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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the quarterly
period ended................................March 31, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the transition period
from __________ to ___________
Commission File Number 005-57091
FIRST MUTUAL BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
WASHINGTON 91-2005970
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(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
400 108th Avenue N.E., Bellevue, WA 98004
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (425) 453-5301
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. May 3, 2005: 5,308,294
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FIRST MUTUAL BANCSHARES, INC.
QUARTERLY REPORT ON FORM 10-Q
March 31, 2005
TABLE OF CONTENTS
Page
----
PART I: FINANCIAL INFORMATION............................................... 1
Forward-Looking Statements Disclaimer............................... 1
ITEM 1. Financial Statements............................................. 1
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 14
General...................................................... 14
Overview..................................................... 14
Results of Operations........................................ 16
Net Income................................................. 16
Net Interest Income........................................ 16
Noninterest Income......................................... 20
Noninterest Expense........................................ 23
Financial Condition.......................................... 25
Asset Quality................................................ 27
Portfolio Information........................................ 28
Deposit Information.......................................... 30
Business Segments............................................ 31
Consumer Lending........................................... 31
Residential Lending........................................ 34
Business Banking Lending................................... 35
Income Property Lending.................................... 36
Liquidity.................................................... 37
Planned Expenditures for Plant and Equipment................. 40
Capital...................................................... 40
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk....... 41
ITEM 4. Controls and Procedures.......................................... 48
PART II: OTHER INFORMATION.................................................. 48
ITEM 1. Legal Proceedings................................................ 48
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds...... 48
ITEM 3. Defaults Upon Senior Securities.................................. 48
ITEM 4. Submission of Matters to a Vote of Security Holders.............. 48
ITEM 5. Other Information................................................ 49
ITEM 6. Exhibits......................................................... 49
SIGNATURES.................................................................. 50
CERTIFICATIONS
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i
PART I : FINANCIAL INFORMATION
FORWARD-LOOKING STATEMENTS DISCLAIMER
- -------------------------------------
Our Form 10-Q contains statements concerning future operations, trends,
expectations, plans, capabilities, and prospects of First Mutual Bancshares,
Inc. and First Mutual Bank (together, the "Bank") that are forward-looking
statements for the purposes of the safe harbor provisions under the Private
Securities Litigation Reform Act of 1995. Such forward-looking statements
include statements regarding our goals and expectations regarding net income and
return on equity; as well as references to potential changes in interest income
and interest rate margins, anticipated growth in loan production and growth in
sales of loans, trends in income and expenses and banking center renovations,
expectations regarding our Business Banking segment, observations pertaining to
the potential disparate movement and repricing of assets and liabilities, and
information based on our market risk models and analysis. Although we believe
that the expectations expressed in these forward-looking statements are based on
reasonable assumptions within the bounds of our knowledge of our business,
operations, and prospects, these forward-looking statements are subject to
numerous uncertainties and risks, and actual events, results, and developments
will ultimately differ from the expectations and may differ materially from
those expressed or implied in such forward-looking statements. Factors which
could affect actual results include economic conditions in our market area and
the nation as a whole, interest rate fluctuations, the impact of competitive
products, services, and pricing, our credit risk management, our ability to
control our costs and expenses, loan delinquency rates, and the legislative and
regulatory changes affecting the banking industry. There are other risks and
uncertainties that could affect us which are discussed from time to time in our
filings 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. We are not
responsible for updating any such forward-looking statements.
ITEM 1. Financial Statements
In the opinion of management, the accompanying consolidated statements of
financial condition and related interim consolidated statements of income,
comprehensive income, stockholders' equity and cash flows reflect all
adjustments (which include reclassifications and normal recurring adjustments)
that are necessary for a fair presentation in conformity with accounting
principles generally accepted in the United States of America ("GAAP"). The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect amounts reported in the financial
statements. Changes in these estimates and assumptions are considered reasonably
possible and may have a material impact on the financial statements.
Certain reclassifications have been made to the 2004 financial statements to
conform to the 2005 presentation. All significant intercompany transactions and
balances have been eliminated.
The information included in this Form 10-Q should be read in conjunction with
the First Mutual Bancshares, Inc. Year 2004 Annual Report on Form 10-K to the
Securities and Exchange Commission. Interim results are not necessarily
indicative of results for a full year.
Consolidated Financial Statements of the Company begin on page 2.
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1
Item 1. Financial Statements
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
March 31, December 31,
2005 2004
--------------- ---------------
(Unaudited)
ASSETS:
CASH AND CASH EQUIVALENTS:
Interest-earning deposits $ 2,166,617 $ 309,125
Noninterest-earning demand deposits
and cash on hand 13,301,269 13,536,316
--------------- ---------------
15,467,886 13,845,441
MORTGAGE-BACKED AND OTHER SECURITIES
AVAILABLE-FOR-SALE 124,349,073 124,224,683
LOANS RECEIVABLE, HELD-FOR-SALE 10,854,155 10,064,155
MORTGAGE-BACKED AND OTHER SECURITIES HELD-TO-MATURITY
fair value of $8,338,606 and $7,826,994 8,287,934 7,719,542
LOANS RECEIVABLE 821,483,149 808,642,531
RESERVE FOR LOAN LOSSES (9,489,886) (9,300,854)
--------------- ---------------
LOANS RECEIVABLE, net 811,993,263 799,341,677
ACCRUED INTEREST RECEIVABLE 4,675,752 4,300,131
LAND, BUILDINGS AND EQUIPMENT, net 29,541,065 27,994,532
FEDERAL HOME LOAN BANK (FHLB) STOCK, 12,998,000 12,918,700
at cost
SERVICING ASSETS 1,893,559 1,525,085
OTHER ASSETS 1,841,751 1,849,401
--------------- ---------------
TOTAL $ 1,021,902,438 $ 1,003,783,347
=============== ===============
2
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Continued)
March 31, December 31,
2005 2004
--------------- ---------------
(Unaudited)
LIABILITIES:
Deposits:
Money market deposit and
checking accounts $ 242,150,355 $ 254,435,583
Regular savings 8,569,626 8,434,423
Time deposits 440,952,367 412,498,902
--------------- ---------------
Total deposits 691,672,348 675,368,908
Drafts payable 445,263 377,814
Accounts payable and other liabilities 12,253,585 14,106,402
Advance payments by borrowers for
taxes and insurance 3,013,663 1,676,175
FHLB advances 234,952,754 234,206,775
Other advances 1,600,000 1,600,000
Long-term debentures payable 17,000,000 17,000,000
--------------- ---------------
Total liabilities 960,937,613 944,336,074
STOCKHOLDERS' EQUITY:
Common stock, $1 par value-
Authorized, 10,000,000 shares
Issued and outstanding, 5,308,294
and 5,288,489 shares, respectively $ 5,308,294 $ 5,288,489
Additional paid-in capital 45,842,341 45,595,319
Retained earnings 11,326,964 9,220,450
Accumulated other comprehensive income(loss):
Unrealized (loss) on securities available-for-sale
and interest rate swap, net of federal income tax (1,512,774) (656,985)
--------------- ---------------
Total stockholders' equity 60,964,825 59,447,273
--------------- ---------------
TOTAL $ 1,021,902,438 $ 1,003,783,347
=============== ===============
3
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
Quarter ended March 31,
---------------------------
2005 2004
----------- -----------
(Unaudited)
STATEMENT OF OPERATIONS
- -----------------------
INTEREST INCOME:
Loans Receivable $13,932,200 $11,880,926
Interest on Available For Sale Securities 1,271,081 776,948
Interest on Held To Maturity Securities 94,146 108,641
Interest Other 101,769 137,125
----------- -----------
15,399,196 12,903,640
INTEREST EXPENSE:
Deposits 3,571,414 2,881,023
FHLB advances and other 2,027,536 1,532,552
----------- -----------
5,598,950 4,413,575
----------- -----------
Net interest income 9,800,246 8,490,065
PROVISION FOR LOAN LOSSES 400,000 250,000
----------- -----------
Net interest income, after provision
for loan losses 9,400,246 8,240,065
NONINTEREST INCOME:
Gain on sales of loans 524,537 345,379
Servicing fees, net of amortization 326,294 32,874
Gain on sales of investments -- 70,870
Fees on deposits 135,328 143,614
Other 383,604 304,951
----------- -----------
Total noninterest income 1,369,763 897,688
4
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Continued)
Quarter ended March 31,
-------------------------
2005 2004
---------- ----------
(Unaudited)
NONINTEREST EXPENSE:
Salaries and employee benefits $3,946,432 $3,262,712
Occupancy 783,459 695,709
Other 2,133,017 1,681,606
---------- ----------
Total noninterest expense 6,862,908 5,640,027
---------- ----------
Income before federal income taxes 3,907,101 3,497,726
FEDERAL INCOME TAXES 1,322,841 1,183,586
---------- ----------
NET INCOME $2,584,260 $2,314,140
========== ==========
PER SHARE DATA:
Basic earnings per common share $ 0.49 $ 0.44
Earnings per common share, assuming dilution $ 0.47 $ 0.42
WEIGHTED AVERAGE SHARES OUTSTANDING 5,301,235 5,222,639
WEIGHTED AVERAGE SHARES OUTSTANDING
INCLUDING DILUTIVE STOCK OPTIONS 5,552,302 5,476,474
5
First Mutual Bancshares, Inc, and Subsidiaries
Consolidated Statements of Stockholders' Equity and Comprehensive Income
Accumulated
Common Stock Additional Comprehensive
----------------------- Paid-in Retained Income
Shares Amount Capital Earnings (Loss) Total
---------- ----------- ----------- ----------- ----------- -----------
BALANCE, December 31, 2002 4,247,166 $ 4,247,166 $24,028,610 $15,214,220 $ 793,841 $44,283,837
---------- ----------- ----------- ----------- ----------- -----------
Comprehensive income:
Net income 8,395,738 8,395,738
Other comprehensive income (loss), net of tax:
Unrealized (loss) on securities available-for-sale (1,294,797) (1,294,797)
Unrealized gain on interest rate swap 87,186 87,186
-----------
Total comprehensive income 7,188,127
Options exercised, including tax benefit of $219,124 53,040 53,040 571,618 624,658
Issuance of stock through employees' stock plans 1,386 1,386 23,617 25,003
10% stock dividend 428,101 428,101 9,054,336 (9,482,437) --
Cash dividend declared ($0.28 per share) (1,294,869) (1,294,869)
---------- ----------- ----------- ----------- ----------- -----------
BALANCE, December 31, 2003 4,729,693 $ 4,729,693 $33,678,181 $12,832,652 $ (413,770) $50,826,756
========== =========== =========== =========== =========== ===========
Comprehensive income:
Net income 9,287,813 9,287,813
Other comprehensive income (loss), net of tax:
Unrealized (loss) on securities available-for-sale (414,879) (414,879)
Unrealized gain on interest rate swap 171,664 171,664
-----------
Total comprehensive income 9,044,598
Options exercised, including tax benefit of $337,052 80,697 80,697 1,138,303 1,219,000
Issuance of stock through employees' stock plans 2,019 2,019 47,992 50,011
10% stock dividend 476,080 476,080 10,730,843 (11,206,923) --
Cash dividend declared ($0.32 per share) (1,693,092) (1,693,092)
---------- ----------- ----------- ----------- ----------- -----------
--
BALANCE, December 31, 2004 5,288,489 $ 5,288,489 $45,595,319 $ 9,220,450 $ (656,985) $59,447,273
========== =========== =========== =========== =========== ===========
Comprehensive income:
Net income 2,584,260 2,584,260
Other comprehensive income (loss), net of tax:
Unrealized (loss) on securities available-for-sale (959,022) (959,022)
Unrealized gain on interest rate swap 103,233 103,233
-----------
Total comprehensive income 1,728,471
Options exercised, including tax benefit of $8,333 15,959 15,959 150,872 166,831
Issuance of stock through employees' stock plans 3,846 3,846 96,150 99,996
Cash dividend declared ($0.09 per share) (477,746) (477,746)
---------- ----------- ----------- ----------- ----------- -----------
--
BALANCE, March 31, 2005 5,308,294 $ 5,308,294 $45,842,341 $11,326,964 $(1,512,774) $60,964,825
========== =========== =========== =========== =========== ===========
6
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months ended March 31,
------------------------------
2005 2004
------------ ------------
(Unaudited)
OPERATING ACTIVITIES:
Net income $ 2,584,260 $ 2,314,140
Adjustments to reconcile net income to net cash
from operating activities:
Provision for loan losses 400,000 250,000
Depreciation and amortization 357,531 318,778
Deferred loan origination fees, net of accretion (21,591) (146,432)
Amortization of servicing assets 210,019 130,127
Gain on sales of loans (524,536) (345,380)
Loss on sale of repossessed real estate and other assets 2,205 1,000
Gain on sale of securities available-for-sale -- (70,870)
FHLB stock dividends (52,900) (109,700)
Changes in operating assets & liabilities:
Loans receivable held-for-sale (790,000) 5,444,905
Accrued interest receivable (375,621) (210,490)
Other assets 7,650 231,913
Drafts payable 67,449 (117,009)
Accounts payable and other liabilities (1,854,599) (7,242,100)
Advance payments by borrowers for taxes and insurance 1,337,488 1,340,239
------------ ------------
Net cash provided by operating activities 1,347,355 1,789,121
------------ ------------
INVESTING ACTIVITIES:
Loan originations (99,348,104) (80,829,174)
Loan principal repayments 79,143,453 45,154,231
Increase in undisbursed loan proceeds 7,720,855 (4,187,516)
Principal repayments & redemptions on
mortgage-backed and other securities 3,891,994 2,281,313
Purchase of securities held-to-maturity (1,015,435) --
Purchase of securities available-for-sale (4,991,406) (9,970,312)
Purchases of premises and equipment (1,931,816) (505,269)
Purchase of FHLB stock (26,400) --
Proceeds from sale of securities -- 2,228,958
------------ ------------
Net cash (used) by investing activities (16,556,859) (45,827,769)
7
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
Three months ended March 31,
--------------------------------
2005 2004
------------- -------------
(Unaudited)
FINANCING ACTIVITIES:
Net increase in deposit accounts $ 12,953,521 $ 17,748,160
Interest credited to deposit accounts 3,349,919 2,753,144
Issuance of stock through employees's stock plans 99,996 50,011
Proceeds from advances 292,286,000 173,633,000
Repayment of advances (291,540,021) (142,896,960)
Dividends paid (475,964) (331,079)
Proceeds from exercise of stock options 158,498 485,755
------------- -------------
Net cash provided by financing activities 16,831,949 51,442,031
------------- -------------
NET INCREASE IN CASH AND CASH EQUIVALENTS $ 1,622,445 $ 7,403,383
CASH & CASH EQUIVALENTS:
Beginning of year 13,845,441 7,427,055
------------- -------------
End of quarter $ 15,467,886 $ 14,830,438
============= =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Loans originated for mortgage banking activities $ 18,579,744 $ 21,375,530
============= =============
Loans originated for investment activities $ 99,348,104 $ 80,829,174
============= =============
Proceeds from sales of loans held-for-sale $ 17,789,744 $ 26,820,435
============= =============
Cash paid during the year for:
Interest $ 5,409,644 $ 4,482,594
============= =============
Income taxes $ -- $ --
============= =============
SUPPLEMENTAL DISCLOSURES OF NONCASH
INVESTING ACTIVITIES:
Loans securitized into securities available-for-sale $ -- $ --
============= =============
Loans transferred to real estate
held-for-sale, net $ -- $ --
============= =============
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The results of operations for the interim periods shown in this report are not
necessarily indicative of results to be expected for the fiscal year. In the
opinion of management, the information contained herein reflects all adjustments
necessary to make the results of operations for the interim periods a fair
statement of such operations.
