UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C.  20549

 

FORM 10-Q

 

 

 

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 ý NO o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

YES ý NO o

 

As of April 29, 2003, 16,891,453 shares of common stock were outstanding with no par value.

 

 

PACIFIC NORTHWEST BANCORP

 

INDEX
PART I.				FINANCIAL INFORMATION
Item 1.				Financial Statements
				Consolidated Statements of Financial Condition as of March 31, 2003 and December 31, 2002
				Consolidated Statements of Income for the three-month periods ended March 31, 2003 and 2002
				Consolidated Statements of Shareholders’ Equity for the three-month periods ended March 31, 2003 and 2002
				Consolidated Statements of Cash Flows for the three-month periods ended March 31, 2003 and 2002
				Notes to Unaudited Consolidated Financial Statements
Item 2.				Management Discussion and Analysis of Financial Condition and Results of Operations
Item 3.				Quantitative and Qualitative Disclosures About Market Risk
Item 4.				Controls and Procedures
PART II.				OTHER INFORMATION
Item 1.				Legal Proceedings
Item 6.				Exhibits and Reports on Form 8-K
SIGNATURES
CERTIFICATIONS

 

 

PART I. FINANCIAL INFORMATION

 

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

 

Dollars in thousands		March 31, 2003			December 31, 2002
		(UNAUDITED)
Assets
Cash and due from banks
Non-interest-bearing		$	72,965		$	92,541
Interest-bearing		10,785			7,461
Federal funds sold and securities purchased under agreements to resell		15,620			950
Securities available for sale		787,308			788,546
Loans held for sale		12,218			25,621
Loans receivable		2,042,069			2,029,753
Allowance for losses on loans		(27,080		)	(26,940		)
Net loans receivable		2,014,989			2,002,813
Interest receivable		13,524			14,306
Other real estate		6,548			7,152
Premises and equipment		45,071			48,082
Goodwill		67,732			67,732
Other intangible assets		10,090			10,505
Bank owned life insurance		57,581			56,995
Other assets		4,676			4,305
Total assets		$	3,119,107		$	3,127,009
Liabilities
Deposits:
Non-interest-bearing		$	359,848		$	345,571
Interest-bearing		1,717,245			1,708,739
Total deposits		2,077,093			2,054,310
Federal Home Loan Bank (FHLB) advances		566,066			609,581
Federal funds purchased and securities sold under agreements to repurchase		121,627			120,706
Guaranteed preferred beneficial interests in subordinated debt		52,000			48,000
Other borrowings		10,067			10,072
Other liabilities		25,796			22,727
Total liabilities		2,852,649			2,865,396
Shareholders’ Equity
Common stock, no par value, authorized shares 30,000,000 issued and outstanding: 16,859,146 and 16,799,472 shares		—			—-
Paid-in-capital		65,818			64,995
Retained earnings		198,967			192,942
Accumulated other comprehensive income		1,673			3,676
Total shareholders’ equity		266,458			261,613
Total liabilities and shareholders’ equity		$	3,119,107		$	3,127,009

 

See accompanying notes to consolidated financial statements.

 

1

 

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

 

		Three-month periods ended March 31,
Dollars in thousands, except per share amounts		2003			2002
Interest Income
Loans receivable and loans held for sale		$	34,570		$	34,509
Securities available for sale		8,464			10,400
Other		19			7
		43,053			44,916
Interest Expense
Deposits		7,770			8,877
FHLB advances and other borrowings		6,184			6,574
Securities sold under agreements to repurchase		733			1,195
Guaranteed preferred beneficial interests in subordinated debt		1,044			926
		15,731			17,572
Net interest income		27,322			27,344
Provision for losses on loans		1,250			1,700
Net interest income after provision for losses on loans		26,072			25,644
Non-interest Income
Service fees		3,836			3,177
Investment product fees and insurance commissions		427			328
Gain on sale of loans		404			748
Loss on sale of securities available for sale		(2		)	—
Bank owned life insurance income		585			—
Other		260			332
		5,510			4,585
Non-interest Expense
Compensation and employee benefits		10,105			9,819
General and administrative		3,903			4,265
Occupancy and equipment		3,201			3,121
Data processing		1,454			1,385
Severance and employment agreements		212			—
Other real estate owned		142			2
		19,017			18,592
Income before income tax expense		12,565			11,637
Income tax expense		4,182			4,073
Net income		$	8,383		$	7,564
Basic net income per share		$	0.50		$	0.49
Diluted net income per share		$	0.48		$	0.48
Dividends declared per share		$	0.14		$	0.14

 

See accompanying notes to consolidated financial statements.

 

2

 

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)

 

Dollars in thousands, except share data		Common Stock, no par value Shares		Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Debt Related To ESOP			Total
January 1, 2002		15,595,204		$	26,757		$	172,967		$	1,305		$	(543)		$	200,486
Dividends declared, $0.14 per share							(2,166		)							(2,166		)
Issuance of common stock:
Stock option plans		56,566		604												604
Purchase and retirement of common stock		(215,896	)	(5,117		)										(5,117		)
ESOP debt repayment		17,707											543			543
Comprehensive income:
Net income							7,564									7,564
Other comprehensive income -
Unrealized loss on securities availablefor sale, net of taxes of $1,444										(2,683		)				(2,683		)
Total comprehensive income																4,881
March 31, 2002		15,453,581		$	22,244		$	178,365		$	(1,378	)	$	0		$	199,231
January 1, 2003		16,799,472		$	64,995		$	192,942		$	3,676		$	0		$	261,613
Dividends declared, $0.14 per share							(2,358		)							(2,358		)
Issuance of common stock:
Stock option plans		163,965		2,401												2,401
Tax deduction on stock option exercises				1,192												1,192
Purchase and retirement of common stock		(104,291	)	(2,770		)										(2,770		)
Comprehensive income:
Net income							8,383									8,383
Other comprehensive income –
Unrealized loss on securities available forsale, net of taxes of $1,080										(2,004		)				(2,004		)
Reclass adjustment for losses included innet income, net of tax of $1										1						1
Total comprehensive income																6,380
March 31, 2003		16,859,146		65,818			$	198,967		$	1,673		$	0		$	266,458

 

See accompanying notes to consolidated financial statements.

 

3

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

		Three-month periods ended March 31,
Dollars in thousands		2003			2002
Operating Activities
Net income		$	8,383		$	7,564
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		1,298			1,332
Amortization of intangible assets		414			232
Provision for losses on loans		1,250			1,700
Amortization of premiums and discounts, net		1,246			249
Gain on sale of loans and loan servicing		(404		)	(748		)
Loss on sale of securities available for sale		2			—
(Gain)/Loss on sale of other real estate		2			(18		)
Write-downs on other real estate		50			—
(Gain)/Loss on disposal of premises and equipment		(136		)	82
Income from bank owned life insurance		(585		)	—
Loan fees deferred, net of amortization		(123		)	589
FHLB stock dividends		(875		)	(682		)
Changes in operating assets and liabilities:
Decrease in interest receivable		776			706
Increase in other assets		(1,114		)	(3,760		)
Increase in other liabilities		5,680			4,973
Net cash provided by operating activities		$	15,864		$	12,219
Investing Activities
Purchases of securities available for sale		(251,012		)	(92,774		)
Proceeds from maturing and principal repayments on securities available for sale		138,210			113,140
Proceeds from sale of securities available for sale		110,614			—
Proceeds from sale of loans		11,069			59,124
Net increase in loans receivable		(11,665		)	(67,854		)
Proceeds from sale of other real estate		1,864			1,852
Improvements capitalized to other real estate		(213		)	(78		)
Purchases of premises and equipment		(1,388		)	(648		)
Proceeds from sales of premises and equipment		3,237			62
Net increase in federal funds sold and securities purchased under agreements to resell		(14,670		)	(11,455		)
Net cash provided by (used in) investing activities		$	(13,954	)	$	1,369

 

See accompanying notes to consolidated financial statements.

