U.S. SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
Form 10-K
[X] Annual Report Pursuant to section 13 or 15(d) of the
Securities and Exchange act of 1934
For the fiscal year ended December 31, 2001
Commission file number
0-23881
COWLITZ BANCORPORATION
(Exact name of registrant as specified in its charter)
Washington 91-152984
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
927 Commerce Ave., Longview, Washington 98632
(Address of principal executive offices) (Zip Code)
(360) 423-9800
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act
Common Stock, No par value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form of this form 10-K. |X|
The aggregate market value of Registrant's Common Stock held by non-affiliates
of the Registrant on February 28, 2002, was $14,633,200.
Common Stock, no par value on February 28, 2002: 3,692,560
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents if incorporated by reference and the Part
of the Form 10-K into which the document is incorporated: Portions of the
registrants proxy statement dated April 19, 2002, for the 2002 annual meeting of
shareholders is incorporated by reference in Part III hereof.
1
TABLE OF CONTENTS
Page
Part I
Item 1. Business............................................................. 3
Item 2. Properties........................................................... 11
Item 3. Legal Proceedings.................................................... 11
Item 4. Submission of matters to vote of securities holders.................. 12
Part II
Item 5. Market price and dividends on registrant's common equity and related
stockholder matters................................................. 12
Item 6. Selected Financial Data.............................................. 13
Item 7. Management's discussion and analysis of financial condition and
results of operations............................................... 14
Item 8. Financial statements and supplementary data.......................... 33
Item 9. Changes in and disagreements with accountants on accounting and
financial disclosure................................................ 71
Part III
Item 10. Director and executive officers of the registrant................... 71
Item 11. Executive compensation.............................................. 71
Item 12. Security ownership of certain beneficial owners and management...... 71
Item 13. Certain relationships and related transactions...................... 71
Part IV
Item 14. Exhibits, financial statement schedules, and reports on form 8-K.... 71
Note: This document has not been reviewed, or confirmed for accuracy or
relevancy by the Federal Deposit Insurance Corporation.
2
Part I
Item 1. Business
Introduction
Cowlitz Bancorporation (the "Company") was organized in 1991 under
Washington law to become the holding company for Cowlitz Bank (also the
"Company" or the "Bank"), a Washington state chartered bank that commenced
operations in 1978. The principal executive offices of the Company are located
in Longview, Washington.
The Company offers or makes available a broad range of financial
services to its customers, primarily small and medium-sized businesses,
professionals and retail customers. The Bank's commercial and personal banking
services include commercial and real estate lending, consumer lending, mortgage
origination and trust services. From 1998 through 2001, the Company also
provided asset-based lending services to companies throughout the Western United
States through its subsidiary, Business Finance Corporation ("BFC"), which was
sold in the first quarter of 2002.
The Company's goal is to expand its position as a community-based
provider of financial services. The Company's growth strategy is based on
providing both exceptional personal service and a wide range of financial
services to its customers. This is done by emphasizing personal service and
developing strong community ties, offering financial products and services that
are focused on small and medium-sized businesses, and increasing business volume
in existing markets. In accordance with this strategy, during 1999 and 2000, the
Company acquired or opened several mortgage and escrow branches. Bay Mortgage
and Bay Escrow of Bellevue, Washington, Bay Mortgage and Bay Escrow of Seattle,
Washington, Bay Mortgage of Silverdale, Washington, and Bay Mortgage of
Vancouver, Washington (collectively "Bay Mortgage") have joined together with
the Longview mortgage operations as a division of Cowlitz Bank. Bay Mortgage
serves customers throughout the greater Bellevue/Seattle market area, Cowlitz
County, and through the Vancouver office, the greater Portland, Oregon market.
The Bank also expanded its commercial banking activities in the Seattle/Bellevue
area with the September 1999 opening of a branch in Bellevue, Washington, which
is doing business as Bay Bank. In mid-2000, the Company acquired Northern Bank
of Commerce ("NBOC") of Portland, Oregon, which operates as a branch of the Bank
doing business as Northern Bank of Commerce. NBOC operates its main office in
downtown Portland, and has 12 limited service branches located within retirement
centers in the Portland metropolitan area.
Products and Services
The Company offers a broad portfolio of products and services tailored
to meet the financial needs of targeted customers in its market areas. It
believes this portfolio is generally competitive with the products and services
of its competitors, including major regional and national banks. These products
and services include:
Deposit Products. The Company provides a range of deposit products for
customers, including non-interest-bearing checking accounts, interest-bearing
checking and savings accounts, money market accounts and certificates of
deposit. These accounts generally earn interest at rates established by
management based on competitive market factors and management's desire to
increase certain types or maturities of deposit liabilities. During times of
asset growth, or as liquidity needs arise, the Company will utilize broker
deposits as a source of funding. The Company strives to establish customer
relations to attract core deposits in non-interest-bearing transactional
accounts and thus to reduce its cost of funds.
Loan Products. The Company offers a broad range of loan products to its
retail and business customers. The Company maintains loan underwriting standards
with written loan policies, conservative individual and branch limits and
reviews by the loan committee. Further, in the case of particularly large loan
commitments or loan participations, loans are reviewed by the Company's board of
directors. Underwriting standards are designed to achieve a high-quality loan
portfolio, compliance with lending regulations and the desired mix of loan
maturities and industry concentrations. Management seeks to minimize credit
losses by closely monitoring the financial condition of its borrowers and the
value of collateral.
Commercial Loans. Commercial lending is the primary focus of the
Company's lending activities, and a significant portion of its loan portfolio
consists of commercial loans. The Company offers specialized loans for its
business and commercial customers. These include equipment and inventory
financing, operating lines of credit and accounts receivable financing. For
regulatory purposes, a substantial portion of the Company's commercial loans are
designated as real estate loans, as the loans are secured by mortgages and trust
deeds on real property, although the
3
loans may be made for purposes of financing commercial activities, such as
accounts receivable, equipment purchases and inventory or other working capital
needs. Lending decisions are based on careful evaluation of the financial
strength, management and credit history of the borrower, and the quality of the
collateral securing the loan. Commercial loans secured by real property are
generally limited to 80% of the value of collateral. In some cases, the Company
may require personal guarantees and secondary sources of repayment. In competing
with major regional and national banks, the Company is limited by its single
borrower lending limits imposed by law. See "Risk Factors" for further
discussion.
Real Estate Loans. Real estate loans are available for construction,
purchasing and refinancing residential owner-occupied and rental properties.
Borrowers can choose from a variety of fixed and adjustable rate options and
terms. Real estate loans reflected in the loan portfolio also include loans made
to commercial customers that are secured by real property.
The Company provides customers access to long-term conventional real
estate loans primarily through Bay Mortgage. Bay Mortgage specializes in all
facets of residential lending from single family homes to small multi-plexes,
including FHA and VA loans, construction and bridge loans.
Consumer Loans. The Company provides loans to individual borrowers for a
variety of purposes, including secured and unsecured personal loans, home
equity, personal lines of credit and motor vehicle loans. Consumer loans can
carry significantly greater risks than other loan products, even if secured, if
the collateral consists of rapidly depreciating assets such as automobiles and
equipment. Repossessed collateral securing a defaulted consumer loan may not
provide an adequate source of repayment of the loan. Consumer loan collections
are dependent on borrowers' continuing financial stability, and are sensitive to
job loss, illness and other personal factors. The Company attempts to manage the
risks inherent in consumer lending by following strict credit guidelines and
conservative underwriting practices. The Company also offers Visa and MasterCard
credit cards to its customers.
Other Banking Products and Services. In support of its focus on
personalized service, the Company offers additional products and services for
the convenience of its customers. These services include a retirement home
branch network, a debit card program, automated teller machines at five branch
locations and an automated telephone banking service with 24-hour access to
accounts that also allows customers to speak directly with a customer service
representative during normal banking hours. The Company does not currently
charge fees for any of these services, with the exception of ATM transactions
through other financial institutions. The Company provides drive-through
facilities at four of its branches, including the Triangle Mall branch in
Longview, which is exclusively a drive-up facility. In 2001, the Company
implemented a website, internet banking, and cash management system to enhance
the services available to both business and private account holders. Account
inquires, wire transfers, bill pay services, and general management of account
portfolios are services now available on line.
Trust Services. Cowlitz Bank is the only bank in Cowlitz County to offer
complete trust services. The trust department, located in the offices of the
main branch in Longview, WA, focuses on the needs of the customer, providing
trust services to individuals, partnerships, corporations and institutions and
acting as fiduciary of living trusts, estates and conservatorships. The trust
department also acts as trustee under wills, trusts, and other plans. The
Company believes these services add to the value of Cowlitz Bank as a community
bank by providing local access to services that have been previously sought from
out of the area institutions.
Internet Banking. Continuing the Company's desire to provide valuable
financial services to its customers, a website and Internet banking and cash
management system was introduced in the second quarter of 2001. Through this
upgrade of our technology capabilities, the Company is able to provide our
clients secure access, information, and services while enhancing the advantages
they presently enjoy. Business clients can avail themselves of a comprehensive
cash management program which allows them to easily and securely move money
between accounts, wire funds, receive funds, pay bills, and generally manage
their financial resources. Retail customers now have the ability to access
account information, pay bills, and manage their accounts from the comfort of
their homes. By offering on-line banking services, the Company hopes to
strengthen existing customer relationships and to attract new customers in the
future.
Other Financial Services. The Company believes that providing its
customers a full range of financial services is an important element of its
strategy to attract and retain customers. To this end, the Company has entered
into a lease arrangement with Raymond James Financial Services, Inc., a
securities broker. This organization maintains an office on the main floor of
the Cowlitz Financial Center, where the main office of the Company is located,
and has access to space in the Company's other branches to allow representatives
of Raymond James to meet with clients. The Company has no financial interest in
Raymond James Financial Services, Inc.
4
Acquisitions
On July 1, 2000, the Company acquired Northern Bank of Commerce (NBOC),
of Portland, Oregon for approximately $3.8 million in cash, including
acquisition costs. The Company has accounted for the transaction using the
purchase method of accounting. Under the terms of the agreement, the
shareholders of NBOC received $2.48 in cash for each share of NBOC stock.
The following table summarizes the acquisition of NBOC. As part of the
transaction, goodwill of $946,000 was recognized.
(dollars in thousands)
Fair value of assets acquired, including goodwill $ 47,192
Less liabilities assumed 43,357
--------
Cash paid for acquisition (3,835)
Less cash acquired 7,023
--------
Net cash received in acquisition $ 3,188
========
The following unaudited pro forma financial information for the Company
gives effect to the acquisitions of NBOC, as if it had occurred on January 1,
2000. These pro forma results have been prepared for comparative purposes only
and do not purport to be indicative of the results of operations which actually
would have resulted had the acquisition occurred on the dates indicated, or
which may result in the future for the combined companies under the ownership
and management of the Company. The pro forma results include certain
adjustments, such as additional expense, as a result of goodwill amortization.
Year Ended December 31,
--------------------------
2001 2000
----------- -----------
(Pro forma)
(dollars in thousands, except per share amounts)
Net interest income $ 13,845 $ 14,326
=========== ===========
Net loss $ (1,450) $ (279)
=========== ===========
Net interest income per share $ 3.72 $ 4.49
=========== ===========
Losses per share $ (.39) $ (0.20)
=========== ===========
During 1999, the Company acquired Bay Mortgage, of Bellevue, Washington,
Bay Mortgage of Seattle, and Bay Escrow of Seattle, Washington. The acquisitions
were accounted for using the purchase method of accounting and included cash
payments of $1.8 million and issuance of common stock with a value of $977,000.
During 2001, additional payments totaling $772,000 were recorded in connection
with the acquisitions, pursuant to a performance earn-out agreement. The
additional acquisition costs have been recorded as goodwill associated with the
purchase.
Market areas
The Company's primary market areas from which it accepts deposits and
makes loans are Cowlitz County, in southwest Washington, King County,
Washington, the Portland metropolitan area in Oregon, and the surrounding
counties in Washington and northwest Oregon. As a community bank, Cowlitz Bank
has certain competitive advantages due to its local focus, but is also more
closely tied to the local economy than many of its competitors, which serve a
number of geographic markets. Bay Mortgage is concentrated in western Washington
and northwest Oregon.
Employees
As of December 31, 2001, the Company employed a total of 199 full-time
equivalent employees. None of the employees are subject to a collective
bargaining agreement and the Company considers its relationships with its
employees to be favorable.
5
Risk Factors
Exposure to Regional Economy
Historically, the Company has been extremely dependent upon and
sensitive to the economy of Cowlitz County, which is firmly dependent on three
industries, pulp and paper, wood products, and aluminum. These industries have
been in a state of decline for the past 15 years, and Cowlitz County felt the
impact particularly in 2001. The impact of the permanent loss of at least 800
manufacturing jobs, double-digit unemployment, two contentious strikes, and
increasing power rates, are factors that have severely dampened the local
economy. The Company's expansion into the Seattle, Washington, and Portland,
Oregon markets has greatly reduced its dependence on the economy of Cowlitz
County. However, the Company is still dependent on the economy in the Pacific
Northwest region, which has experienced similar challenges in unemployment,
increased utility costs, and general economic weakness in the Portland and
Seattle metro areas.
Credit Risk
The Company, like other lenders, is subject to credit risk, which is the
risk of losing principal and interest due to customers' failure to repay loans
in accordance with their terms. Although the Company has established lending
criteria and most loans are secured by collateral, the downturn in the economy
and the real estate market or a rapid increase in interest rates could have a
negative effect on collateral values and borrowers' ability to repay. The
Company's targeted customers are small to medium-size businesses, professionals
and retail customers that may have limited capital resources to repay loans
during an economic downturn.
Interest Rate Risk
The Company's earnings are largely derived from net interest income,
which is interest income and fees earned on loans and investment income, less
interest expense paid on deposits and other borrowings. Interest rates are
highly sensitive to many factors which are beyond the control of the Company's
management, including general economic conditions, and the policies of various
governmental and regulatory authorities. As interest rates change, net interest
income is affected. With fixed rate assets (such as fixed rate loans) and
liabilities (such as certificates of deposit), the effect on net interest income
depends on the maturity of the asset and liability. Although the Company strives
to minimize interest rate risk through asset/liability management policies, from
time to time maturities are not balanced. Further, an unanticipated rapid
decrease or increase in interest rates could have an adverse effect on the
spreads between the interest rates earned on assets and the rates of interest
paid on liabilities and, therefore, on the level of net interest income.
Regulation
The Company is subject to extensive regulations under federal and state
laws. These laws and regulations are intended primarily to protect depositors
and the deposit insurance fund, rather than shareholders. Cowlitz Bank is a
state chartered commercial bank which is not a member of the Federal Reserve
System and is subject to primary regulation and supervision by the Director of
Financial Institutions of the State of Washington (the "Washington Director")
and by the Federal Deposit Insurance Corporation (the "FDIC"), which also
insures bank deposits. The Company is also subject to regulation and supervision
by the Board of Governors of the Federal Reserve System (the "Federal Reserve").