The Bank had three stock-based employee/director compensation plans, which are
described more fully in the 2004 annual report. The plans are accounted for
under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. No
stock-based employee or director compensation cost is reflected in net income,
as all options granted under those plans had an exercise price equal to the
market value of the underlying common stock on the date of grant. The following
table illustrates the effect on net income and earnings per share if the fair
value recognition provisions of FASB Statement No. 123, Accounting for
Stock-Based Compensation, had been adopted.
Quarters Ended March 31,
----------------------------
2005 2004
----------- -----------
Net Income, as reported $ 2,584,260 $ 2,314,140
Deduct: Total stock-based employee/
director compensation expense
determined under fair value based
method for all awards, net of related
tax effects (105,887) (98,151)
----------- -----------
Pro forma net income $ 2,478,373 $ 2,215,989
=========== ===========
Earnings per share:
Basic - as reported $ 0.49 $ 0.44
Basic - pro forma $ 0.47 $ 0.42
Diluted - as reported $ 0.47 $ 0.42
Diluted - pro forma $ 0.45 $ 0.40
Weighted average shares outstanding:
Basic 5,301,235 5,222,639
Diluted 5,552,302 5,476,474
The compensation expense included in the pro forma net income and net income per
share figures in the previous table is not likely to be representative of the
effect on reported net income for future years because options vest over several
years and additional awards generally are made each year.
On April 14, 2005 the Securities and Exchange Commission announced a change in
the compliance date for Financial Accounting Standards Board's Statement of
Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment
(Statement 123R). The compliance date has been changed to first quarter of 2006
from July of 2005. We expect to adopt Statement 123R on January 1, 2006.
Change In Accounting Estimate
In the first quarter of 2005 we made a change to the amortization period assumed
for the Bank's servicing assets. Servicing assets are recorded when we sell
loans from our loan portfolio to other investors, and continue to service those
loans for the investors following the sale. To determine the fair value of the
servicing assets we utilize a valuation model that calculates the present value
of future cash flows for the loans sold, based on assumptions to include market
discount rates, anticipated prepayment speeds, estimated servicing cost per
loan, and other relevant factors. These factors are subject to significant
fluctuations, and the estimates used in the models are subject to review and
revision based on actual experience and changes in expectations for the future.
The calculated value of the servicing rights is then capitalized and amortized
in proportion to, and over the period of, estimated future net servicing income.
Based on a review of our assumptions in the first quarter of 2005, we determined
that the amortization period for the servicing rights on our consumer loan
servicing portfolio was significantly shorter than the term over which these
loans would be expected to provide net servicing income. Consequently, we
revised the amortization period such that the average life of the amortization
schedule would correspond with the average life we are currently observing for
the underlying loan portfolio.
Any projection of servicing asset amortization in future periods is limited by
the conditions that existed at the time the calculations were performed, and may
not be indicative of actual amortization expense that will be recorded in future
periods.
The following table shows the actual results for net income and earnings per
share as well as the results for these items if the change had not been made.
First Quarter 2005
---------------------------
As Reported "Old" Method
----------- ------------
Income Before Federal Income Taxes $ 3,907,101 $ 3,691,463
Federal Income Taxes $ 1,322,841 $ 1,249,832
----------- -----------
Net Income $ 2,584,260 $ 2,441,631
=========== ===========
Earnings Per Share Data:
Basic $ 0.49 $ 0.46
Diluted $ 0.47 $ 0.44
9
Note 2.
Mortgage-Backed and Other Securities Available-for-Sale
The amortized cost and estimated fair value of securities available-for-sale at
March 31, 2005, and December 31, 2004 are summarized as follows:
Gross Gross
Gross unrealized unrealized Estimated
Amortized unrealized losses less losses more fair
cost gains than 1 Year than 1 Year value
------------ -------- ---------- ---------- ------------
March 31, 2005
Freddie Mac securities $ 18,720,034 $ 28,025 $ 41,685 $ 522,482 $ 18,183,892
Fannie Mae securities 37,638,856 47,153 419,751 714,507 36,551,751
Ginnie Mae securities 52,254,143 16,362 379,628 -- 51,890,877
US agency securities 17,961,790 -- 239,237 -- 17,722,553
------------ -------- ---------- ---------- ------------
$126,574,823 $ 91,540 $1,080,301 $1,236,989 $124,349,073
============ ======== ========== ========== ============
December 31, 2004
Freddie Mac securities $ 19,127,613 $ 48,719 $ 173,913 $ 115,062 $ 18,887,357
Fannie Mae securities 39,095,463 75,726 87,354 308,837 38,774,998
Ginnie Mae securities 48,839,639 38,712 270,022 -- 48,608,329
US agency securities 17,946,544 57,761 50,306 -- 17,953,999
------------ -------- ---------- ---------- ------------
$125,009,259 $220,918 $ 581,595 $ 423,899 $124,224,683
============ ======== ========== ========== ============
Certain investment securities shown above currently have fair values less
than amortized cost and therefore contain unrealized losses. The Bank has
evaluated these securities and has determined that the decline in value is
temporary and is related to the change in market interest rates since purchase.
The decline in value is not related to any company or industry specific event.
At March 31, 2005 and December 31, 2004 there were 30 and 23 investment
securities with unrealized losses, respectively. The Bank anticipates full
recovery of amortized cost with respect to these securities at maturity or
sooner in the event of a more favorable market interest rate environment.
Note 3.
Mortgage-Backed and Other Securities Held-to-Maturity
The amortized cost and estimated fair value of mortgage-backed and other
securities are summarized as follows:
Gross Gross
Gross unrealized unrealized Estimated
Amortized unrealized losses less losses more fair
cost gains than 1 Year than 1 Year value
------------ -------- ---------- ---------- ------------
March 31, 2005
Fannie Mae securities $ 6,597,427 $102,783 $ 35,525 $ 26,503 $ 6,638,182
Freddie Mac securities 487,186 11,733 -- -- 498,919
Municipal bonds 1,203,321 1,428 -- 3,244 1,201,505
------------ -------- ---------- ---------- ------------
$ 8,287,934 $115,944 $ 35,525 $ 29,747 $ 8,338,606
============ ======== ========== ========== ============
December 31, 2004
Fannie Mae securities $ 6,010,318 $125,722 $ 30,472 $ -- $ 6,105,568
Freddie Mac securities 492,607 13,408 -- -- 506,015
Municipal bonds 1,216,617 2,622 -- 3,828 1,215,411
------------ -------- ---------- ---------- ------------
$ 7,719,542 $141,752 $ 30,472 $ 63,322 7,826,994
============ ======== ========== ========== ============
Certain investment securities shown above currently have fair values less
than amortized cost and therefore contain unrealized losses. The Bank has
evaluated these securities and has determined that the decline in value is
temporary and is related to the change in market interest rates since purchase.
The decline in value is not related to any company or industry specific event.
At March 31, 2005 and December 31, 2004 there were 4 and 3 investment securities
with unrealized losses, respectively. The Bank anticipates full recovery of
amortized cost with respect to these securities at maturity or sooner in the
event of a more favorable market interest rate environment.
10
NOTE 4.
NONPERFORMING ASSETS
Non-performing loans are summarized as follows:
March 31, 2005 December 31, 2004
-------------- -----------------
Impaired loans with a valuation allowance $ 308,891 $ 317,023
Valuation allowance related to impaired loans 172,475 177,190
Total non-accrual loans 817,382 864,464
Total loans past due 90-days or more and still
accruing interest 66,000 34,000
Interest income recognized on impaired loans 278 1,108
Subsequent to March 31, one of the impaired loans with an impaired balance of
$5,012 paid off in April 2005.
NOTE 5.
EARNINGS PER SHARE
Basic Earnings Per Share is computed by dividing net income by the
weighted-average number of shares outstanding during the year. Diluted EPS
reflects the potential dilutive effect of stock options and is computed by
dividing net income by the weighted-average number of shares outstanding during
the year, plus the dilutive common shares that would have been outstanding had
the stock options been exercised.
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations for quarters ending March 31,
2005 and March 31, 2004:
Income Shares Per share
(numerator) (denominator) amount
----------- ----------- ---------
Quarter ended March 31, 2005
- ----------------------------
Basic EPS:
Income available to common shareholders $ 2,584,260 5,301,235 $ 0.49
=========
Effect of dilutive stock options -- 251,067
----------- -----------
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised $ 2,584,260 5,552,302 $ 0.47
=========== =========== =========
Quarter ended March 31, 2004
- ----------------------------
Basic EPS:
Income available to common shareholders $ 2,314,140 5,222,639 $ 0.44
=========
Effect of dilutive stock options -- 253,835
----------- -----------
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised $ 2,314,140 5,476,474 $ 0.42
=========== =========== =========
11
NOTE 6.
RATE VOLUME ANALYSIS FIRST QUARTER 2005
(Dollars in thousands) VS
FIRST QUARTER 2004
INCREASE (DECREASE) DUE TO
TOTAL
VOLUME RATE CHANGE
- --------------------------------------------------------------------------------
INTEREST INCOME
Investments:
Available-for-sale securities $ 413 $ 81 $ 494
Held-to-maturity securities (7) (8) (15)
Other equity investments 14 (49) (35)
------------------------------
Total investments 420 24 444
------------------------------
Loans:
Residential $ 619 $ 51 $ 670
Residential construction 206 242 448
Multifamily (54) 151 97
Multifamily construction (83) 23 (60)
Commercial real estate and business 252 378 630
Commercial real estate construction 61 47 108
Consumer & other 174 (16) 158
------------------------------
Total loans 1,175 876 2,051
------------------------------
Total interest income $ 1,595 $ 900 $ 2,495
INTEREST EXPENSE
Deposits:
Money market deposit and checking $ 148 $ 113 $ 261
Regular savings (1) (1) (2)
Time deposits 289 142 431
------------------------------
Total deposits 436 254 690
FHLB advances and other 272 223 495
------------------------------
Total interest expense 708 477 1,185
Net interest income $ 887 $ 423 $ 1,310
==============================
12
Note 7.
Business Segments
The management reporting process measures the performance of the operating
segments based on the management structure of the Bank and is not necessarily
comparable with similar information for any other financial institution.
The reportable segments include the following:
Consumer Lending - Consumer lending includes home equity lending, direct
consumer loans, and indirect home improvement loans (sales finance). These
loans include lines of credit and loans for primarily consumer purposes.
Residential Lending - Residential lending offers loans to borrowers to
purchase, refinance, or build homes secured by one-to-four-unit family
dwellings. They also finance the purchase or refinance of buildable
residential lots.
Business Banking Lending- Business banking lending offers a full range of
banking services to small and medium size businesses including deposit and
cash management products, loans for financing receivables, inventory,
equipment as well as permanent and interim construction loans for
commercial real estate. The underlying real estate collateral or business
asset being financed typically secures these loans.
Income Property Lending - Income property lending offers permanent and
interim construction loans for multi-family housing (over four units),
manufactured housing communities, commercial real estate properties, and
spec single-family construction. The underlying real estate collateral
being financed typically secures these loans.
Each of these business segments also sells loans into the secondary market. We
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.
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 derive a majority of
their revenue from interest income, and we rely primarily on net interest
revenue in managing these segments. No single customer provides more than 10% of
the Bank's revenues.
Financial information for the Bank's segments is shown below for Mar 31, 2005,
2004, and 2003:
Business Income
Consumer Residential Banking Property
Quarter ended March 31: Lending Lending Lending Lending Totals
----------- ----------- ----------- ----------- -----------
Interest income 2005 $ 2,245,488 $ 4,544,937 $ 1,953,146 $ 6,655,625 $15,399,196
2004 2,026,129 3,582,827 1,311,138 5,983,546 12,903,640
2003 1,245,091 2,642,878 1,332,149 6,787,944 12,008,062
Interest Expense 2005 738,248 1,882,561 490,713 2,487,428 5,598,950
2004 550,609 1,380,386 328,770 2,153,810 4,413,575
2003 539,444 1,115,400 436,041 2,841,929 4,932,814
Net Interest Income 2005 1,507,240 2,662,376 1,462,433 4,168,197 9,800,246
2004 1,475,520 2,202,441 982,368 3,829,736 8,490,065
2003 705,647 1,527,478 896,108 3,946,015 7,075,248
Provision for loan losses 2005 135,715 48,705 59,125 156,455 400,000
2004 93,099 22,279 25,459 109,163 250,000
2003 32,427 13,997 14,596 73,980 135,000
Net interest income, after 2005 1,371,525 2,613,671 1,403,308 4,011,742 9,400,246
provision for loan losses 2004 1,382,421 2,180,162 956,909 3,720,573 8,240,065
2003 673,220 1,513,481 881,512 3,872,035 6,940,248
Noninterest income 2005 862,255 213,155 102,833 191,520 1,369,763
2004 369,907 172,085 88,964 266,732 897,688
2003 122,514 306,222 108,174 448,793 985,703
Noninterest expense 2005 1,649,215 1,697,541 1,590,520 1,925,632 6,862,908
2004 1,196,233 1,393,090 1,102,515 1,948,189 5,640,027
2003 910,138 1,147,907 969,150 1,745,038 4,772,233
Income before federal income taxes 2005 584,565 1,129,285 (84,379) 2,277,630 3,907,101
2004 556,095 959,157 (56,642) 2,039,116 3,497,726
2003 (114,404) 671,796 20,536 2,575,790 3,153,718
Federal income taxes 2005 198,125 382,218 (29,393) 771,891 1,322,841
2004 188,393 324,540 (19,887) 690,540 1,183,586
2003 (39,432) 227,177 6,333 872,482 1,066,560
Net income 2005 386,440 747,067 (54,986) 1,505,739 2,584,260
2004 367,702 634,617 (36,755) 1,348,576 2,314,140
2003 (74,972) 444,619 14,203 1,703,308 2,087,158
Total Interest Earning assets 2005 110,144,818 305,275,674 123,543,351 439,124,200 978,088,043
(ending period balances) 2004 98,304,930 245,542,118 96,215,039 432,300,709 872,362,796
2003 71,452,381 166,494,407 86,684,836 439,029,146 763,660,770
13
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
GENERAL
- -------
First Mutual Bancshares, Inc. (the "Company"), a Washington corporation, is a
bank holding company owning all of the equity of its wholly owned subsidiary,
First Mutual Bank. The Company is subject to regulation by the Federal Reserve
Bank of San Francisco. This discussion refers to the consolidated statements of
the Company and the Bank, and therefore the references to "Bank" in this
discussion refer to both entities.
