, on-line banking services, tax deferred retirement
programs, and other miscellaneous services.
Our competition for real estate and other loans comes principally from
mortgage banking companies, savings banks, savings and loan associations,
commercial banks, insurance companies and other institutional lenders. We
compete for loan originations primarily through the interest rates and loan fees
we charge and the efficiency and quality of services we provide borrowers, real
estate brokers and builders. The competition for loans we encounter, as well as
the types of institutions with which we compete, varies from time to time
depending upon certain factors. Conditions which affect competition, include
among others, the general availability of lendable funds and credit, general and
local economic conditions, current interest rate levels, volatility in the
mortgage markets and other factors which are not readily predictable.
EMPLOYEES
At December 31, 2002, we employed 157 full-time and 9 part-time
employees. Our employees are not represented by any collective bargaining
agreement. Management considers its relations with our employees to be good.
30
ITEM 2. PROPERTIES
- -------------------
The following table provides the location of the offices, as well as
certain information relating to these offices.
Book Value Lease
Total As of Date of
Cost of December Square Owned/ Initial Termi- Renewal
Year Opened Assets 31, 2002 Feet Leased Lease nation Terms
----------- ------ -------- ------- ------ ------- -------- -------
(Dollars in Thousands)
Branch Locations:
- -----------------
Bellevue Office & October 1985 $ 2,472 $ 727 24,255 Leased June 15, May 31, One five-
Administrative Offices 1985 2007 year option
400 108th Avenue NE
Bellevue, WA 98004
(Originally opened 1953)
Issaquah Office December 1977 1,125 687 2,860 Owned -- -- --
855 Rainier Blvd. N.
Issaquah, WA 98027
(Originally opened
November 1965)
Monroe Office April 1993 1,577 1,066 5,415 Owned -- -- --
19265 State Route 2
Monroe, WA 98272
(Originally opened
April 1968)
Crossroads Office September 1969 409 157 2,972 Owned -- -- --
15635 N.E. 8th Street
Bellevue, WA 98008
Redmond Office December 1977 1,072 531 6,474 Owned -- -- --
16900 Redmond Way
Redmond, WA 98052
Ballard Office September 2002 2,331 2,111 2,400 Owned -- -- --
6301 15th Ave. NW
Seattle, WA 98107
(Originally opened
June 1994)
West Seattle Office July 1996 327 24 2,200 Leased March 1, February One five-
4520 California Ave., S.W. 1996 28, 2006 year options
Seattle, WA 98116
Bellevue West Office July 1997 2,749 2,263 9,190 Owned -- -- --
10001 NE 8th Street
Bellevue, WA 98004
Kirkland Office September 2000 581 381 3,800 Leased September September Two five-
278 Central Way 16, 1999 16, 2009 year options
Kirkland, WA 98033
Juanita Office August 2001 1,760 1,536 4,118 Owned
13633 100th Ave. NE
Kirkland, WA 98034
(table continued on following page)
31
Book Value Lease
Total As of Date of
Cost of December Square Owned/ Initial Termi- Renewal
Year Opened Assets 31, 2002 Feet Leased Lease nation Terms
----------- ------ -------- ------- ------ ------- -------- -------
(Dollars in Thousands)
Loan Production Offices:
- ------------------------
Tacoma Loan Office January 1999 22 7 700 Leased January 1, December 31, One two-
2323 N 31st St., Suite 200 1999 2003 year option
Tacoma, WA 98403
(Originally opened
October 1996)
Bellingham Loan Office March 1998 153 14 1,700 Leased February 14, February 14, Three five-
1100 Harris St. 1998 2003 year options
Bellingham, WA 98225
Florida Loan Office July 2001 10 9 416 Leased July 6, July 31st, One year
3015 Hartley Road #12B/12C 2001 2003 option
Jacksonville, FL 32257
Since year-end 2002 some changes have taken place regarding our
existing office sites. In March 2003 we purchased the office located at 400
108th Avenue NE which includes the Bellevue banking center and our
administrative offices. In addition, the Bellingham branch was closed in March
of 2002 and the income property loan office that was also located within the
Bellingham branch office has relocated, as of February 2003, to a leased office
space that better fits their needs.
A site has also been acquired in Woodinville and is currently under
construction for an additional banking center expected to begin operations
during the third quarter of 2003. In addition, a lease has been signed for a
banking center site located on the Sammamish Plateau with an expectation of
opening in the first quarter of 2004. A site has also been acquired in the
Canyon Park area and is currently in the site development phase, with an
anticipated construction of a three-story office building, to include a banking
center, in the year 2005.
We have reviewed the utilization of our properties on a regular basis
and believe that we have adequate facilities for current operations. We may open
new banking centers from time-to-time, and on a selective basis, depending on
the availability of capital resources, the locations potential for growth and
profitability.
We regularly analyze demographic and geographic data as well as
information regarding our competitors and our current loan and deposit customers
in order to locate potential future bank sites.
ITEM 3. LEGAL PROCEEDINGS
- ---------------------------
At December 31, 2002, the Bank was not engaged in any litigation,
which in the opinion of management, after consultation with its counsel, would
be material to the Bank.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -------------------------------------------------------------
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year ended December 31, 2002.