Federal and state regulations place banks at a competitive disadvantage compared
to less regulated competitors such as finance companies, credit unions, mortgage
banking companies and leasing companies. Although the Company has been able to
compete effectively in its market area in the past, there can be no assurance
that it will be able to continue to do so. Further, future changes in federal
and state banking regulations could adversely affect the Company's operating
results and ability to continue to compete effectively. See "Regulation and
Supervision."
Competition
Competition in the banking industry has intensified for deposits and
loans over the last few years. Competition from outside the traditional banking
system from credit unions, investment banking firms, insurance companies and
related industries offering bank-like products has increased the competition for
deposits and loans.
The banking industry in the market areas in which the Company operates
is generally characterized by well established, large banks. There are also
thrift institutions, other community banks and credit unions within the market
areas that are very competitive in deposit and consumer lending areas.
6
The major competition for commercial and mortgage banking services in
Cowlitz County comes from U.S. Bank, Key Bank, Bank of America and Columbia
State Bank. None of these competitors are headquartered in Cowlitz County and
many have relocated key functions (e.g., loan decisions) into regional offices
outside of the area. However, within the past two years, competition has
increased with the start-up of two community banks in Longview. In the Company's
greater Seattle market area, the main sources of competition are U.S. Bank, Key
Bank, Bank of America, Wells Fargo, Washington Mutual, Evergreen State Bank,
Western Bank, Columbia Bank, First Horizon, and other community banks and
mortgage companies located in the greater Seattle/Bellevue area. For NBOC in the
Portland area, competition comes from banks such as Washington Mutual, US Bank,
Bank of America, Wells Fargo, Centennial Bank, Bank of the Northwest, and Key
Bank. The retirement center branches compete with smaller, in-store branches
(such as Washington Mutual branches in Fred Meyer stores) and credit unions.
Offices of the major financial institutions have competitive advantages
over the Company in that they have high public visibility, may offer a wider
variety of products and are able to maintain advertising and marketing
activities on a much larger scale than the Company can economically maintain.
Since single borrower lending limits imposed by law are dependent on the capital
of the institution, the branches of larger institutions with substantial capital
bases also have an advantage with respect to loan applications that are in
excess of the Company's legal lending limits.
In competing for deposits, the Company is subject to certain limitations
not applicable to non-bank financial institution competitors. Previous laws
limiting the deposit instruments and lending activities of savings and loan
associations have been substantially eliminated, thus increasing the competition
from these institutions. In the Company's Cowlitz County market area, the main
source of competition for deposits is the relatively large number of credit
unions.
With significant competition in the Company's market areas, there can be
no assurance that the Company can continue to attract significant loan and
deposit customers. The inability to attract these customers could have an
adverse effect on the Company's financial position and results of operations.
Regulation and Supervision
The Company and the Bank are subject to extensive regulation under
federal and state laws. The laws, together with the regulations promulgated
under them, significantly affect respective activities of the Company and the
Bank and the competitive environment in which they operate. The laws and
regulations are primarily intended to protect depositors and the deposit
insurance fund, rather than shareholders.
The description herein of the laws and regulations applicable to the
Company and the Bank, does not purport to be a complete description of the laws
and regulations mentioned herein or of all such laws and regulations. Any change
in applicable laws or regulations may have a material effect on the business and
prospects of the Company and the Bank. The operations of the Company and the
Bank may be affected by legislative and regulatory changes as well as by changes
in the policies of various regulatory authorities. The Company cannot accurately
predict the nature or the extent of the effects that such changes may have in
the future on its business and earnings.
Bank Holding Company Regulation. The Company is a bank holding company
within the meaning of the Bank Holding Company Act of 1956, as amended ("BHCA")
and, as such, is subject to the regulations of the Federal Reserve. Bank holding
companies are required to file periodic reports with, and are subject to
periodic examination by, the Federal Reserve. The Federal Reserve has issued
regulations under the BHCA requiring a bank holding company to serve as a source
of financial and managerial strength to its subsidiary banks. It is the policy
of the Federal Reserve that, pursuant to this requirement, a bank holding
company should stand ready to use its resources to provide adequate capital
funds to its subsidiary banks during periods of financial stress or adversity.
Additionally, under the Federal Deposit Insurance Corporation Improvement Act of
1991 ("FDICIA"), a bank holding company is required to guarantee the compliance
of any insured depository institution subsidiary that may become
"undercapitalized" (as defined in the statute) with the terms of any capital
restoration plan filed by such subsidiary with its appropriate federal banking
agency up to the lesser of (i) an amount equal to 5% of the institution's total
assets at the time the institution became undercapitalized, or (ii) the amount
that is necessary (or would have been necessary) to bring the institution into
compliance with all applicable capital standards as of the time the institution
fails to comply with such capital restoration plan. Under the BHCA, the Federal
Reserve has the authority to require a bank holding company to terminate any
activity or relinquish control of a non-bank subsidiary (other than a non-bank
subsidiary of a bank) upon the Federal Reserve's determination that such
activity or control constitutes a serious risk to the financial soundness and
stability of any bank subsidiary of the bank holding company.
7
Capital Adequacy Guidelines for Bank Holding Companies. The Federal
Reserve is the federal regulatory and examining authority for bank holding
companies. The Federal Reserve has adopted capital adequacy guidelines for bank
holding companies. These guidelines are similar to, although not identical with,
the guidelines applicable to banks. See "Bank Capital Requirements." At December
31, 2001, the Company's Tier 1 leverage capital ratio was 6.51%, its Tier 1
risk-based capital ratio was 8.84% and its total risk-based capital ratio was
10.10%.
Bank Regulation. The Bank is organized under the laws of the State of
Washington and is subject to the supervision of the Department of Financial
Institutions ("DFI"), whose examiners conduct periodic examinations of state
banks. Cowlitz Bank is not a member of the Federal Reserve System, so its
principal federal regulator is the FDIC, which also conducts periodic
examinations of the Bank. The Bank's deposits are insured, to the maximum extent
permitted by law, by the Bank Insurance Fund ("BIF") administered by the FDIC
and are subject to the Federal Deposit Insurance Corporation's ("FDIC") rules
and regulations respecting the insurance of deposits. See "Deposit Insurance."
Both federal and state laws extensively regulate various aspects of the
banking business such as reserve requirements, truth-in-lending and
truth-in-savings disclosures, equal credit opportunity, fair credit reporting,
trading in securities and other aspects of banking operations. Current federal
law also requires banks, among other things, to make deposited funds available
within specified time periods.
Insured state-chartered banks are generally prohibited under FDICIA from
engaging as principal in activities that are not permitted for national banks,
unless (i) the FDIC determines that the activity would pose no significant risk
to the appropriate deposit insurance fund, and (ii) the bank is, and continues
to be, in compliance with all applicable capital standards. The Company does not
believe that these restrictions will have a material adverse effect on its
current operations.
Bank Capital Requirements. The FDIC has adopted risk-based capital ratio
guidelines to which the Bank is subject. The guidelines establish a systematic
analytical framework that makes regulatory capital requirements more sensitive
to differences in risk profiles among banking organizations. Risk-based capital
ratios are determined by allocating assets and specified off-balance sheet
commitments to four risk weighted categories, with higher levels of capital
being required for the categories perceived as representing greater risk.
These guidelines divide a bank's capital into two tiers. Tier 1 includes
common equity, certain non-cumulative perpetual preferred stock (excluding
auction rate issues) and minority interest in equity accounts of consolidated
subsidiaries, less goodwill and certain other intangible assets (except mortgage
servicing rights and purchased credit card relationships, subject to certain
limitations). Supplementary (Tier 2) capital includes, among other items,
cumulative perpetual and long-term, limited-life, preferred stock, mandatory
convertible securities, certain hybrid capital instruments, term-subordinated
debt and the allowance for loan and lease losses, subject to certain
limitations, less required deductions. Banks are required to maintain a total
risk-based capital ratio of 8%, of which 4% must be Tier 1 capital. The FDIC
may, however, set higher capital requirements when a bank's particular
circumstances warrant. Banks experiencing or anticipating significant growth are
expected to maintain capital ratios, including tangible capital positions, well
above the minimum levels.
In addition, the FDIC has established guidelines prescribing a minimum
Tier 1 leverage ratio (Tier 1 capital to adjusted total assets as specified in
the guidelines). These guidelines provide for a minimum Tier 1 leverage ratio of
3% for banks that meet certain specified criteria, including that they have the
highest regulatory rating and are not experiencing or anticipating significant
growth. All other banks are required to maintain a Tier 1 leverage ratio of not
less than 4%.
Certain regulatory capital ratios for the Company and the Bank at
December 31, 2001 are set forth below:
Company Bank
------- ----
Total-Risk Based Capital to Risk-Weighted Assets ......... 10.10% 10.72%
Tier 1 Capital to Risk-Weighted Assets ................... 8.84% 9.46%
Tier 1 Leverage Ratio .................................... 6.51% 6.99%
Dividends. The principal source of the Company's cash revenues is
dividends from Cowlitz Bank. Under Washington law, Cowlitz Bank may not pay
dividends in an amount greater than its retained earnings as determined by
generally accepted accounting principles. In addition, the DFI has the authority
to require a state-chartered bank to suspend payment of dividends. The FDIC has
the authority to prohibit a bank from paying dividends if, in its opinion,
8
the payment of dividends would constitute an unsafe or unsound practice in light
of the financial condition of the bank or if it would cause a bank to become
undercapitalized.
Lending Limits. Under Washington law, the total loans and extensions of
credit by a Washington-chartered bank to a borrower outstanding at one time may
not exceed 20% of such bank's capital and surplus. However, this limitation does
not apply to loans or extensions of credit which are fully secured by readily
marketable collateral having market value of at least 115% of the amount of the
loan or the extension of credit at all times.
Branches and Affiliates. Establishment of bank branches is subject to
approval of the DFI and FDIC and geographic limits established by state laws.
Washington's branch banking law permits a bank having its principal place of
business in the State of Washington to establish branch offices in any county in
Washington without geographic restrictions. A bank may also merge with any
national or state chartered bank located anywhere in the State of Washington
without geographic restrictions.
Under Oregon law, an out-of-state bank or bank holding company may merge
with or acquire an Oregon state chartered bank or bank holding company if the
Oregon bank, or in the case of a bank holding company, the subsidiary bank, has
been in existence for a minimum of three years, and the law of the state in
which the acquiring bank in located permits such merger. Branches may not be
acquired or opened separately, but once an out-of-state bank has acquired
branches in Oregon, either through a merger with or acquisition of substantially
all of the assets of an Oregon bank, the bank may open additional branches.
The Bank is subject to Sections 22 (h), 23A and 23B of the Federal
Reserve Act, which restrict financial transactions between banks and affiliated
companies. The statute limits credit transactions between a bank and its
executive officers and its affiliates, prescribes terms and conditions for bank
affiliate transactions deemed to be consistent with safe and sound banking
practices, and restricts the types of collateral security permitted in
connection with a bank's extension of credit to an affiliate.
FDICIA. FDICIA requires, among other things, federal bank regulatory
authorities to take "prompt corrective action" with respect to banks which do
not meet minimum capital requirements. For these purposes, FDICIA establishes
five capital tiers: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized.
The FDIC has adopted regulations to implement the prompt corrective
action provisions of FDICIA. Among other things, the regulations define the
relevant capital measures for the five capital categories. An institution is
deemed to be "well capitalized" if it has a total, risk-based capital ratio of
10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a
leverage ratio of 5% or greater, and is not subject to a regulatory order,
agreement or directive to meet and maintain a specific capital level for any
capital measure. At the end of the 1st and 2nd quarters of 2001, Cowlitz Bank
had dropped below well capitalized in the total risk-based capital category. By
the 3rd quarter of 2001, the Bank had increased capital to a level that brought
the ratios back into the well-capitalized category. Cowlitz Bank currently
exceeds all of these ratios.
FDICIA further directs that each federal banking agency prescribe
standards for depository institutions and depository institution holding
companies relating to internal controls, information systems, internal audit
systems, loan documentation, credit underwriting, interest rate exposure, asset
growth, management compensation, a maximum ratio of classified assets to
capital, minimum earnings sufficient to absorb losses, a minimum ratio of market
value to book value of publicly traded shares and such other standards as the
agency deems appropriate.
The Federal Reserve Board classifies a bank holding company as "well
capitalized" if it has a total, risk-based capital ratio of 10% or greater and a
Tier 1 risk-based capital ratio of 6% or greater. At the end of the 2nd quarter
of 2001, the Company had dropped below well capitalized in the total risk-based
capital category. By the 3rd quarter of 2001, the Company had increased capital
to a level that brought the ratios back into the well capitalized category. The
Company currently exceeds all of these ratios.
Deposit Insurance. The Bank's deposits are insured up to $100,000 per
insured account by the Bank Insurance Fund (BIF). As an institution whose
deposits are insured by BIF, Cowlitz Bank is required to pay deposit insurance
premiums to BIF.
FDICIA required the FDIC to issue regulations establishing a system for
setting deposit insurance premiums based upon the risks a particular bank or
savings association poses to the deposit insurance funds. This system bases an
institution's risk category partly upon whether the institution is well
capitalized, adequately capitalized or less than
9
adequately capitalized. Each insured depository institution is also assigned to
one of three "supervisory" categories based on reviews by regulators,
statistical analysis of financial statements and other relevant information. An
institution's assessment rate depends upon the capital category and supervisory
category to which it is assigned. Annual assessment rates currently range from
zero per $100 of domestic deposits for the highest rated institution to $0.27
per $100 of domestic deposits for an institution in the lowest category. In the
first and second quarters of 2001, the Bank paid an assessment rate of $0.10 per
$100 of domestic deposits, which decreased to $0.03 for the third and fourth
quarters of 2001. Beginning in the first quarter of 2002, the assessment rate
for Cowlitz Bank will increase to $.17 per $100 of domestic deposits. Under
legislation enacted in 1996 to recapitalize the Savings Association Insurance
Fund, the FDIC is authorized to collect assessments against insured deposits to
be paid to the Financing Corporation ("FICO") to service FICO debt incurred in
the 1980's. The current FICO assessment rate for BIF insured deposits is $1.82
cents per $100 of deposits per year. Any increase in deposit insurance of FICO
assessments could have an adverse effect on Cowlitz Bank's earnings.
Gramm-Leach-Bliley Act. On November 12, 1999, the Gramm-Leach-Bliley Act
(the "GLB Act") was signed into law, which significantly reforms various aspects
of the financial services business. Among the provisions in the GLB Act are
those which:
o establish a new framework under which bank holding companies and banks
can own securities firms, insurance companies and other financial
companies; and
o provide consumers with new protections regarding the transfer and use of
their non-public personal information by financial institutions; and
o change the Federal Home Loan Bank ("FHLB") system in numerous ways
including a change in the manner of calculating the Resolution Funding
Corporation obligations payable by the FHLB and a broadening of the
purposes for which FHLB advances may be used.
Community Reinvestment Act. The Community Reinvestment Act ("CRA")
requires financial institutions regulated by the federal financial supervisory
agencies to ascertain and help meet the credit needs of their delineated
communities, including low-income and moderate-income neighborhoods within those
communities, while maintaining safe and sound banking practices. The regulatory
agency assigns one of four possible ratings to an institution's CRA performance
and is required to make public an institution's rating and written evaluation.
The four possible ratings are "outstanding," satisfactory," "needs to improve"
and "substantial non-compliance."
