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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, 2003
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.
(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]
As of June 30, 2003, there were issued and outstanding 4,711,177 shares
of the registrant's common stock. The aggregate market value of the voting stock
held by non-affiliates of 2,629,493 shares of the registrant was $52,589,860
based on the closing sales price of the registrant's common stock as quoted on
the Nasdaq Market System which on June 30, 2003 was $20.00.
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As of March 15, 2004, there were issued and outstanding 4,748,386
shares of the registrant's common stock. (The number of shares does not include
the shares to be issued in connection with the 10% stock dividend declared on
March 17, 2004.)
DOCUMENTS INCORPORATED BY REFERENCE
1. Certain information required by Parts I, III, and IV is
incorporated by reference to the Registrant's Annual Report to
Shareholders for the fiscal year ended December 31, 2003.
2. Certain information required by Parts I, III, and IV is
incorporated by reference to the Registrant's Proxy Statement
dated March 18, 2004 for the 2004 Annual Meeting of Shareholders.
Forward-Looking Statements
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This Form 10-K Report and the other Securities and Exchange Commission
filings made by the Company, which are incorporated by reference, contain
statements concerning future operations, trends, expectations, plans,
capabilities, and prospects of the Company 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," "expect", "objective", "plan," "should," or similar words may
constitute forward-looking statements. Information regarding our Simulation and
GAP Models and our hedging strategies may also constitute forward-looking
statements. Although the Company believes that the expectations expressed in
these forward-looking statements are based on reasonable assumptions within the
bounds of its knowledge of its business 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 Company which are discussed from time to time in the
filings made by the Company 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.
Table of Contents
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Page
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Part I
Item 1. Business
Overview of Business Lines 4
Yields Earned and Rates Paid 5
Rate Volume Analysis 7
Lending Activities 7
Reserve for Loan Losses 15
Interest Rate Risk Management 16
Securities 19
Investment Activities 22
Deposit Activities and Other Sources of Funds 26
2
Critical Accounting Policies 29
Recently Issued Accounting Standards 32
Regulation and Supervision 32
Federal and State Taxation 37
Item 2. Properties 40
Item 3. Legal Proceedings 41
Item 4. Submission of Matters to a Vote of Security Holders 41
Part II
Item 5. Market for Registrant's Common Equity, Related
Stockholder Matters, and Issuer Purchases of
Equity Securities 42
Item 6. Selected Financial Data 42
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 42
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk 42
Item 8. Financial Statements and Supplementary Data 42
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 42
Item 9A. Controls and Procedures 43
Part III
Item 10. Directors and Executive Officers of the Registrant 43
Item 11. Executive Compensation 45
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 45
Item 13. Certain Relationships and Related Transactions 45
Item 14. Principal Accountant Fees and Services 45
Part IV
Item 15. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K 45
PART I
Item 1. Business
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(a) General
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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 refer 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.
3
Our business consists of attracting deposits from the general public as
well as obtaining funds from 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.
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 and investments, 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 twelve
full-service banking centers located in Bellevue (3), Issaquah, Kirkland (2),
Monroe, Redmond, Sammamish, Seattle (2), and Woodinville. 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.
We post our annual report, Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and press releases on our investor relations page
at www.firstmutual.com. These reports are posted as soon as reasonably
practicable after they are electronically filed with the Securities and Exchange
Commission (the "SEC"). All SEC filings of the Company are also available free
of charge at the SEC's website, www.sec.gov or by calling the SEC at
1-800-SEC-0330.
Overview of Business Lines
- --------------------------
We manage our operations by grouping our products and services within
business segments. Our business segments are:
o Consumer Lending
o Commercial Lending
o Investment Securities
These segments are managed separately because each business unit
requires different processes and different marketing strategies to reach the
customer base that purchases the products and services. The segments principal
activities are described below.
o Consumer Lending - Consumer lending includes residential and home
equity lending, direct consumer loans, and consumer dealer
financing contracts (sales finance). Residential lending offers
loans to borrowers to purchase, refinance, or build homes secured
by one-to-four-unit family dwellings. Consumer loans include
lines of credit and loans for purposes other than home ownership.
In addition, this segment also sells loans into the secondary
market. Management may choose to retain or sell the right to
service the loans sold (i.e., collection of principal and
interest payments) depending upon market conditions.
o Commercial Lending - Commercial lending offers permanent and
interim construction loans for multifamily housing (over four
units) and commercial real estate properties, and loans to small-
and medium-sized businesses for financing inventory, accounts
receivable, and equipment, among other things. The underlying
real estate collateral or business asset being financed typically
secures these loans.
4
o Investment Securities - The investment securities segment
includes the investment securities portfolio. Although management
does not consider this to be an operating business line, security
investments are a necessary part of liquidity management for the
Company.
Yields Earned and Rates Paid
- ----------------------------
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
deposits and borrowings. 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, 2003, our portfolio of loans consisted of 89%
adjustable-rate and 11% 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
underwritten 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."
5
AVERAGE BALANCE SHEET
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,
-------------- ---------------------------------------------------------------------------
2003 2003 2002 2001
-------------- ----------------------- ----------------------- -----------------------
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 .................. $725,448 6.15% $683,249 $45,487 6.66% $588,213 $42,925 7.30% $535,229 $46,453 8.68%
Mortgage-backed securities ........ 74,203 4.44 68,841 2,902 4.22 80,523 4,514 5.61 62,369 3,818 6.12
Corporate and municipal bonds ..... 1,324 6.03 1,330 81 6.09 1,342 80 5.96 2,796 161 5.76
Short-term investments ............ 845 0.84 1,568 11 0.70 4,673 50 1.07 8,261 259 3.14
U.S. securities ................... 11,000 4.05 11,425 473 4.14 1,666 49 2.94 21,501 1,480 6.88
Other equity investments .......... 11,036 5.00 10,728 707 6.59 10,095 707 7.00 8,252 558 6.76
-------- ---- -------- ------- ---- -------- ------- ---- -------- ------- ----
Total interest-earning assets .... 823,856 5.94 777,141 49,661 6.39 686,512 48,325 7.04 638,407 52,729 8.26
Non-interest earning assets ........ 36,988 25,929 25,310 22,383
-------- -------- -------- --------
Total assets ....................... $860,844 $803,070 $711,822 $660,790
======== ======== ======== ========
Interest-bearing liabilities:
Deposits ......................... $583,765 2.00% $531,674 $11,984 2.25% $467,702 $13,995 2.99% $441,483 $22,708 6.79%
Long-term debenture related
to TPS ......................... 17,000 4.25 13,333 716 5.37 9,000 251 2.79 -- -- --
FHLB advances and other
borrowed money ................. 194,143 2.85 202,266 6,223 3.08 167,954 7,441 4.43 149,500 8,694 5.82
-------- ---- -------- ------- ---- -------- ------- ---- -------- ------- ----
Total interest-bearing
liabilities .................... 794,908 2.26 747,273 18,923 2.53 644,656 21,687 3.36 590,983 31,402 6.49
Non-interest-bearing
liabilities - deposits
and other ....................... 15,109 8,241 19,038 20,863
-------- -------- -------- --------
Total liabilities ................. 810,017 755,514 663,694 611,846
Shareholders' equity ............... 50,827 47,556 48,128 48,944
-------- -------- -------- --------
Total liabilities and
shareholders' equity............. $860,844 $803,070 $711,822 $660,790
======== ======== ======== ========
Net interest income ................ $30,738 $26,638 $21,327
======= ======= =======
Ratio of average
interest-earning assets
to average interest-
bearing liabilities ............. 1.05x 1.17x 1.19x
Interest rate spread ............... 3.86% 3.68% 2.95%
Net yield (net interest
income as a percentage
of average interest-
earning assets) ................. 3.96% 3.88% 3.34%
Amortized loan fees included
in loan receivable interest
income .......................... $ 1,040 $ 474 $ 981
6
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.
Lending Activities
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General. Our loan portfolio totaled $725.4 million at December 31, 2003
(loans held-for-sale totaled $10.1 million of this amount). On that date before
deductions (see Note 5 to the Consolidated Financial Statements), $131.7
million, or 17%, of total outstanding loans, including loans held-for-sale,
consisted of loans secured by one-to-four-unit residential properties; $184.9
million, or 23%, consisted of loans secured by mortgages on over-four-unit
residential properties; construction loans constituted $163.3 million, or 20%;
$211.5 million, or 27%, consisted of commercial real estate loans; $85.2
million, or 11%, consisted of consumer loans; and $20.1 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 $323.1 million and $342.2 million for the years ended
December 31, 2001 and 2002, respectively, and $424.4 million for the year ended
December 31, 2003.
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, 2003, $646.8
million, or 89%, 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 $123.4 million in residential mortgage loans with rates
adjustable at periods ranging from one to five years, $403.0 million in business
loans and loans secured by income-producing and multifamily residential
properties, $98.9 million in net construction loans, and $21.5 million in
consumer loans.