32
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- -------------------------------------------------------------------------------
The information contained under the caption "Stock Information" in the
Annual Report is incorporated herein by reference.
The following table provides the cash dividends declared by the
Company (and the Bank as its predecessor) during the last five fiscal years.
Quarter Ending Fiscal 2002 Fiscal 2001 Fiscal 2000 Fiscal 1999 Fiscal 1998
- -------------- ----------- ----------- ----------- ----------- -----------
Fiscal year $0.28 $0.22 $0.20 $0.20 $0.60
March 31 0.07 0.05 0.05 0.05 0.45
June 30 0.07 0.05 0.05 0.05 0.05
September 30 0.07 0.05 0.05 0.05 0.05
December 31 0.07 0.07 0.05 0.05 0.05
ITEM 6. SELECTED FINANCIAL DATA
- ---------------------------------
The information contained in the section captioned "Selected Financial
Data" in the Annual Report is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- -------------------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
The information contained under the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in the
Annual Report is incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------
The information contained in the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Market Risk Sensitive Instruments" in the Annual Report is incorporated herein
by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- -----------------------------------------------------
The financial statements contained in the Annual Report, which are
listed under Item 15 herein, are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- -------------------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- ------------------------------------------------------------
The information contained under the section captioned "Proposal Number
One. Election of Directors" in the Company's Proxy Statement is incorporated
herein by reference. Reference is made to the cover page of this report for
information regarding compliance with Section 16(a) of the Exchange Act.
33
The following table sets forth certain information with respect to the
executive officers of the Company and the Bank.
Age at Position
December -------------------------------------
Name 31, 2002 Company Bank
- ---- -------- ------- ----
John R. Valaas 58 President and Chief President and Chief
Executive Officer Executive Officer
Roger A. Mandery 60 Executive Vice President Executive Vice President -
and Treasurer Chief Financial Officer,
Treasurer and Assistant
Secretary
Richard J. Collette 55 Executive Vice President Executive Vice President,
Commercial Banking Group
Manager
James R. Boudreau 55 Executive Vice President Executive Vice President -
Chief Credit Officer
Kari Stenslie 38 Vice President - Controller Vice President - Controller
Robin R. Carey 45 Senior Vice President -
Operations and Administration
Scott Harlan 41 Senior Vice President -
Residential and Consumer
Lending
The following is a description of the principal occupation and
employment of the executive officers of the Bank during at least the past five
years:
JOHN R. VALAAS is the President and Chief Executive Officer for the
Bank and the Company. Prior to his appointment as President of the Bank in 1992,
Mr. Valaas was Senior Vice President and manager of the Commercial Financial
Services Division at Seafirst Bank where he was employed from 1983 to 1992. Mr.
Valaas has over 30 years of experience in commercial banking.
RICHARD J. COLLETTE is the Bank's Executive Vice President and Manager
of its Commercial Banking Group and the Company's Executive Vice President. His
responsibilities include overseeing commercial real estate lending and business
banking. Prior to joining the Bank in December of 2001, he was the Northwest
Region's Senior Credit Risk Management Executive for Bank of America where he
was employed from 1973 to 2001. Mr. Collette has over 28 years of experience in
commercial banking.
ROGER A. MANDERY, CPA, is Executive Vice President for the Bank and
the Company. Prior to serving in that capacity, from March 1984 to 1989, he was
Senior Vice President of Finance. Mr. Mandery serves as the Bank's Chief
Financial Officer and in this capacity is responsible for the Bank's treasury,
accounting, internal audit, and asset/liability functions.
JAMES R. BOUDREAU is the Bank's Executive Vice President and Chief
Credit Officer and the Company's Executive Vice President; he has been employed
by the Bank since 1975. He is responsible for overseeing lending policies for
all lending areas of the Bank. He chairs the Bank's loan committees and
supervises the asset management and residential underwriting departments.
KARI STENSLIE, CPA, CMA, is the Vice President and Controller for the
Bank and the Company and has been employed by the Bank since 1988. She is
responsible for the Bank's accounting systems, financial reporting, tax
accounting functions, and financial analysis.
34
ROBIN R. CAREY is the Bank's Senior Vice President of Operations and
Administration and has been employed by the Bank since 1979. She is responsible
for overseeing facilities and security, human resources, and customer service
and support, which includes lending and deposit support functions.
SCOTT HARLAN is the Bank's Senior Vice President of Residential and
Consumer Lending and has been employed by the Bank since 1985. He is responsible
for consumer and residential lending as well as the information systems
departments.
ITEM 11. EXECUTIVE COMPENSATION
- --------------------------------
The information required by this item is incorporated by reference to
the section captioned - "Board of Directors Committees and Reports; Certain
Relationships and Directors and Executive Compensation" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
- ----------------------------------------------------------------------------
RELATED STOCKHOLDER MATTERS
---------------------------
The information required by this item is incorporated herein by
reference to the sections captioned "Proposal Number One - Election of
Directors" and "Principal Holders of Voting Securities and Management" in the
Company's definitive proxy statement for the Company's 2003 Annual Meeting of
Shareholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
The information required by this item is incorporated by reference to
the section captioned - "Proposal Number One - Election of Directors" and "Board
of Directors Committees and Reports; Certain Relationships and Director and
Executive Compensation" in the Proxy Statement.