 

4

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) continued

 

		Three-month periods ended March 31,
Dollars in thousands		2003			2002
Financing Activities
Net increase in deposits		$	43,599		$	53,589
Net increase (decrease) in certificates of deposit		(20,816		)	42,426
Proceeds from FHLB advances, securities sold under agreements to repurchase, and other borrowings		2,073,010			1,201,554
Repayment of FHLB advances, securities sold under agreements to repurchase and other borrowings		(2,115,608		)	(1,302,920		)
Dividends paid to shareholders		(2,352		)	(2,186		)
Proceeds from re-issuance of guaranteed subordinated debt		4,373			—
Purchase and retirement of common stock		(2,770		)	(5,117		)
Issuance of common stock from exercise of stock options		2,402			604
Net cash used in financing activities		(18,162		)	(12,050		)
Net increase (decrease) in cash and due from banks		(16,252		)	1,538
Cash and due from banks
Beginning of period		100,002			58,625
End of period		$	83,750		$	60,163
Supplemental Disclosures of Cash Flow Information
Cash paid during the period for:
Interest		$	15,214		$	17,668
Income taxes		95			2,500
Non-cash investing and financing activities:
Loans receivable transferred to other real estate		1,099			1,937
ESOP debt repayment		—			543

 

See accompanying notes to consolidated financial statements.

 

5

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE A BASIS OF PRESENTATION

 

Pacific Northwest Bancorp is a bank holding company incorporated in the state of Washington.  Through its commercial banking subsidiary, Pacific Northwest Bank, a wide range of financial services is offered to businesses and individuals in its market area including investment products available through its subsidiary, Pacific Northwest Financial Services, Inc. and insurance products available through its subsidiary, Pacific Northwest Insurance Agency, Inc.  Pacific Northwest Bank operates 58 Financial Centers in the Pacific Northwest, including the metropolitan areas of Seattle and Bellevue, Washington, and Portland, Oregon, and other areas of western and central Washington.

 

The unaudited consolidated financial statements include the accounts of Pacific Northwest Bancorp and its wholly owned subsidiaries (collectively PNWB).  As of March 31, 2003, Pacific Northwest Bancorp’s wholly owned subsidiaries were Pacific Northwest Bank, InterWest Capital Trust I and Pacific Northwest Statutory Trust I.  All material inter-company transactions and balances have been eliminated in consolidation.

 

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect amounts reported in the consolidated financial statements.  Changes in these estimates and assumptions are considered reasonably possible and may have a material impact on the consolidated financial statements and thus actual results could differ from the amounts reported and disclosed herein.

 

The unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.  In the opinion of management, all adjustments necessary for a fair presentation are reflected in the unaudited interim consolidated financial statements.  The consolidated statements of income for the three-month periods ended March 31, 2003 and 2002 are not necessarily indicative of the operating results for the full year.  For further information, refer to the consolidated financial statements and footnotes filed on the Form 10-K for the most recent annual period ended December 31, 2002.

 

NOTE B STOCK BASED COMPENSATION

 

PNWB accounts for stock-based employee compensation plan using the intrinsic value method prescribed in Accounting Principle Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees.”   No stock-based employee compensation cost is reflected in net income, as all stock options are granted at exercise prices not less than the fair value of common stock on the date of grant.  PNWB has elected to apply the disclosure only provisions of Statement of Financial Accounting Standards (SFAS) No. 148, “Accounting for Stock-Based Compensation.”  The following table illustrates the effect on net income and earnings per share if PNWB had applied the fair value recognition provisions of FASB Statement No. 148 to stock-based employee compensation.

 

			Three-months ended
Dollars in thousands, except per share amounts			March 31, 2003			March 31, 2002
Net income, as reported			$	8,383		$	7,564
Less:	Total stock-based employee compensation Expense determined under fair value based method for all awards, net of related tax effects		263			394
Pro forma net income			$	8,120		$	7,170
Earnings per share:
Basic - as reported			$	0.50		$	0.49
Basic - pro forma			$	0.48		$	0.46
Diluted - as reported			$	0.48		$	0.48
Diluted - pro forma			$	0.46		$	0.45

 

6

 

NOTE C NET INCOME PER SHARE

 

Basic net income per share is calculated by dividing net income by the weighted average number of common shares outstanding during the period.  Diluted net income per share is calculated by dividing net income by diluted weighted average shares outstanding, which includes common stock equivalent shares outstanding using the treasury stock method, unless such shares are anti-dilutive.  Common stock equivalents include shares issuable upon exercise of stock options.  Unallocated shares relating to the employee stock ownership plan debt obligation are deducted in the calculation of weighted average shares outstanding.

 

The following table presents the computation of basic and diluted net income per share for the three-month periods ended March 31:

 

Dollars in thousands, except share and per share amounts		2003			2002
Numerator:
Net income		$	8,383		$	7,564
Denominator:
Denominator for basic net income per share- Weighted average shares		16,851,985			15,534,568
Effect of dilutive securities:
Stock options		692,352			314,189
Denominator for diluted net income per share- Weighted average shares and assumed conversion of dilutive stock options		17,544,337			15,848,757
Basic net income per share		$	0.50		$	0.49
Diluted net income per share		$	0.48		$	0.48

 

NOTE D BUSINESS SEGMENT INFORMATION

 

Between the period August 31, 1996 and October 1999, PNWB acquired six commercial banking institutions. Subsequent to the acquisitions of Pacific Northwest Bank, First National Bank of Port Orchard, Pioneer Bank and Kittitas Valley Bank in 1998, PNWB was managed at the individual subsidiary bank level.  Each subsidiary bank had a Board of Directors and an executive management team that was responsible for the operation and performance of the respective subsidiary bank. During the year ended December 31, 2000, PNWB merged the subsidiary banks into one commercial bank.  In addition, PNWB consolidated its executive management functions and implemented a new organizational structure, while converting separate banking systems into a single operating system.

 

On November 13, 2002, PNWB completed the acquisition of Bank of the Northwest (BKNW) and merged BKNW into its commercial bank subsidiary, Pacific Northwest Bank.  BKNW operated five branch offices in the metropolitan Portland market area. On December 9, 2002, PNWB successfully completed the information systems and data conversion of BKNW and all of the five BKNW branches were renamed Pacific Northwest Bank.

 

As a result of these organizational and system changes, the financial information that is used by the chief operating decision maker in allocating resources and assessing performance is only provided for one reportable segment for the three-month periods ended March 31, 2003 and 2002.

 

7

 

NOTE E SECURITIES PLEDGED UNDER AGREEMENTS TO REPURCHASE

 

PNWB has sold certain securities of the U.S. government and its agencies and other approved investments under agreements to repurchase.  The securities sold were classified as securities available for sale with an estimated fair value of $73.7 million and $82.2 million as of March 31, 2003 and December 31, 2002, respectively.