7
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,
-------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------------ ------------------ ------------------ ----------------- -----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
(Dollars in Thousands)
TYPE OF LOAN:
Real Estate Loans:
Interim construction
loans ............... $ 163,309 22.52% $ 107,266 17.10% $ 84,245 14.84% $ 103,727 21.19% $ 72,906 16.05%
Loans on existing
property ............ 299,401 41.26 270,947 43.18 250,038 44.05 198,240 40.49 186,632 41.07
Loans refinanced ...... 228,726 31.53 219,125 34.93 208,383 36.72 196,089 40.05 204,630 45.03
Insured or guaranteed
real estate loans ..... -- -- 103 0.02 244 0.04 257 0.05 275 0.06
Consumer loans & other .... 85,243 11.75 57,627 9.19 42,488 7.49 34,219 6.99 24,435 5.38
Business lines of credit .. 20,089 2.77 14,683 2.34 11,995 2.11 5,033 1.03 3,347 0.74
Less -
Loans in process ...... (64,140) (8.84) (34,528) (5.50) (22,270) (3.92) (40,087) (8.19) (29,959) (6.59)
Reserve for loan
losses .............. (8,406) (1.16) (7,754) (1.24) (7,032) (1.24) (6,729) (1.37) (6,309) (1.39)
Net deferred loan
(fees) or costs ..... 1,226 0.17 (150) (0.02) (537) (0.09) (1,198) (0.24) (1,576) (0.35)
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
TOTAL ..................... $ 725,448 100.00% $ 627,319 100.00% $ 567,554 100.00% $ 489,551 100.00% $ 454,381 100.00%
========= ====== ========= ====== ========= ====== ========= ====== ========= ======
At December 31,
-------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------------ ------------------ ------------------ ----------------- -----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
(Dollars in Thousands)
TYPE OF SECURITY:
Residential:
One-to-four-family .... $ 131,682 18.16% $ 93,208 14.86% $ 83,887 14.78% $ 74,359 15.19% $ 96,418 21.22%
Multifamily ........... 184,919 25.48 177,621 28.30 174,062 30.66 160,297 32.74 148,354 32.65
Construction .............. 163,309 22.51 107,266 17.10 84,245 14.84 103,727 21.19 72,906 16.04
Commercial real estate .... 211,526 29.16 219,346 34.97 200,716 35.37 159,930 32.66 146,765 32.30
Consumer loans & other .... 85,243 11.75 57,627 9.19 42,488 7.49 34,219 6.99 24,435 5.38
Business lines of credit .. 20,089 2.77 14,683 2.34 11,995 2.11 5,033 1.03 3,347 0.74
Less -
Loans in process ...... (64,140) (8.84) (34,528) (5.50) (22,270) (3.92) (40,087) (8.19) (29,959) (6.59)
Reserve for loan
losses .............. (8,406) (1.16) (7,754) (1.24) (7,032) (1.24) (6,729) (1.37) (6,309) (1.39)
Net deferred loan
(fees) or costs ..... 1,226 0.17 (150) (0.02) (537) (0.09) (1,198) (0.24) (1,576) (0.35)
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
TOTAL ..................... $ 725,448 100.00% $ 627,319 100.00% $ 567,554 100.00% $ 489,551 100.00% $ 454,381 100.00%
========= ====== ========= ====== ========= ====== ========= ====== ========= ======
8
Loan Maturity. The following table sets forth certain information at
December 31, 2003, 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, 2003 31, 2003 31, 2003 10 Years 10 Years Total
-------- -------- -------- -------- -------- --------
(Dollars in Thousands)
Real Estate Loans:
Interim construction loans ..... $ 99,169 $ -- $ -- $ -- $ -- $ 99,169
Loans on existing property ..... 250,419 29,649 18,526 807 -- 299,401
Loans refinanced ............... 189,403 24,553 14,153 617 -- 228,726
Consumer loans & other ......... 25,540 1,864 5,145 33,061 19,633 85,243
Business loans .................... 8,498 1,991 2,282 2,541 4,777 20,089
-------- -------- -------- -------- -------- --------
Total Loans ....................... $573,029 $ 58,057 $ 40,106 $ 37,026 $ 24,410 $732,628
======== ======== ======== ======== ======== ========
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, 2003 Due After December 31, 2004
------------------------------ ------------------------------
Fixed Adjustable Fixed Adjustable
Rates Rates Total Rates Rates Total
-------- -------- -------- -------- -------- --------
(Dollars in Thousands)
Mortgage loans .................... $ 7,774 $531,217 $538,991 $ 4,477 $ 83,828 $ 88,305
Consumer loans .................... 550 24,990 25,540 59,703 -- 59,703
Business loans .................... 68 8,430 8,498 682 10,909 11,591
-------- -------- -------- -------- -------- --------
Total ........................ $ 8,392 $564,637 $573,029 $ 64,862 $ 94,737 $159,599
======== ======== ======== ======== ======== ========
RESIDENTIAL LOANS. At December 31, 2003, approximately 17% 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.
9
We offer one-year, two-year, three-year, five-year, seven-year, or
ten-year adjustable-rate loans, with rate adjustment after a period with
subsequent adjustments every one, two or three years. These loans generally 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- or 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, 2003, the largest multifamily loan was for $3.9
million. As of December 31, 2003, multifamily loans were $184.9 million, or 23%,
of the loan portfolio as compared to $177.6 million, or 26%, in 2002.
Interim (construction) financing is available for residential and
commercial property development. At December 31, 2003, we had $163.3 million in
construction loans of which $99.2 million was disbursed. These loans constituted
20% 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
acceptable to the Bank. We oversee the disbursement of construction funds to the
borrower and builder. These loans generally have 15- or 30-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 and interest rate structure for custom construction
loans is typically higher than those assessed on non-construction single-family
loans with similar terms and conditions. The additional loan fee and interest
rate compensates us for the extra cost and interest rate risk associated with
this type of lending.
At December 31, 2003, commercial real estate loans (excluding
multifamily and construction loans) constituted $211.5 million, or approximately
29% of the loan portfolio. These loans are typically secured by office
buildings, warehouse, commercial and retail centers located in our primary
lending area of Washington State 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 that 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
10
$432.4 million at December 31, 2003. That figure compares to $424.8 million at
year-end 2002 and $406.6 million at year-end 2001.
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
that 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 are 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. In addition our loan
policy limits the maximum loan(s) to any one borrower, at any time, to not
exceed the maximum allowed under state or federal regulations.
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 2003, total business banking
loans grew to $76.7 million compared to $73.6 million the previous year.
Non-real-estate business loans included in those totals were $18.1 million and
$13.1 million at December 31, 2003 and 2002, 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 businesses 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
loans tied to other indexes 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 reasons. 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.
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 $85.2
11
million at December 31, 2003, compared to $57.6 million the previous year. The
increase is due to growth in the sales finance portfolio. Sales finance loans
totaled $61.6 million and $31.4 million at year-end 2003 and 2002, respectively.
The Sales Finance Department began operations in 1997. This department
purchases consumer financing contracts from approved dealers in many states. The
purchases are without recourse to the dealers. Typical collateral for these
contracts include retrofitted windows, siding, roofs, spas, and other home
improvements. Dealers must be acceptable to 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 by applying various underwriting criteria.
In 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 the Bank.
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.
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 is generally set in a range
between 680 and 740.
The Direct Consumer Lending Department processes and closes consumer
loan requests generated within the banking centers 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.
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,
2003, consumer loans past due 90 days or more totaled $223,000 as compared to
$44,000 at year-end 2002.
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
12
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 primary lending areas.
Approximately 83% of all residential loans closed during the year ended December
31, 2003, were obtained through mortgage brokers as compared to 79% during 2002.
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, Young and Zavaglia. Commercial
real estate loans can be approved by the Chief Credit Officer up to $1.0 million
or by a designated member of the Commercial Loan Committee up to $500,000. The
entire Commercial Loan Committee can approve these loans up to $3.5 million.
This committee can also approve other secured or unsecured business loans up to
$1.5 million; its members are officers Collette, Boudreau, Davis, Everett,
Harlan, Kasanders, Mandery, Werth, Valaas, Young, and Zavaglia. Larger loans are
further reviewed and approved by the Investment Committee of the Board, which is
comprised of Directors Doud, Florence, Parker, Rowley, Valaas, and Wallace.
Except for small consumer or community business loans, the Investment Committee
must also approve loans where the cumulative debt exceeds $3.5 million for
residential and consumer loans or $5.0 million for commercial loans.
LOAN ORIGINATIONS AND SALE OF LOANS INTO THE SECONDARY MARKET. Loan
originations increased in 2003 to $424 million from $342 million in 2002, and
the comparable figure for 2001 was $319 million. The increase in originations
came largely from sales finance and residential loan closings. Sales finance
loan closings increased from $39.7 million in 2002 to $70.2 million in 2003. In
addition, residential loan closings increased $50.5 million from $147.9 million
last year to $198.4 million in 2003.
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, 2003, we serviced loans for others aggregating
approximately $76 million as compared to $46 million in 2002. Loan servicing
fees, net, totaled $69,000 for the year ended December 31, 2003, and $103,000
for the year ended December 31, 2002.
Currently, long-term mortgage loans and some sales finance loans are
being originated for sale and sold to investors. During the year ended December
31, 2003, we sold $58.4 million in residential loans and $12.9 million in sales
finance loans as compared to $53.5 million and $6.9 million, respectively,
during 2002.
Set forth below is a table showing our loan origination and sales
activity for the periods indicated.
Years Ended December 31,
------------------------------
2003 2002 2001
---- ---- ----
(Dollars in Thousands)
Total loans at beginning
of period (net of undisbursed loan proceeds) ...... $ 635,223 $ 575,123 $ 497,478
Loans originated:
Real estate loans:
Construction loans .............................. 138,238 85,059 54,330
Loans on existing property ...................... 133,341 128,445 172,252
Loans refinanced ................................ 75,385 78,301 59,408
Insured and guaranteed loans .................... -- 103 244
13
Consumer and other loans .......................... 77,400 50,293 36,824
--------- --------- ---------
Total loans originated ................... $ 424,364 $ 342,201 $ 323,058
Principal reductions ................................ (231,131) (192,698) (154,513)
Loans sold:
Whole loans ....................................... (71,299) (72,197) (76,619)
Participation loans ............................... (24,529) (17,206) (14,281)
--------- --------- ---------
Total loans sold ......................... (95,828) (89,403) (90,900)
--------- --------- ---------
Total loans at end of period (net of undisbursed
loan proceeds) ................................... $ 732,628 $ 635,223 $ 575,123
========= ========= =========
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, including commitments for income property loans, totaled $230.4
million at December 31, 2003, and $185.7 million at year-end 2002.