First Mutual Bank is a Washington-chartered savings bank subject to regulation
by the State of Washington Department of Financial Institutions and the Federal
Deposit Insurance Corporation ("FDIC"). The Bank conducts business from its
headquarters in Bellevue, Washington, and has 12 full-service retail 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 Vancouver, Washington and a
consumer loan office located in Jacksonville, Florida. The Bank's business
consists mainly of attracting deposits from the general public as well as
wholesale funding sources, and investing those funds primarily in real estate
loans, small and mid-sized business loans, and consumer loans.
OVERVIEW
- --------
The first quarter of 2005 marked our 50th consecutive quarter of year-over-year
quarterly earnings growth, as net income increased 12% for the first quarter
ended March 31, 2005, to $2.6 million, or $0.47 per diluted share, compared to
$2.3 million, or $0.42 per diluted share in the first quarter a year ago.
As general corporate goals, we seek to obtain a 15% or better return on equity
(ROE) and year-over-year net income growth in the range of 10% to 12%. This net
income growth goal represents a reduction from our previous target of a 15%
year-over-year increase. We elected to reduce our target in response to a number
of factors including general economic conditions and trends, the current
competitive environment for loan and deposit products in our local market, and
the continued investment required in our Business Banking division. We consider
these to be our corporate goals, and not indicative of current forecasts or
expected future operating results.
Year-Over-Year Annualized
Net Income Growth Return on Equity
----------------- ----------------
First Quarter 2001 5% 14.8%
First Quarter 2002 14% 14.9%
First Quarter 2003 6% 18.5%
First Quarter 2004 11% 17.7%
First Quarter 2005 12% 17.2%
14
While our ROE has typically met or exceeded our corporate target, our net income
growth has generally fallen short of our objective. Over the last several years,
we have utilized part of our earnings for the purpose of investing in new
business lines. About eight years ago, we realized that in order to continue to
achieve our goal of consistent earnings, we needed to expand our business lines
from two to four. At that time, our operations consisted of residential and
income property (commercial real estate) lending. Those business lines were, and
continue to be, solid operations. However, for the Bank to continue to produce
consistent earnings, we needed to broaden the operating base by two new lines,
Business Banking and Consumer Lending. The process of developing those lines has
been expensive and has added to both our staff and operating costs. The
encouraging news is that the Consumer Lending business line has been
contributing to the Bank's profit goals for some time. Although the Business
Banking division has not yet achieved its objectives, we remain committed to
developing this business line based upon its ability to attract low-cost core
deposits, which help reduce our overall cost of funds, the diversification it
brings to our portfolio of earning assets, and the potential it offers for
generating longer-term relationship-banking opportunities and additional sources
of noninterest income. Please refer to the "Business Segments" and "Noninterest
Expense" sections for a further discussion of this topic.
Net interest income represents the primary source of revenue for each of our
business lines. A key ratio that measures net interest income is the net
interest margin. Our net interest margin improved to 4.08%, compared to 3.99% in
the previous quarter and 4.03% in the first quarter last year. Reflecting the
rising interest rate environment, the yield on our earning assets grew to 6.16%
in the March 2005 quarter, compared to 5.98% in the December 2004 quarter, and
5.91% in the March 2004 quarter. The cost of interest-bearing liabilities
increased to 2.36% in the first quarter, from 2.13% in the fourth quarter of
2004 and from 2.09% in the first quarter of 2004. For second quarter 2005, we
are forecasting a decline in the margin to the 3.90% to 4.00% range, as we
anticipate that a combination of a fixed-rate securities portfolio, the
non-payment of dividends on our FHLB stock, and a shifting customer preference
for time deposits will degrade the margin.
The second key component of net interest income is the growth of the business
lines' earning assets. On a first quarter 2005 versus 2004 comparison, the
growth in earning assets contributed $887,000 to net interest income, while the
improvement in the margin added $423,000. In the last 12 months, our assets
increased 12%, slightly exceeding the national average of 11% for all FDIC
insured institutions for year 2004*. Please see the "Net Interest Income" and
"Asset and Liability Management" sections for a further discussion of net
interest income and the processes by which we manage that source of revenue.
A secondary source of revenue is our noninterest income, which grew 53% from the
level earned in the first quarter of 2004, and contributed 12% of our first
quarter revenues (defined as net interest income plus noninterest income). As
was the case last year, gains on loan sales were the largest contributor to our
first quarter noninterest income, accounting for 38% of the total. Servicing
fees, based on a change in estimates and year-over-year growth in the size of
our servicing portfolio, also increased significantly relative to the first
quarter of last year and contributed 24% of the total noninterest income.
Additionally, fees from deposit accounts contributed 10%, with other
miscellaneous sources making up the remaining 28%. Within the miscellaneous
category, 43% of the income was received as rental income principally from the
First Mutual Center building, our corporate headquarters in Bellevue. Please
refer to the "Noninterest Income" section for a further discussion of this
subject.
15
A critical factor in achieving our goal of consistent earnings is the credit
quality of our loan portfolio. Fortunately, for many years we have enjoyed
overall credit quality that has exceeded the national average. Credit quality
remained strong in the first quarter of 2005, with total non-performing assets
(NPAs) declining to $957,000, or 0.09% of total assets as of the quarter-end. By
comparison, the national average for all FDIC Insured Institutions as of
December 31, 2004* was 0.53%. Additionally, our provision for loan losses
totaled $400,000 for the first quarter of 2005, with net charge offs of
$211,000. As a result, the loan loss reserve grew to $9.5 million, or 1.14% of
gross loans, from $8.6 million, or 1.12% of gross loans at the end of the first
quarter last year. For additional information regarding our credit quality
please refer to the "Asset Quality" section.
*FDIC QUARTERLY BANKING PROFILE - FOURTH QUARTER 2004
RESULTS OF OPERATIONS
- ---------------------
NET INCOME
----------
Net income increased approximately 12%, from $2.3 million in the first quarter
of 2004 to $2.6 million in the same period of 2005. Net interest income, after
provision, rose $1.2 million, and noninterest income increased $472,000 on a
first quarter comparison. Partially offsetting the growth in revenue was a rise
of $1.2 million in noninterest expense.
NET INTEREST INCOME
-------------------
Our net interest income for the first quarter increased $1.3 million, or 15%,
relative to the same period last year. This improvement resulted from growth in
our earning assets, which accounted for the majority of the improvement, as well
as the net effects of asset and liability repricing. The following table
illustrates the effects to our net interest income of balance sheet growth and
rate changes on our assets and liabilities, with the results attributable to the
level of earning assets classified as "volume" and the effects of asset and
liability repricing labeled "rate."
Quarter Ended
Rate/Volume Analysis March 31, 2005 vs. March 31, 2004
(Dollars in 000s) Increase/(Decrease) due to
Volume Rate Total
------ ---- -----
Interest Income
Total Investments $ 420 $ 24 $ 444
Total Loans 1,175 876 2,051
------------------------------------
Total Interest Income $ 1,595 $ 900 $ 2,495
------------------------------------
Interest Expense
Total Deposits $ 436 $ 254 $ 690
FHLB and Other 272 223 495
------------------------------------
Total Interest Expense $ 708 $ 477 $ 1,185
------------------------------------
------------------------------------
Net Interest Income $ 887 $ 423 $ 1,310
====================================
16
EARNING ASSET GROWTH (VOLUME)
For the first quarter of 2005, the growth in our earning assets contributed an
additional $1.6 million in interest income relative to the first quarter of last
year. Partially offsetting this income, however, was additional interest expense
incurred from the funding sources used to accommodate the asset growth. The
additional expense associated with these funding sources totaled $708,000 for
the quarter. Consequently, the net impact of asset growth was an improvement in
net interest income of $887,000, or 68% of the total increase in net interest
income compared to the first quarter of last year.
(Dollars in 000s)
Quarter Ended Average Earning Assets Average Net Loans Average Deposits
- ------------- ---------------------- ----------------- ----------------
March 31, 2004 $ 844,439 $ 742,498 $ 594,141
June 30, 2004 893,451 773,561 620,606
September 30, 2004 929,335 790,319 647,560
December 31, 2004 945,684 801,235 666,835
March 31, 2005 962,613 816,127 683,521
Our average earning assets totaled $963 million during the first quarter, an
increase of $118 million, or 14% over the first quarter of 2004. As can be
observed in the table above, the majority of this growth was attributable to
additional balances in our loan portfolio, which grew substantially,
particularly in the second quarter of 2004, with some of the strongest growth
observed in residential construction and permanent mortgage loans. In addition
to the loan growth illustrated in the table above, we significantly increased
the size of our securities portfolio in the second quarter of 2004.
Prior to 2001, our securities portfolio represented a much larger component of
our total asset mix than in the years that followed. As rates declined in 2001,
2002 and 2003, prepayments on mortgage-backed securities held in our portfolio
accelerated, due in large part to the refinancing of the underlying mortgages at
lower interest rates. Additionally, the falling interest rates resulted in many
securities trading at premiums to their par values. Consequently, some
securities were sold from the portfolio during this timeframe to recognize those
gains before the securities paid off at their par values. The volume of new
securities acquired during these periods was typically well below the value of
securities paid off and/or sold, as we were reluctant to add significant volumes
of securities to the balance sheet with interest rates at very low levels. With
rates finally starting to move upward in 2004, we felt more comfortable
acquiring securities, typically short-term hybrid ARM securities. As a result,
our securities portfolio totaled $133 million as of March 31, 2005, an increase
of 43%, or $40 million over the level one year earlier.
Most of our asset growth was funded with additional deposits, including time
deposits issued in institutional markets through deposit brokerage services. We
also used advances from the Federal Home Loan Bank of Seattle (FHLB) to
facilitate asset growth and to match fund specific asset categories. For the
first quarter, our deposits averaged nearly $684 million, representing growth of
almost $90 million over the average level of first quarter 2004. On a
quarter-end March 31, 2005 versus March 31, 2004 basis, deposits grew by $87
million, with checking and money market balances accounting for $36 million, or
42% of the total growth. In the first three months of this year, however, our
checking and money market balances declined $12 million
17
from their level as of December 31, 2004. While our total deposits continued to
grow, with over $28 million in new time deposits added over the same period,
this represented a departure from the last couple of years in which growth of
checking and money market balances accounted for the majority of all deposit
growth.
While short-term interest rates remained at historically low levels, most
investors viewed the rates offered on time deposits as unattractive.
Consequently, these depositors often chose to keep their balances in money
market accounts, which offered greater liquidity in exchange for a modest
trade-off in yield. With the increases in short-term interest rates over the
last year now affecting the pricing of retail deposits, however, the rates paid
on time deposits have become more attractive. Since rate increases apply not
only to newly opened accounts but all existing balances as well, it is now more
difficult to grow checking and money market balances without incurring
substantial marginal expense. While the growth of checking and money market
balances remains a priority and is an important part of our future funding
strategy, at this point we believe the marginal cost that would be incurred to
drive growth in these account types would outweigh the benefits of such a
strategy.
ASSET YIELDS AND FUNDING COSTS (RATE)
For the first quarter of 2005, the net effects of repricing on our assets and
liabilities contributed an additional $423,000 to our net interest income, or
32% of the total difference relative to first quarter 2004.
On the asset side, our loan portfolio accounted for $876,000, or virtually all
of the $900,000 rate-related increase in interest income. As adjustable-rate
loans account for approximately 91% of our loan portfolio, almost all loan types
benefited from increases in short-term market interest rate indices over the
last 12 months and earned additional interest income relative to the first
quarter of 2004 as a result of rate movements and repricing.
By comparison, very little impact from repricing was observed in our securities
portfolio, due to the percentage of the portfolio invested in fixed-rate and
hybrid ARM securities, which have not benefited from rising rate indices over
the last 12 months. Additionally, the rate-related benefits that were recognized
from the repricing of adjustable-rate securities in our portfolio were largely
offset by a reduction in the dividend on our holdings of stock in the FHLB
relative to the prior year.
As a member of the FHLB, and to utilize FHLB advances as a funding source for
our lending and investment activities, we maintain a position in FHLB stock. Our
position in this stock, which totaled approximately $13 million for the first
quarter, has historically paid dividends on a quarterly basis. Based on recent
events at the FHLB, however, no dividend was received from the FHLB in the
fourth quarter of 2004, and the dividend in the first quarter of 2005 was well
below the rate paid in the first quarter of last year. No dividend is expected
in the second quarter.
On the liability side of the balance sheet, repricing increased our first
quarter interest expense on both deposits and FHLB advances relative to the
first three months of 2004. The interest rate increases that drove loan and
wholesale funding rates higher over the last year have also begun to
18
influence the deposit rates offered by our competitors. That resulted in
rate-related increases in interest expense on both our non-maturity and time
deposit accounts. Also contributing to the higher rates for money market
accounts for the quarter were our higher rate/higher balance "Extreme"
market-rate accounts for both our individual and business depositors, which were
introduced last summer.
NET INTEREST MARGIN
QUARTER ENDED NET INTEREST MARGIN
------------- -------------------
March 31, 2004 4.03%
June 30, 2004 3.97%
September 30, 2004 3.99%
December 31, 2004 3.99%
March 31, 2005 4.08%
Our net interest margin totaled 4.08% for the first quarter of 2005, exceeding
its first quarter 2004 level by five basis points. It rose nine basis points
from its level in the second half of 2004 and was in the middle of our
forecasted range of 4.05% to 4.10%. This improvement was largely attributable to
the rising short-term interest rates observed over the last 12 months and the
timing differences between the resulting impacts on our loan and retail deposit
portfolios.