 

NOTE F OFF BALANCE SHEET LOAN COMMITTMENTS

 

As of March 31, 2003, PNWB had $237,957,000 in real estate loan commitments to extend credit.  Other loan commitments to extend credit, which include commercial and consumer lines of credit, totaled $499,040,000 as of March 31, 2003.  Outstanding commitments to extend credit under standby letters of credit and commercial letters of credit totaled $63,645,000 and $17,290,000 as of March 31, 2003.

 

NOTE G ACCOUNTING CHANGES

 

In January 2003, the FASB issued SFAS No. 148 “Accounting for Stock-Based Compensation-Transition and Disclosure”. SFAS No. 148 amends FASB Statement No. 123 “Accounting for Stock-Based Compensation” and provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based compensation. In addition, SFAS No. 148 amends the disclosure requirements of Statement 123 to require more prominent and quarterly disclosures in financial statements about the effects of stock-based compensation.  SFAS No. 148 became effective immediately for fiscal years ending after December 15, 2002.  The adoption of this statement affected the disclosures in PNWB’s consolidated financial statements; however, it had no material impact on PNWB’s financial condition or results of operations.

 

In July 2002, the FASB issued SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities”.  SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3 “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)”.  SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred as opposed to when a plan is developed as required by EITF Issue No. 94-3.  SFAS No. 146 became effective on January 1, 2003.  The adoption of SFAS No. 146 had no material impact on PNWB’s financial condition or results of operations.

 

8

 

Item 2.    MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

FORWARD-LOOKING STATEMENTS

 

This document, including information included with or incorporated by reference in this document, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict.  Actual outcomes and results may differ materially from those expressed in, or implied by, our forward-looking statements.  Words such as “expects,” “anticipates,” “believes,” “estimates,” “intends,” “strategy,” other similar expressions or future or conditional verbs such as “will,” “may,” “should,” “would,” and “could” are intended to identify such forward-looking statements.  Readers should not rely solely on the forward-looking statements and should consider all uncertainties and risks throughout this document.  The statements are representative only as of the date they are made, and PNWB undertakes no obligation to update any forward-looking statement.

 

Possible events or factors that could cause results or performance to differ materially from those expressed in our forward-looking statements include, but are not limited to, the following:  changes in general economic conditions and economic conditions in the geographic areas in which PNWB operates which may affect, among other things, the level of nonperforming loans, charge-offs, and provision expense; changes in the interest rate environment which may reduce interest margins and impact funding sources; litigation liabilities, including costs, expenses, settlements and judgments; changes in tax laws, rules and regulations as well as Internal Revenue Service (IRS) or other governmental agencies’ interpretations thereof; legislative, regulatory and accounting changes affecting the banking and financial services industry; competition with other local, regional and national banks, thrifts, credit unions and other non-bank financial institutions; ability to grow core businesses; ability to develop and introduce new banking-related products, services and enhancements and gain market acceptance of such products; mergers and acquisitions and their integration into PNWB; and management’s ability to manage these and other risks.

 

OVERVIEW

 

Headquartered in Seattle, WA, Pacific Northwest Bancorp is a Washington based bank holding company providing financial services through its commercial banking subsidiary, Pacific Northwest Bank.  Pacific Northwest Bank operates 58 Financial Centers in the Pacific Northwest, including the metropolitan areas of Seattle and Bellevue, Washington, and Portland, Oregon, and other areas of western and central Washington. Pacific Northwest Bank offers a wide range of financial services to businesses and individuals in its market area, including investment products available through its subsidiary, Pacific Northwest Financial Services, Inc. and insurance products available through its subsidiary, Pacific Northwest Insurance Agency, Inc. As part of the migration to a commercial bank, PNWB has made significant progress in restructuring its balance sheet since mid-2000 so that it is more reflective of a commercial bank.

 

A source of future growth may be through mergers and acquisitions.  PNWB’s management believes that many other financial institutions are considering selling their institutions for a variety of reasons, including lack of shareholder liquidity, management succession issues, technology challenges, and increasing competition. PNWB actively reviews proposals for various acquisition opportunities.  PNWB has a due diligence review process to evaluate potential acquisitions and has established parameters for potential acquisitions relating to market factors, financial performance and certain non-financial factors.  Successful completion of acquisitions by PNWB depends on several factors such as the availability of suitable acquisition candidates, necessary regulatory and shareholder approval and compliance with applicable capital requirements.  No assurance can be made that acquisition activity will continue in the future.

 

9

 

RESULTS OF OPERATIONS

 

PNWB had net income of $8.4 million for the three-month period ended March 31, 2003, compared to $7.6 million for the three-month period ended March 31, 2002.  Diluted net income per share was $0.48 for the three-month periods ended March 31, 2003 and 2002. PNWB’s return on average shareholders’ equity was 12.64 percent for the three-month period ended March 31, 2003, compared to 15.06 percent for the three-month period ended March 31, 2002.  PNWB’s return on average assets was 1.08 percent for the three-month period ended March 31, 2003, compared to 1.11 percent for the three-month period ended March 31, 2002.

 

The following table summarizes net income, net income per share and key financial ratios for the three-month periods ended March 31:

 

Dollars in thousands, except per share amounts		2003			2002
Net income		$	8,383		$	7,564
Basic net income per share		$	0.50		$	0.49
Diluted net income per share		$	0.48		$	0.48
Return on average shareholders’ equity		12.64%			15.06%
Return on average assets		1.08%			1.11%
Net interest margin		3.88%			4.26%
Efficiency ratio		57.92%			58.23%

 

Net Interest Income  |PNWB’s net income is significantly affected by changes in net interest income, which is the interest income received on loans receivable and other interest-earning assets less the interest expense on deposits and borrowings. PNWB’s net interest income is sensitive to changes in interest rates.  Net interest income before the provision for losses on loans were $27.3 million for both the three-month periods ended March 31, 2003 and March 31, 2002.

 

Net interest margin, which is net interest income divided by average interest-earning assets, was 3.88 percent for the three-month period ended March 31, 2003, compared to 4.26 percent for the three-month period ended March 31, 2002. Net interest margin decreased as a result of PNWB’s asset sensitive position in the low and decreasing interest rate environment during the past year.  Loans repriced at lower rates and the proceeds from investments that matured, were called or prepaid were reinvested at lower yields.  The decrease in net interest margin was also a result of management’s implementation of the bank owned life insurance (BOLI) strategy in April of 2002.

 

Interest income was $43.1 million for the three-month period ended March 31, 2003, compared to $44.9 million for the three-month period ended March 31, 2002. This decrease was primarily due to lower yields earned on loans and securities, partially offset by increases in volume from the first quarter of 2002. The yield on interest-earning assets was 6.11 percent and 7.00 percent for the three-month periods ended March 31, 2003 and, 2002, respectively.

 

Interest expense was $15.7 million for the three-month period ended March 31, 2003, compared to $17.6 million for the three-month period ended March 31, 2002.  The decrease in interest expense was primarily due to a decrease in the cost of funds as a result of reductions of market interest rates and management’s restructuring of the funding base.  The average balances of lower-costing deposits increased while the higher-costing borrowings decreased from the first quarter of 2003.  The cost of funds was 2.55 percent for the three-month period ended March 31, 2003, compared to 3.13 percent for the same period in 2002.