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.
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 we are reasonably assured that all principal and interest due on the
loan will be fully recovered. 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, 2003, the total of non-performing loans, repossessed
assets, and real estate acquired through foreclosure was $538,000 as compared to
$2.1 million at year-end 2002.
The following table sets forth information regarding non-performing
assets at the dates indicated.
At December 31,
--------------------------
2003 2002 2001
------ ------ ------
(Dollars in Thousands)
Loans greater than 90 days delinquent and
still accruing............................... $ -- $ -- $ --
Nonaccrual loans ................................ 527 2,074 498
Other assets and real estate acquired
through foreclosure ........................ 11 45 23
------ ------ ------
14
Total ......................................... $ 538 $2,119 $ 521
====== ====== ======
As a percentage of net loans .................... 0.07% 0.34% 0.09%
As a percentage of total assets ................. 0.06% 0.28% 0.08%
Gross interest income that would have
been recorded in the period if loans
had been current with original terms ......... $ 104 $ 156 $ 40
Interest income on loans included
in net income for the period ................. $ 87 $ 117 $ 30
Non-performing assets at December 31, 2003, were composed of loans
collateralized by single-family residences, an unsecured line of credit, and
consumer loans.
There were two impaired loans totaling $16,445 and $16,684 (net of
impairment allowances) at year end 2003 and 2002, respectively. The amount of
impairment totaled $4,600 for both years.
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 collection 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,
2003, the reserve for loan losses totaled $8.4 million which compares to $7.8
million at December 31, 2002.
While we believe we have established our existing reserve for loan
losses in accordance with generally accepted accounting principles as of
December 31, 2003, there can be no assurance that regulators, when reviewing our
loan portfolio in the future, will not request us to increase 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,
--------------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
(Dollars in Thousands)
Balance at beginning of period ..... $ 7,754 $ 7,032 $ 6,729 $ 6,309 $ 5,569
Charge-offs ................... (640) (271) (144) (112) (68)
Residential real estate .... -- -- -- -- (17)
Commercial real estate ..... -- (6) -- -- --
Construction ............... -- -- -- -- --
Business ................... (174) (42) (14) -- (23)
Consumer and other ......... (466) (223) (130) (112) (28)
Recoveries .................... 142 83 82 2 3
15
Residential real estate .... -- -- -- -- --
Commercial real estate ..... -- -- -- -- --
Construction ............... -- -- -- -- --
Business ................... -- 8 3 -- --
Consumer and other ......... 142 75 79 2 3
Provision .................. 1,150 910 365 530 805
-------- -------- -------- -------- --------
Balance at end of period ........... $ 8,406 $ 7,754 $ 7,032 $ 6,729 $ 6,309
======== ======== ======== ======== ========
Ratio of net charge-offs during
the period to average loans
outstanding during the period 0.07% 0.03% 0.01% 0.02% 0%
Interest Rate Risk Management
- -----------------------------
Market risk is defined as the sensitivity of income and capital to
changes in interest rates and other relevant market rates or prices. Our
profitability is largely dependent on our net interest income. Consequently, our
primary exposure to market risk arises from the interest rate risk inherent in
our lending, mortgage banking, deposit, and borrowing activities. Interest rate
risk is the risk to earnings or capital resulting from adverse movements in
interest rates. To that end, we actively monitor and manage our exposure to
interest rate risk.
A number of measures are utilized to monitor and manage interest rate
risk, including net interest income and economic value of equity simulation
models, as well as traditional "gap" models, each of which is described below.
We prepare these models on a monthly basis for review by our Asset Liability
Committee (ALCO), senior management, and Board of Directors. The use of these
models requires us to formulate and apply assumptions to various balance sheet
items. Assumptions regarding interest rate risk are inherent in all financial
institutions, and may include prepayment speeds on loans and mortgage-backed
securities, cash flows and maturities of financial instruments held for purposes
other than trading, changes in market conditions, loan volumes and pricing,
deposit sensitivities, consumer preferences, and management's capital leverage
plans. We believe that the data and assumptions used for our models are
reasonable representations of our portfolio and possible outcomes under the
various interest rate scenarios. Nonetheless, these assumptions are inherently
uncertain; therefore, the models cannot precisely estimate net interest income
or predict the impact of higher or lower interest rates on net interest income.
Actual results may differ significantly from simulated results due to timing,
magnitude, and frequency of interest rate changes, and changes in market
conditions and specific strategies, among other factors.
ASSET AND LIABILITY MANAGEMENT
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 maximize net
interest margin, utilize capital effectively, and provide adequate liquidity. We
rely primarily on our asset and liability structure to control interest rate
risk.
Asset and liability management is the responsibility of the Asset
Liability Committee, which acts within policy directives established by the
Board of Directors. This committee meets regularly to monitor the composition of
the balance sheet, assess projected earnings trends, and formulate strategies
consistent with the objectives for liquidity, interest rate risk, and capital
adequacy. The objective of asset/liability management is to maximize long-term
shareholder returns by optimizing net interest income within the constraints of
credit quality, interest rate risk policies, levels of capital leverage, and
adequate liquidity. Assets and liabilities are managed by matching maturities
and repricing characteristics in a systematic manner.
16
HEDGING TECHNIQUES
We review interest rate trends on a monthly basis, and employ hedging
techniques which we believe are appropriate. These techniques may include
financial futures, options on financial futures, interest rate caps and floors,
interest rate swaps, and extended commitments on future lending activities.
Typically, the extent of our off-balance-sheet derivative agreements has been
the use of forward loan commitments, which are used to hedge our loans
held-for-sale (see Note 24 - "Derivative Activities and Market Risk" in the 2003
Annual Report). Additionally, in 2002 we entered into an interest rate swap with
the FHLB. The purpose of the swap is to protect against potential adverse
interest rate volatility that could be realized from the Trust Preferred
Securities issued in June 2002. The swap accomplishes this by fixing the
interest rate payable for the first five years of the TPS's life.
NET INTEREST INCOME (NII) AND ECONOMIC VALUE OF EQUITY (EVE) SIMULATION
MODEL RESULTS
December 31, 2003 December 31, 2002
Percentage Percentage
Change Change
- -------------------------------------------------------------------------------
Change in Economic Economic
Interest Rates Net Interest Value of Net Interest Value of
(in basis points) Income Equity Income Equity
- -------------------------------------------------------------------------------
+200 1.14% (8.50%) 1.94% (10.58%)
+100 n/a (5.06%) n/a (3.89%)
-100 (1.18%) 2.34% (1.44%) 0.18%
-200 * * * *
* Because a large percentage of our loan portfolio is tied to indexes that are
at historic low levels, a downward 200 basis point scenario could not be
computed.
NET INTEREST INCOME SIMULATION
The "Net Interest Income" figures in the above table refer to changes
from "base case" and assume a zero-growth balance sheet and a steady increase or
decrease in interest rates in the magnitudes specified over a 12 month period.
The "base case" represents our forecast of net interest income under the
simulation assumptions if rates were to remain unchanged from the current rates.
In the event the simulation model demonstrates that a gradual 200 basis point
("bps") increase or 100 basis point decrease in interest rates over the next 12
months would adversely affect our "base case" net interest income over the same
period by more than 10%, we consider the indicated risk to exceed our policy
limit. In such a case, our Risk Management Policy calls for senior management to
meet with the Board of Directors to discuss the policy exception and recommend
what action(s), if any, to pursue. As illustrated in the above results, we are
operating within the 10% policy limit.
The December 31, 2003, results of our income simulation model indicate
that our net interest income is projected to increase by 1.14% in an environment
where interest rates increase by 200 bps, and decline 1.18% in a 100 bps falling
interest rate scenario. These results imply an asset sensitive position in both
the rising and falling interest rate scenarios. The magnitudes of these changes,
however, suggest that there is little sensitivity in net interest income over a
12-month horizon, with relatively consistent net interest income in the base
case projection and the rising and falling rate ramp scenarios.
Incorporated into the model assumptions is the observed tendency for
loan and investment prepayments to accelerate in falling interest rate scenarios
and slow when interest rates rise. In all interest rate scenarios, the size of
the balance sheet is assumed to remain stable, with no balance sheet growth or
contraction regardless of interest rate movements. Therefore, implicit in this
assumption are additional assumptions for increased new securities purchases and
loan originations at lower interest rate levels to offset accelerated
prepayments, and conversely, reduced securities purchases and loan production
when rates increase and prepayments slow.
17
ECONOMIC VALUE OF EQUITY (EVE) SIMULATION
The EVE analysis goes beyond simulating earnings for a specified period
to estimating the present value of all financial instruments in our portfolio
and then analyzing how the economic value of the portfolio would be affected by
various alternative interest rate scenarios. The portfolio's economic value is
calculated by generating principal and interest cash flows for the entire life
of all assets and liabilities, then discounting these cash flows back to their
present values. The assumed discount rate used for each projected cash flow is a
current market rate, such as a LIBOR, FHLB, or swap curve rate, and from
alternative instruments of comparable risk and duration. In the event the
simulation model demonstrates that a 200 basis point increase or 100 basis point
(200 basis point when applicable) decrease in rates would adversely affect our
EVE by more than 25%, we consider the indicated risk to exceed our policy limit.