ITEM 14. CONTROLS AND PROCEDURES
- ---------------------------------
The Bank's Chief Executive Officer and Chief Financial Officer and
other appropriate officers have evaluated the Bank's disclosure controls and
procedures designed to ensure that information required to be disclosed in our
filings under the Securities and 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 December 31, 2002, those disclosure controls and
procedures are effective.
There have been no changes in the Bank's internal controls or in other
factors known to the Bank that could significantly affect these controls
subsequent to their evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
While the Bank 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.
ITEM 16. COST OF ACCOUNTANTS
- -----------------------------
The information required by this item is incorporated by reference to
the section captioned -- "Board of Directors Committees and Reports, Certain
Relationships and Director and Executive Compensation -- Report of the Audit
Committee and Audit Fees" in the Proxy Statement.
35
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------
(a) (1) Consolidated Financial Statements (*)
---------------------------------
Independent Auditors' Report
Consolidated Statements of Financial Condition at December 31, 2002
and 2001
Consolidated Statements of Income for the three years ended
December 31, 2002
Consolidated Statements of Stockholders' Equity for the three years
ended December 31, 2002
Consolidated Statements of Cash Flows for the three years ended
December 31, 2002
Notes to Consolidated Financial Statements
(2) All required financial statement schedules are included in the Notes
to Consolidated Financial Statements.
(b) Exhibits
--------
(3) a. Articles of Incorporation (a)
b. Bylaws (as amended and restated)
We are parties to certain debt instruments under which the
total amount of securities authorized does not exceed ten
percent of our total consolidated assets. Pursuant to
paragraph 4(iii)(A) of Item 601(b) of Regulation S-K, we
agree to furnish a copy of those instruments to the
Securities and Exchange Commission upon request.
(11) Statement regarding computation of per share earnings.
Reference is made to the Company's Consolidated Statements
of Income attached hereto as part of Exhibit 13, which are
incorporated herein by reference.
(13) 2002 Annual Report to Shareholders.
(21) Subsidiaries
(23.1) Consent of Moss Adams LLP, Independent Auditors
(99) Certification Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(*) Incorporated by reference from 2002 Annual Report to Shareholders attached
hereto as Exhibit 13.
(a) Incorporated by reference to the Current Report on Form 8-K filed with the
SEC on September 21, 2000.
36
SIGNATURES
Pursuant to the requirements of Section 13 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.
FIRST MUTUAL BANCSHARES, INC.
DATE: March 31, 2003 BY: /s/ John R. Valaas
----------------------------------
John R. Valaas, President
and Chief Executive Officer
and Duly Authorized Representative
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
By: /s/ Roger A. Mandery By: /s/ Victor E. Parker
---------------------------- ----------------------------
Roger A. Mandery Victor E. Parker
Principal Financial Officer Director
Date: March 31, 2003 Date: March 31, 2003
By: /s/ Kari A. Stenslie By: /s/ George W. Rowley, Jr.
---------------------------- ----------------------------
Kari A. Stenslie George W. Rowley, Jr.
Principal Accounting Officer Director
Date: March 31, 2003 Date: March 31, 2003
By: /s/ F. Kemper Freeman, Jr. By: /s/ Richard S. Sprague
---------------------------- ----------------------------
F. Kemper Freeman, Jr. Richard S. Sprague
Chairman of the Board Director
Date: March 31, 2003 Date: March 31, 2003
By: /s/ James J. Doud, Jr. By: /s/ John R. Valaas
---------------------------- ----------------------------
James J. Doud, Jr. John R. Valaas
Director Director
Date: March 31, 2003 Date: March 31, 2003
By: /s/ Mary Case Dunnam By: /s/ Robert C. Wallace
---------------------------- ----------------------------
Mary Case Dunnam Robert C. Wallace
Director Director
Date: March 31 , 2003 Date: March 31, 2003
By: /s/ Janine Florence
----------------------------
Janine Florence
Director
Date: March 31, 2003
37
CERTIFICATION
-------------
I, John R. Valaas, President and Chief Executive Officer of the Company certify
that:
1. I have reviewed this annual report on Form 10-K of First Mutual Bancshares,
Incorporated;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and 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 which this annual report is
being prepared;
b. Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c. Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors:
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether 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: March 31, 2002 By: /s/ John R. Valaas
----------------- -------------------------------------
John R. Valaas
President and Chief Executive Officer
CERTIFICATION
-------------
I, Roger A. Mandery, Executive Vice President and Principal Financial Officer of
the Company certify that:
1. I have reviewed this annual report on Form 10-K of First Mutual Bancshares,
Incorporated;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and 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 which this annual report is
being prepared;
b. Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c. Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors:
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether 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: March 31, 2002 By: /s/ Roger A. Mandery
----------------- ----------------------------
Roger A. Mandery
Executive Vice President and
Principal Financial Officer