 

Average Rates and Balances | The following table indicates the average balance and average interest rates earned or paid, interest rate spread and net interest margin for the three-month periods ended March 31:

 

10

 

		2003					2002
Dollars in thousands		Average Balance			Rate		Average Balance			Rate
Loans receivable and loans held for sale		$	2,028,899		6.86	%	$	1,839,789		7.56	%
Securities held to maturity and other interest-earning assets		805,164			4.21	%	742,558			5.61	%
Total interest-earning assets		2,834,063			6.11	%	2,582,347			7.00	%
Interest-bearing deposits		1,680,221			1.88	%	1,387,649			2.59	%
FHLB advances, securities sold under agreements to repurchase and other borrowings		826,399			3.91	%	887,330			3.97	%
Total interest-bearing liabilities		2,506,620			2.55	%	2,274,979			3.13	%
Non-interest-bearing deposits		$	302,717				$	226,639
Net interest spread					3.56	%				3.87	%
Net interest margin					3.88	%				4.26	%

 

The following table provides information on changes in net interest income for the periods that are attributable to changes in interest rates and changes in volume:

 

Three-month periods March 31, 2003 to 2002

Increase  (Decrease)

Due to changes in

Dollars in thousands		Rate			Volume			Total
Interest-earning assets
Loans receivable and loans held for sale		$	(3,355	)	$	3,416		$	61
Securities available for sale, securities held to maturity and other interest-earning assets		(2,748		)	824			(1,924		)
Total net change in income on interest-earning assets		(6,103		)	4,240			(1,863		)
Interest-bearing liabilities
Interest-bearing deposits		2,793			(1,686		)	1,107
FHLB advances, securities sold under agreement to repurchase and other borrowings		138			596			734
Total net change in expense on interest-bearing liabilities		2,931			(1,090		)	1,841
Net change in net interest income		$	(3,172	)	$	3,150		$	(22	)

 

11

 

Provision for losses on loans | The provision for losses on loans was $1.3 million for the three-month period ended March 31, 2003, compared to $1.7 million for the three-month period ended March 31, 2002. The level of the provision was based on management’s evaluation about the current Pacific Northwest regional economy and its resulting impact on the loan portfolio. The level of provision was lower than the first quarter of 2002 as a result of our quarterly assessment of the risk inherent within our loan portfolio in consideration with the level of the allowance for losses on loans. Management continues to assess the level of the provision for loan losses based on the known and inherent risk characteristics in the loan portfolio.  These risk characteristics include changes in the size and composition of the loan portfolio, delinquency levels, actual loan loss experience, detailed analysis of individual loans for which full collectibility may not be assured, and current economic conditions in PNWB’s market area.

 

Non-interest Income | Non-interest income was $5.5 million for the three-month period ended March 31, 2003, compared to $4.6 million for the three-month period ended March 31, 2002.  The increase was primarily due to income from BOLI that management obtained in April 2002, and higher service fees, partially offset by decreased gain on sale of loans.

 

During the second quarter of 2002, PNWB implemented the financial strategy to purchase $50.0 million of BOLI on certain key employees. PNWB is the beneficiary of these BOLI contracts and the proceeds from the death benefit payments will be used to offset the cost of employee benefits. In addition, PNWB added another $5.3 million of BOLI through the BKNW acquisition in November 2002. BOLI income was $585,000 for the first quarter of 2003, which represented tax-exempt income from BOLI during that period.

 

Service fees increased to $3.8 million from $3.2 million for the same quarter in 2002 primarily as a result of the Bank of the Northwest acquisition completed November 13, 2002.  The increase in non-interest income was partially offset by a decrease in gain on sale of loans. This decrease was due to the outsourcing of the residential mortgage lending function beginning in the first quarter of 2003. This was done to reduce mortgage banking business risk and improve operational efficiencies.  As a result, PNWB expects gain on sale of loans to decrease further for the remainder of 2003.

 

Non-interest Expense | Non-interest expense was $19.0 million for the three-month period ended March 31, 2003, compared to $18.6 million for the three-month period ended March 31, 2002. The increase from prior periods were primarily due to higher compensation expense as a result of the Bank of the Northwest acquisition and increased expenses related to severance and employment agreements, partially offset by lower mortgage banking related expenses.

 

General and administrative expenses was $3.9 million for the quarter ended March 31, 2003, compared to $4.3 million for the quarter ended March 31, 2002. The decrease from the first quarter of 2002 was primarily due to lower mortgage banking related expenses and management’s initiatives to increase operational efficiencies.

 

The efficiency ratio is computed by dividing total operating expenses by net interest income and non-interest income.  An increase in the efficiency ratio indicates that more resources are being utililized to generate the same volume of income while a decrease would indicate a more efficient allocation of resources.  The efficiency ratio for the three-month period ended March 31, 2003 was 57.9 percent, compared to 58.2 percent for the three-month period ended March 31, 2002.

 

Income Tax Expense | Income tax expense was $4.2 million for the three-month period ended March 31, 2003, compared to $4.1 million for the three-month period ended March 31, 2002.  The effective tax rate was 33.3 percent and 35.0 percent for the three-month periods ended March 31, 2003 and 2002, respectively.  The decrease in effective tax rate from 2002 was primarily due to the increase in tax-exempt income from BOLI.

 

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REVIEW OF FINANCIAL CONDITION

 

PNWB’s consolidated assets were $3.12 billion as of March 31, 2003, compared to $3.13 billion as of December 31, 2002.

 

Securities | As of March 31, 2003, PNWB had $787.3 million of securities available for sale, compared to $788.5 million as of December 31, 2002.

 

PNWB maintains liquidity in accordance with an internal liquidity policy.  Liquidity levels may be increased or decreased depending upon the yields on investment alternatives, management’s judgment as to the attractiveness of the yields then available in relation to other opportunities, and management’s expectation of the yield that will be available in the future.  Management’s projections as to the short-term demand for funds to be used for loan originations and other activities can also affect liquidity levels.

 

Securities classified as available for sale are reported at estimated fair value, with unrealized gains (net of income taxes) reported in accumulated other comprehensive income, a separate component of shareholders’ equity. Periodically management assesses the gross unrealized losses in the securities portfolio and determines whether the losses were temporary or other than temporary. During this process, PNWB considers (1) recent performance of the security, (2) the credit rating of the security, (3) the amount of credit support available for the security, if any, (4) circumstances contributing to the decline in value, (5) the length of time and extent to which the fair value has been less than cost or carrying value, and (6) the intent and ability of PWNB to retain the investment for a period of time sufficient to allow for anticipated recovery.   In consideration of the above factors, management deems the gross unrealized losses in PNWB’s securities portfolio as of March 31, 2003 to be temporary.

 

Loans Held for Sale | Loans held for sale totaled $12.2 million as of March 31, 2003 compared to $25.6 million as of December 31, 2002.  Loans held for sale are primarily single-family mortgage loans, construction loans and, to a much less extent, loans originated under the Small Business Administration program.  Loans held for sale are carried at the lower of cost or estimated fair value in aggregate.  Loans held for sale are typically sold to other financial institutions. The significant decrease from December 31, 2002 is due to loans sold during the first quarter of 2003 and more resources being focused on the transition of single-family mortgage loan origination to an outsourcing model.

 

Net Loans Receivable | Net loans receivable were $2.01 billion as of March 31, 2003, compared to $2.00 billion as of December 31, 2002.  We continue to experience moderate growth in the commercial loan portfolio despite the sluggish economic conditions in our market area.

 

Total commercial loans outstanding were $1.44 billion or 70.2 percent of the loan portfolio as of March 31, 2003, compared to $1.39 billion or 68.3 percent as of December 31, 2002. The first quarter growth in the commercial loan portfolio was primarily in the commercial real estate loan category.