Our Risk Management Policy would then call for senior management to meet with
the Board of Directors to discuss the policy exception and to receive guidance
as to what action(s), if any, to pursue. Again, as illustrated in the above
results, we are operating within the 25% policy limit.
In the simulated 200 bps upward shift of the yield curve, the discount
rates used to calculate the present values of assets and liabilities will
increase, causing the present values of both assets and liabilities to fall,
with more prominent effects on longer-term, fixed-rate instruments.
Additionally, when interest rates rise, the cash flows on our assets will
typically decelerate as borrowers become less likely to prepay their loans. As
the cash flows on these assets are shifted further into the future, their
present values are further reduced. Based on our December 31, 2003 model
results, the effects of rising rates were more pronounced for our assets, which
would have declined in value by an estimated 3.16% versus an approximately 2.61%
decline in the value of liabilities. Consequently, the economic value of our
equity was negatively impacted in this scenario, declining 8.50%.
The opposite occurs when rates decline, as the discount rates used to
calculate the present values of assets and liabilities will decrease, causing
the present values of both assets and liabilities to rise. Based on the above,
our EVE would be expected to be positively impacted in this scenario.
Counteracting this effect, however, is the tendency of cash flows to accelerate
in a falling rate environment, as borrowers refinance their existing loans at
lower interest rates. These loan prepayments prevent the present values of these
assets from increasing in a declining rate scenario, illustrating an effect
referred to as negative convexity. Taking this negative convexity into account,
the simulation results indicated that the impact to EVE was less pronounced in
the falling rate scenario. In this case, the economic values of both assets and
liabilities at December 31, 2003 were positively impacted when rates were
assumed to fall by 100 bps, assets by 1.47% and liabilities by 1.38%. This
resulted in a positive impact to the economic value of our equity of 2.34%.
The Net Interest Income and Economic Value of Equity sensitivity
analyses do not necessarily represent forecasts. As previously noted, there are
numerous assumptions inherent in the simulation models as well as in the gap
report, including the nature and timing of interest rate levels, the shape of
the yield curve, loan and deposit growth, prepayments on loans and securities,
deposit decay rates, pricing decisions on loans and deposits,
reinvestment/replacement of asset and liability cash flows, customer
preferences, and competitor and economic influences.
GAP MODEL
The gap model, which represents a traditional view of interest rate
sensitivity, quantifies the mismatch between assets maturing, repricing, or
prepaying within a period, and liabilities maturing or repricing within the same
period. A gap is considered positive when the amount of interest-rate-sensitive
assets exceeds the amount of interest-rate-sensitive liabilities within a given
period. A gap is considered negative in the reverse situation.
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. This
18
illustrates a facet of interest rate exposure referred to as "basis risk."
Additionally, 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, for example a limit on the amount
by which the interest rate on the loan is allowed to adjust each year. This
illustrates another area of interest rate exposure referred to as "option risk."
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 could 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.
Our 12 month interest rate sensitivity gap, expressed as a percentage
of assets, fell from 16.5% at year-end 2002 to 7.9% at December 31, 2003. These
results indicate that we remain asset sensitive, or positively gapped, with more
assets than liabilities expected to mature, reprice, or prepay within the next
year, though less so than at the 2002 year-end. The gap report has implied an
asset sensitive position for a number of quarters, dating back to September
2001. The change in the gap was driven by the mix of the additions to each side
of the balance sheet during 2003, as well as the overall balance sheet growth.
ONE YEAR INTEREST RATE SENSITIVITY GAP
(Dollars in Thousands)
12/31/03 12/31/02
-------- --------
One Year Repricing / Maturing Assets $632,428 $600,577
One Year Repricing / Maturing Liabilities 564,707 477,932
-------- --------
One Year Gap $ 67,721 $122,645
======== ========
Total Assets $860,844 $745,295
======== ========
One Year Interest Rate Gap as a
Percentage of Assets 7.9% 16.5%
Asset growth of nearly $116 million, or 15.5%, in 2003 was centered in
assets that would not be subject to maturity or repricing in the following 12
months. These assets included $12 million for the purchase of our corporate
headquarters, First Mutual Center, and $30 million of growth in fixed-rate
consumer loans. Also falling into this category were new single- and
multi-family residential and commercial real estate ARMs, often tied to one-year
FHLB or LIBOR indexes, but for which the interest rate is fixed for the first
three to ten years of the loan. Overall, those assets not subject to maturity or
repricing within 12 months rose nearly $84 million over the year, while assets
expected to mature or reprice within the 12-month time horizon increased
approximately $32 million from their level as of December 2002.
By comparison, liabilities subject to maturity or repricing in the next
12 months rose approximately $87 million over the prior year-end. This increase
was the result of many factors, including growth in money market accounts, a
shift in time deposits from longer- to shorter-term instruments, as well as a
net increase in Federal Home Loan Bank advances maturing within the subsequent
12 month period.
The greater increase of liabilities maturing/repricing in the next 12
months versus assets resulted in a net $55 million reduction in our dollar gap.
This gap ratio was further reduced by the overall growth in the balance sheet
during the period, which increased from $745 million to $861 million. The
combined effect of these two factors led to the decline in the one-year gap
ratio from 16.5% to 7.9% of total assets.
Securities
- ----------
The following table sets forth certain information regarding carrying
values and percentage of total carrying
19
values of the consolidated portfolio of securities classified as
available-for-sale and held-to-maturity (in thousands).
---------------------------------------------------------
At December 31,
---------------------------------------------------------
2003 2002
--------------------------- -------------------------
Carrying Percent Carrying Percent
Available-for-Sale: Value of Total Value of Total
- ------------------ ---------------------------------------------------------
US Government Treasury and agency obligations $ 11,053 14% $ 13,081 22%
Mortgage backed securities:
Freddie Mac 15,546 21% 4,260 8%
Ginnie Mae 7,986 10% -- 0%
Fannie Mae 43,038 55% 41,039 70%
-------------------------------------------------------
Total mortgage-backed securities 66,570 86% 45,299 78%
- ------------------------------------------------------------------------------------------------------------
Total securities available-for-sale $ 77,623 100% $ 58,380 100%
- ------------------------------------------------------------------------------------------------------------
---------------------------------------------------------
At December 31,
---------------------------------------------------------
2003 2002
--------------------------- -------------------------
Carrying Percent Carrying Percent
Held-to-Maturity: Value of Total Value of Total
- ---------------- ---------------------------------------------------------
Municipal Bonds $ 1,324 15% $ 1,337 8%
Mortgage backed securities:
Freddie Mac 550 6% 729 4%
Fannie Mae 7,029 79% 14,266 88%
-------------------------------------------------------
Total mortgage-backed securities 7,579 85% 14,995 92%
CMO's 1 0% 26 0%
-------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
Total securities held-to-maturity $ 8,904 100% $ 16,358 100%
- ------------------------------------------------------------------------------------------------------------
--------------------------------------------
Estimated Market Value $ 9,110 $ 16,926
--------------------------------------------
20
The following table shows the maturity or period to repricing of the Bank's
consolidated portfolio of securities available-for-sale and held-to-maturity
(dollars in thousands):
----------------------------------------------------------------------
Available-for-sale at December 31, 2003
----------------------------------------------------------------------
One Year or Less One to Three Years Three to Five Years
----------------------------------------------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Available-for-Sale: Value Yield Value Yield Value Yield
- ------------------- ----------------------------------------------------------------------
US Government Treasury and agency obligations $ -- 0.00% $ -- 0.00% $ -- 0.00%
Mortgage backed securities:
Ginnie Mae -- 0.00% -- 0.00% 7,986 3.75%
Freddie Mac 354 3.18% -- 0.00% 1,273 5.29%
Fannie Mae 633 3.63% -- 0.00% 2,627 5.29%
----------------------------------------------------------------------
Total mortgage-backed securities 987 3.47% -- 0.00% 11,886 4.26%
----------------------------------------------------------------------
Total securities available-for-sale -- Carrying Value $ 987 3.47% $ -- 0.00% $ 11,886 4.26%
----------------------------------------------------------------------
----------------------------------------------------------------------
Total securities available-for-sale -- Amortized Cost $ 957 3.58% $ -- 0.00% $ 11,763 4.31%
----------------------------------------------------------------------
----------------------------------------------------------------------
Held-to-Maturity at December 31, 2003
----------------------------------------------------------------------
One Year or Less One to Three Years Three to Five Years
----------------------------------------------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Held-to-Maturity: Value Yield Value Yield Value Yield