Under new regulations that apply to CRA performance ratings after
July 1, 1997, many factors play a role in assessing a financial institution's
CRA performance. The institution's regulator must consider its financial
capacity and size, legal impediments, local economic conditions and demographics
and the competitive environment in which it operates. The evaluation does not
rely on absolute standards and financial institutions are not required to
perform specific activities or to provide specific amounts or types of credit.
The Company's most recent rating under CRA is "outstanding." This rating
reflects the Company's commitment to meeting the credit needs of the communities
it serves. No assurance can be given, however, that the Company will be able to
maintain an "outstanding" rating under the new regulations in the future.
Additional Matters. In addition to the matters discussed above, the
Company and Cowlitz Bank are subject to additional regulation of their
activities, including a variety of consumer protection regulations affecting
their lending, deposit and collection activities and regulations affecting
secondary mortgage market activities.
The earnings of financial institutions, including the Company and
Cowlitz Bank, are also affected by general economic conditions and prevailing
interest rates, both domestic and foreign and by the monetary and fiscal
policies of the U.S. Government and its various agencies, particularly the
Federal Reserve.
Additional legislation and administrative actions affecting the banking
industry may be considered by the United States Congress, the Washington
Legislature and various regulatory agencies, including those referred to above.
It cannot be predicted with certainty whether such legislation or administrative
action will be enacted or the extent to which the banking industry in general or
the Company and Cowlitz Bank in particular would be affected.
10
Cowlitz Bancorporation/CFC Bay Bank Northern Bank of Commerce
- -------------------------- -------- -------------------------
927 Commerce Ave. 10500 NE 8th Street, STE 1750 1001 SW 5th Ave., Suite 250
Longview, Wa 98632 Bellevue, Wa 98004 Portland, Or 97204
(360) 423-9800 (425) 452-1543 (360) 308-0959
Cowlitz Bank Northern Bank of Commerce
Kalama Branch Bay Mortgage & Escrow - Bellevue Retirement Centers:
- ------------- -------------------------------- -------------------
195 N. 1st St. 10500 NE 8th Street, STE 1550 Gresham Manor (Gresham, Or)
Kalama, Wa 98625 Bellevue, Wa 98004 Springridge at Charbonneau (Wilsonville,Or)
(360) 673-2226 (425) 635-5151 Creekside Retirement (Beaverton,Or)
Carman Oaks (Lake Oswego, Or)
Cowlitz Bank Beaverton Lodge (Beaverton, Or)
Triangle Mall Branch Bay Mortgage & Escrow - Seattle Parkrose Chateau (Portland, Or)
- -------------------- ------------------------------- Royal Marc (Milwaukie, Or)
800 Triangle Mall 2825 Eastlake E., STE 300 Vinyard Place (Milwaukie, Or)
Longview, Wa 98632 Seattle, Wa 98102 Somerset Lodge (Gladstone, Or)
(360) 577-6067 (206) 324-7777 Edgewood Downs (Beaverton, Or)
Summerfield Estates (Tigard, Or)
Cowlitz Bank Rock Creek (Hillsboro, Or)
Kelso Branch Bay Mortgage - Vancouver
- ------------ ------------------------
1000 South 13th 201 NE Park Plaza Drive STE 296
Kelso, Wa 98626 Vancouver, Wa 98684
(360) 423-7800 (360) 944-9431
Cowlitz Bank
Castle Rock Branch Bay Mortgage - Silverdale
- ------------------ -------------------------
202 Cowlitz St. W. 9230 Bay Shore Dr. NW STE 201
Castle Rock, Wa 98611 Silverdale, Wa 98383
(360) 274-6685 (360) 308-0959
Item 3. Legal Proceedings
The Company from time to time enters into routine litigation resulting
from the collection of secured and unsecured indebtedness as part of its
business of providing financial services. In some cases, such litigation will
involve counterclaims or other claims against the Company. Such proceedings
against financial institutions sometimes also involve claims for punitive
damages in addition to other specific relief. Currently, the Company is not a
party to any litigation other than in the ordinary course of business, except as
noted below. In the opinion of management, the ultimate outcome of all pending
legal proceedings will not individually or in the aggregate have a material
adverse effect on the financial condition or the results of operations of the
Company.
On March 8, 2002, a lawsuit was filed against the Company by
Independent Financial Network, Inc. ("IFN"), and one of IFN's shareholders,
Scott Rerucha. The Company acquired certain assets and operations from IFN in
1999 pursuant to a purchase agreement with IFN, Mr. Rerucha, and other
individuals. The operations acquired from IFN are the core of the Company's Bay
Mortgage division. The complaint alleges, among other things, that the Company
has materially breached its obligations under the purchase agreement and
requests that the plaintiffs be awarded unspecified damages and that Mr. Rerucha
be relieved of his non-competition obligations under the purchase agreement. The
Company does not believe it has breached its obligations under the IFN agreement
and intends to vigorously defend this action.
11
Item 4. Submission of matters to a vote of securities holders
None.
PART II
Item 5. Market price and dividends on the registrant's common equity and related
stockholder matters
Effective March 12, 1998, Cowlitz Bancorporation stock began trading on
the Nasdaq National Market under the symbol "CWLZ". Prior to that date, there
had been no organized market for the Common Stock, and to the knowledge of the
Company, no third party bid and ask information was available.
2001 2000
------------------------------ ------------------------------
Market Price Market Price
--------------- Cash Dividend --------------- Cash Dividend
High Low Declared High Low Declared
---- --- -------- ---- --- --------
1st Quarter $6.00 $4.56 $.018 $5.25 $4.50 $.018
2nd Quarter $5.50 $5.00 $.018 $5.75 $4.44 $.018
3rd Quarter $6.00 $5.01 $.000 $4.88 $4.28 $.018
4th Quarter $6.00 $5.25 $.000 $5.13 $4.38 $.018
During 2001, the Company paid three dividends, including the $.018
declared in the fourth quarter of 2000, which was paid in the first quarter of
2001. The Company suspended dividends indefinitely after the 2nd quarter of
2001. Based upon the number of record holders, there were 3,692,560 shares of
common stock outstanding, held by 329 shareholders of record, which excludes
shares held in street name, as of February 28, 2002.
12
Item 6. Selected Financial Data
As of and for the Year Ended December 31,
------------------------------------------------------------------------
2001 2000 1999 1998 1997
----------- ----------- ----------- ----------- -----------
(dollars in thousands except per share data)
Income Statement Data
Interest income ............................... $27,227 $22,848 $15,276 $15,838 $15,032
Interest expense .............................. 13,382 9,940 5,248 5,973 6,889
----------- ----------- ----------- ----------- -----------
Net interest income ........................... 13,845 12,908 10,028 9,865 8,143
Provision for loan loss ....................... 5,262 1,155 1,349 509 375
----------- ----------- ----------- ----------- -----------
Net interest income after provision
for loan loss ............................ 8,583 11,753 8,679 9,356 7,768
Non-interest income ........................... 9,591 5,219 3,191 978 749
Non-interest expense .......................... 19,474 15,492 10,794 6,927 5,284
----------- ----------- ----------- ----------- -----------
Income (loss) before provision for income taxes (1,300) 1,480 1,076 3,407 3,233
Provision for income taxes .................... 150 611 420 1,181 1,109
----------- ----------- ----------- ----------- -----------
Net income (loss) ............................. $(1,450) $869 $656 $2,226 $2,124
=========== =========== =========== =========== ===========
Dividends
Cash .......................................... 200 281 281 212 126
Ratio of dividends to net income .............. N/A 32.34% 42.84% 9.52% 5.93%
Per Share Data
Diluted earnings per share .................... $(0.39) $0.22 $0.16 $0.57 $0.78
Cash dividends per common share ............... $0.05 $0.07 $0.07 $0.06 $0.05
Weighted average shares outstanding ........... 3,691,728 3,885,946 4,054,657 3,715,901 2,601,650
Balance Sheet Data (at period end)
Investment securities ......................... $34,303 $12,071 $12,991 $11,530 $8,481
Loans, net .................................... 229,215 229,078 147,105 129,160 129,993
Total assets .................................. 370,660 296,898 198,495 178,345 173,293
Total deposits ................................ 315,490 241,216 137,607 122,361 136,209
Total short-term borrowings ................... 2,750 1,275 3,825 2,275 725
Total long-term borrowings .................... 19,009 21,348 24,281 21,799 21,900
Total shareholders' equity .................... 28,748 30,409 31,490 30,920 13,887
Selected Ratios
Return on average total assets ................ (0.41)% 0.34% 0.37% 1.24% 1.28%
Return on average shareholders' equity ........ (4.72)% 2.82% 2.08% 8.34% 16.65%
Net interest margin ........................... 4.21% 5.51% 6.31% 6.08% 5.33%
Efficiency ratio (1) .......................... 83.09% 85.46% 81.66% 63.89% 59.42%
Asset Quality Ratios
Allowance for loan losses to:
Ending total loans ....................... 2.55% 1.95% 1.53% 1.39% 1.49%
Non-performing assets (2) ................ 80.09% 58.18% 76.88% 54.66% 81.51%
Non-performing assets to ending total assets .. 2.02% 2.64% 1.49% 1.86% 1.39%
Net loan charge-offs to average loans ......... 1.60% 0.43% 0.67% 0.54% 0.23%
Capital Ratios
Shareholders' equity to average assets ........ 8.14% 11.93% 17.73% 17.29% 8.37%
Tier 1 capital ratio (3) ................. 8.84% 9.74% 17.51% 22.21% 9.61%
Total risk-based capital ratio (4) ....... 10.10% 10.99% 18.76% 23.46% 11.34%
(1) Efficiency ratio is non-interest expense divided by the sum of net
interest income plus non-interest income.
(2) Non-performing assets consist of non-accrual loans, loans contractually
past due 90 days or more, other real estate owned, and other repossessed
assets.
(3) Tier 1 capital divided by risk-weighted assets.
(4) Total risk-based capital divided by risk-weighted assets.
Certain interest income, non-interest income, and non-interest expense amounts
have been restated from prior years to conform to the current year presentation.
These reclassifications have no effect on the Company's previously stated
results of operation or earnings per share.
13
Item 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial
Condition and Results of Operations includes a discussion of certain significant
business trends and uncertainties as well as other forward-looking statements
and is intended to be read in conjunction with and is qualified in its entirety
by reference to the consolidated financial statements of the Company and
accompanying notes included elsewhere in this report. For a discussion of
important factors that could cause actual results to differ materially from such
forward-looking statements, see "Risk Factors."
Critical Accounting Policies
Cowlitz Bancorporation (the "Company") and its wholly owned subsidiary,
Cowlitz Bank (also the "Company" or the "Bank") have identified their most
critical accounting policy to be that related to the allowance for loan losses.
The Company utilizes both quantitative and qualitative considerations in
establishing an allowance for loan losses believed to be appropriate as of each
reporting date. Quantitative factors include historical loss experience, recent
delinquency and charge-off experience, changes in the levels of non-performing
loans, portfolio size, and other known factors with specific loans. Qualitative
factors include assessments of the types and quality of the loans within the
loan portfolio as well as current local, regional, and national economic
considerations. Changes in the above factors could have a significant affect on
the determination of the allowance for loan losses. Therefore, a full analysis
is performed by management on a quarterly basis to ensure that changes in
estimated loan loss levels are adjusted on a timely basis. For further
discussion of this significant management estimate, see "Allowance for Loan
Losses."
Introduction
For all periods reported, the Company has reclassified certain income
and expense items relating to the loans funded or processed by Bay Mortgage in
order to conform with changes in the current period presentation. Fees collected
on loans brokered, but not funded, by Bay Mortgage to outside lenders had been
recorded as interest income but are now properly classified as non-interest
income. Similarly, loan origination fees related to loans held-for-sale and
previously reported as interest income have been reclassified. Loan origination
fees on loans held-for-sale, net of certain direct origination costs, are
deferred and amortized as an adjustment of the yield on the related loan using
the interest method. Such net deferred loan origination fees are recognized when
the related loans are subsequently sold or repaid. These reclassifications have
no effect on the Company's previously reported financial position, results of
operations, or earnings per share.
The Company has recently undertaken significant business changes to
strengthen its position as a leading provider of financial services in Cowlitz
County and to expand its services throughout western Washington and the
Portland, Oregon markets.
In July of 2000, the Company acquired Northern Bank of Commerce ("NBOC")
of Portland, Oregon in a business combination accounted for using the purchase
method. Also in July of 2000, the Company expanded its mortgage division by
opening a branch of Bay Mortgage in Silverdale, Washington. The results of
operations of the Company for year ended December 31, 2000 do not include the
results of operations for NBOC prior to the date of purchase. In addition, the
balance sheet annual averages used throughout this report have not been adjusted
to reflect the acquisition and expansion in mid-2000.
During 1999, the Company also expanded its business operations.
Beginning in February 1999, the Company opened a loan office in Vancouver,
Washington. In July and August 1999, the Company acquired Bay Mortgage of
Bellevue, Washington and Bay Mortgage of Seattle, Washington, both of which are
residential mortgage companies located in the greater Seattle area. In September
1999, Cowlitz Bank opened a branch in Bellevue doing business as Bay Bank and
acquired Bay Escrow of Seattle, Washington. The addition of the new mortgage
divisions, collectively "Bay Mortgage," has increased the Company's non-interest
income through fees associated with the origination and sale of residential
mortgage loans.
14
In 1999, 2000, and 2001, the Company's business also included Business
Finance Corporation ("BFC"), its finance subsidiary which was acquired in
September of 1998. This operation was sold in its entirety in the first quarter
of 2002.
The Company's results of operation for 2001 were greatly affected by the
overall slowing of the national economy. During 2001 the Federal Reserve Board
cut the fed fund interest rates eleven times, dropping the rate from 6.5% to
1.75%. Cowlitz Bank responded with corresponding reductions in its internal
prime rate from 9.50% at the beginning of 2001 to 4.75% currently. Approximately
40% of Cowlitz Bank's loan portfolio is indexed to the prime rate, and such
significant reductions over a relatively short period of time, greatly reduced
the yields earned on the Bank's loan portfolio, and interest-earning assets in
general. However, many of the interest rates paid on interest -bearing
liabilities did not re-price as quickly as the assets. Over one-half of the
Bank's funding is in fixed rate certificates of deposit and borrowings from the
Federal Home Loan Bank (FHLB), which do not re-price until the maturity of the
instrument. These factors created a narrowing of the interest spread between
interest-earning assets and interest-bearing liabilities, reducing the Company's
net interest income yield and net income from the banking segment. (See the net
interest income section for additional discussion.) Adverse economic conditions
also contributed to the increase in charged off loans and the Company's decision
to record greater loan loss provisions than in past periods.