 

Single-family residential mortgage loans outstanding totaled $201.5 million as of March 31, 2003 compared to $231.2 million as of December 31, 2002.  The decrease was primarily due to early payoffs associated with the current interest rate environment and management’s decision not to retain single-family mortgage loans in our loan portfolio.

 

The following table sets forth the composition of PNWB’s loan portfolio by type as of the dates indicated:

 

Dollars in thousands		March 31, 2003			December 31, 2002
Commercial loans:
Commercial		$	555,232		$	571,283
Commercial real estate		835,322			770,413
Agriculture		50,053			51,653
Total commercial loans:		1,440,607			1,393,349
Single-family residential		201,522			231,232
Real estate construction		274,828			274,581
Consumer loans		134,103			139,784
		2,051,060			2,038,946
Less:
Allowance for losses on loans		27,080			26,940
Deferred loan fees and discounts		9,025			9,193
Net loans receivable		$	2,014,955		$	2,002,813

 

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Non-performing Assets | Loans are generally placed on non-accrual when they become past due over 90 days, or 120 days if they are single-family mortgage loans, or when the collection of interest or principal is considered unlikely.  Loans past due over 90 or 120 days that are not on non-accrual status must be well-secured by tangible collateral and in the process of collection.  PNWB does not return a loan to accrual status until it is brought current with respect to both principal and interest and future principal payments are no longer in doubt.  When a loan is placed on non-accrual status, any previously accrued and uncollected interest is reversed from interest income.  PNWB performs a review of its loan portfolio for weaknesses in credit quality on an ongoing basis to identify problem loans.  This review results in internal loan classifications based on risk characteristics and loan performance.  The overall objective of this review process is to identify trends in the credit quality of the loan portfolio and to determine the level of loss exposure to evaluate the need for an adjustment to the allowance for losses on loans.

 

Non-accrual loans totaled $12.2 million as of March 31, 2003 compared to $11.9 million as of December 31, 2002. Other real estate was $6.5 million as of March 31, 2003 compared to $7.2 million as of December 31, 2002. Total non-performing assets, including non-accrual loans and other real estate, totaled $18.7 million or 0.60 percent of consolidated assets as of March 31, 2003, compared to $19.1 million or 0.61 percent of consolidated assets as of December 31, 2002.

 

The following table summarizes non-performing assets as of the dates indicated:

 

Dollars in thousands		March 31, 2003			December 31, 2002
Non-accrual loans
Commercial loans:
Commercial		$	5,924		$	5,562
Commercial real estate		755			657
Agriculture		1,103			1,658
Total commercial loans:		7,782			7,877
Single-family residential		3,825			3,733
Real estate construction		363			130
Consumer loans		190			173
Total non-accrual loans		12,160			11,913
Other real estate		6,548			7,152
Total non-performing assets		$	18,708		$	19,065

 

Allowance for Losses on Loans | The allowance for losses on loans was $27.1 million or 1.33 percent of loans receivable as of March 31, 2003, compared to $26.9 million or 1.33 percent of loans receivable as of December 31, 2002.  Net loan charge-offs were $1.1 million or 0.22 percent (annualized) of the average balance of loans outstanding for the three-month period ended March 31, 2003, compared to $783,000 or 0.16 percent (annualized) of the average balance of loans outstanding for the three-month period ended December 31, 2002.

 

When available information confirms that specific loans, or portions thereof, are uncollectible, these amounts are charged off against the allowance for losses on loans. The existence of some or all of the following criteria will generally confirm that a loss has been incurred: the loan is significantly delinquent and the borrower has not evidenced the ability or intent to bring the loan current; there is no recourse to the borrower, or if there is recourse, the borrower has insufficient assets to pay the debt; the fair value of the loan collateral is significantly below the current loan balance, and there is little or no near-term prospect for improvement.  A provision for losses on loans, which is a charge against income, is added to the allowance for losses on loans based on ongoing assessments of credit risk in the loan portfolio.

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The allowance for losses on loans is maintained at an amount to sufficiently provide for estimated losses based on evaluating known and inherent risks in the loan portfolio.  Management analyzes certain factors underlying the quality of the loan portfolio.  These factors include changes in the size and composition of the loan portfolio, delinquency levels, actual loan loss experience, detailed analysis of individual loans for which full collectibility may not be assured, and current economic conditions in PNWB’s market area.  Management has assessed the impact of the Pacific Northwest regional economy on the credit risk in the loan portfolio.  To date, delinquency trends and classified loan levels relative to comparable periods do not indicate any material deterioration in the loan portfolio.  Management continues to closely monitor PNWB’s credit quality and focus on identifying potential problem credits and any loss exposure in a timely manner.  Industry concentration and related limits will also be subject to on-going assessment.

 

PNWB has established its allowance for losses on loans in accordance with accounting principles generally accepted in the United States.  However, there can be no assurance that in the future, regulators, when reviewing PNWB’s loan portfolio, will not request PNWB to increase its allowance for losses on loans, thereby affecting PNWB’s financial condition and results of operations.  Substantial increases may be necessary should the quality of loans deteriorate as a result of the factors discussed above.

 

PNWB’s allowance for losses on loans is allocated to specific loans, certain loan categories based on the relative risk characteristics, asset classifications and actual loss experience of the loan portfolio.  Although the allocation of the allowance for losses on loans is an important credit management tool, the entire allowance for losses on loans is available for the entire loan portfolio.  Management reviewed the allocations in the various loan categories and believes the allowance for losses on loans was adequate as of March 31, 2003.

 

The following tables summarize the activity in allowance for losses on loans during the three-month periods ended March 31:

 

Dollars in thousands		2003			2002
Allowance as of beginning of period		$	26,940		$	20,123
Provision for losses on loans		1,250			1,700
Recoveries		142			129
Charge-offs		(1,252		)	(853		)
Allowance as of end of period		$	27,080		$	21,099

 

Goodwill and Other Intangible Assets | Goodwill and other intangible assets totaled $77.8 million or 2.50 percent of total assets and 29.2 percent of total shareholder’s equity as of March 31, 2003. Goodwill and other intangible assets totaled $78.2 million or 2.50 percent of total assets and 29.9 percent of total shareholder’s equity as of December 31, 2002. The decrease in goodwill and other intangible assets is due to amortization of mortgage servicing intangibles and core deposit intangibles.

 

Goodwill arising from acquisitions represents the excess of the purchase price over the estimated fair value of net assets acquired. Prior to 2002, goodwill was amortized using the straight-line method over periods not exceeding twenty years.  Effective January 1, 2002, upon adoption of SFAS No. 142 “Accounting for Goodwill and Other Intangible Assets”, PNWB no longer amortizes its goodwill. PNWB reviews its goodwill for impairment annually or more frequently if impairment indicators arise.

 

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Other intangible assets consist of core deposit intangibles and mortgage servicing rights, and are amortized using straight-line and accelerated methods over periods not exceeding twenty years.  Mortgage servicing rights are capitalized when acquired either through the purchase or origination of loans that are subsequently sold or securitized with the servicing rights retained.  The estimated fair value of mortgage servicing rights at the date of the sale of loans is determined based on the discounted present value of expected future cash flows using key assumptions for servicing income and costs and prepayment rates on the underlying loans. The estimated fair value is periodically evaluated for impairment by comparing actual cash flows and estimated future cash flows from the servicing assets to those estimated at the time servicing assets were originated.  Mortgage servicing rights are amortized as an offset to service fees in proportion to and over the period of estimated net servicing income.