- ---------------- ----------------------------------------------------------------------
Municipal Bonds $ -- 0.00% $ -- 0.00% $ -- 0.00%
Mortgage backed securities:
Freddie Mac 550 3.61% -- 0.00% -- 0.00%
Fannie Mae 2,598 4.50% 2,301 5.65% -- 0.00%
----------------------------------------------------------------------
Total mortgage-backed securities 3,148 4.64% 2,301 5.65% -- 0.00%
CMO's -- 0.00% -- 0.00% -- 0.00%
----------------------------------------------------------------------
Total securities held-to-maturity -- Carrying Value $ 3,148 4.34% $ 2,301 5.65% $ -- 0.00%
----------------------------------------------------------------------
----------------------------------------------------------------------
Total securities held-to-maturity -- Fair Market Value $ 3,245 4.21% $ 2,374 5.48% $ -- 0.00%
----------------------------------------------------------------------
----------------------------------------------------------------------
Available-for-sale at December 31, 2003
----------------------------------------------------------------------
Five to Ten Years Ten to Twenty Years Over Twenty Years
----------------------------------------------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Available-for-Sale: Value Yield Value Yield Value Yield
- ------------------- ----------------------------------------------------------------------
US Government Treasury and agency obligations $ 6,086 4.01% $ 4,967 4.03% $ -- 0.00%
Mortgage backed securities:
Ginnie Mae -- 0.00% -- 0.00% -- 0.00%
Freddie Mac 4,692 3.56% 9,227 4.57% -- 0.00%
Fannie Mae -- 0.00% 39,778 4.39% -- 0.00%
----------------------------------------------------------------------
Total mortgage-backed securities 4,692 3.56% 49,005 4.40% -- 0.00%
----------------------------------------------------------------------
Total securities available-for-sale -- Carrying Value $ 10,778 3.82% $ 53,972 4.38% $ -- 0.00%
----------------------------------------------------------------------
----------------------------------------------------------------------
Total securities available-for-sale -- Amortized Cost $ 10,754 3.83% $ 54,296 4.36% $ -- 0.00%
----------------------------------------------------------------------
----------------------------------------------------------------------
Held-to-Maturity at December 31, 2003
----------------------------------------------------------------------
Five to Ten Years Ten to Twenty Years Over Twenty Years
----------------------------------------------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Held-to-Maturity: Value Yield Value Yield Value Yield
- ---------------- ----------------------------------------------------------------------
Municipal Bonds $ -- 0.00% $ 220 5.38% $ 1,104 6.16%
Mortgage backed securities:
Freddie Mac -- 0.00% -- 0.00% -- 0.00%
Fannie Mae 1,171 5.50% 959 4.50% -- 0.00%
----------------------------------------------------------------------
Total mortgage-backed securities 1,171 5.50% 959 4.50% -- 0.00%
CMO's -- 0.00% 1 6.50% -- 0.00%
----------------------------------------------------------------------
Total securities held-to-maturity -- Carrying Value $ 1,171 5.50% $ 1,180 4.66% $ 1,104 6.16%
----------------------------------------------------------------------
----------------------------------------------------------------------
Total securities held-to-maturity -- Fair Market Value $ 1,230 5.24% $ 1,180 4.66% $ 1,081 6.29%
----------------------------------------------------------------------
--------------------
Total
--------------------
Weighted
Carrying Average
Available-for-Sale: Value Yield
- ------------------- --------------------
US Government Treasury and agency obligations $ 11,053 4.02%
Mortgage backed securities:
Ginnie Mae 7,986 3.75%
Freddie Mac 15,546 4.29%
Fannie Mae 43,038 4.43%
--------------------
Total mortgage-backed securities 66,570 4.53%
--------------------
Total securities available-for-sale -- Carrying Value $ 77,623 4.27%
--------------------
--------------------
Total securities available-for-sale -- Amortized Cost $ 77,770 4.27%
--------------------
--------------------
Total
--------------------
Weighted
Carrying Average
Held-to-Maturity: Value Yield
- ---------------- --------------------
Municipal Bonds $ 1,324 6.03%
Mortgage backed securities:
Freddie Mac 550 3.61%
Fannie Mae 7,029 5.04%
--------------------
Total mortgage-backed securities 7,579 5.06%
CMO's 1 6.50%
--------------------
Total securities held-to-maturity -- Carrying Value $ 8,904 5.10%
--------------------
--------------------
Total securities held-to-maturity -- Fair Market Value $ 9,110 4.99%
--------------------
21
Investment Activities
- ---------------------
Under Washington law, savings banks are permitted to own 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, 2003, the book value of the investment securities
portfolio totaled $86.5 million, while the estimated fair market value amounted
to $86.7 million as compared to $74.7 million and $75.3 million, respectively,
for 2002. Securities with stated maturities greater than ten years comprised 79%
of the investment portfolio in 2003. Mortgage-backed securities guaranteed by
Fannie Mae, Freddie Mac, and Ginnie Mae totaled $74.1 million including those
held as 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.
During the past year the investment portfolio increased 16%.
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, Freddie Mac, and Ginnie Mae
mortgage-backed obligations with a book value of $74.1 million and a market
value totaling $74.4 million. In comparison, the related figures for 2002
totaled a book value of $60.3 million and a market value of $60.9 million. Also
included in the current mortgage-backed security portfolio are Real Estate
Mortgage Investment Conduit Securities (REMICS) with a book value of $522 and
$25,600 at December 31, 2003 and 2002, respectively. The single REMIC remaining
in the portfolio at the end of 2003 has a stated maturity date of April 25,
2022, although due to early prepayments on the underlying mortgages, the
security was paid in full in January 2004.
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
22
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, 2003, 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.
23
The following table sets forth information regarding the mortgage-backed
securities (including REMICs) activity for the periods indicated.
Years Ended December 31,
------------------------------------
2003 2002 2001
-------- -------- --------
(Dollars in Thousands)
Beginning balance ......................... $ 60,320 $ 71,234 $ 73,345
Mortgage-backed securities purchased ...... 69,104 39,477 39,413
Amortization of premiums and discounts .... (1,865) 2,093 8
Principal repayments ...................... (53,409) (52,484) (41,532)
-------- -------- --------
Ending balance ....................... $ 74,150 $ 60,320 $ 71,234
======== ======== ========
The following table sets forth the composition of the mortgage-backed
securities portfolio at the dates indicated.
Years Ended December 31,
---------------------------------------------------------------------------
2003 2002 2001
--------------------- --------------------- ---------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
-------- -------- -------- -------- -------- --------
(Dollars in Thousands)
Mortgage-backed securities:
Freddie Mac....................... $ 16,096 21.7% $ 4,989 8.3% $ 6,388 9.0%
Fannie Mae........................ 50,067 67.5% 55,305 91.7% 64,746 90.9%
Ginnie Mae........................ 7,986 10.8% -- 0.0% -- 0.0%
REMICs............................ 1 0.0% 26 0.0% 100 0.1%
-------- -------- -------- -------- -------- --------
Total........................... $ 74,150 100.0% $ 60,320 100.0% $ 71,234 100.0%
======== ======== ======== ======== ======== ========
The following table presents the carrying value of the investment
securities portfolio. The market value of the investments in the table at
December 31, 2003, was approximately $86.7 million.
At December 31,
----------------------------------
2003 2002 2001
-------- -------- --------
(Dollars in Thousands)
Investment securities:
US Government and agency obligations .... $ 11,053 $ 13,081 $ --
Corporate and municipals ................ 1,324 1,337 1,113
Mortgage-backed certificates ............ 74,150 60,320 71,234
-------- -------- --------
Total ................................. $ 86,527 $ 74,738 $ 72,347
======== ======== ========
24
The following table provides the scheduled maturities, carrying
values, market values, and average yields for the investment securities at
December 31, 2003.
One to Five Five to Ten More than Ten
One Year Years Years Years
------------- ------------- ------------- ------------- Total Total
Book Yield Book Yield Book Yield Book Yield Book Market Yield
---- ----- ---- ----- ---- ----- ---- ----- ---- ------ -----
(Dollars in Thousands)
Municipals* ............... $ -- 0.0% $ -- 0.0% $ -- 0.0% $ 1,324 6.0% $ 1,324 $ 1,303 6.0%
US Agencies ............... -- 0.0% -- 0.0% 6,086 4.1% 4,967 4.0% 11,053 11,053 4.0%
Freddie Mac Securities .... -- 0.0% 1,273 5.5% 4,692 3.5% 10,132 4.4% 16,097 16,108 4.2%
Fannie Mae Securities ..... 1 6.5% 4,927 5.6% 1,171 5.5% 43,967 4.4% 50,066 50,282 4.5%
Ginnie Mae Securities ..... -- 0.0% -- 0.0% -- 0.0% 7,986 3.8% 7,986 7,986 3.8%
REMICs-Fannie Mae ......... -- 0.0% -- 0.0% -- 0.0% 1 6.5% 1 1 6.5%
-------- --- -------- --- -------- --- -------- --- -------- -------- ---
Total ................... $ 1 6.5% $ 6,200 5.6% $ 11,949 4.0% $ 68,377 4.3% $ 86,527 $ 86,733 4.4%
======== === ======== === ======== === ======== === ======== ======== ===
* Municipal bond yields are not shown on a tax equivalent basis.
25
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
position of 30% of assets. At year-end 2003 and 2002, borrowings represented
24.7% of assets.
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, 2003. Rates paid on jumbo time
deposits are negotiable.
Jumbo
Maturity Period Time Deposits
(Dollars in Thousands)
Three months or less.......................... $ 54,631
Four through six months ..................... 39,394
Over six through 12 months.................... 23,152
Over 12 months................................ 31,731
--------
Total........................................ $148,908
========
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.