Although the environment of lowering interest rates presented unique
challenges to the banking segment, the mortgage segment flourished under those
conditions. Bay Mortgage originated over three times the volume of residential
mortgage loans during 2001 compared to 2000. The resulting income from interest,
fee and sales premiums on these loans, allowed Bay Mortgage to contribute a
substantial after tax net income to the Company's results of operation. However,
the boom in residential lending presented funding challenges that the banking
segment absorbed. Loans held-for-sale grew from $10.0 million at December 31,
2000 to $37.3 million at December 31, 2001. During the 1st and 2nd quarters of
2001, in order to fund the rapid increase in loan volume, management utilized
the broker CD market as a funding and liquidity source. Although the loans
held-for-sale are typically sold within 14-45 days after funding, at the peak
during 2001, approximately $68.0 million of loans had been funded, but remained
unsold. Management purchased brokered certificates to fund this activity, but as
asset origination volumes declined, the CD's had not yet matured, which resulted
in excess liquidity. A portion of this excess cash was used to increase the
Company's investment portfolio by $22.2 million, but the Company's cash and cash
equivalents are still $24.6 million higher at December 31, 2001 than at December
31, 2000. The Company anticipates a reduction in broker CD's as they mature
unless the volume of loan originations continues at the rapid pace experienced
in 2001.
For the 12 months ended December 31, 2001, the Company's net loss was
$1.5 million or $(.39) per diluted share of common stock compared to $869,000
net income or $.22 per diluted share for 2000. The 2001 results of operation
included a $2.3 million net loss from the Company's finance subsidiary, Business
Finance Corporation. During 2001, the collection of certain accounts receivable
at BFC was considered doubtful so a provision for loan losses of $1.6 million
was recorded to fully reserve for the charge-off of those credits. In addition,
an analysis of the carrying value of goodwill on the balance sheet of BFC
revealed an impairment of that asset, so the Company wrote down the goodwill
asset value to zero. This decision resulted in a charge against income of $1.2
million, which contributed to the $2.3 million loss in 2001 for that operating
segment.
Total assets at December 31, 2001 were $370.7 million, up 24.9% compared
to assets of $296.9 million at December 31, 2000. Gross loans increased $1.6
million or less than 1% from $233.6 million at December 31, 2000 to $235.2
million at December 31, 2001. Non-performing assets as a percentage of total
assets decreased from 2.64% at December 31, 2000 to 2.02% at December 31, 2001.
Total non-performing assets decreased from $7.8 million to $7.5 million over the
same period. Total liabilities for the Company increased 28.3% or $75.4 million
from $266.5 million at the end of 2000 to $341.9 million at the end of 2001.
Deposits increased to $315.5 million at December 31, 2001, an increase of $74.3
million from $241.2 million at December 31, 2000. As discussed above, this
increase was primarily due to the need to fund the growth of loans held-for-sale
during 2001.
15
Results of Operations
Certain reclassifications have been made to prior year interest income,
non-interest income and non-interest expense. These restatements reduced
interest income by $3.2 million from $26.0 million to $22.8 million in 2000, and
by $1.4 million from $16.7 million to $15.3 million in 1999. Non-interest
expense was reduced by $1.2 million from $16.7 million to $15.5 million in 2000,
and by approximately $100,000 from $10.9 million to $10.8 million in 1999.
Non-interest income was increased by the net effect of the interest income and
non-interest expense reclassifications. The non-interest income previously
reported in 2000 was $3.3 million, and was increased by $1.9 million to $5.2
million. The 1999 restatement was $1.4 million, increasing non-interest income
from $1.8 million to $3.2 million.
Net Interest Income
For financial institutions, the primary component of earnings is net
interest income. Net interest income is the difference between interest income,
principally from loans and investment securities portfolios, and interest
expense, principally on customer deposits. Changes in net interest income result
from changes in "volume," "spread" and "margin." Volume refers to the dollar
level of interest-earning assets and interest-bearing liabilities. Spread refers
to the difference between the yield on interest-earning assets and the cost of
interest-bearing liabilities. Net interest margin is the ratio of net interest
income to total interest-earning assets and is influenced by the level and
relative mix of interest-earning assets and interest-bearing liabilities.
Other than the reclassifications discussed above, a number of factors
affected the Company's interest yields, margins, and spread when comparing the
twelve months ending December 31, 2001 to the same period for 2000. Following
the trend of the Federal Reserve Board in cutting the national fed funds rate,
the Company enacted eleven decreases in its prime rate during 2001. Variable
rate loans re-price immediately to changes in prime, but fixed rate liabilities,
particularly certificates of deposit do not immediately adjust with prime
changes, but do so when the CD matures and is replaced at the lower rate. The
Company's current mix of loans includes approximately 60% fixed rate loans, and
40% that re-price to prime. The falling rate environment experienced during 2001
caused yields on assets to decline more rapidly than the liability costs,
narrowing the interest spread. Increased volumes of both interest-earning assets
and average interest-bearing liabilities have offset the decline in rates earned
and paid, resulting in the increase in both interest income and interest expense
in 2001 when compared to 2000 and 1999. The decline in interest margin from year
to year is due to the mix of interest-earning assets, and interest-bearing
liabilities. Higher yielding fixed rate commercial loans made up a lower
percentage of the total interest-earning assets due to the increase in volume of
lower rate residential mortgage loans held-for-sale, interest-bearing deposits
due from banks, and available-for-sale investments. Conversely, certificates of
deposit, which typically carry a higher rate than other deposit products, made
up a higher percentage of the average total interest-bearing liabilities mix in
2001. The increase in low rate interest-bearing deposits due from banks, and the
increase in high rate certificates of deposit are the result of the same market
factors. The Company purchased funds through the broker CD market to create the
liquidity needed to fund the rapid growth of the mortgage division during 2001.
Although the mortgage loans held-for-sale typically sell within 15-45 days after
funding, interest rates were dropping so quickly early in and throughout 2001,
the Company's pipeline of loans funded but not yet sold increased from $10.0
million at the end of December to over $50.0 million at March 31, 2001. This
rapid increase in volume outstripped the Company's available liquidity,
necessitating the use of wholesale funding. The volume of loans funded but not
yet sold remained at approximately $40.0 million throughout 2001, but peaked at
about $68.0 million in the fourth quarter of 2001. Rather than create additional
liquidity by purchasing additional brokered funds, management utilized the
broker loan market, removing the necessity of the Bank to fund the high volumes
of loans, and also hired additional employees to speed up and streamline the
loan selling process. These changes brought the volume of loans held-for-sale to
$37.3 million at December 31, 2001, reversing the Company's liquidity position.
This resulted in excess cash and deposits due from banks which were invested at
a lower fed funds rate, weakening the interest yields, spread, and margins. The
Company anticipates a reduction in broker CD's as they mature, unless the volume
of mortgage loan originations continues at the rapid pace experienced in 2001.
16
The yield earned on loans outstanding (including residential mortgage
loans held-for-sale) during 2001 was 8.97% compared to 10.20% in 2000, and
10.37% in 1999. The increase in the average volume of loans from year to year
more than offset the decline in rates causing the total interest income on loans
to increase to $25.1 million in 2001 compared to $21.3 million for 2000 and
$13.9 million in 1999. The yield earned on taxable securities decreased to 5.42%
in 2001 from 7.79% in 2000 primarily due to overall interest rate reductions.
The average interest-earning balances due from banks increased significantly to
$28.4 million during 2001 from $12.9 million in 2000 and $9.5 million in 1999.
As a result, total interest earned on balances due from banks also increased
from year to year, but the yield earned decreased to 3.62% in 2001 from 4.7% in
2000, and 4.89% in 1999. The total yield earned on all interest-earning assets
declined to 8.28% in 2001 from 9.76% and 9.61% for the years 2000 and 1999,
respectively. As discussed above, the decline is due to the interest rate cuts,
the higher percentage of loans which are lower rate mortgage loans
held-for-sale, and the higher percentage of cash and due from banks. Despite the
drop in yields earned, volumes increased significantly, explaining the increase
in total interest earned.
Liability costs were also affected during 2001 by the declining rate
environment. The rates paid on all interest-bearing liabilities were lower in
2001 when compared to 2000 and 1999, but did not fall as fast or as far as
interest-earning assets, narrowing the interest spread to 3.46% in 2001 from
4.43% in 2000 and 5.11% in 1999. The yield on savings and interest-bearing
demand deposit accounts decreased to 2.91% compared to 3.35% and 2.99% in 2000
and 1999, respectively. Certificates of deposit also had a decline in average
rates paid to 5.70% during 2001 from 6.31% in 2000, but was higher than 5.39% in
1999. Both of these types of deposits experienced increases in volume and
interest expense from year to year as a response to liquidity needs. Long-term
borrowings had a decline in rate, volume and interest expense in 2001 when
compared to 2000. In 2001, the Company took advantage of an opportunity to
refinance a $2.5 million loan with the FHLB at a much lower rate. For all
interest-bearing liabilities, the average rate paid decreased to 4.82% in 2001
from 5.33% in 2000.
Net interest income for the year ended December 31, 2001 was $13.8
million, an increase of 7.0% from $12.9 million in 2000, which was $2.9 million
higher than 1999. The net interest margins for the periods ended December 31,
2001, 2000, and 1999 were 4.21%, 5.52%, and 6.31%, respectively. Interest
expense as a percentage of average earning assets decreased to 4.07% in 2001,
compared to 4.25% in 2000 and 3.30% in 1999.
17
Average Balances and Average Rates Earned and Paid. The following table
sets forth, for the periods indicated, information with regard to (i) average
balances of assets and liabilities, (ii) the total dollar amount of interest
income on interest-earning assets and interest expense on interest-bearing
liabilities, (iii) resulting yields or costs, (iv) net interest income and (v)
net interest spread. Non-accrual loans have been included in the table as loans
carrying a zero yield. Loan fees are recognized as income using the interest
method over the life of the loan.
As of and For The Year Ended December 31,
------------------------------------------------------------------------------------------------------
2001 2000 1999
--------------------------------- -------------------------------- ---------------------------------
Average Interest Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
Balance Paid Rate Balance Paid Rate Balance Paid Rate
----------- ---------- -------- ----------- ---------- ------- ----------- ---------- --------
(dollars in thousands)
ASSETS:
Loans ...................... $279,556 $25,088 8.97% $208,574 $21,283 10.20% $134,017 $13,901 10.37%
Taxable securities ......... 20,087 848 5.42% 11,127 651 7.79% 15,205 681 5.93%
Non-taxable securities(1) .. 200 11 5.50% 200 11 5.50% 200 11 5.50%
Federal funds sold ......... 544 14 2.57% 1,281 83 6.48% 6 -- 0.00%
Interest-earning balances
due from bank .......... 28,415 1,269 3.62% 12,905 823 4.70% 9,514 686 4.89%
-------- ------- ----- ------- ------- ------ -------- ------- -------
Total interest-
earning assets ...... 328,802 27,230 8.28% 234,087 22,851 9.76% 158,942 15,279 9.61%
------- ------- -------
Cash and due from banks .... 11,774 9,500 8,792
Premises and equipment ..... 5,452 5,793 5,953
Allowance for loan losses .. (4,139) (3,738) (1,996)
Net intangibles ............ 5,068 5,191 3,911
Other assets ............... 6,207 3,996 2,055
-------- -------- --------
Total assets ......... $353,164 $254,829 $177,657
======== ======== ========
LIABILITIES AND
SHAREHOLDERS' EQUITY:
Savings and interest-
bearing demand
deposits ................ $89,336 $2,600 2.91% $64,667 $2,169 3.35% $49,128 $1,469 2.99%
Certificates of deposit .... 164,736 9,382 5.70% 97,715 6,164 6.31% 43,299 2,332 5.39%
Long-term borrowings ....... 20,166 1,285 6.37% 21,979 1,501 6.83% 22,067 1,350 6.12%
Short-term borrowings ...... 3,523 115 3.26% 2,115 106 5.01% 2,117 97 4.58%
-------- ------- ----- ------- ------- ------ -------- ------- -------
Total interest-
bearing
Liabilities ......... 277,761 13,382 4.82% 186,476 9,940 5.33% 116,611 5,248 4.50%
------- ------- -------
Non-interest-bearing
deposits ................. 41,652 35,564 28,602
Other liabilities .......... 3,050 2,007 1,024
-------- -------- --------
Total liabilities ..... 322,463 224,047 146,237
Shareholders' equity ....... 30,701 30,782 31,420
-------- -------- --------
Total liabilities and
shareholders' equity.. $353,164 $254,829 $177,657
======== ======== ========
Net interest income $13,848 $12,911 $10,031
======= ======= =======
Net interest spread 3.46% 4.43% 5.11%
Average yield on earning assets 8.28% 9.76% 9.61%
Interest expense to earning assets 4.07% 4.25% 3.30%
Net interest income to earning assets 4.21% 5.52% 6.31%
(1) Interest earned on non-taxable securities has been computed on a 34 percent
tax equivalent basis. (2) Certain interest income amounts have been restated
from prior years to conform to the current year presentation. These restatements
have no effect on the Company's previously reported net income or earnings per
share.
18
Analysis of changes in interest differential. The following table shows
the dollar amount of the increase (decrease) in the Company's net interest
income and expense and attributes such dollar amounts to changes in volume as
well as changes in rates. Rate/volume variances have been allocated to volume
changes:
Year Ended December 31,
------------------------------------------------------------------------------
2001 versus 2000 2000 versus 1999
------------------------------------- -------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------- Total Increase/ ------------------- Total Increase/
Volume Rate (Decrease) Volume Rate (Decrease)
------ ---- ---------- ------ ---- ----------
(dollars in thousands)
Interest income:
Interest-earning balances due
from banks ............................ $562 $(140) $422 $159 $(17) $142
Federal funds sold ........................ (19) (50) (69) 83 -- 83
Investment security income:
Taxable securities .................... 485 (264) 221 (318) 283 (35)
Non-taxable securities ................ -- -- -- -- -- --
Loans, including fees on loans ............ 6,370 (2,565) 3,805 7,608 (226) 7,382
------- ------- ------- ------- ------- -------
Total interest income ................. 7,398 (3,019) 4,379 7,532 40 7,572
------- ------- ------- ------- ------- -------
Interest expense:
Savings and interest-bearing
demand ................................ 718 (287) 431 521 179 700
Certificates of deposit ................... 3,817 (599) 3,218 3,433 399 3,832
Short-term borrowings ..................... 46 (37) 9 -- 9 9
Long-term borrowings ...................... (116) (100) (216) (6) 157 151
------- ------- ------- ------- ------- -------
Total interest expense ................ 4,465 (1,023) 3,442 3,948 744 4,692
------- ------- ------- ------- ------- -------
Net interest spread ............................ $2,877 $(1,940) $937 $3,584 $(704) $2,880
======= ======= ======= ======= ======= =======
Non-interest income
Non-interest income consists of the following components:
Year Ended December 31,
--------------------------
2001 2000 1999
---- ---- ----
(dollars in thousands)
Service charge on deposit accounts ............ $ 737 $ 714 $ 698
Gains on loans sold ........................... 4,872 1,813 852
Brokerage fees ................................ 2,450 1,497 857
Fiduciary income .............................. 238 301 151
Credit card income ............................ 507 381 381
Escrow fees ................................... 895 316 105
ATM income .................................... 82 70 54
Safe deposit box fees ......................... 32 31 32
Gain/(loss) on sale of repossessed assets ..... (429) 92 --
Gain/(loss) on sale of AFS securities ......... 89 (4) (2)
Other miscellaneous fees and income ........... 118 8 63
------- ------- -------
Total non-interest income ..................... $ 9,591 $ 5,219 $ 3,191
======= ======= =======
Total non-interest income has increased year-to-year to $9.6 million in
2001, from $5.2 million in 2000 and $3.2 million in 1999. The majority of this
income is due to the brokerage fees and gains on loans sold, both of which have
been generated by the increased volume of residential mortgage loans originated
by Bay Mortgage. With the falling rate environment experienced in 2001, there
has been a significant increase in mortgage lending activity. Lower interest
rates have attracted consumers to refinance existing mortgages, apply for new
mortgage or construction loans, or request bridge loans for short-term
financing. Each of these types of loans generates additional non-interest income
for the Bank, and from 2000 to 2001 has added $4.6 million of additional
non-interest income. Gains on loan sold increased $3.1 million from $1.8 million
in 2000 to $4.9 million in 2001, which was an increase from the 1999 level of
$852,000. Escrow fees increased $579,000 from $316,000 in 2000 to $895,000 in
2001 and $105,000 in 1999. Brokerage fees, which includes points and processing
fees on loans held-for-sale and fees collected for lenders the Bank brokers
loans to, also increased significantly from year to year. In 2001, the Company
recorded $2.5 million of such fees, an increase of $1.0 million from $1.5
million in 2000, and an increase over the 1999 level of $857,000. Non-
19
interest income was reduced in 2001 by $429,000 in losses taken on the sales of
repossessed assets. These losses occur when the Bank's recorded value in a
repossessed asset, usually real property, is higher than the amount actually
realized upon sale of the asset.