 

Goodwill and other intangible assets consisted of the following as of the dates indicated:

 

Dollars in thousands		March 31, 2003			December 31, 2002
Goodwill		$	67,732		$	67,732
Mortgage servicing intangibles		703			836
Core deposit intangibles		9,387			9,669
		$	77,822		$	78,237

 

Deposits | PNWB offers various types of deposit accounts, including checking accounts, savings accounts, money market accounts and certificate of deposit accounts.  Deposit accounts vary as to terms; the principal differences are the minimum balance required, the time period the funds must remain on deposit, the interest rate, and the deposit or withdrawal option.  PNWB relies on generating deposits through a marketing strategy that employs a sales staff responsible for retaining and generating new customer relationships.  We emphasize developing total client relationships in order to increase our core deposit base.

 

Non-interest-bearing deposits were $359.8 million as of March 31, 2003 compared to $345.6 million as of December 31, 2002.  Non-interest-bearing deposits represented 17.3 percent and 16.8 percent of total deposits as of March 31, 2003 and December 31, 2002, respectively.  Interest-bearing transaction accounts (which include interest-bearing checking, money market and savings accounts) totaled $933.3 million as of March 31, 2003 compared to $904.0 million as of December 31, 2002.  Interest-bearing transaction accounts represented 44.9 percent of total deposits as of March 31, 2003, compared to 44.0 percent as of December 31, 2002.

 

Certificates of deposit totaled $783.9 million as of March 31, 2003, compared to $804.7 million as of December 31, 2002.  Certificates of deposit represented 37.7 percent of total deposits as of March 31, 2003, compared to 39.2 percent as of December 31, 2002. The increase in the core deposit balances (which include non-interest bearing and non-interest bearing transactional accounts) and the decrease in certificate of deposit balance reflect management’s efforts to restructure the deposit portfolio as a means to reduce the costs of funds.

 

The following table sets forth the balances of deposits by account type as of the dates indicated:

 

Dollars in thousands		March 31, 2003			December 31, 2002
Non-interest-bearing deposits		$	359,848		$	345,571
Interest-bearing checking accounts		267,803			263,591
Money market accounts		554,826			531,698
Savings accounts		110,703			108,721
Certificates of deposit		783,913			804,729
Total		$	2,077,093		$	2,054,310

 

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FHLB Advances and Securities Sold Under Agreements to Repurchase | PNWB borrows through advances from the Federal Home Loan Bank (FHLB) and securities sold under agreements to repurchase with third parties. These borrowing sources totaled $687.7 million as of March 31, 2003 compared to $730.3 million as of December 31, 2002.  The need for this type of borrowings decreased primarily as a combined result of the increase in deposits.

 

The FHLB provides credit for member financial institutions.  As members, financial institutions are required to own capital stock in the FHLB, and are authorized to apply for advances on the security of such stock, certain home mortgages and other assets (principally securities that are obligations of, or guaranteed by, the United States).  Advances are made to member financial institutions pursuant to several different programs.  These programs are generally designed to meet the financial institution’s need while still reflecting market terms and conditions.  PNWB uses advances from the FHLB to supplement funds available to lend and to meet liquidity guidelines.  Interest rates on these advances vary in response to general economic conditions.  PNWB also uses the securities market for borrowings by utilizing its securities available for sale as collateral. These borrowings are collateralized by securities with an estimated fair value exceeding the face value of the borrowings.

 

Other borrowings  | Other borrowings were $10.1 million as of March 31, 2003 and 2002.  The balances were comprised primarily of notes from another financial institution. This borrowing qualifies as Tier II capital under the capital guidelines of the Federal Reserve Board.

 

Guaranteed Preferred Beneficial Interests in Subordinated Debt  | On September 26, 2002, $12 million of Capital Securities were issued by Pacific Northwest Statutory Trust I (the Trust).  The Trust is a business trust organized in September 2002, and Bancorp owns 100 percent of the common equity of the Trust.  The proceeds of the offering were invested by the Trust in junior subordinated debentures of Pacific Northwest Bancorp.  The debentures held by the Trust are the sole assets of Pacific Northwest Statutory Trust I.  The Capital Securities are subject to mandatory redemption, in whole or in part, upon repayment of the debentures.  The debentures will not mature earlier than September 26, 2007, and not later than September 26, 2012. The interest rate on the Capital Securities is based upon three-month LIBOR plus 3.55 percent and adjusts on a quarterly basis.  As of March 31, 2003, the interest rate on the Capital Securities was 4.84 percent.  Pacific Northwest Bancorp entered into agreements which, taken collectively, fully and unconditionally guarantee the capital securities subject to the terms of each of the guarantees.  The Capital Securities qualify as Tier I capital under the capital guidelines of the Federal Reserve Board.

 

On November 15, 1999, $40,000,000 of 9.875 percent Capital Securities were issued by InterWest Capital Trust I (the Trust I).  The Trust I is a business trust organized in November 1999, and Bancorp owns 100 percent of the common equity of the Trust I.  The proceeds of the offering were invested by the Trust I in junior subordinated debentures of Bancorp.  The debentures held by the Trust I are the sole assets of the Trust I. At the Bancorp’s option, the debentures will not mature earlier than November 15, 2009, and not later than November 15, 2029.  After November 15, 2019, the debentures can be redeemed at par value. Distributions on the capital securities issued by the Trust I are payable semiannually at 9.875 percent per annum, which is equal to the interest rate being earned by the Trust I on the debentures it held.  The capital securities are subject to mandatory redemption, in whole or in part, upon repayment of the debentures. Bancorp has entered into agreements which, taken collectively, fully and unconditionally guarantee the capital securities subject to the terms of each of the guarantees. The capital securities qualify as Tier I capital under the capital guidelines of the Federal Reserve Board.  Pacific Northwest Bancorp purchased $4.0 million of the capital securities (guaranteed subordinated debt) during 2002 and the $4.0 million capital securities were subsequently reissued at a premium of $372,500 during the first quarter of 2003.  The premium will be amortized using the straight-line method through November 9, 2009.

 

Shareholders’ Equity | PNWB is committed to managing capital for maximum shareholder benefit and maintaining strong protection for depositors and creditors.  PNWB manages various capital levels at both the holding company and subsidiary bank level to maintain adequate capital ratios and levels in accordance with external regulations and capital guidelines established by the Board of Directors.

 

On January 28, 2003, the Board of Directors of Pacific Northwest Bancorp authorized the purchase of up to five percent of Pacific Northwest Bancorp’s outstanding shares of common stock over the next twelve months.  As of March 31, 2003 PNWB repurchased, on the open market, a total of 104,291 shares at an average price of $27.56.

 

 

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There were 15,453,581 shares of common stock outstanding at March 31, 2002. At December 31, 2002 there were 16,799,472 shares of common stock outstanding. During the fourth quarter of 2002, Bancorp issued approximately 1.7 million shares of Bancorp common stock as part of the Northwest merger consideration and this increased Bancorp’s shareholders’ equity by approximately $57.0 million. There was an additional 217,000 shares issued during 2002 related to stock option plans. These increases were partially offset by stock repurchases of approximately 781,000 shares during 2002.