26
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 % of Increase December % of Increase December % of
31, 2003 Deposits (Decrease) 31, 2002 Deposits (Decrease) 31, 2001 Deposits
-------- ----- -------- -------- ----- -------- -------- -----
(Dollars in Thousands)
NOW and Business
Checking Accounts ..................... $ 47,696 8.2% $ 9,462 $ 38,234 7.7% $ 9,952 $ 28,282 6.6%
Jumbo Time Deposits ................... 148,908 25.5 24,300 124,608 25.0 11,923 112,685 26.3
Extreme Checking Accounts ............. 13,503 2.3 7,661 5,842 1.2 1,910 3,932 0.9
Savings Accounts ...................... 8,711 1.5 324 8,387 1.7 531 7,856 1.9
Money Market Deposit Accounts ......... 130,750 22.4 40,579 90,171 18.1 13,330 76,841 17.9
3 Months or less Time Deposits ........ 3,434 0.6 1,534 1,900 0.4 (2,369) 4,269 1.0
4-6 Month Time Deposits ............... 10,165 1.7 2,160 8,005 1.6 (3,752) 11,757 2.7
7 Month - One Year Time Deposits ...... 132,571 22.7 5,306 127,266 25.6 16,685 110,580 25.7
13 Month - Five Year Time Deposits .... 87,355 15.0 (4,808) 92,163 18.5 20,322 71,841 16.8
6-10 Year Time Deposits ............... 798 0.1 4 794 0.2 (61) 855 0.2
-------- ----- -------- -------- ----- -------- -------- -----
Total Deposits ................... $583,891 100.0% $ 86,522 $497,370 100.0% $ 68,471 $428,898 100.0%
======== ===== ======== ======== ===== ======== ======== =====
IRA/Keogh Accounts .................... $ 27,321 4.7% $ 1,622 $ 25,699 5.2% $ 2,078 $ 23,621 5.5%
======== ===== ======== ======== ===== ======== ======== =====
27
The following table represents an analysis of the deposit accounts by
interest rate and maturity ranges at December 31, 2003.
1 Year to 2 Years to
Less Than Less Less 5 Years
One Year Than 2 Years Than 5 Years or More Total
-------- ------------ ------------ ------- -----
(Dollars in Thousands)
Less than 2.01% .... $376,262 $ 13,829 $ 220 $ 143 $390,454
2.01 - 3.00% ....... 70,343 22,924 1,949 4 95,220
3.01 - 4.00% ....... 45,479 2,463 12,122 7 60,071
4.01 - 5.00% ....... 2,010 6,828 20,865 -- 29,703
5.01 - 6.00% ....... 993 623 1,916 131 3,663
6.01 - 8.00% ....... 1,159 1,091 2,530 -- 4,780
-------- -------- -------- -------- --------
Total .............. $496,246 $ 47,758 $ 39,602 $ 285 $583,891
======== ======== ======== ======== ========
The following table provides the savings activity for the periods
indicated.
Years Ended December 31,
----------------------------------------
2003 2002 2001
---------- ---------- ----------
(Dollars in Thousands)
Deposits ...................... $1,421,920 $1,170,547 $ 944,371
Withdrawals ................... 1,346,744 1,115,618 995,770
---------- ---------- ----------
Net Deposits (Withdrawals)
Before Interest Credited .... 75,176 54,928 (51,399)
Interest Credited ............. 11,345 13,544 22,805
---------- ---------- ----------
Net Increase (Decrease) in
Deposits ................... $ 86,521 $ 68,472 $ (28,594)
========== ========== ==========
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,
multifamily permanent loans, and securities. At December 31, 2003, we had
advances totaling $193.6 million from the FHLB, which mature in 2004 through
2011 at interest rates ranging from 1.10% to 6.25%.
At the Holding Company level we borrow from other banks. Those
borrowings totaled $500,000 at the end of 2003. For further information on
borrowings, see Note 10 of the "Notes to Consolidated Financial Statements" in
the Annual Report.
28
Years Ended December 31,
------------------------------------
2003 2002 2001
-------- -------- --------
(Dollars in Thousands)
FHLB advances .............................. $193,643 $184,144 $191,104
======== ======== ========
FHLB advances:
Maximum outstanding at any month end .... $221,751 $196,437 $191,104
Average outstanding ..................... $203,275 $175,573 $145,329
Weighted average interest rates:
Annual ............................. 2.852% 4.111% 5.962%
End of Year ........................ 2.350% 3.520% 4.321%
Other advances ............................ $ 500 $ 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, we are required to own capital stock
in the FHLB and are authorized to apply for advances on the security of our 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, 2003, the percentage of assets represented by FHLB
borrowings was 22%. See "Regulation and Supervision - Federal Home Loan Bank
System" below.
CRITICAL ACCOUNTING POLICIES
We prepare our Consolidated Financial Statements in conformity with
accounting principles generally accepted in the United States of America
("GAAP"). In accordance with GAAP, management is required to make a number of
judgments, estimates, and assumptions that affect the reported amounts of
assets, liabilities, income, and expenses in our Consolidated Financial
Statements and accompanying footnotes. We have identified three policies as
being critical because they require management to make particularly difficult,
subjective and/or complex judgments about matters that are inherently uncertain
and because the likelihood that materially different amounts would be reported
under different conditions or using different assumptions. The three critical
accounting policies that we have identified are related to the allowance for
loan losses, determining the fair value of servicing assets, and the value and
amortization methods regarding loan origination fees and costs. We believe that
the judgments, estimates, and assumptions used in the preparation of our
Consolidated Financial Statements are appropriate given the factual
circumstances as of December 31, 2003. However, given the sensitivity of our
Consolidated Financial Statements to these critical accounting policies, the use
of other judgments, estimates, and assumptions could result in material
differences in our results of operations or financial condition. Management has
discussed these critical accounting policies with the Audit Committee of our
Board of Directors.
The table below represents information about the nature of and rational
for our critical accounting policies:
- -------------------- --------------------- -------------------- ----------------------------------- -----------------
Critical Consolidated Consolidated
Accounting Balance Sheet Income Statement Nature of Estimates Required Reference
Policy Caption Caption
- -------------------- --------------------- -------------------- ----------------------------------- -----------------
Allowance for loan Reserve for loan Provision for loan The allowance for loan losses The estimates
losses losses losses represents management's estimate and judgments
of credit losses inherent in the are described
Bank's loan portfolio as of the in further detail
balance sheet date. The estimation in the Management's
29
- -------------------- --------------------- -------------------- ----------------------------------- -----------------
of the allowance is based on a Discussion and
variety of factors, including the Analysis -
profile of the loan portfolio, the "Reserve and
local and national economic Provision for
outlook, and the current and Loan Losses"
historical performance of the loan and in Note 1
portfolio. The Bank's to the
methodology for assessing the Consolidated
adequacy of the allowance includes Financial
the evaluation of three distinct Statements -
elements: the formula allowance, "Summary of
the specific allowance and the Significant
unallocated allowance. The Accounting
ultimate recovery of all loans is Policies."
susceptible to future market
factors beyond the Bank's control.
- -------------------- --------------------- -------------------- ----------------------------------- -----------------
Fair value of Servicing assets Other operating Determining the fair value of See further
servicing assets income, servicing servicing assets requires us to discussion in the
fees, net of formulate conclusions about Management's
amortization anticipated changes in future Discussion and
market conditions, including Analysis section of
interest rates. Our servicing the Annual Report -
portfolio is subject to prepayment Other Operating
risk, which subjects our servicing Income, Gain on
assets to impairment risk. We use a Sales of Loans,
valuation model to calculate the Servicing Fees, Net
present value of the future cash of Amortization as
flows to determine the value of our well as Note 1 to
servicing assets. Assumptions used the Consolidated
in the valuation model include Financial Statements
market discount rates and in the Annual Report
anticipated prepayment speeds. The - Servicing Assets
prepayment speeds are based upon
loan prepayment forecasts derived
from the consensus of investment
banking firms as reported by online
quotation systems for the income
property participations and for the
sales finance loans the actual
previous 3-month prepayment history
is utilized. Additionally,
estimates of the cost of servicing
a loan, an inflation rate,
ancillary income per loan, and
default rates are used in the
valuation process. We assess
impairment of the capitalized
servicing assets based on
recalculations of the present value
of the remaining future cash flows
30
- -------------------- --------------------- -------------------- ----------------------------------- -----------------
using updated prepayment speeds.
Impairment is assessed on a
stratum-by-stratum basis with any
impairment recognized through a
valuation for each impaired
stratum.
- -------------------- --------------------- -------------------- ----------------------------------- -----------------
Loan origination Loans receivable Interest income, Loan origination fees and costs are See further
fees and costs Loans receivable netted and deferred over the life discussion in Note 1
of each loan. These net fees and to the Consolidated
costs are amortized into income Financial
over the life of the underlying Statements, in the
loan using one of two methods: the annual report - Loan
straight-line method or the fee income and
constant level yield method. If the interest income on
loan is prepaid prior to maturity, loans receivable as
the remaining net fees/costs are well as Note 5 -
recognized when the loan is paid Loans Receivable,
off. Included in these deferred Net and Loans
fees/costs is a standard loan cost. Receivable
The standard loan cost is Held-for-Sale.
calculated for each loan class
using a model that incorporates the
costs associated with originating
and processing a loan. This cost is
netted against the qualifying fees
received from the borrower to
determine the net deferred fee or
cost associated with each loan. The
amortization of these net
fees/costs is then recognized into
income as the loan matures.
Estimates and assumptions are used
to determine the cost of each
process that is essential to
process the loan request and
originate it on our books. These
estimates mainly include the number
of hours and rate of compensation
paid to all parties involved in the
origination process of a loan.
These estimates are updated on a
yearly basis to ensure that any new
loan classes have been added and
any new processes have been
incorporated as well as
incorporating any changes in the
average compensation rates. These
estimates can vary significantly
from year to year depending upon
demand and overall mix of the
varying loan types from year to
year as well as the changes in the
processes involved in the various
kinds of loans.