Non-interest Expense
Non-interest expense consists of the following components:
Year Ended December 31,
------------------------------
2001 2000 1999
---- ---- ----
(dollars in thousands)
Salaries and employee benefits .......... $ 9,365 $ 8,641 $ 5,766
Net occupancy and equipment ............. 2,440 2,115 1,457
Amortization of intangible assets ....... 582 559 445
Impairment of BFC goodwill .............. 1,215 -- --
Business taxes .......................... 613 415 274
Data processing and communications ...... 543 430 238
Stationary and supplies ................. 378 340 227
Parking/travel/education ................ 333 356 235
Credit Card Expense ..................... 408 307 315
Loan expense ............................ 716 230 202
Advertising ............................. 246 232 149
Professional fees ....................... 641 492 379
Postage and freight ..................... 478 331 164
FDIC insurance .......................... 214 94 15
Other miscellaneous expenses ............ 1,302 950 928
------- ------- -------
Total non-interest expense .............. $19,474 $15,492 $10,794
======= ======= =======
Non-interest expenses increased 25.8% to $19.5 million for the year
ended December 31, 2001 compared to $15.5 million for the year ended December
31, 2000, which was an increase of 43.5% compared to $10.8 million for the year
ended December 31, 1999. Much of the increase in non-interest expense from 2000
to 2001 is the direct result of the increase in volume at Bay Mortgage, which
management expects to decrease if mortgage volumes decline. The write-down of
goodwill originally associated with the purchase of BFC contributed $1.2 million
of non-interest expense in 2001. Another factor in the increase is the expenses
relating to the operations of NBOC which was acquired in mid 2000, but had a
full year of operations and expenses in 2001.
A measure of the Company's ability to contain non-interest expenses is
the efficiency ratio. This measurement is derived by dividing total non-interest
expenses by total net interest income and non-interest income. The Company's
efficiency ratio decreased slightly to 83.09% for the year ended December 31,
2001 compared to 85.46% for the corresponding period in 2000 and 81.66% for the
year ended December 31, 1999. The decrease in 2001 when compared to 2000 is the
result of management's efforts to reduce overhead expenses of its banking
operations in an attempt to offset the narrowing interest spread.
Salaries, benefits, and commissions expense of $9.4 million in 2001
represented an increase of $724,000 or 8.4% from the $8.6 million reported in
2000 which was $2.9 million or 49.9% higher than the $5.8 million reported in
1999. The increase from 2000 to 2001 is partially due to the NBOC employee's
wages paid for a full year in 2001, but only for half of the year in 2000. Also
contributing was the overall increase in the number of employees at Bay
Mortgage, where the full time equivalent count increased from 64 at the end of
2000 to 88 at the end of 2001. These additional employees were brought in to
help process and sell the increased volume of loans originated during the year.
The increase of 24 employees in the mortgage division was offset by a staff
reduction of ten full time equivalent employees in other divisions. The increase
from 1999 to 2000 reflects the addition of 22 employees from the acquisition of
NBOC, and reduction of six employees due to streamlining of operations. In
addition, the 2000 expense includes the severance salary of the Company's former
president in the amount of $540,000. Another factor contributing to the increase
in salaries and employee benefits from 1999 to 2000 is that new employees, which
were added in the third quarter of 1999 in connection with the acquisition of
Bay Mortgage and the start up of Bay Bank, were on the payroll for all of 2000.
Also contributing to the increases in both years were ordinary wage increases
for existing employees, which generally range from three to six percent each
year. At December 31, 2001, the Company had 199 full-time equivalent employees
compared to 185 and 169 at December 31, 2000 and 1999, respectively. Many of the
additional employees in 2001 are commissioned mortgage loan officers.
20
Net occupancy and equipment expenses consist of depreciation on
premises, lease costs, equipment, maintenance and repair expenses, utilities and
related expenses. The Company's net occupancy expense in 2001 of $2.4 million
was $325,000 or 15.4% higher than the $2.1 million reported in 2000, which was
$658,000 or 45.2% higher than the $1.5 million reported in 1999. The majority of
the increase is the result of NBOC's full year of operation in 2001 compared to
only half of the year in 2000. The increase in occupancy expenses in 2000
reflects an increase of approximately $513,000 in lease payments due to the
acquisition of Bay Mortgage, NBOC, the start up of Bay Bank, and due to rental
increases over the period. The year 2000 also includes increased depreciation
expense of approximately $100,000, which resulted from the equipment and
leasehold improvements acquired during the period.
For the period ended December 31, 2001, expenses related to the
amortization of intangibles were $582,000 compared to $559,000 and $445,000 for
the periods ended December 31, 2000 and 1999 respectively. An additional cost of
$1.2 million was recorded in 2001 to recognize to the impairment of goodwill
originally associated with the purchase of BFC. Intangible assets included a
deposit premium of $767,000 and $1.0 million, net of accumulated amortization,
at December 31, 2001 and 2000, respectively. The deposit premium is being
amortized using an accelerated method over a ten-year life. Intangible assets at
December 31, 2001 and 2000 also included goodwill of $3.6 and $4.3 million, net
of accumulated amortization, respectively. Goodwill represents the unamortized
portion of excess of acquisition costs over the fair value of net assets that
arose in connection with the Company's business acquisitions. Goodwill at Bay
Mortgage was increased by $772,000 at December 31, 2001 as the result of
additional payments recorded relating to an earn-out agreement specified in the
purchase contract. All goodwill has been amortized on a straight-line basis over
a 15-year period. However, beginning in January 2002, with the adoption of SFAS
No. 142, non-interest expenses will be reduced because no amortization expense
will be recognized on unidentifiable intangible assets, including the Company's
goodwill unless the unidentifiable intangible asset is deemed to be impaired.
This will result in a decrease of amortization expense of $325,000 per year. The
intangible asset associated with the deposit premium will continue to amortize
as discussed above, with an estimated amortization expense of $265,000.
In 2001, FDIC insurance premiums increased because in 2000 the Bank was
not required to pay an assessment charge on deposits. However, for the first two
quarters of 2001, the Bank was required to pay $0.10 per $100 of domestic
deposits, which decreased in the 3rd and 4th quarters to $0.03. Beginning in the
1st quarter of 2002, the assessment rate increases to $0.17 per $100 of domestic
deposits. These assessment charges are imposed based on FDIC analysis of the
Bank's capital position, rating, and other factors. As these factors improve or
deteriorate, the assessment rates change.
Loan expenses were much higher in 2001 compared to 2000 and 1999 due to
the volume increases experienced at Bay Mortgage, and the increased loan costs
associated with booking those loans. Another factor was the expenses related to
repossessed assets such as carrying costs and repossession costs of assets
obtained in exchange for defaulted loans.
Professional fees include exam and audit expenses, consulting and legal
fees, and other professional fees. The increase in these expenses in 2001 is the
result of higher legal fees relating to the repossession of assets on defaulted
loans, and general consulting fees to business brokers regarding the sale of
BFC, which was finalized in February of 2002, as well as consulting on other
strategic alternatives.
Other operating expenses such as business taxes, travel and meals,
postage and freight, advertising, data and loan processing costs, office
supplies, and other business expenses were $4.3 million at December 31, 2001,
$3.4 million at December 31, 2000, and $2.5 million at December 31, 1999. The
increases from year to year were due to the Company's continued growth and
expansion, and specifically in 2001, the growth experienced at Bay Mortgage.
Income Taxes
The provision for income taxes amounted to $150,000, $611,000, and
$420,000 for 2001, 2000, and 1999, respectively. The provision resulted in an
effective tax rate of (11.5)% in 2001, 41.3% in 2000, and 39.0% in 1999. The
variance from the 34% corporate tax rate is due to the amortization of goodwill
associated with the BFC and the Northern Bank of Commerce acquisitions, and key
man insurance expense, that are not deductible for income tax purposes. In 2001,
there were significant expenses recorded for book purposes, including $1.2
million of BFC goodwill impairment expense, not deductible for tax purposes.
After making these and certain other adjustments to the net loss before tax of
$1.3 million, the result was taxable income of $441,000 resulting in the
Company's reported $150,000 provision for income taxes.
21
Provision for Loan Losses
The amount of the allowance for loan losses is analyzed by management on
a regular basis to ensure that it is adequate to absorb losses inherent in the
loan portfolio as of the reporting date. When a provision for loan losses is
recorded, the amount is based on past charge-off experience, a careful analysis
of the current loan portfolio, the level of non-performing and impaired loans,
evaluation of future economic trends in the Company's market area, and other
factors relevant to the loan portfolio. See "Allowance for Loan Losses"
disclosure for a more detailed discussion.
The Company's provision for loan losses was $5.3 million for the year
ended December 31, 2001. For the year ending December 31, 2000 the provision was
$1.2 million and was $1.3 million in 1999. Included in 2001 was an increase to
the provision resulting from charge-offs of $1.6 million at BFC for doubtful
accounts receivable. While this substantial provision was necessary, with the
subsequent sale of BFC in February of 2002, management believes it won't
reoccur. Charge-offs, net of recoveries, were $3.8 million in 2001, $863,000 in
2000 and $882,000 in 1999. As discussed more fully in the "Allowance for Loan
Losses" section, the Company recognized an adjustment to the allowance for loan
losses of $2.0 million at the time of its acquisition of NBOC in 2000. At
December 31, 2001, the allowance for loan losses was 2.55% of total loans
compared to 1.95% at December 31, 2000 and 1.53% at December 31, 1999.
The allowance for loan losses is based upon estimates of probable losses
inherent in the loan portfolio. The amount actually realized for these losses
can vary significantly from the estimated amounts.
The following table shows the Company's loan loss performance for the
periods indicated:
Year Ended December 31,
----------------------------
2001 2000 1999
---- ---- ----
(dollars in thousands)
Loans outstanding at end of period ........................ $235,212 $233,639 $149,386
Average loans outstanding during the period ............... $239,678 $202,016 $134,017
Allowance for loan losses, beginning of period ............ $ 4,561 $ 2,281 $ 1,814
Loans charged off:
Commercial ............................................ 2,729 1,983 838
Real estate ........................................... 1,743 -- 41
Consumer .............................................. 53 36 50
Credit cards .......................................... 86 51 96
-------- -------- --------
Total loans charged-off ............................ 4,611 2,070 1,025
-------- -------- --------
Recoveries:
Commercial ............................................ 115 1,183 104
Real estate ........................................... 652 -- 15
Consumer .............................................. 15 9 1
Credit cards .......................................... 3 15 23
-------- -------- --------
Total recoveries ................................... 785 1,207 143
-------- -------- --------
Provision for loan losses ................................. 5,262 1,155 1,349
-------- -------- --------
Adjustment incident to acquisition ........................ -- 1,988 --
-------- -------- --------
Allowance for loan losses, end of period .................. $ 5,997 $ 4,561 $ 2,281
======== ======== ========
Ratio of net loans charged-off to average loans outstanding 1.60% 0.43% 0.66%
Ratio of allowance for loan losses to loans at year-end ... 2.55% 1.95% 1.53%
22
Financial Condition
Summary Balance Sheet
December 31, Increase (Decrease)
--------------------------- ---------------------------------------------
2001 2000 1999 12/31/00 - 12/31/01 12/31/99 - 12/31/00
---- ---- ---- ------------------- -------------------
(dollars) (percent) (dollars) (percent)
(dollars in thousands)
ASSETS
Cash and cash equivalents ... $ 50,177 $ 25,589 $ 19,054 $ 24,588 96.1% $ 6,535 34.3%
Investment securities ....... 34,303 12,071 12,991 22,232 184.2% (920) (7.1)%
Loans, net .................. 229,215 229,078 147,105 137 0.1% 81,973 55.7%
Loans, held-for-sale ........ 37,322 10,013 2,255 27,309 272.7% 7,758 344.0%
Other assets ................ 19,643 20,147 17,090 (504) (0.3)% 3,057 17.9%
--------- --------- --------- --------- ---------
Total assets ............ $ 370,660 $ 296,898 $ 198,495 $ 73,762 24.8% $ 98,403 49.6%
========= ========= ========= ========= =========
LIABILITIES
Non-interest-bearing deposits $ 43,225 $ 40,201 $ 28,004 $ 3,024 7.5% $ 12,197 43.6%
Interest-bearing deposits ... 272,265 201,015 109,603 71,250 35.4% 91,412 83.4%
--------- --------- --------- --------- ---------
Total deposits .............. 315,490 241,216 137,607 74,274 30.8% 103,609 75.3%
Other liabilities ........... 26,422 25,273 29,398 1,149 4.6% (4,125) (14.0)%
--------- --------- --------- --------- ---------
Total liabilities ....... 341,912 266,489 167,005 75,423 28.3% 99,484 59.8%
SHAREHOLDERS' EQUITY ........ 28,748 30,409 31,490 (1,661) (5.5)% (1,081) (3.4)%
--------- --------- --------- --------- ---------
Total liabilities and
shareholders equity ... $ 370,660 $ 296,898 $ 198,495 $ 73,762 24.8% $ 98,403 49.6%
========= ========= ========= ========= =========
Investment Securities
At December 31, 2001, the Company's portfolio of investment securities
totaled $34.3 million, 1.8 times the amount of investment securities of $12.1
million owned at December 31, 2000. The large increase in securities in 2001 is
the result of investing some of the Company's excess liquidity from broker
deposits originally purchased to fund the growth of the mortgage division.
The Company follows financial accounting principles which requires the
identification of investment securities as held-to-maturity, available-for-sale
or trading assets. Securities designated as held-to-maturity are those that the
Company has the intent and ability to hold until they mature or are called.