 

PNWB’s total shareholders’ equity was $266.5 million as of March 31, 2003, compared to $261.6 million as of December 31, 2002.  The increase in shareholders’ equity during the first three months of 2003 was primarily due to net income of $8.3 million, stock issued under stock option plans of $2.4 million, a tax deduction on stock option exercises of $1.2 million, offset by the decrease in the estimated fair value of securities available for sale of $2.0 million (net of tax), cash dividends declared of $0.14 per share or $2.4 million, and repurchases of common stock totaling $2.8 million.  Book value per share was $15.80 as of March 31, 2003, compared to $15.57 as of December 31, 2002.

 

SUPERVISION AND REGULATION

 

Pacific Northwest Bancorp is a registered bank holding company under the Bank Holding Company Act of 1956 (BHCA) and is subject to the supervision of, and regulation by, the Board of Governors of the Federal Reserve System  (FRB).  Under the BHCA, Pacific Northwest Bancorp files with the FRB annual reports of operations and such additional information as the FRB may require.  Under the BHCA, a bank holding company may engage in banking, managing or controlling banks, furnishing or performing services for banks it controls, and conducting activities that the FRB has determined to be closely related to banking.

 

Pacific Northwest Bank is a member of the Federal Deposit Insurance Corporation (FDIC), and as such, is subject to examination thereby.  Pacific Northwest Bank is a state-chartered commercial bank subject to regulation and supervision by the Washington Department of Financial Institutions, Division of Banks.  In practice, the primary regulator makes regular examinations of the subsidiary bank subject to its regulatory review or participates in joint examinations with other regulators.  Areas subject to regulation by federal or state authorities include the allowance for losses on loans, investments, loans, mergers and acquisitions, issuance of securities, payment of dividends, establishment of branches and other aspects of operations.

 

The enforcement powers available to banking regulators are substantial and include, among other things, the ability to assess civil monetary penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions against banking organizations and institution-affiliated parties, as defined.  In general, enforcement actions must be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions, or inactions, may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities.  Applicable law also requires public disclosure of final enforcement actions.

 

Pacific Northwest Bancorp and Pacific Northwest Bank are subject to risk-based capital guidelines requiring minimum capital levels based on the credit risk of assets.  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary, actions by regulators that, if undertaken, could have a material effect on PNWB’s consolidated financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Pacific Northwest Bancorp and Pacific Northwest Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices.  Capital classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

 

The regulations define the relevant capital levels for the five categories.  In general terms, the capital definitions are as follows:

 

		Total Capital (to Risk Weighted Assets)		Tier 1 (to Risk Weighted Assets)		Tier 1 (to Average Assets)
Well capitalized		10%		6%		5%
Adequately capitalized		8%		4%		4%
Undercapitalized		Below 8%		Below 4%		Below 4%
Significantly undercapitalized		Below 6%		Below 3%		Below 3%
Critically undercapitalized		—		—		2% or less

 

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Pacific Northwest Bancorp is subject to risk-based capital guidelines issued by the FRB, which establish a risk-adjusted ratio relating capital to different categories of assets.  Tier I capital is comprised of shareholders’ equity and guaranteed preferred beneficial interests in subordinated debt less certain intangibles, and excludes the equity impact of adjusting securities available for sale to estimated fair value. Total capital is Tier I capital, the allowance for losses on loans and certain long-term debt that qualifies for inclusion as regulatory capital.  The FRB’s risk-based capital rules have been supplemented by a leverage capital ratio, defined as Tier I capital to adjusted quarterly average total assets.  As of March 31, 2003, under the FRB’s capital guidelines, PNWB’s levels of consolidated regulatory capital exceeded the FRB’s well-capitalized requirements.  The capital amounts and ratios for Pacific Northwest Bancorp and Pacific Northwest Bank as of March 31, 2003 and December 31, 2002, are presented in the following table:

 

CAPITAL RATIOS

 

		Amount					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions
Dollars in thousands		Amount			Ratio		Amount			Ratio		Amount			Ratio
March 31, 2003 -
Pacific Northwest Bancorp:
Total capital (to risk-weighted assets)		$	274,826		11.31%		$	194,349		8.0%		$	242,937		10.0%
Tier I capital (to risk-weighted assets)		237,360			9.77%		97,175			4.0%		145,762			6.0%
Tier I capital (to average assets)		237,360			7.85%		120,908			4.0%		151,135			5.0%
Pacific Northwest Bank:
Total capital (to risk-weighted assets)		$	267,321		11.09%		$	192,762		8.0%		$	240,953		10.0%
Tier I capital (to risk-weighted assets)		239,850			9.95%		96,381			4.0%		144,572			6.0%
Tier I capital (to average assets)		239,850			7.94%		120,791			4.0%		150,988			5.0%
December 31, 2002
Pacific Northwest Bancorp:
Total capital (to risk-weighted assets)		$	264,965		11.03%		$	192,262		8.0%		$	240,328		10.0%
Tier I capital (to risk-weighted assets)		227,653			9.47%		96,131			4.0%		144,197			6.0%
Tier I capital (to average assets)		227,653			7.77%		117,201			4.0%		146,502			5.0%
Pacific Northwest Bank:
Total capital (to risk-weighted assets)		$	257,462		10.80%		$	190,747		8.0%		$	238,434		10.0%
Tier I capital (to risk-weighted assets)		230,150			9.65%		95,374			4.0%		143,060			6.0%
Tier I capital (to average assets)		230,150			7.87%		116,902			4.0%		146,128			5.0%

 

As of March 31, 2003, Pacific Northwest Bancorp and Pacific Northwest Bank were in compliance with well-capitalized capital requirements. Management believes that under the current regulations the Bank and the Bancorp will continue to meet well-capitalized capital requirements in the foreseeable future.  However, events beyond the control of the Bank and Bancorp, such as a downturn in the economy in areas where Pacific Northwest Bank has most of its loans, could adversely affect future earnings and, consequently, the ability of Pacific Northwest Bank to meet future well-capitalized capital requirements.

 

LIQUIDITY RESOURCES

 

Liquidity management focuses on the need to meet both short-term funding requirements and PNWB’s long-term strategies and goals. Specifically, the objective of liquidity management is to ensure the continuous availability of funds to meet the demands of depositors, creditors and borrowers.

 

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Management manages the balance sheet to meet these needs. PNWB desires to attract and retain business and retail customer relationships with a focus on transaction accounts and commercial and consumer lending.  PNWB also uses wholesale funds through advances from the FHLB and the sale of securities under agreements to repurchase to fund asset growth and meet liquidity needs. PNWB also uses wholesale and brokered certificates of deposit to supplement wholesale borrowings.  Other sources of funds for liquidity include loan repayments, loan sales, security sales and mortgage-backed and related security repayments. Repayments on loans and mortgage-backed and related securities and deposit inflows and outflows are affected by changes in interest rates.

 

PNWB has the capacity to borrow funds from the FHLB through pre-approved credit lines.  These credit lines have pledge requirements whereby PNWB must maintain unencumbered collateral with a value at least equal to the outstanding balance. PNWB also uses the securities market as a vehicle for borrowing by utilizing its securities available for sale as collateral.  If the estimated fair value of the securities were to decline as a result of an increase in interest rates or other factors, PNWB would be required to pledge additional securities or cash as collateral. In addition, PNWB has the ability to borrow funds from the Federal Reserve.