- -------------------- --------------------- -------------------- ----------------------------------- -----------------
31
RECENTLY ISSUED ACCOUNTING STANDARDS
In January 2003, the FASB issued Interpretation No. 46, Consolidation
of Variable Interest Entities (VIE), as amended and interpreted. It defined a
VIE as a corporation, partnership, trust, or any other legal structure used for
the business purpose that either does not have equity investors with voting
rights or has equity investors that do not provide sufficient financial
resources for the entity to support its activities. This interpretation will
require a VIE to be consolidated or deconsolidated by a company generally based
on the risk of loss or return. Effective December 31, 2003, we adopted
Interpretation No. 46. Accordingly, our VIEs in the form of trusts set up to
issue Trust Preferred Securities have been deconsolidated. The adoption of the
Interpretation did not have a significant impact on our financial position or
results of operations.
In April 2003, the FASB issued Statement No. 149, Amendment of
Statement 133 on Derivative Instruments and Hedging Activities. This Statement
amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities
under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging
Activities. This Statement is effective for contracts entered into or modified
after June 30, 2003. Adoption of the Statement did not result in an impact on
our statement of financial position or results of operations.
In May 2003, the FASB issued Statement No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity. This
Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability, or an asset in some circumstances. Many of
those instruments were previously classified as equity. This Statement is
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003, except for mandatory redeemable financial
instruments of nonpublic entities. Adoption of the Statement did not result in
an impact on our statement of financial position or results of operations.
In November 2003, the Emerging Issues Task Force (EITF) researched a
consensus that certain quantitative and qualitative disclosures should be
required for debt and marketable equity securities classified as
available-for-sale or held-to-maturity under FASB Statement Numbers 115 and 124,
that are impaired at the balance sheet date but for which an
other-than-temporary impairment has not been recognized. This EITF consensus is
effective for fiscal years ending after December 15, 2003. Accordingly, we have
adopted this statement as of December 31, 2003 and the result did not have an
impact on our statement of financial position or results of operations.
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 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.
32
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 banking centers. 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 to be no less than $1.25 per
$100. Both funds currently meet this reserve ratio. During 2003, 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 2003.
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 2003, BIF FICO assessment rates ranged from
1.52 cents to 1.68 cents per $100 of insured deposits.
Any insured bank which does not operate in accordance with or conform
to supervisory 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
perpetual preferred stock, less most intangible assets and includes hybrid
capital instruments designated by the FDIC for inclusion as Tier 1 capital. 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-
33
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 ratio to be 11.8% as of December 31, 2003, and
our Tier 1 risk-based capital ratio to be 10.6% for the Bank.
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.
During 2002 and 2003, 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 by the Company at par after five years, with certain exceptions. The
TPS securities have been deconsolidated from our financial statements this year
as a result of adoption of FASB Interpretation No. 46 (see Recently Issued
Accounting Standards), 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 $17 million in securities ($9 million in 2002 and $8 million in 2003),
which is 33% of our December 31, 2003, shareholder equity. There are no present
plans to issue additional TPS securities, and we believe that our current
capital, plus retained earnings for year 2004, will meet our budgeted growth in
assets for the forthcoming year.
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. Another potential concern is that the status of TPS
securities could be changed for regulatory capital purposes. The recent FASB
Interpretation No. 46 has altered the status of those securities from equity to
debt for financial reporting. There is the possibility that the FDIC could take
a similar position and no longer allow TPS securities to be treated as Tier 1
capital; the Chairman of the FDIC has recently announced that the FDIC will be
examining this issue. However, directives from the Federal Banking authorities
subsequent to the issuance of Interpretation No. 46 was, issued on July 2, 2003,
and December 15, 2003, state that banking institutions were not to alter their
treatment of TPS securities for regulatory capital calculations at that time.
FEDERAL DEPOSIT INSURANCE CORPORATION 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
34
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 $500 or
0.75% of the member's home mortgage loans outstanding as of the most
recent calendar year end.
As of December 31, 2003, we held stock in the FHLB of Seattle in the
amount of $11.0 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 (will increase to $45.4 million effective September
2004) or less, plus 10% on amounts in excess of $42.1 million (will increase to
$45.4 million effective September 2004). We may designate and exempt $6.0
million (will increase to $6.6 million effective September 2004) 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, 2003, our deposit with the Federal Reserve
Bank and vault cash exceeded the reserve requirements.
CONTROL ACQUISITIONS. The Change in Bank Control Act prohibits a person
or group of persons from acquiring "control" of a bank holding company unless
the Federal Reserve Board has been notified and has not objected to the
transaction. Under a rebuttable presumption established by the Federal Reserve
Board, the acquisition of 10% or more
35
of a class of voting stock of a bank holding company with a class of securities
registered under Section 12 of the Exchange Act, such as the Company, would,
under the circumstances set forth in the presumption, constitute acquisition of
control of the Company.
In 2002, in connection with the Company's previously reported
repurchase of shares from an institutional investor, the percentage of shares
beneficially owned by F. Kemper Freeman, Jr., Chairman of our Board of Directors
and certain family members and affiliated companies, increased to a percentage
interest exceeding 10% of our stock even though such persons were not acquiring
any additional shares of stock. Mr. Freeman and the family members and
affiliated companies requested and received approval form the Federal Reserve
for the increase in percentage interest in connection with and prior to the
repurchase transaction by the Company.
In addition, any entity is required to obtain the approval of the
Federal Reserve Board under the BHCA before acquiring 25% (5% in the case of an
acquirer that is a bank holding company) or more of the outstanding Common Stock
of the Company, or otherwise obtaining control or a "controlling influence" over
the Company.
REGULATORY RESTRICTIONS ON DIVIDENDS. It is the policy of the Federal
Reserve Board that bank holding companies should pay cash dividends on common
stock only out of income available over the past year and only if prospective
earnings retention is consistent with the organization's expected future needs
and financial condition. The policy provides that bank holding companies should
not maintain a level of cash dividends that undermines the bank holding
company's ability to serve as a source of strength to its banking subsidiaries.
SCOPE OF PERMISSIBLE ACTIVITIES. Except as provided below, the Company
is prohibited from acquiring a direct or indirect interest in or control of more
than 5% of the voting shares of any company which is not a bank or bank holding
company and from engaging directly or indirectly in activities other than those
of banking, managing or controlling banks or furnishing services to its
subsidiary banks, except the Company may engage in or own shares of companies
engaged in certain activities found by the Federal Reserve Board to be so
closely related to banking or managing and controlling banks as to be a proper
incident thereto. These activities include, among others, operating a mortgage,
finance, credit card or factoring company; performing certain data processing
operations; providing investment and financial advice; acting as an insurance
agent for certain types of credit-related insurance; and providing certain stock
brokerage and investment advisory services. In approving acquisitions or the
addition of activities, the Federal Reserve considers whether the acquisition or
the additional activities can reasonably be expected to produce benefits to the
public, such as greater convenience, increased competition, or gains in
efficiency, that outweigh possible adverse effects such as undue concentration
of resources, decreased or unfair competition or unsound banking practices.
In 2001, the Gramm-Leach-Bliley Act granted certain expanded powers to
bank holding companies and allowed them to become financial holding companies
and thereby affiliate with securities firms and insurance companies and engage
in other activities that are financial in nature. The Gramm-Leach-Bliley Act
defines "financial in nature" to include securities underwriting, dealing and
market making; sponsoring mutual funds and investment companies; insurance
underwriting and agency; merchant banking activities; and activities that the
Federal Reserve has determined to be closely related to banking. No regulatory
approval will be required for a financial holding company to acquire a company,
other than a bank or savings association, engaged in activities that are
financial in nature or incidental to activities that are financial in nature, as
determined 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
Company 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
36
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. The Sarbanes-Oxley Act and SEC rules and the related NASDAQ rules
which are applicable to the holding company have also mandated certain new
requirements related to corporate governance. Such rules, among other
requirements, provide certain independence and qualification requirements for
our Board of Directors and the Audit Committee and Nomination and Compensation
Committees of the Board of Directors and make provisions for a Code of Ethics
and certain committee charters. The Company has carefully monitored the adoption
of these new rules to assure that it remains in compliance with such standards.
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.
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.
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 8% of risk-weighted
assets. As of December 31, 2003, the Company's total risk-based capital was
12.2% of risk-weighted assets and its risk-based capital of Tier 1 capital was
10.2% 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
37
intended only as a summary and does not purport to be a comprehensive
description of the tax rules applicable to the Bank.
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 since 1995, the Bank's bad debt deduction
is determined 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. Alternative minimum tax
paid can be credited against regular tax due in later years.
Our federal income tax returns have been audited by the Internal
Revenue Service through year-end 1991.
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 banking center 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,
business owners, 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. The conditions that affect
competition include, among others, the general availability of 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.
38
EMPLOYEES
At December 31, 2003, we employed 192 full-time and seven part-time
employees. Our employees are not represented by any collective bargaining
agreement. Management considers relations with our employees to be good.
39
ITEM 2. PROPERTIES
The following table provides the location of the banking centers and
loan offices, as well as certain information relating to these offices.