As noted above, adjustable-rate loans accounted for approximately 91% of our
loan portfolio as of March 31, 2005. For the majority of these loans, repricing
occurs on an annual basis. A notable exception to this would be those loans tied
to the prime rate, which typically reprice within one or two days of any
increase in the Federal Funds target rate by the Federal Reserve. Consequently,
most of the loans in our portfolio benefited from increases in short-term market
interest rate indices over the last 12 months and earned additional interest
income relative to the first quarter of 2004.
By comparison, rates on our retail deposits are managed internally and not
typically subject to any sort of systematic adjustments based on movements in
market rate indices. Instead, retail deposit rates tend to lag major interest
rate indices; they remain static until some time after the market indices have
begun moving. Retail deposit rates then typically continue to move for some time
after the market rates stabilize or plateau at a given level. Consequently,
while loan rates systematically repriced upwards, we postponed raising our
retail deposit rates for as long as practical given our funding requirements and
the rates offered by other institutions in our local market. By the end of the
first quarter, however, the deposit rates offered by our competitors in our
local market had begun moving upwards in response to increases in market
interest rates, and were rising at a faster rate than most major indices used
for pricing in our loan portfolio. As a result, it is unlikely that we will
continue to see similar margin expansion going forward as a result of the timing
differences between loan and deposit repricing. In fact, if short-term rates
near a point of stabilization, we would likely see compression occurring in our
net interest margin in subsequent quarters as the effects of systematic loan
repricing diminish, while deposit rates continue to trend upward for some time
afterwards based on the lagging nature of retail deposit rate movements.
19
Additionally, the change in our deposit mix in the first quarter could
potentially contribute to future compression of our net interest margin. While
growth was observed in our checking and money market deposits relative to March
31, 2004, these balances have declined since year end. They typically represent
a lower-cost source of funding and time deposits a higher-cost source, even more
so as rates rise. To the extent that we continue to see movement from the
checking and money market balances to time deposits, our net interest margin
could continue to be negatively impacted. As noted above, the growth of checking
and money market balances remains a priority for us and is still viewed as an
important part of our future funding strategy. At this point, however, based on
the existing balances that would be subject to repricing, we believe the
marginal cost that would be incurred to drive growth in these account types
would outweigh the benefits of such a strategy.
NONINTEREST INCOME
------------------
Noninterest income increased $472,000, or 53%, for the first quarter of 2005 as
compared to the like quarter in 2004. The increase for the quarter was mainly
attributable to the rise in net servicing fees and gain on sales of loans which
was slightly offset by the decline in gain on sales of investments.
GAIN ON SALES OF LOANS
Quarter Ended March 31,
-----------------------------
Gain on Loan Sales 2005 2004 $ Change % Change
------------ ------------ ------------ ------------
Consumer Loans $ 501,000 $ 275,000 $ 226,000 82%
Commercial Loans -- 43,000 (43,000) NA
Residential Loans 24,000 27,000 (3,000) (15%)
------------ ------------ ------------ ------------
Total Gains on Loan Sales $ 525,000 $ 345,000 $ 180,000 52%
============ ============ ============ ============
Quarter Ended March 31,
-----------------------------
Loans Sold 2005 2004 $ Change % Change
------------ ------------ ------------ ------------
Consumer Loans $ 10,638,000 $ 7,672,000 $ 2,966,000 39%
Commercial Loans -- 10,828,000 (10,828,000) NA
Residential Loans 7,152,000 8,320,000 (1,168,000) (14%)
------------ ------------ ------------ ------------
Total Loans Sold $ 17,790,000 $ 26,820,000 $ (9,030,000) (34%)
============ ============ ============ ============
In the first quarter of 2005, our gains on loan sales significantly exceeded
those of the prior year, driven largely by increased sales of consumer loans.
Gains totaled $525,000, representing an increase of 52% over the first quarter
of 2004. As evidence that the increase in gains on sales was attributable to a
change in the mix of loans sold, rather than increased sales volumes, total
loans sold declined 34% from the same period last year.
Continuing a trend established during 2004, consumer loan sales had the most
significant impact on our loan sale gain this quarter with gains of $501,000 on
sales totaling $10.6 million. This far exceeded the $275,000 realized on sales
of $7.7 million for the first quarter of 2004. Our current plan is to continue
selling approximately $6 million to $8 million in sales finance loans each
quarter, though actual sales in a given quarter may fall above or below this
range depending on a number of factors including, but not limited to, quarterly
loan production and net portfolio growth. Additionally, as we typically continue
the servicing functions for those loans, these sales have resulted in
substantial growth in our service fee income.
20
In contrast, residential loan sale gains were down 15% from the prior year based
on a 14% reduction in the volume of loans sold compared to the same period last
year. While production volumes for residential loans exceeded those in the first
quarter of last year, a greater percentage of this year's production was
centered in custom construction loans, which have been retained within our
portfolio.
No commercial loans were sold in the first three months of this year, which is
in sharp contrast to significant loan sales in the first quarter of last year.
Commercial loan sales are generally used to limit our credit exposure to
specific borrowers. In the first quarter, we did not originate loans to any
borrowers whose aggregate credit exposure needed to be reduced.
SERVICE FEE INCOME
Quarter Ended March 31,
-----------------------------
2005 2004 $ Change % Change
------------ ------------ ------------ ------------
Consumer Loan Service Fees $ 300,000 $ 23,000 $ 277,000 1204%
Commercial Loan Service Fees 24,000 12,000 12,000 100%
Residential Loan Service Fees 2,000 (2,000) 4,000 200%
------------ ------------ ------------ ------------
Service Fee Income $ 326,000 $ 33,000 $ 293,000 888%
============ ============ ============ ============
For the first quarter of 2005, our total servicing fee income rose 888% over
that earned in the first quarter of 2004, based on a 12-fold increase in fees
earned on consumer loans serviced for others. This increase in consumer loan
service fees was attributable in large part to a change in estimate for the
amortization period assumed for the underlying servicing asset.
Servicing assets are recorded when we sell loans to other investors and continue
to service those loans following the sale. To determine the fair value of the
servicing assets, we utilize a valuation model that calculates the present value
of future cash flows for the loans sold, based on assumptions including market
discount rates, anticipated prepayment speeds, estimated servicing cost per
loan, and other relevant factors. These factors are subject to significant
fluctuations, and the estimates used in the models are subject to review and
revision based on actual experience and changes in expectations for the future.
The calculated value of the servicing rights is then capitalized and amortized
in proportion to, and over the period of, estimated future net servicing income.
Based on a review of our assumptions in the first quarter of 2005, we determined
that the amortization period for the servicing rights on our consumer loan
servicing portfolio was significantly shorter than the term over which these
loans would be expected to provide net servicing income. Consequently, we
revised the amortization period such that the average life of the amortization
schedule would correspond with the average life we are currently observing for
the underlying loan portfolio. Please refer to Footnote No. 1 - Summary of
Significant Accounting Policies for more information.
Any projection of servicing asset amortization in future periods is limited by
the conditions that existed at the time the calculations were performed, and may
not be indicative of actual amortization expense that will be recorded in future
periods.
21
In addition to the effects of this change in estimates, the income received for
servicing consumer loans has grown as a result of the increased level of sales
finance loan sales over the last several quarters, and corresponding growth in
our portfolio of consumer loans serviced for others. The fees earned on the
portfolio of sales finance loans sold and serviced are expected to continue to
grow, though at a decreasing rate, as additional loans are sold each quarter to
manage the size of the sales finance loan portfolio.
An increase was also observed in service fee income earned on our commercial
loans serviced for others based on participations sold in the last three
quarters of 2004. By comparison, residential loans are typically sold servicing
released, which means we no longer service those loans once they are sold.
Consequently, we do not view these loans as a significant source of servicing
fee income.
OTHER NONINTEREST INCOME
Quarter Ended March 31,
-----------------------------
2005 2004 $ Change % Change
------------ ------------ ------------ ------------
Rental Income $ 166,000 $ 168,000 $ (2,000) (1%)
Loan Fees 69,000 22,000 47,000 214%
ATM/Wires/Safe Deposit 56,000 38,000 18,000 47%
Late Charges 48,000 36,000 12,000 33%
Miscellaneous 45,000 41,000 4,000 10%
------------ ------------ ------------ ------------
Total Other Noninterest
Income $ 384,000 $ 305,000 $ 79,000 26%
============ ============ ============ ============
Our other noninterest income for the first quarter of 2005 rose $79,000, or 26%
over the first quarter of last year. While an increase in loan fee income made
the largest single contribution, significant improvements were also observed in
late charge fees received on our loan portfolio, as well as Visa and ATM fees,
which have grown and are expected to continue rising as checking accounts become
a greater piece of our overall deposit mix.
Loan fees increased $47,000 compared to the first quarter of 2004, as prepayment
fees totaled $68,000, up from $21,000 last year. In recent quarters, short-term
interest rates have risen, while longer-term interest rates, such as the 10-year
U.S. Treasury rate, which are more indicative of mortgage rates, have tended to
move within a range without any discernible upward or downward tendency.
Combined, these movements have resulted in a flattening of the yield curve. We
believe that this flattening, and expectations that rates could move upwards in
the foreseeable future, have contributed to the higher level of loan payoffs and
prepayment fees observed over the last several quarters. As this flattening of
the yield curve reduces the rate differential between short- and long-term
financing costs, the financial incentive for borrowers to use shorter-term,
adjustable-rate financing rather than longer-term, fixed-rate loans diminishes.
This, in turn, provides borrowers with short-term or adjustable-rate loans an
incentive to refinance with long-term fixed rates. Given the uncertainties in
interest rates and borrower expectations, we do not know if the higher level of
prepayment fees is likely to continue.
22
NONINTEREST EXPENSE
SALARIES AND EMPLOYEE BENEFITS
Salaries and benefits expense increased by $683,000, or 21%, from $3.3 million
in the first quarter of 2004 to more than $3.9 million for the same period in
2005, and accounted for approximately 56% of the increase in total noninterest
expense.
Quarter Ended March 31,
-----------------------------
2005 2004 $ Change % Change
------------ ------------ ------------ ------------
Salaries $ 2,621,000 $ 2,199,000 $ 422,000 19%
Commissions and Incentive
Bonuses 511,000 333,000 178,000 53%
Employment Taxes &
Insurance 289,000 260,000 29,000 11%
Temporary Office Help 42,000 35,000 7,000 20%
Benefits 483,000 436,000 47,000 11%
------------ ------------ ------------ ------------
Total Salary & Benefit
Expenses $ 3,946,000 $ 3,263,000 $ 683,000 21%
============ ============ ============ ============
The majority of the increase in salary and benefit expense was the result of
higher staffing levels, which, as measured by full-time-equivalent (FTE)
employee count, increased 7% between the ends of the first quarters of 2004 and
2005. The staff additions over the last 12 months have been distributed
throughout the Bank, and consisted primarily of positions pertaining to the
origination and/or servicing of our loan portfolio or retail deposits. Near the
end of the first quarter of 2004, we added two senior management level positions
that resulted in a greater than normal impact on compensation cost relative to
the first quarter of last year.
Also contributing to the increase in salary and benefit expense was higher
incentive compensation, particularly in our Business Banking and Residential
Lending divisions. The increase for the Business Banking division was due
primarily to a return to a more normal level of incentive compensation this
year, compared to a below average level of expense in the first quarter of 2004,
while payouts to residential lending officers increased relative to the prior
year based on higher loan volumes.
The table below details our staffing levels, total salaries and benefits expense
and the quarterly changes over the last five quarters. As would be expected, on
a sequential-quarter basis, our personnel expenses peak in the final quarter of
each year based on the payouts of year-end commissions, bonuses, and other
incentive compensation. Following these year-end payouts, personnel expenses
typically decline in the first quarter. The decline in the first quarter of 2004
was particularly noticeable due to the previously mentioned below-average level
of incentive compensation paid in that quarter. For the first quarter of 2005,
quarterly incentive compensation payments returned to what we would consider a
more normal level, thus the decline observed between the fourth quarter of 2004
and the first quarter of 2005 is more representative of our expectation for a
typical quarter-to-quarter change. Annual salary increases for existing staff
occur in April, and thus are reflected in the second quarter each year.
Consequently, as was the case in 2004, an increase can be observed between the
first and second quarters without any additions to staff. In the third quarter
of 2004, our compensation-related expenses then rose 5% on a
quarter-over-quarter basis based on a high level of staff additions. The
significant increase in the fourth quarter was attributable to the combination
of several additions to staff and the payout of year-end incentive compensation.
23
Salary and Benefit Quarter-to-Quarter
Quarter Ended FTE Expense $ Change % Change
- ------------- --- ------- -------- --------
March 31, 2004 204 $ 3,263,000 $ (249,000) (7%)
June 30, 2004 201 3,392,000 129,000 4%
September 30, 2004 214 3,553,000 161,000 5%
December 31, 2004 220 4,053,000 500,000 12%
March 31, 2005 219 3,946,000 (107,000) (3%)
OCCUPANCY
Occupancy expense increased $88,000, or 13% relative to the first quarter of
last year, based primarily on higher software licensing costs and depreciation
expense.
Quarter Ended March 31,
-----------------------------
2005 2004 $ Change % Change
------------ ------------ ------------ ------------
Rent Expense $ 78,000 $ 83,000 $ (5,000) (6%)
Utilities and Maintenance 189,000 175,000 14,000 8%
Depreciation Expense 338,000 314,000 24,000 8%
Other Occupancy Costs 179,000 124,000 55,000 44%
------------ ------------ ------------ ------------
Total Occupancy Expenses $ 784,000 $ 696,000 $ 88,000 13%
============ ============ ============ ============
Depreciation expense rose $24,000 compared to the first quarter of last year due
to capital expenditures made over the last 12 months for retail banking center
remodel projects, growth in our information systems infrastructure, and
investment in enterprise software. We expect these costs to continue to rise in
2005 as we complete the remodeling projects on our First Mutual Center
headquarters building and additional banking centers and begin depreciating
those assets.
Most of the increase in occupancy expense occurred in "other occupancy costs,"
which includes items such as real estate and personal property taxes,
expenditures for rental or acquisition of non-capitalized equipment, and
software licensing. For the first quarter of 2005, our software licensing costs
accounted for the majority of this category's increase, rising $30,000 over the
prior year, as a result of a new software licensing agreement with Microsoft
that began in January of this year. This new method of software licensing will
continue throughout 2005 for a total cost for the year of $109,000. Also
contributing to the increased level of expenses were higher property taxes and
non-capitalized equipment expenditures associated with the relocation of several
departments to recently remodeled areas within First Mutual Center.
OTHER NONINTEREST EXPENSES
Other noninterest expense rose by $452,000, or 27%, driven largely by credit
insurance premiums paid on our sales finance loan portfolio as well as
additional outside services and marketing expenses.