Available-for-sale securities are those that management may sell if liquidity
requirements dictate or alternative investment opportunities arise. Trading
assets are purchased and held principally for the purpose of reselling them
within a short period of time. The mix of available-for-sale and
held-to-maturity investment securities is considered in the context of the
Company's overall asset-liability management policy and illustrates management's
assessment of the relative liquidity of the Company. At December 31, 2001, the
investment portfolio consisted of 88.0% available-for-sale securities and 12.0%
held-to-maturity investments. At December 31, 2000, available-for-sale
securities were 62.1% and held-to-maturity investments were 37.9% of the
investment portfolio. The Company did not conduct any trading activities during
2001 or 2000.
23
The following table provides the amortized cost and fair value of the
Company's investment securities as of December 31, 2001 and 2000.
December 31,
---------------------------------------------------
2001 2000
---------------------- ----------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
---------- --------- --------- ----------
(dollars in thousands)
Available-for-sale
U.S. Government and agency securities....... $ 19,566 $ 19,644 $ 7,441 $ 7,499
Mortgage backed securities................. 10,606 10,544 - -
---------- --------- --------- ----------
Total.............................. $ 30,172 $ 30,188 $ 7,441 $ 7,499
========== ========= ========= ==========
Held-to-maturity
U.S. Government and agency securities....... $ 1,016 $ 1,055 $ 1,007 $ 1,006
Municipal bonds............................. 200 203 200 198
Certificates of deposit..................... 2,899 2,899 3,365 3,365
---------- --------- --------- ----------
Total.............................. $ 4,115 $ 4,157 $ 4,572 $ 4,569
========== ========= ========= ==========
At December 31, 2001, the Company's available-for-sale and
held-to-maturity investments had total net unrealized gains of approximately
$58,000. This compares to net unrealized losses of approximately $55,000 at
December 31, 2000. Unrealized gains and losses reflect changes in market
conditions and do not represent the amount of actual profits or losses the
Company may ultimately realize. Actual realized gains and losses occur at the
time investment securities are sold or redeemed.
In 1991, the Company became a member and shareholder in the Federal Home
Loan Bank of Seattle. The Company's relationship and stock investment with the
FHLB provides a borrowing source for meeting liquidity requirements, in addition
to dividend earnings. Investment in FHLB stock was $3.5 million at December 31,
2001 compared to $3.3 million at December 31, 2000.
At December 31, 2001, net unrealized gains on available-for-sale
securities were $16,000 representing less than one tenth of one percent of the
total portfolio. Management has no current plans to sell any of these
securities.
The following table summarizes the contractual maturities and weighted
average yields of both available-for-sale and held-to-maturity investment
securities at December 31, 2001.
One After 5
One year through through
Or less Yield 5 years Yield 10 years Yield Total Yield
--------- ----- -------- ----- -------- ----- ----- -----
(dollars in thousands)
U.S. Government and
agency securities....... $ 1,248 6.78% $ 19,412 4.35% $ -- -- $ 20,660 4.50%
Mortgage backed securities... 510 4.49% 8,579 4.93% 1,455 5.52% 10,544 4.99%
Other securities............. 2,999 2.95% 100 4.15% -- -- 3,099 2.99%
--------- --------- --------- ---------
Total............... $ 4,757 4.12% $ 28,091 4.53% $ 1,455 5.52% $ 34,303 4.51%
========= ========= ========= =========
For the purposes of the maturity schedule, mortgage-backed securities,
which are not due at a single maturity date, have been allocated over maturity
groupings based on the expected maturity of the underlying collateral.
Mortgage-backed maturity securities may mature earlier than their stated
contractual maturities because of accelerated principal repayments of the
underlying loans.
Loans
Gross outstanding loans totaled $235.2 million at December 31, 2001,
representing an increase of $1.6 million compared to $233.6 million at December
31, 2000. Loan commitments were $53.7 million at December 31, 2001 and amounted
to $54.4 million at December 31, 2000.
24
The following table presents the composition of the Company's loan portfolio at
the dates indicated.
December 31,
---------------------------------------------------
2001 2000
--------------------- ----------------------
Amount Percent Amount Percent
(dollars in thousands)
Commercial.................................. $ 50,152 21.26% $ 46,738 19.94%
Real estate construction.................... 26,520 11.24 10,744 4.58
Real estate commercial...................... 111,437 47.23 130,272 55.58
Real estate mortgage........................ 36,190 15.34 34,402 14.68
Consumer and other.......................... 11,650 4.94 12,247 5.22
---------- ------ ---------- ------
235,949 100.00% 234,403 100.00%
====== ======
Deferred loan fees.......................... (737) (764)
---------- ----------
Total loans........................ 235,212 233,639
Allowance for loan losses................... (5,997) (4,561)
---------- ----------
Total loans, net................... $ 229,215 $ 229,078
========== ==========
The following table shows the contractual maturities of the Company's
loans and sensitivity to changes in interest rates at the dates indicated:
December 31, 2001
-----------------------------------------------------
Due after one
Due in one through Due after Total
year or less 5 years 5 years Loans
------------ ------- ------- -----
(dollars in thousands)
Commercial loans............................ $ 40,640 $ 7,667 $ 1,845 $ 50,152
Real estate construction.................... 21,675 2,192 2,653 26,520
Real estate commercial...................... 41,224 52,106 18,107 111,437
Real estate mortgage........................ 15,341 15,927 4,922 36,190
Consumer and other.......................... 3,817 6,369 1,464 11,650
---------- --------- ---------- ----------
$ 122,697 $ 84,261 $ 28,991 $ 235,949
========== ========= ========== ==========
Loans with fixed interest rates............. $ 141,701
Loans with floating interest rates.......... 94,248
----------
Total.............................. $ 235,949
==========
Allowance for Loan Losses
The allowance for loan losses represents management's estimate of
probable losses which have occurred as of the date of the financial statements.
The loan portfolio is regularly reviewed to evaluate the adequacy of the
allowance for loan losses. In determining the level of the allowance, the
Company evaluates the amount necessary for specific non-performing loans and
estimates losses inherent in other loans. An important element in determining
the adequacy of an allowance for loan losses is an analysis of loans by loan
rating categories. The risk of a credit is evaluated by the Company's management
at inception of the loan using an established grading system. This grading
system currently includes ten levels of risk. Risk gradings range from "1" for
the strongest credits to "10" for the weakest; a "10" rated loan would normally
represent a loss, and all loans rated 6-10 are collectively the Company's watch
list. The specific gradings from 6-10 are "management attention", "special
mention", "substandard", "doubtful", or "loss". When indicators such as
operating losses, collateral impairment or delinquency problems show that a
credit may have weakened, the credits will be downgraded as appropriate.
Similarly, as borrowers bring loans current, show improved cash flows, or
improve the collateral position of the loan, the credits may be upgraded.
Management reviews all credits periodically for changes in such factors.
The result is an allowance with two components:
Specific Reserves: Loans on the Company's watch list, as described
above, are specifically reserved for by applying a separate reserve factor to
the volume of loans within each risk grade. The reserve factors are determined
on the basis of suggested regulatory guidelines. Management assesses each loan
on the watch list to assure the reserve factor applied to each risk grade is
sufficient for each individual loan within the pool. When significant conditions
or circumstances exist on an individual loan indicating greater risk, additional
specific reserves may be required.
25
Management considers in its analysis expected future cash flows, the value of
collateral and other factors that may impact the borrower's ability to pay.
General Allowance: Any loan that does not require a specific reserve is
subject to a general reserve loss factor. Management determines this factor by
analyzing the volume and mix of the existing loan portfolio, including the
volume and severity of non-performing loans and adversely classified credits;
analysis of net charge-offs experienced on previously classified loans; the
nature and value of collateral securing the loans; the trend in loan growth,
including any rapid increase in loan volume within a relatively short period of
time; management's subjective evaluation of general and local economic and
business conditions affecting the collectibility of the Company's loans; the
relationship and trend over the past several years of recoveries in relation to
charge-offs; and any changes in lending policies, lending management, or the
loan review system. This decision also reflects management's attempt to ensure
that the overall allowance appropriately reflects a margin for the imprecision
necessarily inherent in estimates of expected loan losses.
The quarterly analysis of specific and general loss components of the
allowance is the principal method relied upon by management to ensure that
changes in estimated loan loss levels are adjusted on a timely basis. The
inclusion of historical loss factors in the process of determining the general
component of the allowance also acts as a self-correcting mechanism of
management's estimation process, as loss experience more remote in time is
replaced by more recent experience. In its analysis of the specific and the
general components of the allowance, management also considers regulatory
guidance in addition to the Company's own experience.
Loans and other extensions of credit deemed uncollectable are charged to
the allowance. Subsequent recoveries, if any, are credited to the allowance.
Actual losses may vary from current estimates and the amount of the provision
may be either greater than or less than actual net charge-offs. The related
provision for loan losses that is charged to income is the amount necessary to
adjust the allowance to the level determined through the above process. In
accordance with the Company's methodology for assessing the appropriate
allowance for loan losses, the general portion of the allowance increased to
$1.9 million at December 31, 2001 compared to $1.2 million at December 31, 2000.
Management believes this increase is prudent given the increase in the average
non-accrual loans and the level of net charge-offs during 2001 and 2000. This
increase is also necessary to help absorb potential losses from companies
impacted by the state of the local, regional, and national economies.
At December 31, 2001, approximately $3.6 million of the allowance for
loan losses was allocated based on an estimate of the amount that was necessary
to provide for potential losses related to the watch list and other specific
loans, compared to $3.2 million at December 31, 2000. Specific reserves
increased as those loans requiring such reserves have been identified.
Management's evaluation of the factors above resulted in allowances for
loan losses of $6.0 million and $4.6 million at the end of 2001 and 2000,
respectively. The allowance as a percentage of year-end total loans increased
from 1.95% at year-end 2000 to 2.55% at year-end 2001. The increase in provision
between December 31, 2000 and December 31, 2001 was to reserve against potential
future losses resulting from the charge-off of loans currently in the portfolio.
Factors affecting the decision to increase these reserves include the high level
of non-performing loans, the increase in recent charge-off experience,
deteriorating loan quality of the Company's finance subsidiary, and the overall
state of the current local, regional, and national economies.
The Company, during its normal loan review procedures, considers a loan
to be impaired when it is probable that the Company will be unable to collect
all amounts due according to the contractual terms of the loan agreement. A loan
is not considered to be impaired during a period of minimal delay (less than 90
days) unless available information strongly suggests impairment. The Company
measures impaired loans based on the present value of expected future cash flows
discounted at the loan's effective interest rate or, as a practical expedient,
at the loan's observable market price or the fair market value of the collateral
if the loan is collateral dependent. Impaired loans are charged to the allowance
when management believes, after considering economic and business conditions,
collection efforts, and collateral position, that the borrower's financial
condition is such that collection of principal is not probable.
At December 31, 2001 and 2000, the Company's recorded investment in
certain loans that were considered to be impaired was $7.3 million and $6.7
million, respectively. Of these impaired loans, $2.5 million and $2.1 million
have related specific reserves of $792,000 and $1.3 million, while $4.8 million
and $4.6 million did not require specific reserves. The balance of the allowance
for loan losses in excess of these specific reserves is available to absorb
losses from all loans. The average recorded investment in impaired loans for the
years ended December 31, 2001, 2000, and 1999, was approximately $6.0 million,
$4.9 million, and $3.7 million, respectively. The Company's policy is to include
in impaired loans all loans that are past due 90 days or more as to either
principal or interest and any loans that the
26
Company believes collection of principal or interest is doubtful, except for
loans that are currently measured at fair value or at the lower of cost or fair
value, and credit card receivables, which are considered large groups of smaller
balance homogeneous loans that are collectively evaluated for impairment.
Interest payments received on impaired loans are recorded as interest income,
unless collection of the remaining recorded investment is not probable, in which
case payments received are recorded as a reduction of principal. For the years
ended December 31, 2001, 2000, and 1999, interest income on impaired loans
totaled $324,000, $159,000, and $153,000, respectively, all of which was
recognized on a cash basis.
Generally, no interest is accrued on loans when factors indicate
collection of interest is doubtful or when the principal or interest payments
become 90 days past due, unless collection of principal and interest are
anticipated within a reasonable period of time and the loans are well secured.
For such loans, previously accrued but uncollected interest is charged against
current earnings, and income is only recognized to the extent payments are
subsequently received and collection of the remaining recorded principal balance
is considered probable.
The following table presents information on non-performing loans and
other assets:
December 31,
--------------
2001 2000
---- ----
(dollars in thousands)
Loans on non-accrual status ....................... $4,807 $5,110
Loans past due greater than 90 days but not on
non-accrual status ............................ 1,178 1,170
Other real estate owned ........................... 1,498 1,247
Other assets ...................................... 5 312
------ ------
Total non-performing assets ................... $7,488 $7,839
====== ======
Percentage of non-performing assets to total assets 2.02% 2.64%
At December 31, 2001 non-performing assets were $7.5 million or 2.0% of
total assets compared to $7.8 million or 2.6% at December 31, 2000. Non-accrual
loans were $4.8 million at December 31, 2001 and $5.1 million at December 31,
2000. Approximately $3.4 million of the non-accrual loans reflect loans
primarily secured by real estate and the remainder consists of commercial and
consumer loans with varying collateral. Any losses on non-accrual loans that are
considered probable have been estimated by management in its regular quarterly
assessment of the allowance for loan losses as discussed above. The increase in
the provision for loan losses each year is largely reflective of the increases
in the average non-accrual loans and the level of net charge-offs during the
periods, as well as total asset growth.
The Company is actively working on identifying and reducing the level of
non-performing assets, and has undertaken a more aggressive approach relating to
the collection and ultimate reduction of non-performing assets. Although the
level of non-performing assets is virtually unchanged from December 31, 2000 to
December 31, 2001, the Company's aggressiveness is evidenced by the changes in
the level of non-performing assets from quarter to quarter in 2001. Total
non-performing assets were $8.9 million, $7.7 million and $8.8 at the end of the
first, second and third quarters, respectively. As these impaired loans are
identified and brought current, charged-off, or the repossessed collateral sold,
the level of non-performing assets is expected to decrease.
Other real estate owned ("OREO") increased by $251,000 from year to year
due to the migration of non-performing loans to OREO, while other repossessed
assets were reduced by $307,000. All properties are being actively marketed
through local real estate agencies.
27
Deposits
The following table sets forth the composition of the Company's deposit
liabilities and associated weighted average rates on the dates indicated:
December 31,
---------------------------------
2001 2000
-------------- -------------
Volume Rate Volume Rate
------ ---- ------ ----
(dollars in thousands)
Non-interest-bearing deposits......................... $ 43,225 N/A $ 40,201 N/A
Savings............................................... 13,275 1.77% 12,894 2.78%
NOW accounts.......................................... 34,979 0.87% 22,736 1.63%
Money market accounts................................. 48,333 2.45% 38,140 4.64%
Certificates of deposit under $100,000................ 80,611 5.00% 80,867 6.41%
Certificates of deposit over $100,000................. 95,067 4.24% 46,378 6.63%
-------- ----- -------- -----
Total deposits.................................... $315,490 3.10% $241,216 4.46%
======== ===== ======== =====
Total deposits increased to $315.5 million at December 31, 2001, an
increase of $74.3 million or 30.8% from $241.2 million at December 31, 2000.
Non-volatile, non-interest-bearing deposits, also referred to as core deposits,
have declined as a percentage of the Company's deposit base, but have increased
in dollar value from year to year. At December 31, 2001, non-interest-bearing
demand deposits were $43.2 million or 13.7% of total deposits, compared to $40.2
million or 16.7% of total deposits at December 31, 2000.