Lease Information
Book Value ---------------------------------------
Total As of Date of
Cost of December Square Owned/ Initial Termi- Renewal
Year Opened Assets 31, 2003 Feet Leased Lease nation Terms
----------- ------ -------- ------- ------ ------- -------- -------------
(Dollars in Thousands)
Banking Center Locations
- ------------------------
Bellevue Banking Center & October 1985 $ 14,826 $12,773 73,247 Owned -- -- --
Administrative Offices
400 108th Avenue NE
Bellevue, WA 98004
(Originally opened 1953)
Issaquah Banking Center December 1977 1,181 679 2,860 Owned -- -- --
855 Rainier Blvd. N
Issaquah, WA 98027
(Originally opened
November 1965)
Monroe Banking Center April 1993 1,591 1,050 5,415 Owned -- -- --
19265 State Route 2
Monroe, WA 98272
(Originally opened April 1968)
Crossroads Banking Center September 1969 501 225 2,972 Owned -- -- --
15635 N.E. 8th Street
Bellevue, WA 98008
Redmond Banking Center December 1977 1,095 507 6,474 Owned -- -- --
16900 Redmond Way
Redmond, WA 98052
Ballard Banking Center September 2002 2,327 2,080 2,400 Owned -- -- --
6301 15th Ave. NW
Seattle, WA 98107
(Originally opened June 1994)
West Seattle Banking Center July 1996 337 26 2,200 Leased March 1, February One five-
4520 California Ave. S.W 1996 28, 2006 year option
Seattle, WA 98116
Bellevue West Banking Center July 1997 2,785 2,241 9,190 Owned -- -- --
10001 NE 8th Street
Bellevue, WA 98004
Kirkland Banking Center September 2000 613 322 3,800 Leased September September Two five-
278 Central Way 16, 1999 16, 2009 year options
Kirkland, WA 98033
Juanita Banking Center August 2001 1,788 1,416 4,118 Owned -- -- --
13633 100th Ave. NE
Kirkland, WA 98034
Woodinville Banking Center July 2003 1,896 1,813 2,893 Owned -- -- --
13415 NE 175th Street
Woodinville, WA 98072
Sammamish Banking Center November 2003 620 610 3,721 Leased December December Two five-
336 - 228th Avenue NE, Ste. 100 23, 2002 23, 2012 year options
Sammamish, WA 98074
40
Lease
Book Value ---------------------------------------
Total As of Date of
Month/Year Cost of December Square Owned/ Initial Termi- Renewal
Opened Assets 31, 2003 Feet Leased Lease nation Terms
----------- ------ -------- ------- ------ ------- -------- -------------
(Dollars in Thousands)
Loan Production Offices:
- ------------------------
Tacoma Loan Office January 1999 23 5 700 Leased January 1, December 31,--
2323 N 31st St., Suite 200 1999 2005
Tacoma, WA 98403
(Originally opened October 1996)
Bellingham Loan Office February 2003 154 10 1,700 Leased February 28, February 28, Three five-
1200 Tenth Street, Suite 103 2003 2006 year options
Bellingham, WA 98225
(originally opened in 1998)
Florida Loan Office July 2001 10 6 416 Leased July 6, July 31, Year-to-year
3015 Hartley Road #12B/12C 2001 2004
Jacksonville, FL 32257
During the first quarter of 2003 we purchased the First Mutual Center
building where our corporate headquarters resides in downtown Bellevue for $12
million. Additionally during 2003 we opened two new banking centers, the
Woodinville banking center in July 2003 and the Sammamish banking center in
November 2003. Our plans for 2004 include extensive remodeling of four of our
existing offices. In one of those offices we will need to build an entire new
facility. The capital cost of the updates is expected to be approximately $3.2
million. In addition, a property acquisition that has been under consideration
for several years is the Canyon Park site. If that banking center and office
building were to be completed in 2005, the capital costs would approach $4.3
million. Since year end the Bank has also entered into a contract to purchase
land in West Seattle for approximately $1.0 million to build a new banking
center location for the existing West Seattle banking center.
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, and if the business model for the banking center is favorable.
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, 2003, the Bank was not engaged in any litigation, which
in the opinion of management, after consultation with its counsel, would be
material to the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -----------------------------------------------------------
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year ended December 31, 2003.
41
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND
- -------------------------------------------------------------------------------
ISSUER PURCHASES OF EQUITY SECURITIES
-------------------------------------
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
during the last five fiscal years.
Quarter Ending Fiscal 2003 Fiscal 2002 Fiscal 2001 Fiscal 2000 Fiscal 1999
- -------------- ----------- ----------- ----------- ----------- -----------
Fiscal year $ 0.28 $ 0.28 $ 0.22 $ 0.20 $ 0.20
March 31 0.07 0.07 0.05 0.05 0.05
June 30 0.07 0.07 0.05 0.05 0.05
September 30 0.07 0.07 0.05 0.05 0.05
December 31 0.07 0.07 0.07 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.
42
ITEM 9A. 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, 2003, 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 we believe that our existing disclosure controls and procedures
have been effective to accomplish these objectives, we intend to continue to
examine, refine and formalize our disclosure controls and procedures and to
monitor ongoing developments in this area.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- -----------------------------------------------------------
The information contained under the section captioned "Election of
Directors" and "Board of Directors Committees and Reports; Certain Relationships
and Director and Executive Compensation" 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.
The following table sets forth certain information with respect to the
executive officers of the Company and the Bank.
43
Age at Position
December -------------------------------------------------------------------------------
Name 31, 2003 Company Bank
- ---- -------- ------- ----
John R. Valaas 59 President and Chief Executive President and Chief Executive
Officer Officer
Roger A. Mandery 61 Executive Vice President, CFO, Executive Vice President, Chief Financial
and Treasurer Officer, and Treasurer
Richard J. Collette 56 Executive Vice President, Commercial
Banking Group
James R. Boudreau 56 Executive Vice President and Executive Vice President - Chief Credit
Assistant Secretary Officer
Joseph P. Zavaglia 55 Executive Vice President - Retail Banking
Group
Scott B. Harlan 42 Executive Vice President - Residential and Consumer Lending
Robin R. Carey 46 Senior Vice President, Operations and
Administration and Assistant Secretary
Kari A. Stenslie 39 Vice President, Controller and Vice President, Controller and Assistant
Assistant Treasurer Treasurer
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.
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.
RICHARD J. COLLETTE is the Bank's Executive Vice President and Manager
of its Commercial Banking Group. 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.
JAMES R. BOUDREAU is the Bank's Executive Vice President and Chief
Credit Officer and the Company's Executive Vice President and has been employed
by the Bank since 1975. He is responsible for overseeing lending
44
policies for all lending areas of the Bank. He chairs the Bank's loan committees
and supervises the asset management and residential underwriting departments.
JOSEPH P. ZAVAGLIA is the Bank's Executive Vice President of the Retail
and Community Business Banking Groups. His responsibilities include overseeing
the banking center distribution network and the community business banking
department. Prior to joining the Bank in February 2003, Mr. Zavaglia was Senior
Vice President and Consumer Market Executive for Bank of America where he was
employed from 1975 to 2003. Mr. Zavaglia has over 28 years of commercial and
retail banking experience.
SCOTT B. HARLAN is the Bank's Executive Vice President of Consumer and
Residential Lending and has been employed by the Bank since 1985. He is
responsible for consumer and residential lending as well as the information
systems department.
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.
KARI A. STENSLIE, CPA, CMA, is the Senior 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.
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 Director and Executive Compensation" in the Proxy Statement
for the Company's 2004 Annual Meeting of Shareholders.
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 "Election of Directors" and "Principal
Holders of Voting Securities and Management" in the Company's Proxy Statement
for the Company's 2004 Annual Meeting of Shareholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
The information required by this item is incorporated by reference to
the sections captioned "Election of Directors" and "Board of Directors
Committees and Reports; Certain Relationships and Director and Executive
Compensation" in the Company's Proxy Statement for the Company's 2004 Annual
Meeting of Shareholders.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
- ------------------------------------------------
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 Company's Proxy Statement for the Company's
2004 Annual Meeting of Shareholders.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------
(a) (1) Consolidated Financial Statements (*)
45
Independent Auditors' Report
Consolidated Statements of Financial Condition at December 31, 2003
and 2002
Consolidated Statements of Income for the three years ended December
31, 2003
Consolidated Statements of Stockholders' Equity and Comprehensive
Income for the three years ended December 31, 2003
Consolidated Statements of Cash Flows for the three years ended
December 31, 2003
Notes to Consolidated Financial Statements
(2) All required financial statement schedules are included in the Notes to
Consolidated Financial Statements.
(3) Exhibits
(3) a. Articles of Incorporation (a)
b. Bylaws (a)
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.
(10.1) Agreement for purchase of company headquarters building
(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) 2003 Annual Report to Shareholders
(14) Code of Business Conduct and Ethics adopted February 26, 2004
(21) Subsidiaries
(23.1) Consent of Moss Adams LLP, Independent Auditors
(31.1) Certification of Chief Executive Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
(31.2) Certification of Chief Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
(32.0) Certification of Chief Executive Officer and Chief Financial
Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
(*) Incorporated by reference from 2003 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.
(c) The exhibits required to be filed by this item are listed under Item
15(a)(3) above.
46
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST MUTUAL BANCSHARES, INC.
DATE: March 29, 2004 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 29, 2004 Date: March 29, 2004
By: /s/Kari A. Stenslie By: /s/George W. Rowley, Jr.
------------------------------------ -------------------------------
Kari A. Stenslie George W. Rowley, Jr.
Principal Accounting Officer Director
Date: March 29, 2004 Date: March 29, 2004
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 29, 2004 Date: March 29, 2004
By: /s/James J. Doud, Jr. By: /s/John R. Valaas
----------------------------------- -------------------------------
James J. Doud, Jr. John R. Valaas
Director Director
Date: March 29, 2004 Date: March 29, 2004
By: /s/Mary Case Dunnam By: /s/Robert C. Wallace
----------------------------------- ------------------------------
Mary Case Dunnam Robert C. Wallace
Director Director
Date: March 29 , 2004 Date: March 29, 2004
By: /s/Janine Florence By: /s/Robert J. Herbold
----------------------------------- ------------------------------
Janine Florence Robert J. Herbold
Director Director
Date: March 29, 2004 Date: March 29, 2004
47