Quarter Ended March 31,
-----------------------------
2005 2004 $ Change % Change
------------ ------------ ------------ ------------
Marketing & Public Relations $ 354,000 $ 285,000 $ 69,000 24%
Credit Insurance 333,000 157,000 176,000 112%
Outside Services 198,000 149,000 49,000 33%
Taxes 141,000 128,000 13,000 10%
Information Systems 247,000 216,000 31,000 14%
Other 860,000 746,000 114,000 15%
------------ ------------ ------------ ------------
Total Other Noninterest
Expenses $ 2,133,000 $ 1,681,000 $ 452,000 27%
============ ============ ============ ============
24
The most significant growth in the first quarter's other noninterest expenses
came from credit insurance premiums for our sales finance loan portfolio, which
increased $176,000 relative to the first three months of 2004. In the fourth
quarter of 2002, we began to insure against default risk on loans to borrowers
with credit scores below 720. The premiums for this coverage, currently 2.7% of
insured balances, have risen steadily based on the growth of insured loan
balances in the sales finance portfolios. As of March 31, 2005, insured balances
had grown to $49.6 million and accounted for 45% of the total Bank and
serviced-for-others sales finance portfolios. We expect to see further increases
in our premiums going forward as the balances of our insured sales finance loans
continue to grow.
Marketing and public relations expenses totaled $354,000 for the first quarter
this year, an increase of 24% over the same period last year, as an unusually
high level of marketing expense was observed in January 2005. Following that
spike, marketing expense returned to a significantly lower, normalized level.
Expenses associated with miscellaneous outside services rose $49,000, or 33%,
compared with the first quarter of the prior year. Most of this increase was the
result of outside services associated with the relocation of several departments
to recently remodeled areas within First Mutual Center.
Accounting and auditing fees also increased significantly, rising $33,000, or
79%, from their first quarter 2004 level. The growth in these expenses has been
largely attributable to additional work mandated by the Sarbanes-Oxley Act of
2002. We also expect to engage consultants on a limited basis in 2005, an
expense that we did not incur in 2004. It is also possible that new regulations
related to the Act will be promulgated that will result in our incurring
additional costs implementing those regulations.
FINANCIAL CONDITION
- -------------------
ASSETS. Assets increased 2% in the first quarter of 2005, totaling $1,022
million at March 31, up from $1,004 million at the 2004 year-end, based
primarily on growth in our loan portfolio.
SECURITIES. We classify investment securities in one of the following
categories: 1) trading, 2) available-for-sale, or 3) held-to-maturity.
Securities classified as available-for-sale are reviewed regularly, and any
unrealized gains or losses are recorded in the shareholders' equity account. As
of March 31, 2005, the balance of the unrealized loss, net of federal income
taxes, was $1,469,000, compared to an unrealized loss at year-end 2004 of
$510,000. Generally, falling interest rates will increase the amount recorded as
unrealized gain, and rising rates will decrease any unrealized gains, as the
market value of securities inversely adjusts to the change in interest rates.
Percentage of
Quarter Ended Total Securities Total Assets Total Assets
------------- ---------------- ------------ ------------
(Dollars in 000s)
-----------------
December 31, 2004 $ 131,944 $1,003,783 13%
March 31, 2005 $ 132,637 $1,021,902 13%
25
Security investments (available-for-sale and held-to-maturity) remained little
changed from their level as of the 2004 year-end, increasing less than $1
million over the last three months. With the securities purchased in 2004, we
believe the current size of our portfolio to be adequate, and do not anticipate
additional securities purchases, other than the amount necessary to maintain the
current portfolio level.
LOANS. Loans receivable, excluding loans held-for-sale, increased by $13 million
from $809 million at the 2004 year-end to $821 million at the end of the first
quarter, as loan originations increased 15% over the first quarter of last year
to $118 million. Income property loans accounted for 40% of our loan portfolio
at the end of the first quarter, unchanged relative to the year-end and down
from 45% as of March 2004. Business banking loans accounted for 12% of total
loans, compared to 13% at the 2004 year-end and 11% one year ago, while
commercial construction loans remained unchanged at 3% of loans. Single-family
mortgage loans, including loans held for sale, increased to 23% of the portfolio
at quarter-end, compared to 19% at the end of the first quarter last year and
22% as of the 2004 year-end. Single-family construction loans remained
relatively consistent and accounted for 11% of total loans. Consumer loans,
largely home improvement loans originated on a national scale through the Sales
Finance Division, declined from 12% of the loan portfolio at the year-end to 11%
as of March 31, 2005, following $10.6 million in loan sales during the first
quarter. Our current plan is to continue to sell approximately $6 million to $8
million each quarter, though actual sales in a given quarter may fall above or
below this range depending on a number of factors including quarterly loan
production and net portfolio growth.
We anticipate that our loan growth will be in the range of $15-$20 million for
the second quarter of 2005, after taking into account our expected loan
origination volumes, and loan payoffs and sales.
SERVICING ASSETS. Servicing assets grew by $368,000, or 24%, in the three months
since the 2004 year-end. The servicing asset balance has grown steadily since
our sales finance area began selling consumer loans with servicing retained in
the third quarter of 2003.
1st Qtr. 2005 4th Qtr. 2004 3rd Qtr. 2004 2nd Qtr. 2004
------------- ------------- ------------- -------------
Servicing Assets:
Commercial $ 151,000 $ 173,000 $ 134,000 $ 115,000
Residential 12,000 13,000 17,000 21,000
Consumer 1,730,000 1,339,000 1,085,000 741,000
------------- ------------- ------------- -------------
Total $ 1,893,000 $ 1,525,000 $ 1,236,000 $ 877,000
============= ============= ============= =============
Loan Balances
Serviced for others $ 120,898,000 $ 117,852,000 $ 109,226,000 $ 97,177,000
Servicing assets represent the deferred servicing rights generated from sales of
loans that are sold servicing retained, offset by the amortization and
prepayments of loans serviced, as well as any impairment charges that may occur.
Although the increases in servicing assets have not been a major factor in our
overall asset growth, this area is expected to continue increasing with the
anticipated future sales of consumer loans.
LIABILITIES. In the first three months of this year, our total deposit balances
rose 2% from their year-end level, totaling $692 million at the end of the first
quarter. Our checking and money
26
market balances, however, declined $12 million from their 2004 year-end level,
representing a departure from the trend observed over the last couple of years,
in which growth of checking and money market balances accounted for the majority
of all deposit growth.
While short-term interest rates remained at historically low levels, most
investors viewed the rates offered on time deposits as unattractive.
Consequently, these depositors often chose to keep their balances in money
market accounts, which offer greater liquidity, typically in exchange for a
modest trade-off in yield. With the increases in short-term interest rates over
the last year now affecting the pricing of retail deposits, however, the rates
paid on time deposits have become more attractive. Since rate increases for
checking and money market products apply not only to newly opened accounts, but
all existing balances as well, it is now more difficult to grow checking and
money market balances without incurring substantial marginal expense. While the
growth of checking and money market balances remains a priority and is an
important part of our future funding strategy, at this point we believe the
marginal cost that would be incurred to drive growth in these account types
would outweigh the benefits of such a strategy.
The deposit growth, together with changes in other liabilities and our retained
earnings, were nearly sufficient to fully support the quarter's asset growth. As
a result, our utilization of FHLB advances, the preferred supplemental funding
mechanism, remained virtually unchanged at $235 million as of March 31, 2005.
This represented an increase of less than $1 million over the level as of the
2004 year-end. As of March 31, 2005, we had the authority to borrow up to a
total of nearly $409 million in FHLB advances, subject to sufficient collateral
to support those advances.
ASSET QUALITY
- -------------
PROVISION AND RESERVE FOR LOAN LOSS
The provision for loan losses increased from $250,000 in the first quarter of
last year to $400,000. The provision in the third and fourth quarters of 2004
were $525,000 and $350,000, respectively. The provision for loan losses reflects
the amount deemed appropriate to produce an adequate reserve for loan losses
inherent in the risk characteristics of the loan portfolio. In determining the
appropriate reserve balance, we consider the amount and type of new loans added
to the portfolio, our level of non-performing loans, the amount of loans charged
off, and the economic conditions that we currently operate within.
The provision for the first quarter is largely due to the inherent risks
identified in the portfolio. The loan portfolio (excluding loans held for sale
(LHFS)) grew $13 million in the quarter, or 6.4% annualized. Also affecting the
level of reserve for loan losses are the net loan charge-offs, which were
$211,000, up substantially compared to $71,000 for the same quarter last year.
On a sequential quarterly basis the charge-offs totaled $206,000 in the previous
quarter and $233,000 in the third quarter of 2004. Most of the charge-offs this
quarter (67%) are related to our sales finance loan portfolio. This pattern of
sales finance loans representing the largest category of charge-offs is
generally consistent with the trends that we have experienced in prior years.
Sales finance loans only constitute 8% of the total loan portfolio; however, due
to the characteristics of these loans, they comprise the bulk of our loan
write-offs. Please see the section, "Sales Finance (Home Improvement) Loans" for
a further discussion of this business line.
27
Our non-performing assets have fallen from $1,586,000 at March 31, 2004 to
$957,000 at the end of the first quarter 2005. The current level of
non-performing assets has also improved as compared to the year-end 2004 level
of $1,007,000. The ratio of non-performing assets to total assets was 0.09% at
March 31, 2005, which compares to 0.10% at year-end 2004 and 0.17% at March 31,
2004. Those ratios compare to 0.53% for FDIC insured institutions at December
31, 2004.*
* FDIC Quarterly Banking Profile, Fourth Quarter 2004
NON-PERFORMING ASSETS
Noted below is a summary of our exposure to non-performing loans and repossessed
assets:
Three single-family residences, one in OR, one in ID, and one in WA. No anticipated loss $ 607,000
Thirty-two consumer loans. Full recovery anticipated from insurance claims 238,000
Two business loans. No anticipated loss 73,000
Three consumer loans. Possible loss of $34,000 36,000
----------
TOTAL NON-PERFORMING LOANS $ 954,000
TOTAL REAL ESTATE OWNED AND REPOSSESSED ASSETS 3,000
----------
TOTAL NON-PERFORMING ASSETS $ 957,000
==========
PORTFOLIO INFORMATION
- ---------------------
COMMERCIAL REAL ESTATE LOANS. The average loan size (excluding construction
loans) in the Commercial Real Estate portfolio was $742,555 as of March 31,
2005, with an average loan-to-value ratio of 64%. At quarter-end, three of these
commercial loans were delinquent for 30 days or more. Small individual investors
or their limited liability companies and business owners typically own the
properties securing these loans. The portfolio is split between residential use
(multifamily or mobile home parks) and commercial use. At quarter-end, the
breakdown was 45% residential and 55% commercial.
The loans in our commercial real estate portfolio are well diversified, secured
by small retail shopping centers, office buildings, warehouses, mini-storage
facilities, restaurants and gas stations, as well as other properties classified
as general commercial use.
To diversify our risk and to continue serving our customers, we sell
participation interests in some loans to other financial institutions. About 14%
of commercial real estate loan balances originated by the Bank have been sold in
this manner. We continue to service the customer's loan and are paid a servicing
fee by the participant. Likewise, we occasionally buy an interest in loans
originated by other lenders. About $15 million of the portfolio, or 4%, has been
purchased in this manner.
SALES FINANCE (HOME IMPROVEMENT) LOANS. The level of loan production in the
first quarter of 2005 was essentially the same as production in the first
quarter of 2004. While production remained steady, portfolio growth has been
negative because we are selling a greater percentage of the new production.
Prepayment speeds continue to remain in a range of between 30% and 40%.
28
INSURED BALANCE (BANK
BANK PORTFOLIO SERVICING PORTFOLIO AND
BALANCE BALANCE SERVICING BALANCE)
- --------------------------------------------------------------------------------
March 31, 2004 $63 million $16 million $32 million
June 30, 2004 67 million 22 million 39 million
September 30, 2004 68 million 31 million 45 million
December 31, 2004 69 million 37 million 48 million
March 31, 2005 67 million 44 million 50 million
During the first quarter 2005, the average new loan amount was $10,700. The
current average remaining loan amount in the servicing portfolio is $9,300.
Loans with principal balances representing 40% of the Bank's portfolio balance
have credit insurance in place, and 33% (by balance) of the loans originated in
the first quarter were insured.
Noted below is the charge-off table for the uninsured portfolio and the claims
experience table for the insured portfolio:
UNINSURED PORTFOLIO
CHARGE-OFFS AS PERCENT (%)
LOAN NET CHARGE- A PERCENT (%) DELINQUENT
BALANCE OFFS OF PORTFOLIO LOANS
- --------------------------------------------------------------------------------
March 31, 2004 $40 million $50,000 0.13% 0.81%
June 30, 2004 41 million 136,000 0.33% 0.51%
September 30, 2004 40 million 71,000 0.18% 0.75%
December 31, 2004 41 million 100,000 0.24% 0.66%
March 31, 2005 40 million 141,000 0.35% 0.62%
INSURED PORTFOLIO
PERCENT (%) OF
DELINQUENT
CLAIMS AS A PERCENT LOANS
(%) OF INSURED (FMSB
CLAIMS PAID BALANCE PORTFOLIO)
- --------------------------------------------------------------------------------
March 31, 2004 $351,000 1.18% 1.93%
June 30, 2004 315,000 0.89% 1.51%
September 30, 2004 265,000 0.64% 2.11%
December 31, 2004 492,000 1.06% 2.58%
March 31, 2005 516,000 1.05% 2.75%
Our portfolio at March 31, 2005, totaled $67 million, of which $27 million was
insured. The $40 million of uninsured loans with an average credit score of 729
has performed at a fairly consistent level in terms of loan losses as a percent
of the portfolio over the last five quarters, ranging from 0.13% to 0.35% during
that time. The significant change has occurred in the lower credit score
(insured) portfolio, which has an average credit score of 668. Losses incurred
in that portfolio are submitted to our credit insurer for reimbursement. The
claims experience in the last 12 months has ranged between 0.64% (claims as a
percent of insured balances) and 1.18%. The
29
delinquency ratios on the insured portfolio have ranged between 1.51% and 2.75%
over the last five quarters.