 

The analysis of liquidity also includes a review of PNWB’s consolidated statement of cash flows for the three-month period ended March 31, 2003.  The consolidated statement of cash flows details PNWB’s operating, investing and financing activities during the period.  The most significant items under operating activities include net income of $8.4 million for the three-month period ended March 31, 2003, an increase in other assets of $1.1 million, and an increase in accrued expenses and other liabilities of $5.7 million.  Also included in operating activities are the add-back of non-cash depreciation, amortization of intangible assets, provision for losses of loans, and amortization of premium on investments totaling $4.2 million. Investing activities included purchases of securities available for sale of $251.0 million, proceeds from maturing and principal repayments on securities available for sale of $138.2 million, and proceeds from sale of securities available for sale of $110.6 million. During the period, financing activities included $42.6 million in borrowing repayments, net of borrowing proceeds, a $22.8 million net increase in deposits, $4.4 million of cash proceeds from re-issuance of guaranteed subordinated debt, and $2.4 million paid in cash dividends to shareholders.

 

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Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

PNWB’s results of operations are largely dependent upon its ability to manage interest rate risk. Management considers interest rate risk to be a significant market risk that could have a material effect on PNWB’s financial condition and results of operations.

 

PNWB is sensitive to potential changes in interest rates and the resulting impact on net interest income.  It is an objective of management to reduce this sensitivity through the use of adjustable rate loans and short-term commercial and consumer loans.  This enables PNWB to better match the duration of its deposit base with these types of assets.

 

In addition to adjustable rate loans and short-term commercial and consumer loans, PNWB uses a number of other strategies to minimize the impact of significant interest rate changes on net income. The strategies utilized by PNWB include sales of long-term, fixed-rate mortgage loans, emphasis on growth in non-interest-bearing deposits and adjustable rate commercial lending.

 

Management uses simulation analysis to measure PNWB’s interest sensitivity position.  This simulation analysis is used to evaluate the effects of potential interest rate movements on net interest income.  The simulation analysis model is dynamic in nature, and incorporates management’s current balance sheet strategy. Management develops assumptions regarding interest rate spreads, projected balances, expected maturities, cash flows and prepayment assumptions under different interest rate scenarios.

 

For further information on interest rate risk, reference is made to the sections “Net Interest Income” and “Average Rates and Balances” in Item 2. Management Discussion and Analysis of Financial Condition and Results of Operations contained in this quarterly report on Form 10-Q.  Information regarding the expected maturities of financial assets and financial liabilities has not changed materially from disclosures made in the Annual Report on Form 10-K for the year ended December 31, 2002.

 

Item 4.  CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

PNWB, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of March 31, 2003 (the “Evaluation Date”).  Based upon this evaluation, the Chief Executive Officer and Chief Financial Officer concluded as of the Evaluation Date that PNWB’s disclosure controls and procedures were effective for purposes of recording, processing, summarizing and timely reporting material information required to be disclosed in reports filed by the Company under the Securities Exchange Act of 1934.

 

Changes in Internal Controls

 

There were no significant changes in PNWB’s internal controls or in other factors that could significantly affect these controls subsequent to the Evaluation Date.  PNWB did not implement any corrective actions with regard to any significant deficiency or material weakness in its internal controls.

 

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PART II. OTHER INFORMATION

 

Item 1.  Legal Proceedings

 

PNWB faces ordinary routine litigation arising in the normal course of business.  In the opinion of management, liabilities (if any) arising from such claims will not have a material effect upon the business, results of operations or financial condition of PNWB.

 

Items 2, 3, 4 and 5 are not applicable and have been omitted.

 

Item 6        Exhibits and Reports on Form 8-K

 

(a)          Exhibits

 

3.1		Articles of Incorporation of Pacific Northwest Bancorp (incorporated by reference to Exhibit 3.1 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2000).
3.2		Bylaws of Pacific Northwest Bancorp (incorporated by reference to Exhibit 3.2 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2000).
3.3		Amendment to the Bylaws of Pacific Northwest Bancorp (incorporated by reference to Exhibit 3.21 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2001).
10		Material contracts of Pacific Northwest Bancorp (incorporated by reference to Exhibits 10.1 through 10.29 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.30		First Amendment to Employment Agreement entered into between Pacific Northwest Bancorp and Kim S. Brace is filed with this report.
10.31		Severance/Change of Control Agreement entered into between Pacific Northwest Bancorp and Joseph H. Ward is filed with this report.
10.32		Pacific Northwest Bancorp 2003 Long-Term Stock Incentive Plan is filed with this report.
10.33		Amendment to Severance Pay and Change in Control Agreement entered into between Pacific Northwest Bancorp and Bette J. Floray.
10.34		Amendment to Severance Pay and Change in Control Agreement entered into between Pacific Northwest Bancorp and David H. Straus
99.1		Certifications of Patrick M. Fahey, Chief Executive Officer, and Bette J. Floray, Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b)                                  Reports on Form 8-K

 

PNWB filed a current report on Form 8-K on January 24, 2003. The report included under Items 5 and 7 of Form 8-K a press release announcing PNWB’s 2002 financial results and unaudited consolidated financial statements for the three- and twelve-month periods ended December 31, 2002.

 

PNWB filed a current report on Form 8-K on January 30, 2003. The report included under Item 5 of Form 8-K a press release announcing that the Board of Directors of Pacific Northwest Bancorp authorized the purchase in the open market, over the next twelve months, of up to 5 percent of its outstanding shares of common stock.

 

PNWB filed a current report on Form 8-K on March 3, 2003. The report included under Item 5 of Form 8-K announcing executive management changes including the appointment of David H. Straus to the position of President and Chief Operating Officer of Pacific Northwest Bancorp’s principal subsidiary Pacific Northwest Bank. Mr. Fahey will continue as the Chairman and Chief Executive Officer of the Bank.

 

PNWB filed a current report on Form 8-K on March 27, 2003. The report included under Item 5 of Form 8-K announcing that on April 18, 2003 Stephen M. Walden will step down as Chairman of the Board of Pacific Northwest Bancorp, but will continue as a Director. Meanwhile, the Board appointed Patrick M. Fahey to the role of Chairman of the Board of Pacific Northwest Bancorp.

 

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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.

 

 

			PACIFIC NORTHWEST BANCORP
				By:	/s/ Patrick M. Fahey
					Patrick M. Fahey
					President and Chief Executive Officer
					/s/ Bette J. Floray
					Bette J. Floray
					Executive Vice President and Chief Financial Officer
	Dated:  May 7, 2003

 

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CERTIFICATIONS

 

CERTIFICATION OF QUARTERLY REPORT ON FORM 10-Q

PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

 

I, Patrick M. Fahey, certify that:

 

1.                     I have reviewed this quarterly report on Form 10-Q of Pacific Northwest Bancorp;

 

2.                     Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3.                     Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4.                     The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a)        designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b)       evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c)        presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5.                     The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a)        all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b)       any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls;

 

6.   The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

	Date: May 7, 2003
		/s/  Patrick M. Fahey
		Patrick M. Fahey,
		President and Chief Executive Officer

 

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CERTIFICATION OF QUARTERLY REPORT ON FORM 10-Q

PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

 

I, Bette J. Floray, certify that:

 

1.     I have reviewed this quarterly report on Form 10-Q of Pacific Northwest Bancorp;

 

2.               Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3.               Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4.               The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a)              designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b)             evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c)              presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5.               The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a)              all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b)             any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls;

 

6.               The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

	Date: May 7, 2003
		/s/  Bette J. Floray
		Bette J. Floray,
		Executive Vice President and Chief
		Financial Officer

 

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