Interest-bearing deposits consist of NOW, money market, savings and time
certificate accounts. By their nature, interest-bearing account balances will
tend to grow or decline as the Company reacts to changes in competitors' pricing
and interest payment strategies. At December 31, 2001, NOW accounts totaled
$35.0 million reflecting an increase of $12.3 million or 53.8% from $22.7
million at December 31, 2000. The majority of this increase is related to
mortgage escrow funds on deposit at the Bank. The increase in mortgage activity
during 2001 resulted in a corresponding increase in escrow funds. The balance of
money market accounts was $48.3 million at December 31, 2001, an increase of
$10.2 million or 26.8% from the December 31, 2000 level of $38.1 million. With
the overall decline in the stock market and general economy, consumers have
utilized the money market accounts, despite the lower interest rates. The money
market product allows the consumer more stability than an investment in stock,
but is more liquid and has greater flexibility than the higher rate certificates
of deposit. As the economy and interest rates rebound from the lower levels
experienced in 2001, the Company expects to see a decline in money market
deposits as consumers re-enter the stock market, or utilize higher rate CD's.
At December 31, 2001, certificates of deposit over $100,000 totaled
$95.1 million compared to $46.4 million at December 31, 2000, an increase of
$48.7 million or 105%. As more fully discussed earlier, the mortgage loans
held-for-sale peaked at $68.0 million during 2001, and broker CD's over $100,000
were used to fund the growth.
The following table sets forth, by time remaining to re-pricing or
maturity, all time certificates of deposit accounts outstanding at December 31,
2001:
Time deposits of $100,000 or more (1) All other time deposits (2)
------------------------------------- ---------------------------
Amount Percentage Amount Percentage
(dollars in thousands)
Three months or less.............. $ 30,116 31.68% $18,309 22.71%
After three months through six months 26,942 28.34 22,197 27.54
After six months through one year. 19,760 20.78 24,036 29.82
After one year through five years. 18,249 19.20 16,069 19.93
-------- ------ ------- ------
Total $ 95,067 100.00% $80,611 100.00%
======== ====== ======= ======
(1) Time certificates of deposit of $100,000 or more represent 54.1% of
total outstanding time certificates of deposit at December 31, 2001.
(2) All other time certificates of deposit represent 45.9% of total time
certificates of deposit at December 31, 2001.
28
Other Borrowings
The scheduled repayment of other borrowings subsequent to December 31, 2001, is
as follows:
Due Due
After 3 After 1
Due in 3 months year Due
Months through through after 5
Or less one year 5 years years Total
------- -------- ------- ----- -----
(dollars in thousands)
Short-term borrowings...................... $2,750 $ -- $ -- $ -- $ 2,750
Long-term borrowings....................... -- 10,126 5,831 3,052 19,009
------ ------- ------ ------- -------
Total borrowings....................... $2,750 $10,126 $5,831 $ 3,052 $21,759
====== ======= ====== ======= =======
Historically, the Company has utilized borrowings from the FHLB as an
important source of funding for its long-term growth and to meet temporary
funding needs. The Company maintains a borrowing line limited to 15% of the
Bank's assets, subject to certain collateral limitations. Advances from the
FHLB, as a percentage of total assets, were 4.3%, and 6.2% at December 31, 2001,
and 2000, respectively.
The FHLB has required the Company to provide physical delivery of
collateral in the amount of 110% of funds borrowed. Physical delivery requires
the Company to provide the FHLB with 1-4 family residential notes and/or
securities at their location in Seattle, Washington. Prior to this requirement,
the Company was under a blanket bond collateral agreement allowing it to borrow
funds without the FHLB taking possession of the specific collateral. An analysis
performed in 2000 by the FHLB of the Company's financial position and balance
sheet ratios precipitated this change. The FHLB has indicated that physical
delivery is not a permanent change, and the blanket bond arrangement could be
reinstated when their analysis of the Company shows improvement of its financial
position. Management believes that a future FHLB analysis will indicate the
Company has improved its financial position and balance sheet ratios.
Advances from the FHLB mature over periods ranging from 1 through 15
years and at December 31, 2001 bear interest rates ranging from 2.00% to 8.62%.
At December 31, 2001 and 2000, $16.0 million and $18.3 million, respectively, in
advances were outstanding from the FHLB.
During 2000, the Company obtained a $3.0 million term loan from a
regional bank in order to provide working capital to the Bank and to increase
the Bank's regulatory reserves. The note bears interest at 8%, and matures in
December 2007. This loan is subject to restrictive covenants that require the
Company to maintain minimum levels of net income to required annual debt-service
payments. The Company was in violation of certain of these covenants as of
December 31, 2001; however, a waiver from the lender was obtained. At December
31, 2001, the principal balance of this loan was $2.9 million. The Company has
pledged the Bank's stock as collateral for the borrowings.
Asset-Liability Management/Interest Rate Sensitivity
The principal purpose of asset-liability management is to manage the
Company's sources and uses of funds to maximize net interest income under
different interest rate conditions with minimal risk. A part of asset-liability
management involves interest rate sensitivity, the difference between re-pricing
assets and re-pricing liabilities in a specific time period. The policy of the
Company is to control the exposure of the Company's earnings to changing
interest rates by generally maintaining a position within a narrow range around
an "earnings neutral" or "balanced" position. The Board of Directors has
established guidelines for maintaining the Company's earnings risk due to future
interest rate changes. This analysis provides an indication of the Company's
earnings risk due to future interest rate changes. At December 31, 2001, the
analysis indicated that the earnings risk was within the Company's policy
guidelines.
29
A key component of the asset-liability management is the measurement of
interest-rate sensitivity. Interest-rate sensitivity refers to the volatility in
earnings resulting from fluctuations in interest rates, variability in spread
relationships, and the mismatch of re-pricing intervals between assets and
liabilities. Interest-rate sensitivity management attempts to maximize earnings
growth by minimizing the effects of changing rates, asset and liability mix, and
prepayment trends.
The following table presents interest-rate sensitivity data at December
31, 2001. The interest rate gaps reported in the table arise when assets are
funded with liabilities having different re-pricing intervals. Since these gaps
are actively managed and change daily as adjustments are made in interest rate
views and market outlook, positions at the end of any period may not be
reflective of the Company's interest rate view in subsequent periods. Active
management dictates that longer-term economic views are balanced against the
prospects of short-term interest rate changes in all re-pricing intervals.
Estimated Maturity or Repricing at December 31, 2001
-------------------------------------------------------------------
0 - 3 3 - 6 6 -12 1 - 5 Over
Months Months Months Years 5 Years Total
--------- --------- -------- -------- ------- --------
(dollars in thousands)
Interest-earning assets:
Interest-earning balances due
from banks .................................. $ 36,020 $ -- $ -- $ -- $ -- $ 36,020
Investments available-for-sale ..................... -- -- 742 27,991 1,455 30,188
Investments held-to-maturity ....................... 2,599 300 1,116 100 -- 4,115
Federal Home Loan Bank Stock (1) ................... 3,531 -- -- -- -- 3,531
Loans held-for-sale ................................ 37,322 -- -- -- -- 37,322
Loans, including fees .............................. 105,026 7,518 9,870 83,974 28,824 235,212
--------- --------- -------- -------- ------- --------
Total interest-earning assets ............... 184,498 7,818 11,728 112,065 30,279 346,388
--------- --------- -------- -------- ------- --------
Allowance for loan losses .................................. (5,997)
Non-interest-bearing cash and due from banks ............... 14,157
Other assets ............................................... 16,112
--------
Total assets ................................ $370,660
========
Interest-bearing Liabilities:
Savings and interest-bearing demand deposits ....... $ 96,587 $ -- $ -- $ -- $ -- $ 96,587
Certificates of deposit ............................ 48,425 49,139 43,796 34,318 -- 175,678
Borrowings ......................................... 2,782 2,032 8,062 5,831 3,052 21,759
--------- --------- -------- -------- ------- --------
Total interest-bearing liabilities .......... 147,794 51,171 51,858 40,149 3,052 294,024
--------- --------- -------- -------- ------- --------
Non-interest-bearing liabilities
Demand deposits .................................... 43,225
Other .............................................. 4,663
Shareholders' equity ....................................... 28,748
--------
Total liabilities and shareholders' equity .. $370,660
--------
Interest sensitivity gap ................................... 36,704 (43,353 (40,130) 71,916 27,227 $ 52,364
--------- --------- -------- -------- ------- ========
Cumulative interest sensitivity gap ........................ $ 36,704 $(543,353) $(79,288) $ 25,137 $52,364
========= ========= ======== ======== =======
(1) Equity investments have been placed in the 0-3 month category
Market Risk
Interest rate and credit risks are the most significant market risks
impacting the Company's performance. Other types of market risk, such as foreign
currency exchange rate risk and commodity price risk, do not arise in the normal
course of the Company's business activities. The Company relies on loan reviews,
prudent loan underwriting standards and an adequate allowance for loan losses to
mitigate credit risk.
Interest rate risk is managed through the monitoring of the Company's
gap position (see Asset-Liability Management/Interest Rate Sensitivity) and
sensitivity to interest rate risk by subjecting the Company's balance sheet to
hypothetical interest rate shocks. The Company's primary objective in managing
interest rate risk is to minimize the adverse impact of changes in interest
rates on the Company's net interest income and capital, while structuring the
Company's asset/liability position to obtain the maximum yield-cost spread on
that structure.
Rate shock is an instantaneous and complete adjustment in market rates
of various magnitudes on a static or level balance sheet to determine the effect
such a change in rates would have on the Company's net interest income for the
succeeding 12 months, and the fair values of financial instruments.
30
The Company utilizes asset/liability modeling software to determine the
effect of a shift in market interest rates, with scenarios of interest rates
increasing 100 and 200 basis points and decreasing 100 and 200 basis points. The
model utilized to create the table presented below is based on the concept that
all rates do not move by the same amount or at the same time. Although certain
assets and liabilities may have similar maturities or periods to repricing, they
may not react correspondingly to changes in market interest rates. In addition,
interest rates on certain types of assets and liabilities may fluctuate with
changes in market interest rates, while interest rates on other types of assets
may lag behind changes in market rates. Further, in the event of a change in
interest rates, prepayment and early withdrawal levels would likely deviate from
those assumed in the table. The ability of certain borrowers to make scheduled
payments on the adjustable rate loans may decrease in the event of an interest
rate increase due to adjustments in the amount of the payments.
The model attempts to account for such limitations by imposing weights
on the gaps between assets and liabilities. These weights are based on the ratio
between the amount of rate change and each category of asset/liability, and the
amount of any change in the federal funds rate. Local conditions and the
strategy of the Company determine the weights for loan and core deposits; the
others are set by national markets. In addition, a timing factor has been used
as (a) fixed rate instruments do not reprice immediately; (b) renewals may have
different terms than original maturities; and, (c) there is a timing factor
between rates on different instruments (i.e. core deposits usually reprice long
after there has been a change in the federal funds rate). Due to the various
assumptions used for this simulation analysis, no assurance can be given that
actual results will correspond with projected results.
The following table shows the estimated impact on the Company of the
interest rate shock on "Economic Value of Equity" which measures change in net
interest income, and the "Changes in Total Economic Value" which measures change
in the fair value of financial instruments, at December 31, 2001:
Change in Economic Change in Total
Value of Equity Economic Value
------------------- -------------------
Rate Shock $(000's) %Equity $(000's) %Equity
---------- -------- ------- -------- -------
+2% $(336) (1.2%) $11,636 40%
+1% $(168) (0.6%) $5,818 20%
-1% $ 76 0.3% $(5,818) (20%)
-2% $ 152 0.5% $(11,749) (40%)
Loans and certificates of deposit represent the majority of interest
rate exposure. Investments only represent 9.9% of interest-earning assets and,
therefore, the impact of the investments on net interest income of moving rates
may not be significant. Historically, savings and interest-bearing checking
accounts have not re-priced in proportion to changes in overall market interest
rates. The change in net interest income can be attributed to the balance of
loans and certificates of deposit maturing/re-pricing.
The change in fair values of financial assets is mainly a result of
total loans representing 67.9% of total interest-earning assets. Of these loans
60.0% or $140.2 million have fixed interest rates, which decline in value during
a period of rising interest rates.
While asset/liability models have become a main focus of risk
management, the Company believes that statistical models alone do not provide a
reliable method of monitoring and controlling risk. The quantitative risk
information provided is limited by the parameters established in creating the
related models. Therefore, the Company uses these models only as a supplement to
other risk management tools.
31
Return on Equity and Assets
Return on daily average assets and equity and certain other ratios for
the periods indicated are presented below:
Year Ended December 31,
-------------------------------------------
2001 2000 1999
----------- ----------- -----------
Net income (loss) ........... $ (1,450) $ 869 $ 656
Average assets .............. $ 353,164 $ 254,829 $ 177,657
Return on average assets .... (0.41)% 0.34% 0.37%
Net income (loss) ........... $ (1,450) $ 869 $ 656
Average equity .............. $ 30,701 $ 30,782 $ 31,420
Return on average equity .... (4.72)% 2.82% 2.09%
Cash dividends paid per share $ 0.05 $ 0.07 $ 0.07
Diluted earnings per share .. $ (0.39) $ 0.22 $ 0.16
Dividend payout ratio ....... N/A 32.34% 42.84%
Average equity .............. $ 30,701 $ 30,782 $ 31,420
Average assets .............. $ 353,164 $ 254,829 $ 177,657
Average equity to asset ratio 8.69% 12.08% 17.69%
Liquidity
Liquidity represents the ability to meet deposit withdrawals and fund
loan demand, while retaining the flexibility to take advantage of business
opportunities. The Company's primary sources of funds are customers deposits,
loan payments, sales of assets, advances from the FHLB (Federal Home Loan Bank)
and the use of the federal funds market. As of December 31, 2001, approximately
$4.3 million of the securities portfolio matures within one year.
Historically the Company has utilized borrowings from the FHLB as an
important source of funding for its growth. The Company has an established
borrowing line with the FHLB that permits it to borrow up to 15% of the Bank's
assets, subject to collateral limitations. Advances from the FHLB have maturity
periods ranging from 1 through 15 years and at December 31, 2001, bear interest
at rates ranging from 2.00% to 8.62%. At December 31, 2001, $16.0 million in
advances were outstanding from the FHLB. See the section on "Other Borrowings"
for further discussion.
During 2001, the Company experienced extremely rapid growth in its
residential lending segment as consumers took advantage of relatively low
housing market interest rates to refinance, build, or purchase homes. Although
these residential mortgage loans are typically sold within 15-45 days after
funding, the volume funded but unsold grew from $10.0 million at December 31,
2000 to over $55.0 million during the first quarter of 2001, and to over $68.0
million at the peak during the fourth quarter of 2001. In order to take
advantage of the income generated by the increase in mortgage loan volume, the
Company utilized the broker CD market to fund the growth. As origination volumes
of loans held-for-sale began to taper off toward the end of 2001 to the ending
balance of $37.3 million, the excess funds were deposited in the Company's cash
account with the FHLB. The higher rate broker certificates of deposit will not
be renewed if the volume of mortgage loans remains steady or subsides, reducing
the excess liquidity. The Company has $34.3 million in broker and out-of-market
certificates of deposit maturing in the first six months of 2002.