Our contract with the credit insurer provides them with a maximum exposure limit
of 10% of the loan balances. Each year's loan production that is insured is
treated as a separate portfolio in terms of the 10% limit. The first pool that
was insured included loans closed between October 2002 and September 2003 and
totaled $21.8 million, with a maximum loss that could be claimed of $2.2
million. The loans in that pool currently have a balance of $12.3 million, and
we have a remaining lifetime loss credit of $760,000. Our loss credit balance is
6.2% of the remaining balance on the loans in the 2002/2003 policy year. The
remaining lifetime loss credit in this first policy year has steadily declined
from 9.2% in the second quarter of 2004 to 6.2% at the end of first quarter
2005. This indicates that claims are occurring faster than the pool's principal
balance is paid down. Projecting from historical claims rates and current
delinquency rates, the possibility exists that potential claims in this pool
year could exceed the remaining $760,000 available to pay claims. Absent a
renegotiated insurance policy with the current insurance company or a new policy
with another insurance company, claims in excess of $760,000 would likely not be
paid by the current insurance company. There are risks associated with the loss
of coverage on this pool. The immediate risk would be related to those loans
that are no longer eligible for reimbursement from the insurance carrier.
Charge-offs on those loans still on the Bank's books would be charged against
the Bank's reserve for loan losses. Charge-offs on loans sold to investors would
be passed to those investors. The Bank is exploring alternative credit
enhancements for this pool that would result in continued credit insurance for
the loans in this policy year. There is also the risk that investors in this
pool, and investors in future pools could react adversely to the lack of
insurance coverage.
The 2003 pool (loans insured between October 2003 and September 2004) contained
insured loans of $35 million and a maximum loss that could be claimed of $3.5
million. Our remaining insured balance is $25.6 million, and our remaining
lifetime loss credit is $2.85 million (or 11.1% of the remaining balances).
Through March 31, 2005, we have to date submitted $650,000 in claims against
this pool. The delinquency rate on the loans from that policy year, after a year
of normal seasoning, has ranged between 2.44% and 3.18%, which was the
delinquency rate on March 31, 2005.
DEPOSIT INFORMATION
- -------------------
The number of business checking accounts increased 26%, from 1,605 at March 31,
2004, to 2,021 as of March 31, 2005, a gain of 416 accounts. The deposit
balances for those accounts grew 53%. Consumer checking accounts also increased
from 5,967 in the first quarter of 2004 to 7,059 this year, an increase of 1,092
accounts, or 18%. Our total balances for consumer checking accounts rose 23%.
The following table shows the distribution of our deposits.
TIME MONEY MARKET REGULAR
DEPOSITS CHECKING ACCOUNTS SAVINGS
- --------------------------------------------------------------------------------
March 31, 2004 64% 11% 23% 2%
June 30, 2004 65% 12% 22% 1%
September 30, 2004 63% 13% 23% 1%
December 31, 2004 61% 14% 24% 1%
March 31, 2005 64% 13% 22% 1%
30
BUSINESS SEGMENTS
- -----------------
The management reporting process measures the performance of the operating
segments based on the management structure of the Bank and is not necessarily
comparable with similar information for any other financial institution.
The reportable segments include the following:
o CONSUMER LENDING - Consumer lending includes home equity lending,
direct consumer loans, and indirect home improvement loans (sales
finance). These loans include lines of credit and loans for primarily
consumer purposes.
o RESIDENTIAL LENDING - Residential lending offers loans to borrowers to
purchase, refinance, or build homes secured by one-to-four-unit family
dwellings. They also finance the purchase or refinance of buildable
residential lots.
o BUSINESS BANKING LENDING - Business Banking lending offers a full
range of banking services to small and medium size businesses
including deposit and cash management products, loans for financing
receivables, inventory, equipment as well as permanent and interim
construction loans for commercial real estate. The underlying real
estate collateral or business asset being financed typically secures
these loans.
o INCOME PROPERTY LENDING - Income Property lending offers permanent and
interim construction loans for multifamily housing (over four units),
manufactured housing communities, commercial real estate properties,
and spec single-family construction.
The underlying real estate collateral being financed typically secures these
loans. Each of these business segments also sells loans into the secondary
market. We 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.
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 derive a majority of
their revenue from interest income, and we rely primarily on net interest
revenue in managing these segments. No single customer provides more than 10% of
the Bank's revenues.
CONSUMER LENDING
----------------
First Quarter Return on Earning
Ended Net Income Equity Assets
----- ---------- ------ ------
2005 $ 386,000 18.2% $ 110,145,000
2004 368,000 18.4% 98,305,000
2003 (75,000) (6.1%) 71,452,000
Net income for the Consumer Lending segment totaled $386,000 for the first
quarter of 2005, representing a 5% increase over the first quarter 2004 result.
The segment's net interest income
31
was little changed relative to the first quarter of last year, and growth in
noninterest income was largely offset by additional noninterest expense.
The Consumer segment's earning assets totaled $110 million for the first quarter
of 2005, representing an increase of 12% over the first quarter 2004 level.
Asset growth for this segment has slowed over the last year as a result of sales
of loans from our sales finance (home improvement) loan portfolio. Through 2002,
the majority of these loans originated outside the Pacific Northwest were sold,
rather than retained in our portfolio. In late 2002, however, the decision was
made to retain a greater portion of these loans within the portfolio. This
decision contributed significantly to the earning asset growth observed between
2002 and 2003. As loan production increased and the portfolio gained in size, it
became necessary to manage that growth through quarterly loan sales.
Consequently, we revised our position on selling these consumer loans in late
summer 2003, with sales resuming in late 2003 and continuing through the present
time, resulting in a deceleration in earning asset growth. In addition to the
slowdown in earning asset growth, the Consumer Lending segment's interest income
was impacted by the fixed-rate nature of the sales finance loans, which comprise
most of the Segment's loan portfolio. The combination of a falling rate of asset
growth and fixed-rate loans resulted in an interest income increase of only 11%
as compared to the first quarter of 2004.
By comparison, interest expense rose over 34% relative to the first quarter of
2004, based on increases in both retail deposit and wholesale funding rates, as
well as the cost of the additional funds required to support the growth in
earning assets. Funding costs bank-wide had previously declined over the 2002 to
2004 timeframe as rates on our time deposits gradually repriced at lower levels
after interest rates fell between 2001 and 2003. Near the end of 2004, however,
the rates paid on our deposits began to trend upwards. This upward movement
accelerated in the first quarter of 2005 as competition for deposits in our
local market increased significantly, pushing time deposit rates substantially
higher. These effects were then compounded as we observed balances moving from
our lower cost checking and money market accounts to higher rate certificates.
The Consumer segment's net interest income increased approximately $32,000, or
2%, over the first quarter 2004 level. Following a $43,000 increase in the
provision for loan loss, however, the segment's net interest income after
provision declined $11,000, or slightly less than 1%, relative to the first
quarter of 2004.
The segment's noninterest income rose 133% this year, an increase of $492,000,
due to increased gains on sales of consumer loans and a significant increase in
service fee income. For the first quarter of 2005, we realized gains of $501,000
on loan sales totaling $10.6 million. This far exceeded the $275,000 in gains
realized on sales of $7.7 million in the first quarter of last year. Our current
plan is to continue to sell approximately $6 million to $8 million in sales
finance loans each quarter, although actual sales in any given quarter may fall
above or below this range depending on a number of factors, to include the
quarterly loan production and net portfolio growth.
Additionally, our income from servicing loans increased dramatically. Fees
earned on the consumer loans serviced for others totaled $300,000 for the first
quarter this year, a 12-fold increase over the first quarter of 2004. This
increase in consumer loan service fees was attributable in large part to a
change in estimates for the amortization period assumed for the underlying
servicing asset.
32
Servicing assets are recorded when we sell loans from our portfolio to other
investors, and continue to service those loans for the investors following the
sale. To determine the fair value of the servicing assets, we utilize a
valuation model that calculates the present value of future cash flows for the
loans sold based on assumptions including market discount rates, anticipated
prepayment speeds, estimated servicing cost per loan, and other relevant
factors. These factors are subject to significant fluctuations, and the
estimates used in the models are subject to review and revision based on actual
experience and changes in expectations for the future. The calculated value of
the servicing rights is then capitalized and amortized in proportion to, and
over the period of, estimated future net servicing income.
Based on a review of our assumptions in the first quarter of 2005, we determined
that the amortization period for the servicing rights on our consumer loan
servicing portfolio was significantly shorter than the term over which these
loans would be expected to provide net servicing income. Consequently, we
revised the amortization period such that the average life of the amortization
schedule would correspond with the average life we are currently observing for
the underlying loan portfolio.
Any projection of servicing asset amortization in future periods is limited by
the conditions that existed at the time the calculations were performed, and may
not be indicative of actual amortization expense that will be recorded in future
periods.
In addition to the effects of this change in estimates, the income received for
servicing consumer loans has grown as a result of the increased level of sales
finance loan sales over the last several quarters, and corresponding growth in
our portfolio of consumer loans serviced for others. The fees earned on the
portfolio of sales finance loans sold and serviced are expected to continue to
grow, though at a decreasing rate, as additional loans are sold each quarter to
manage the size of the sales finance loan portfolio.
Noninterest expense for the Consumer Lending segment increased $453,000, or 38%,
attributable primarily to higher credit insurance premium expense on the insured
part of our sales finance portfolio, though increases in administrative and
other allocated costs also contributed to the increase.
The insurance premium expense pertains to a credit insurance policy, which
insures us against default risk on loans to borrowers with credit scores below
720, and has risen as our portfolio of insured loans has increased in size. Our
insurance contract contains a variable premium that ranges between a low of
0.60% and a ceiling of 2.70% (as an annualized percentage of the outstanding
insured balances). We expect a premium of 2.70%, though the final premium will
be determined at a later date based on our actual loan loss history. There is
the possibility that our loss experience in the future will be more favorable,
in which case we could receive a rebate on premiums paid. However, based on our
loss experience to this point in time, we are not optimistic about any future
rebates.
Among other noninterest expense categories, administrative and support costs
allocated to this segment increased relative to the prior year. Included in
these allocated costs are expenses related to our Consumer Loan Administration
and Asset Management departments. The Consumer Loan Administration and Asset
Management expenses allocated to this segment have risen based on the increased
efforts required to manage the growing sales finance portfolio, including those
loans serviced for others.
33
RESIDENTIAL LENDING
-------------------
First Quarter Return on Earning
Ended Net Income Equity Assets
----- ---------- ------ ------
2005 $ 747,000 24.0% $ 305,276,000
2004 635,000 25.8% 245,542,000
2003 445,000 28.5% 166,494,000
Net income for the Residential Lending segment totaled $747,000 for the first
quarter of 2005, representing an 18% increase over the first quarter of 2004. As
was the case last year, the increase in net income was a result of substantial
growth in earning assets and net interest income, which was partly offset by
rising operating expenses.
Earning assets for the Residential segment totaled $305 million for the first
quarter of 2005, a 24% increase over the first quarter last year. With these
additional assets, interest income earned on the portfolio totaled $4.5 million,
a 27% increase over the first quarter of 2004. Interest expense, however, rose
36% from the first quarter of last year due to the rising funding rates
described above and the cost of the additional funds required to support the
earning asset growth. The increase in funding costs, combined with a $26,000
increase in the provision for loan losses, reduced the overall increase in the
Residential segment's net interest income after the provision to 20% over the
first quarter of 2004.
The Residential Lending segment's noninterest income increased $41,000, or 24%,
relative to the first quarter of 2004, based largely on higher loan fees,
specifically prepayment fees. In recent quarters, short-term interest rates have
risen, while longer-term interest rates, such as the 10-year U.S. Treasury rate,
which are more indicative of mortgage rates, have tended to move within a range
without any discernible upward or downward tendency. Combined, these movements
have resulted in a flattening of the yield curve. We believe that this
flattening, and expectations that rates could move upwards in the foreseeable
future, have contributed to the higher level of loan payoffs and prepayment fees
observed over the last several quarters. As this flattening of the yield curve
reduces the rate differential between short- and long-term financing costs, the
financial incentive for borrowers to use shorter-term, adjustable-rate financing
rather than longer-term, fixed-rate loans diminishes. This, in turn, provides
borrowers with short-term or adjustable-rate loans with an incentive to
refinance with long-term fixed rates. Given the uncertainties in interest rates
and borrower expectations, we do not know if the higher level of prepayment fees
is likely to continue.
For the first quarter of 2005, the Residential Lending segment's noninterest
expense increased 22%, or $304,000, relative to the same period in 2004, largely
attributable to rising administrative and other allocated costs. The
administrative costs include both expenses for general corporate activities,
which are allocated to all the business segments, as well as loan servicing and
administration costs attributable to the Residential Lending segment's
originations and portfolio management. Other allocated expenses included
expenses incurred at the banking centers and allocated to the Residential
Lending segment. These allocations have increased with the growth of the
Residential segment.
34
BUSINESS BANKING LENDING
------------------------
First Quarter Return on Earning
Ended Net Income Equity Assets
----- ---------- ------ ------
2005 $ (55,000) (2.3%) $ 123,543,000
2004 (37,000) (1.9%) 96,215,000
2003 14,000 0.9% 86,685,000
Our Business Banking segment's net income declined $18,000 to a net loss of
$55,000 for the first quarter of 2005, as increasing net interest income was
more than offset by additional operating expenses. These results were similar to
those observed in 2004, both for the first quarter and fiscal year.
The Business Banking segment is one of the newer business lines in which we have
invested, and continue to invest our resources with the eventual goal of
achieving our targeted 15% ROE and consistent year-over-year earnings growth. At
this time, these results have not yet been achieved, nor do we anticipate
reaching these goals in 2005. We continue to invest in this segment, however,
based upon its ability to attract low-cost core deposits, which help reduce our
overall cost of funds, the diversification it brings to our portfolio of earning
assets, and the potential it offers for generating longer-term
relationship-banking opportunities and additional sources of noninterest income.
For the first three months of 2005, the Business Banking segment's net interest
income after provision for loan losses rose $446,000, or 47%, as interest income
and expense each rose 49% from the first quarter of 2004. This represented the
most significant net interest income increase for any of the four business
segments. Like the Consumer and Residential segments, the Business Banking
segment succeeded in building incremental assets over the first quarter of last
year, with earning assets totaling $124 million for the first quarter of 2005,
representing an increase of 28% compared to the first quarter of 2004.
Also contributing to the increase in interest income is the prevalence of
prime-based loans in the business banking portfolio. Most of the adjustable-rate
loans in our portfolio reprice according to contractually defined schedules,
most commonly on an annual basis. The rates on prime-based loans, on the other
hand, typically adjust in response to any change in the prime rate.
Consequently, these loans reprice within days of any change to the index, rather
than at a specified reset date potentially months into the future, and may
reprice on several occasions over the course of the year, as has been the case
over the last 12 months.
The Business Banking segment's noninterest income rose 16% for the quarter,
totaling $103,000. In addition to the earning asset growth illustrated above,
the Business Banking segment has been very successful in growing its deposit
base, measured by both total deposit balances as well as the number of open
accounts. This deposit growth contributed greatly to the improvement in
noninterest income. Also contributing was an increase in the First Mutual Center
rental income allocated to this segment relative to the first quarter of last
year.
The additional net interest and noninterest income, however, were more than
offset by $488,000 in additional noninterest expense relative to the first
quarter of the prior year. This 44% increase in noninterest expense was largely
attributable to increases in compensation expense, particularly loan officer
commissions, as well as expenses from our retail banking centers allocated to
the Business Banking segment. The additional compensation expense was due to a
35
return to a normal level of incentive compensation this year, compared to a
below-average level of expense in the first quarter of 2004. The expenses from
our retail banking centers allocated to the Business Banking segment have
increased largely as a result of the strong growth of our business checking and
other commercial deposit accounts, costs for which are allocated to the Business
Banking segment.
INCOME PROPERTY LENDING
-----------------------
First Quarter Return on Earning
Ended Net Income Equity Assets
----- ---------- ------ ------
2005 $ 1,506,000 19.9% $ 439,124,000
2004 1,349,000 18.9% 432,301,000
2003 1,703,000 24.0% 439,029,000
For the first three months of 2005, the Income Property segment's net income
rose 12% from its first quarter 2004 level based on additional net interest
income and a modest reduction in operating expenses, which were partially offset
by a decline in noninterest income.
While the Income Property segment, one of our established business lines, has
traditionally met its ROE goal of at least 15%, it has had more difficulty in
accomplishing its objective of consistent earnings growth in recent years.
Interest income for this segment has declined steadily between 2002 and 2004, as
the yields earned on its portfolio of predominantly adjustable-rate multifamily
and commercial real estate loans has gradually fallen in response to
historically low short-term indices used to establish rates on the loans. For
the first quarter of 2005, the segment achieved 12% year-over-year net income
growth as asset yields began rising. While we are encouraged by this result, we
believe it premature at this point in time to consider this a trend to be
continued through the remainder of the year.
For the quarter, the Income Property segment's net interest income after
provision for loan loss rose $291,000, or 8%, relative to the first quarter of
2004, based on an 11% increase in interest income and offsetting 16% increase in
expense. Unlike the other segments, the Income Property segment has not
benefited from double-digit year-over-year growth in average earning assets,
instead growing less than 2% relative to the first quarter of last year. This
earning asset growth includes the effect of securities purchases made during
this timeframe, and particularly during the second quarter of 2004, when we
significantly increased the size of our securities portfolio. As noted earlier,
prior to 2004 our investment securities activities were contained within their
own business segment. Beginning in 2004, however, our segments were revised and
the assets, income, and expenses associated with our securities activities were
allocated to the new segments based upon their asset size. As our largest
business segment, Income Property is the recipient of the largest allocations of
our investment securities operations. Were it not for these allocations and the
substantial securities balances acquired in the second quarter of 2004, this
segment would not have achieved the asset growth noted above.
The Income Property segment's noninterest income declined significantly compared
to the first quarter of last year, falling 28%, or $75,000. Part of this
reduction was attributable to a decrease in our gains on securities sales. As
previously noted, the income associated with our securities activities,
including gains on sales, is allocated to the four business segments based upon
their asset size. In the first three months of 2004, gains on investment sales
totaled $71,000. By
36
comparison, we had no investment sales in the first quarter of 2005. As the
Income Property segment accounted for nearly half of all earning assets in 2004,
it was the recipient of the largest allocation of these gains. Also contributing
to the decline was a reduction in the First Mutual Center rental income
allocated to this segment relative to the first quarter of last year.
In contrast to the other business segments, noninterest expense for the Income
Property segment declined by slightly more than 1% compared to the first quarter
of 2004. Relative to the first quarter of 2004, the asset growth exhibited by
the other business lines was not observed with the Income Property segment.
Instead, the Income Property segment remained relatively static as the other
business lines grew their operations and became larger components of our overall
asset mix. Consequently, for a number of different expenses that we allocate out
to the business segments, such as banking center and administrative costs, the
percentages allocated to other business lines increased with their activity and
asset balances, and reduced the percentage allocated to the Income Property
segment relative to the first quarter of last year.
For the remainder of 2005, we expect to see the Income Property segment's
noninterest expenses increase relative to the levels for the same periods in
2004. This expectation is based on recent investment in the business line and,
ultimately, expected growth in the segment's loan portfolio. In recent months,
we successfully recruited experienced lending officers to replace personnel that
left the Bank over the course of 2004. Additionally, in April 2005, we hired a
new manager for this business line. This hiring will allow a senior level
officer, who previously divided his time between loan production and managing
the segment, to focus entirely on loan production and growing the segment's
earning assets. We anticipate that these changes will result in higher
noninterest expense for the segment going forward due to both the higher direct
expenses incurred as a result of the staffing changes as well as increases in
the banking center and other costs allocated to the segment as production ramps
up and earning asset growth increases.
LIQUIDITY
- ---------
Our primary sources of liquidity are loan and security sales and repayments,
deposits, and wholesale funds. A secondary source of liquidity is cash from
operations, which, though not a significant source of liquidity, is a consistent
source based upon the quality of our earnings. Our principal uses of liquidity
are the origination and acquisition of loans and securities. Liquidity is also
used to purchase facilities and equipment.
During the first quarter of 2005, we originated $118 million in loans and
purchased $6 million in securities.
37
Quarter Quarter
Ended Ended
March 31, March 31,
(Dollars in 000s) 2005 2004
-------------------------
Loan Originations (disbursed balance) $ 118,000 $ 102,000
Security Purchases 6,000 10,000
Draws on Lines of Credit (8,000) 4,000
-------------------------
Total Originations and Purchases 116,000 116,000
Loan and Security Repayments $ 83,000 $ 47,000
Sales of Securities 0 2,000
Sales of Loans 18,000 27,000
-------------------------
Total Repayments and Sales 101,000 76,000
Net Difference $ 15,000 $ 40,000
=========================
Loan and security sales and repayments, our primary sources of funding, are
heavily influenced by trends in mortgage rates. When rates trend downward, our
prepayment speeds typically increase as borrowers refinance their loans at lower
interest rates. Conversely, as rates move upwards, prepayments will generally
tend to slow, as fewer borrowers will have a financial incentive to refinance
their loans. The loan portfolio, excluding loans sold into the secondary market
and spec construction loans, experienced an annualized prepayment rate of 29% in
the first quarter of 2005, compared to 26% and 32% for the first quarter and
fiscal year 2004.
Movements in rates and the resulting shape of the yield curve have likely
contributed to the sustained high prepayment levels. As short-term rates
continued to rise in the third and fourth quarters of 2004, longer-term rates
declined in the third quarter, then tended to move within a fairly narrow range
in the fourth quarter, with no discernible upward or downward tendency. This
increase in short-term rates and decline in longer-term rates resulted in a
flattening of the yield curve, which continued into the first quarter of 2005.
With this flattening, the rate differential between short- and long-term
financing diminished, thus reducing the financial incentive for borrowers to use
shorter-term, adjustable-rate financing rather than longer-term, fixed-rate
loans. This, in turn, provides borrowers with short-term or adjustable-rate
loans with an incentive to refinance with long-term fixed rates. We believe this
situation contributed to the acceleration in prepayments observed in the second
half of 2004 and sustained high prepayment rates observed in the first quarter
of 2005.
Our preferred method of funding the net difference between
originations/purchases and repayments/sales is with deposits. To the extent that
deposit growth is insufficient to fully fund the difference, we may rely on
wholesale funding sources including, but not limited to FHLB advances, brokered
time deposits, and reverse repurchase agreements. During the first quarters of
2004 and 2005, growth in funds from deposits and FHLB borrowings were as
follows:
Quarter Quarter
Ended Ended
March 31, March 31,
(Dollars in 000s) 2005 2004
-------------------------
Deposits $ 16,000 $ 21,000
FHLB Advances 1,000 31,000
-------------------------
Total $ 17,000 $ 52,000
=========================
The inflow of deposits varies from period to period, and our ability to raise
liquidity from this source is dependent on our effectiveness in competing with
other financial institutions in our local market. That competition tends to
focus on rate and service. Although we control the
38
quality of service that we provide, we have no control over the prevailing rates
in our marketplace.
Our other major source of liquidity is wholesale funds, which include borrowings
from the FHLB, brokered deposits, reverse repurchase agreements, and a revolving
line of credit at the Company level. We rely significantly upon these wholesale
funds as sources of liquidity, as doing so allows us to avoid maintaining
balances of lower-yielding liquid assets for liquidity requirements.
Our most utilized wholesale funding source is FHLB advances, which totaled $235
million at March 31, 2005 and $234 million at December 31, 2004. Our credit line
with the FHLB is reviewed annually, and our maximum allowable borrowing level is
currently set at 40% of assets. As a percentage of period-ending assets, our
FHLB borrowings totaled 23% at both March 31, 2005 and the 2004 year-end.
Potential risks associated with this funding source include the reduction or
non-renewal of the line and insufficient collateral to utilize the line. We try
to mitigate the risk of non-renewal of the line by maintaining the credit
quality of our loans and securities and attending to the quality and consistency
of our earnings.
The risk of insufficient collateral to fully utilize the line is a more
strategic concern. Our long-term goal is to increase the relative level of our
business banking loan portfolio. As a general rule, these loans are not
considered eligible for collateral. Construction loans and many types of
consumer and commercial real estate loans are also not considered eligible for
collateral. The two principal sources of collateral are single-family
residential and multifamily loans. As we continue to evolve towards a community
bank, we are likely to reduce these sources of FHLB collateral relative to our
total asset base. We presently have sufficient collateral to meet our
anticipated 2005 funding needs; however, the long-term trend is an item of
continuing management attention.
Brokered deposits, which are included in the deposit totals, amounted to $40
million at the 2004 year-end and $36 million as of March 31, 2005. Internal
policies limit our total usage of these deposits to no more than 10% of all
deposits, and we do not have plans at this time to substantially increase our
use of these deposits.
Reverse repurchase lines are lines of credit collateralized by securities. We
have lines totaling $60 million, of which the full amount is currently
available. There was no usage of these lines in the previous three years. The
risks attendant with these lines are the withdrawal of the line based on the
credit standing of the Bank or the potential lack of sufficient collateral to
support the lines.
An additional source of liquidity has been our cash from operations, which,
though not a significant source of liquidity, is a consistent source, based upon
the quality of our earnings. On a very limited basis it can be viewed as cash
from operations adjusted for items such as the provision for loan loss and
depreciation. See the "Consolidated Statements of Cash Flows" in the financial
statements section of this filing for a calculation of net cash provided by
operating activities.
In addition to using liquidity to fund loans and securities, we routinely invest
in facilities and equipment. In the first quarter of 2005, we invested $1.9
million in these assets, up from $505,000 in the first quarter of 2004.
39
PLANNED EXPENDITURES FOR PLANT AND EQUIPMENT
- --------------------------------------------
In 2004 we completed the interior remodel of one banking center and began the
construction of an entire new facility for another existing banking center. We
continued this process in 2005 with the remodeling of two additional banking
centers. Once those are complete, we do not anticipate the need for any further
banking center remodels. In 2004 we also completed two land acquisitions, one in
West Seattle for $1,000,000 and one in Canyon Park for $1,038,000. We anticipate
construction of our new West Seattle banking center to begin in second quarter,
2005. It is possible that construction on our Canyon Park banking center can
begin as early as fourth quarter, 2005. In 2004 we also began a maintenance and
upgrade plan for our seven-story corporate headquarters, and we anticipate that
these plans will be completed by fourth quarter, 2005. We estimate that the
expenditures in the next three quarters will range from $5.0 million to $6.0
million depending on what projects are initiated this year and the extent to
which the existing facilities are remodeled.
We review 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, depending on the availability of capital resources
and the locations potential for growth and profitability.
We regularly analyze demographic and geographic data as well as information
regarding our competitors and our current loan and deposit customers in order to
locate potential future Bank sites.
CAPITAL
- -------
The FDIC's statutory framework for capital requirements establishes five
categories of capital strength, ranging from a high of well capitalized to a low
of critically under-capitalized. An institution's category depends upon its
capital level in relation to relevant capital measures, including a risk-based
capital measure, a leverage capital measure, and certain other factors. At March
31, 2005, we exceeded the capital levels required to meet the definition of a
well-capitalized institution:
40
Minimum to be Categorized
as "Well Capitalized" Under
Minimum for Capital Prompt Corrective Action
Actual Adequacy Purposes Provisions
------ ----------------- ----------
Total capital (to risk-weighted assets):
First Mutual Bancshares, Inc. 11.98% 8.00% N/A
First Mutual Bank 11.68 8.00 10.00
Tier I capital (to risk-weighted assets):
First Mutual Bancshares, Inc. 10.73 4.00 N/A
First Mutual Bank 10.43 4.00 6.00
Tier I capital (to average assets):
First Mutual Bancshares, Inc. 7.40 4.00 N/A
First Mutual Bank 7.32 4.00 5.00
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
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. 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, but are not
limited to, 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.
41
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, to assess projected earnings trends, and to 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.
HEDGING TECHNIQUES
We review interest rate trends on a monthly basis and employ hedging techniques
where 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. 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 (TPS) issued in June 2002. The
swap accomplished this by fixing the interest rate payable for the first five
years of the TPS' life.
NET INTEREST INCOME (NII) AND ECONOMIC VALUE OF EQUITY (EVE)
SIMULATION MODEL RESULTS
March 31, 2005 December 31, 2004
Percentage Change Percentage Change
Change in ----------------------------------------------------------------------------
Interest Rates Net Interest Economic Value Net Interest Economic Value
(in basis points) Income of Equity Income of Equity
- ------------------- ----------------- ---------------- ---------------- ----------------
+200 0.66% (2.68%) 0.89% (2.51%)
+100 n/a (0.56%) n/a (0.40%)
-100 (0.99%) (1.36%) (1.26%) (1.26%)
-200 * * * *
* Because a large percentage of our loan portfolio is tied to indexes that were
at very low levels as of December 31, 2004 and March 31, 2005, the downward 200
bps scenario was not computed.
NET INTEREST INCOME SIMULATION
The results of our income simulation model constructed using data as of March
31, 2005 indicate that our net interest income is projected to increase by 0.66%
from its "base case" level in an environment where interest rates gradually
increase by 200 bps over a 12-month period, and to decline 0.99% from the "base
case" in a scenario in which rates fall 100 bps. The magnitude of these changes
suggest that there is little sensitivity in net interest income from the "base
case" level over a 12-month horizon, with relatively consistent net interest
income in all three scenarios.
These changes indicated by the simulation model represent variances from a "base
case" scenario, which is our forecast of net interest income assuming interest
rates remain unchanged from their current levels and that zero balance sheet
growth occurs over the forecasted timeframe. The base model will, however,
illustrate the future effects of rate changes that have
42
already occurred but have not yet flowed through to all the assets and
liabilities on our balance sheet. These changes will either increase or decrease
net interest income, depending on the timing and magnitudes of those changes.
The current forecast of a decline in the margin in the second quarter of 2005
represents an implication of the "base case" scenario. As a result of recent
movement in retail deposit rates and resulting changes observed in customer
deposit preferences, as well as the change in the slope of the yield curve, the
"base case" forecast suggests that the net interest income margin will decline
from its first quarter level. The rising and falling rate ramp scenarios, on the
other hand, indicate that if the slope of the yield curve remains the same, and
customer loan and deposit preferences do not further change in response to
additional parallel movements of the yield curve, then a further 200 basis point
increase in rates will not significantly degrade net interest income from what
is presently expected in the base case. In the event the simulation model
indicated that the increase or decrease in interest rates over the following 12
months would adversely affect our net interest income over the same period by
more than 10% relative to the "base case" scenario, we would consider the
indicated risk to have exceeded our internal policy limit.
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.
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
based on 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 have exceeded our
internal policy limit. Again, as illustrated in the above results, we are
operating within the 25% internal policy limit in all scenarios.
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. Our EVE simulation model results as of March 31, 2005 indicate that our
assets and liabilities would be expected to exhibit nearly identical sensitivity
to the effects of rising rates, with the economic value of assets declining by
an estimated 2.64%, and liabilities within rounding error of the same number.
43
Given, however, that the economic value of assets exceeds that of liabilities
and that the sensitivity of assets was slightly higher than that of liabilities,
the reduction in the asset value was greater than the impact on liabilities.
Consequently, the economic value of our equity was negatively impacted in this
scenario, declining 2.68%.
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. The EVE is expected to be
positively impacted in this scenario. Counteracting this effect, however, is the
tendency of cash flows to accelerate in a falling rate scenario, 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 a negative
impact to EVE in the falling rate scenario as well. In this case, the economic
values of both assets and liabilities at March 31, 2005 were positively impacted
when rates were assumed to fall by 100 bps, assets by 1.12% and liabilities by
1.43%. In contrast to the rising rate scenario described above, in this instance
the impact of the 1.43% increase in the economic value of liabilities exceeded
that of the 1.12% increase in the economic value of assets. As a result, with
the value of liabilities rising more than asset values, our economic value of
equity was negatively impacted in this scenario as well, declining 1.36%.
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 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
In addition to the above simulation models, an interest "gap" analysis is used
to measure the matching of our assets and liabilities and exposure to changes in
interest rates. This 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 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
and economic value of equity models.
44
Our 12-month interest rate sensitivity gap, expressed as a percentage of assets,
fell from 2.6% at December 31, 2004 to 0.4% at the end of the first quarter.
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 year-end. The gap report has implied an
asset sensitive position for a number of quarters, dating back to September
2001.
ONE-YEAR INTEREST RATE SENSITIVITY GAP
(DOLLARS IN 000S)
March 31, 2005 December 31, 2004
-------------- --------------
One-Year Repricing/Maturing Assets $ 675,870 $ 665,665
One-Year Repricing/Maturing Liabilities 671,856 639,430
-------------- --------------
One-Year Gap $ 4,014 $ 26,235
============== ==============
Total Assets $ 1,021,903 $ 1,012,783
============== ==============
(Dec. 31, 2004 figure includes a $9 million off-balance-sheet item)
-------------- --------------
One-Year Interest Rate Gap as a Percentage of Assets 0.4% 2.6%
============== ==============
The significant factors contributing to the reduction in our 12-month gap ratio
since the year-end have been the continued popularity of our 15-month "bump"
time deposit with our customers, and the rolling of existing time deposits and
FHLB advances from expected terms to maturity or repricing of more than 12
months to within the 12-month timeframe.
Through the first quarter of 2005, our 15-month "bump" time deposit remained a
popular option with our deposit customers, as balances in this product increased
from $61 million at December 31, 2004 to $86 million at March 31, 2005. While
these time deposits are issued with a 15-month term to maturity, the depositor
is granted an option to reprice the time deposit to the prevailing 15-month
certificate rate on one occasion at any time during those 15 months. For the
purposes of the gap report we assume that the majority of depositors will
reprice their time deposits within one year of issue. Consequently, the majority
of these time deposits are considered to be less than one-year instruments for
gap purposes.
Also contributing significantly to the reduction in our gap ratio was the
rolling of existing time deposits and FHLB advances from expected terms to
maturity or repricing of more than 12 months to within the 12-month timeframe.
While total FHLB advances were little changed from the December 31, 2004
year-end, the volume of advances scheduled to mature or reprice within the
following 12 months increased $27 million between the year-end and the end of
the first quarter. A similar situation was observed with some of our time
deposit products, as the balances of outstanding 13- and 24-month time deposits
scheduled to mature within the next 12 months increased relative to the year-end
levels.
A change in modeling procedure impacted the total asset base used for the gap
ratio calculation by $9 million. As previously noted, in 2002 we entered into an
interest rate swap agreement to fix the interest rate on our first trust
preferred security issue for a period of five years. As of the December 2004
year-end, we classified the TPS as a variable-rate liability, offset by the
asset side of the swap, under which the Bank receives payments tied to the same
quarterly adjustable rate as the TPS issue. The other side of the swap, under
which the Bank makes payments based on a fixed interest rate, was applied to the
liability side of the gap report based on the remaining life of the swap. For
the March 31, 2005 model, the fixed-payment side of the swap, formerly a
45
$9 million liability, was moved to the asset side as a $9 million contra-asset.
As a result of this modification, our asset base for gap purposes now
corresponds to the level of total assets reflected on our financial statements,
rather than exceeding that amount by the $9 million notional principal of the
swap.
The greater increase of liabilities maturing or repricing in the next 12 months
versus assets resulted in a net $22 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 approximately $9 million, net of the $9 million
impact for the modeling change for our off-balance-sheet interest rate swap. The
combined effect of these two factors led to the decline in the one-year gap
ratio from 2.6% to 0.4% of total assets.
SECURITIES
ITEM 3
------
The following table sets forth certain information regarding carrying values and
percentage of total carrying values of the Bank's consolidated portfolio of
securities classified as available-for-sale and held-to-maturity (dollars in
thousands).
March 31,
---------------------------------------------------------
2005 2004
--------------------------- ---------------------------
Carrying Percent of Carrying Percent of
Available-for-Sale: Value Total Value Total
- ------------------- --------------------------- ---------------------------
US Government Treasury and agency obligations $ 17,723 14% $ 11,219 13%
Mortgage backed securities:
Freddie Mac 18,184 15% 15,370 18%
Ginnie Mae 51,891 42% 13,159 16%
Fannie Mae 36,551 29% 44,965 53%
--------------------------- ---------------------------
Total mortgage-backed securities 106,626 86% 73,494 87%
--------------------------------------------------------------------------- ---------------------------
Total securities available-for-sale $124,349 100% $ 84,713 100%
--------------------------------------------------------------------------- ---------------------------
March 31,
---------------------------------------------------------
2005 2004
--------------------------- ---------------------------
Carrying Percent of Carrying Percent of
Held-to-Maturity: Value Total Value Total
- ----------------- --------------------------- ---------------------------
Municipal Bonds $ 1,203 14% $ 1,281 15%
Mortgage backed securities:
Freddie Mac 487 6% 508 6%
Fannie Mae 6,597 80% 6,481 79%
--------------------------- ---------------------------
Total mortgage-backed securities 7,084 86% 6,989 85%
--------------------------------------------------------------------------- ---------------------------
Total securities held-to-maturity $ 8,287 100% $ 8,270 100%
--------------------------------------------------------------------------- ---------------------------
------------------------------------------------------------ ------------
Estimated Market Value $ 8,339 $ 8,438
------------------------------------------------------------ ------------
46
ITEM 3A
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 March 31, 2005
-------------------------------------------------------------------------------------
Over One to Over Three to Over Five to
One Year or Less Three Years Five Years Ten Years
-------------------------------------------------------------------------------------
Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
-------------------------------------------------------------------------------------
Available-for-Sale:
US Government Treasury and agency
obligations $ 6,936 1.88% $ -- 0.00% $ 5,882 4.08% $ -- 0.00%
Mortgage backed securities:
Ginnie Mae -- 0.00% 42,084 4.09% 9,806 4.00% -- 0.00%
Freddie Mac 295 4.10% -- 0.00% 2,403 4.18% 7,554 4.04%
Fannie Mae 517 4.47% -- 0.00% 835 5.50% 4,251 4.13%
------------------------------------------------------------------------------------
Total mortgage-backed securities 812 4.34% 42,084 4.09% 13,044 4.13% 11,805 4.07%
------------------------------------------------------------------------------------
Total securities available-for-sale
-- Carrying Value $ 7,748 2.13% $ 42,084 4.09% $ 18,926 4.12% $ 11,805 4.07%
------------------------------------------------------------------------------------
Total securities available-for-sale
-- Amortized Cost $ 7,769 2.13% $ 42,315 4.09% $ 19,146 4.11% $ 12,051 4.06%
------------------------------------------------------------------------------------
Available-for-sale at March 31, 2005
---------------------------------------------------------------
Over Ten to
Twenty Years Over Twenty Years Total
---------------------------------------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
---------------------------------------------------------------
Available-for-Sale:
US Government Treasury and agency
obligations $ 4,905 4.00% $ -- 0.00% $ 17,723 3.20%
Mortgage backed securities:
Ginnie Mae -- 0.00% -- 0.00% 51,890 4.07%
Freddie Mac 7,933 4.50% -- 0.00% 18,185 4.26%
Fannie Mae 30,948 4.30% -- 0.00% 36,551 4.31%
--------------------------------------------------------------
Total mortgage-backed securities 38,881 4.34% -- 0.00% 106,626 4.18%
--------------------------------------------------------------
Total securities available-for-sale
-- Carrying Value $ 43,786 4.30% $ -- 0.00% $124,349 4.04%
--------------------------------------------------------------
Total securities available-for-sale
-- Amortized Cost $ 45,294 4.30% $ -- 0.00% $126,574 4.04%
--------------------------------------------------------------
Held-to-Maturity at Mar 31, 2005
-------------------------------------------------------------------------------------
Over One to Over Three to Over Five to
One Year or Less Three Years Five Years Ten Years
-------------------------------------------------------------------------------------
Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
-------------------------------------------------------------------------------------
Held-to-Maturity:
Municipal Bonds $ -- 0.00% $ -- 0.00% $ -- 0.00% $ -- 0.00%
Mortgage backed securities:
Freddie Mac 487 3.53% -- 0.00% -- 0.00% -- 0.00%
Fannie Mae 2,828 4.92% 167 6.50% 1,736 4.54% -- 0.00%
------------------------------------------------------------------------------------
Total mortgage-backed securities 3,315 4.72% 167 6.50% 1,736 4.54% -- 0.00%
------------------------------------------------------------------------------------
Total securities held-to-maturity
-- Carrying Value $ 3,315 4.72% $ 167 6.50% $ 1,736 4.54% $ -- 0.00%
------------------------------------------------------------------------------------
Total securities held-to-maturity
-- Fair Market Value $ 3,411 4.72% $ 170 6.50% $ 1,731 4.56% $ -- 0.00%
------------------------------------------------------------------------------------
Held-to-Maturity at Mar 31, 2005
---------------------------------------------------------------
Over Ten to
Twenty Years Over Twenty Years Total
---------------------------------------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
---------------------------------------------------------------
Held-to-Maturity:
Municipal Bonds $ 220 5.38% $ 983 6.27% $ 1,203 6.11%
Mortgage backed securities:
Freddie Mac -- 0.00% -- 0.00% 487 3.53%
Fannie Mae 1,867 4.77% -- 0.00% 6,598 4.82%
--------------------------------------------------------------
Total mortgage-backed securities 1,867 4.77% -- 0.00% 7,085 4.73%
--------------------------------------------------------------
Total securities held-to-maturity
-- Carrying Value $ 2,087 4.84% $ 983 6.27% $ 8,288 4.93%
--------------------------------------------------------------
Total securities held-to-maturity
-- Fair Market Value $ 2,047 4.84% $ 980 6.27% $ 8,338 4.93%
--------------------------------------------------------------
47
ITEM 4. Controls and Procedures
An evaluation of the Company's disclosure controls and procedures (as defined in
Rules 13a-15(e) of the Securities Exchange Act of 1934 (the "Act")) was carried
out under the supervision and with the participation of the Company's Chief
Executive Officer, Chief Financial Officer, and other members of the Company's
senior management, as of the end of the period covered by this report (the
"Evaluation Date"). Based upon this evaluation, the Company's Chief Executive
Officer and Chief Financial Officer concluded that, as of the Evaluation Date,
the Company's disclosure controls and procedures are effective in providing
reasonable assurance that the material information required to be disclosed by
the Company in the reports it files or submits under the Act is (i) accumulated
and communicated to the Company's management (including the Company's Chief
Executive Officer and Chief Financial Officer) in a timely manner, and (ii)
recorded, processed, summarized, and reported within the time periods specified
in the SEC's rules and forms.
PART II: OTHER INFORMATION
ITEM 1. Legal Proceedings
At March 31, 2005, the Company was not engaged in any litigation, which in the
opinion of management, after consultation with its legal counsel, would be
material to the Company.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
48
ITEM 5. Other Information
None.
ITEM 6. Exhibits
(a)
(3.1) Articles of Incorporation, incorporated by reference to the
Current Report on Form 8-K filed with the SEC on September 21,
2000.
(3.2) Amendment to Articles of Incorporation, incorporated by reference
on Form 10-Q filed with the SEC on May 13, 2002.
(3.3) Bylaws (as amended and restated), incorporated by reference on
Form 10-Q filed with the SEC on August 13, 2004.
(11) Statement regarding computation of per share earnings. Reference
is made to the Company's Consolidated Statements of Income
attached hereto as part of Item I Financial Statements, which are
incorporated herein by reference.
(14) Code of Business Conduct and Ethics, incorporated by reference on
Form 10-K filed with the SEC on March 16, 2005.
(31.1) Certification by President and Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act.
(31.2) Certification by Executive Vice President and Chief Financial
Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
(32) Certification by Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act.
49
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 6, 2005 FIRST MUTUAL BANCSHARES, INC.
/s/ John R. Valaas
-----------------------------------------
John R. Valaas
President and Chief Executive Officer
/s/ Roger A. Mandery
-----------------------------------------
Roger A. Mandery
Executive Vice President
(Principal Financial Officer)
50