Capital
The Company and the Bank are required to maintain minimum amounts of
capital to "risk-weighted" assets, as defined by banking regulators. The Company
and the Bank are required to have Tier 1 and Total Capital ratios of 4.0% and
8.0%, respectively. In addition the Bank is required to maintain a Tier 1
leverage ratio of not less than 4%. At December 31, 2001, the Company's Tier 1
and Total Capital ratios were 8.84% and 10.10%, respectively; and at December
31, 2000, the Company's ratios were 9.74% and 10.99%, respectively. The ratio of
shareholder's equity to average assets was 8.14% and 11.93% at December 31, 2001
and 2000, respectively. At December 31, 2001, the Bank's Tier 1, Total Capital,
and Tier 1 leverage ratios were 9.46%, 10.72%, and 6.99%, respectively and at
December 31, 2000 were 9.37%, 10.62%, and 8.19%, respectively.
32
Item 8. Financial Statements and Supplementary Data
INDEPENDENT AUDITOR'S REPORT (MOSS ADAMS LLP)
To the Shareholders and Board of Directors
Cowlitz Bancorporation
We have audited the accompanying consolidated statements of condition of Cowlitz
Bancorporation (a Washington Corporation) and Subsidiaries as of December 31,
2001 and 2000, and the related consolidated statements of operations, changes in
shareholders' equity and cash flows for the years then ended. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits. The consolidated statements of operations,
changes in shareholder's equity, and cash flows of Cowlitz Bancorporation and
Subsidiaries as of December 31, 1999, and for the year then ended, were audited
by other auditors whose report dated January 21, 2000, expressed an unqualified
opinion on those statements.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Cowlitz
Bancorporation and Subsidiaries as of December 31, 2001 and 2000, and the
results of their operations and their cash flows for the years then ended, in
conformity with accounting principles generally accepted in the United States of
America.
Portland, Oregon /s/ Moss Adams, LLP
February 14, 2002
33
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS (ARTHUR ANDERSEN LLP)
To the Shareholders and Board of Directors of
Cowlitz Bancorporation
We have audited the consolidated statements of income, changes in shareholders'
equity and cash flows of Cowlitz Bancorporation (a Washington Corporation) and
its subsidiaries for the year ended December 31, 1999. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the results of operations and cash flows of Cowlitz
Bancorporation and its subsidiaries for the year ended December 31, 1999 in
conformity with accounting principles generally accepted in the United States.
San Francisco, California /s/ Arthur Andersen LLP
January 21, 2000
34
COWLITZ BANCORPORATION
CONSOLIDATED STATEMENTS OF CONDITION
(dollars in thousands)
ASSETS
December 31,
----------------------
2001 2000
--------- ---------
Cash and cash equivalents $ 50,177 $ 25,589
Investment securities:
Investments available-for-sale (at fair value, cost of $30,172
and $7,441 at December 31, 2001 and 2000,
respectively) 30,188 7,499
Investments held-to-maturity (at amortized cost, fair value of
$4,157 and $4,569 at December 31, 2001
and 2000, respectively) 4,115 4,572
--------- ---------
Total investment securities 34,303 12,071
Federal Home Loan Bank stock, at cost 3,531 3,302
Loans held-for-sale 37,322 10,013
Loans, net of deferred loan fees 235,212 233,639
Allowance for loan losses (5,997) (4,561)
--------- ---------
Loans, net 229,215 229,078
--------- ---------
Premises and equipment, net of accumulated depreciation of
$4,029 and $3,238 at December 31, 2001 and 2000,
respectively 5,235 5,625
Intangible assets, net of accumulated amortization of $1,691
and $1,435 at December 31, 2001 and 2000, respectively 4,327 5,352
Accrued interest receivable and other assets 6,550 5,868
--------- ---------
TOTAL ASSETS $ 370,660 $ 296,898
========= =========
35
COWLITZ BANCORPORATION
CONSOLIDATED STATEMENTS OF CONDITION
(dollars in thousands)
LIABILITIES AND SHAREHOLDERS' EQUITY
December 31,
--------------------
2001 2000
--------- --------
LIABILITIES
Deposits:
Non-interest-bearing demand $ 43,225 $ 40,201
Savings and interest-bearing demand 96,587 73,770
Certificates of deposit 175,678 127,245
-------- --------
Total deposits 315,490 241,216
Short-term borrowings 2,750 1,275
Long-term borrowings 19,009 21,348
Accrued interest payable and other liabilities 4,663 2,650
-------- --------
Total liabilities 341,912 266,489
-------- --------
COMMITMENTS AND CONTINGENCIES (Note 13)
SHAREHOLDERS' EQUITY
Preferred stock, no par value; 5,000,000 shares authorized as of December
31, 2001 and 2000, no shares issued and
outstanding -- --
Common stock, no par value; 25,000,000 shares authorized
as of December 31, 2001 and 2000, 3,692,560
and 3,689,327 shares issued and outstanding at
December 31, 2001 and 2000, respectively 16,802 16,785
Additional paid-in capital 1,538 1,538
Retained earnings 10,398 12,048
Accumulated other comprehensive income, net of taxes 10 38
-------- --------
Total shareholders' equity 28,748 30,409
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $370,660 $296,898
======== ========
See accompanying notes.
36
COWLITZ BANCORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share amounts)
Years Ended December 31,
--------------------------------------
2001 2000 1999
---------- ---------- ----------
INTEREST INCOME
Interest and fees on loans $ 25,088 $ 21,283 $ 13,901
Interest on taxable investment securities 848 651 681
Interest on non-taxable investment securities 8 8 8
Other interest and dividend income 1,283 906 686
---------- ---------- ----------
Total interest income 27,227 22,848 15,276
---------- ---------- ----------
INTEREST EXPENSE
Savings and interest-bearing demand 2,600 2,169 1,469
Certificates of deposit 9,382 6,164 2,332
Short-term borrowings 115 106 97
Long-term borrowings 1,285 1,501 1,350
---------- ---------- ----------
Total interest expense 13,382 9,940 5,248
---------- ---------- ----------
Net interest income before provision for loan losses 13,845 12,908 10,028
PROVISION FOR LOAN LOSSES (5,262) (1,155) (1,349)
---------- ---------- ----------
Net interest income after provision for loan losses 8,583 11,753 8,679
---------- ---------- ----------
NON-INTEREST INCOME
Gains on loans sold 4,872 1,813 852
Brokerage fees 2,450 1,497 857
Escrow fees 895 316 105
Service charges on deposit accounts 737 714 698
Credit card income 507 381 381
Fiduciary income 238 301 151
Net gains (losses) on maturities and sales of available-
for-sale securities 89 (4) (2)
Gain (loss) on sale of repossessed assets (429) 92 --
Other income 232 109 149
---------- ---------- ----------
Total non-interest income 9,591 5,219 3,191
---------- ---------- ----------
37
COWLITZ BANCORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share amounts)
Years Ended December 31,
--------------------------------------
2001 2000 1999
---------- ---------- ----------
NON-INTEREST EXPENSE
Salaries and employee benefits $ 9,365 $ 8,641 $ 5,766
Net occupancy and equipment expense 2,440 2,115 1,457
Impairment of goodwill 1,215 -- --
Loan expense 716 230 202
Professional fees 641 492 379
Business taxes 613 415 274
Amortization of intangible assets 582 559 445
Data processing and communications 543 430 238
Postage and freight 478 331 164
Credit card expense 408 307 315
Stationary and supplies 378 340 227
Travel and education 333 356 235
Other expenses 1,762 1,276 1,092
---------- ---------- ----------
Total non-interest expense 19,474 15,492 10,794
---------- ---------- ----------
Income (loss) before provision for income taxes (1,300) 1,480 1,076
PROVISION FOR INCOME TAXES 150 611 420
---------- ---------- ----------
Net income (loss) $ (1,450) $ 869 $ 656
========== ========== ==========
BASIC EARNINGS (LOSS) PER SHARE OF
COMMON STOCK $ (0.39) $ 0.22 $ 0.16
========== ========== ==========
DILUTED EARNINGS (LOSS) PER SHARE OF
COMMON STOCK $ (0.39) $ 0.22 $ 0.16
========== ========== ==========
See accompanying notes.
38
COWLITZ BANCORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(dollars in thousands)
Accumulated
Common stock Additional Other Total
---------------------------- Paid-in Retained Comprehensive Shareholders' Comprehensive
Shares Amount Capital Earnings Income (Loss) Equity Income (Loss)
------------ ------------ ------------ ------------ ------------ -------------- --------------
BALANCE, December 31, 1998 4,001,999 $ 18,251 $ 1,538 $ 11,085 $ 46 $30,920
Comprehensive income:
Net income -- -- -- 656 -- 656 $ 656
Net changes in unrealized
gains on investments
available-for-sale,
net of deferred taxes
of $43 -- -- -- -- (84) (84) (84)
--------
Comprehensive income $572
========
Issuance of common
stock for cash 5,743 34 -- -- -- 34
Purchase of treasury
stock (134,500) (732) -- -- -- (732)
Issuance of common stock
for acquisition 148,810 977 -- -- -- 977
Cash dividend paid
($.07 per share) -- -- -- (281) -- (281)
--------- --------- --------- --------- ------ --------
BALANCE, December 31, 1999 4,022,052 18,530 1,538 11,460 (38) 31,490
Comprehensive income:
Net income -- -- -- 869 -- 869 $869
Net changes in unrealized
loss on investments
available-for-sale,
net of deferred taxes
of $38 -- -- -- -- 76 76 76
--------
Comprehensive income $945
========
Issuance of common
stock for cash 8,207 39 -- -- -- 39
Purchase of treasury stock (340,932) (1,784) -- -- -- (1,784)
Cash dividend paid
($.07 per share) -- -- -- (281) -- (281)
--------- --------- --------- --------- ------
BALANCE, December 31, 2000 3,689,327 16,785 1,538 12,048 38 30,409
Comprehensive income:
Net loss -- -- -- (1,450) -- (1,450) $(1,450)
Net changes in unrealized
gains on investments
available-for-sale,
net of deferred taxes
of $8 -- -- -- -- (28) (28) (28)
--------
Comprehensive loss
Issuance of common stock
for cash 3,233 17 -- -- -- 17 $(1,478)
========
Cash dividend paid
($.05 per share) -- -- -- (200) -- (200)
--------- --------- --------- --------- ------ --------
BALANCE, December 31, 2001 3,692,560 $ 16,802 $ 1,538 $ 10,398 $ 10 $28,748
========= ========= ========= ========= ====== =======
See accompanying notes.
39
COWLITZ BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Years Ended December 31,
--------------------------------------
2001 2000 1999
---------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (1,450) $ 869 $ 656
Adjustments to reconcile net income (loss) to net cash from operating
activities:
Deferred tax benefit (205) (1,166) (211)
Depreciation and amortization 1,408 1,316 1,098
Impairment of goodwill 1,215 -- --
Provision for loan losses 5,262 1,155 1,349
Net (gains) losses on maturities and sales of
investments securities available-for-sale (89) 4 2
Net amortization of investment security premiums
and accretion of discounts (9) (4) (1)
Net loss (gain) on sales of foreclosured assets 429 (92) --
Gains on loans sold (4,872) (1,813) (852)
Origination of loans held-for-sale (467,554) (138,704) (63,084)
Proceeds of loan sales 445,117 132,759 62,753
(Increase) decrease in accrued interest receivable
and other assets (528) 1,177 62
Increase in accrued interest payable and other liabilities 2,013 942 (154)
Federal Home Loan Bank stock dividends (229) (212) (221)
---------- ---------- ----------
Net cash from operating activities (19,492) (3,769) 1,397
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of foreclosed assets 2,979 942 --
Proceeds from maturities of investment securities
held-to-maturity 8,865 4,365 3,267
Proceeds from maturities and sales of investment
securities available-for-sale 10,848 5,472 2,000
Purchases of investment securities:
Held-to-maturity (8,399) (4,369) (3,365)
Available-for-sale (34,253) (224) (3,490)
Net increase in loans (8,751) (51,941) (15,291)
Purchases of premises and equipment (436) (288) (609)
Net cash received (paid) in acquisition of business -- 3,188 (1,565)
---------- ---------- ----------
Net cash from investment activities (29,147) (42,855) (19,053)
---------- ---------- ----------
40
See accompanying notes.
Years Ended December 31,
--------------------------------------
2001 2000 1999
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in demand, savings, and
interest-bearing demand deposits $ 25,841 $ 12,463 $ (2,834)
Net increase in certificates of deposit 48,433 48,205 18,080
Dividends paid (200) (281) (281)
Net increase in short-term borrowings 1,475 -- 1,550
Proceeds from long-term borrowings 10,000 11,450 5,000
Repayment of long-term borrowings (12,339) (16,933) (6,812)
Repurchase of common stock -- (1,784) (732)
Issuance of common stock for cash, net of amount
paid for fractional shares and offering costs 17 39 34
---------- ---------- ----------
Net cash from financing activities 73,227 53,159 14,005
---------- ---------- ----------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 24,588 6,535 (3,651)
CASH AND CASH EQUIVALENTS, beginning of year 25,589 19,054 22,705
---------- ---------- ----------
CASH AND CASH EQUIVALENTS, end of year $ 50,177 $ 25,589 $ 19,054
========== ========== ==========
SUPPLEMENTAL DISCOSURE OF CASH FLOW
INFORMATION
Cash paid for interest $ 13,313 $ 9,548 $ 5,221
========== ========== ==========
Cash paid for income taxes $ 9 $ 797 $ 560
========== ========== ==========
SUPPLEMENTAL DISCLOSURE OF INVESTING
ACTIVITIES
Loans transferred to other real estate owned $ 3,352 $ 1,892 $ 769
========== ========== ==========
See accompanying notes.
41
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of operations - Cowlitz Bancorporation (the "Company") is a holding
company located in southwest Washington. The Company's principal subsidiaries
are Cowlitz Bank (also the "Company" or the "Bank"), a Washington
state-chartered commercial bank, and, until its sale in February of 2002,
Business Finance Corporation ("BFC") of Bellevue, Washington. Business Finance
Corporation provided asset-based financing to companies throughout the western
United States. Cowlitz Bank is the largest community bank headquartered in
Cowlitz County and offers commercial banking services primarily to small and
medium-sized businesses, professionals, and retail customers.
During the third quarter of 1999, the Company acquired Bay Mortgage of Bellevue,
Washington and Bay Mortgage of Seattle, Washington. Bay Mortgage of Seattle and
Bay Mortgage of Bellevue have joined together as a division ("Bay Mortgage") of
Cowlitz Bank and serve customers throughout the greater Bellevue/Seattle market
area. Other markets served by Bay Mortgage include Silverdale and Vancouver,
Washington, Cowlitz County, Washington, and Portland, Oregon. Bay Escrow also
operates as a division of Cowlitz Bank and completes escrow transactions for Bay
Mortgage primarily for the Bellevue/Seattle market. Cowlitz Bank operates a
branch in Bellevue, Washington, doing business as Bay Bank.
On July 1, 2000 the Company acquired Northern Bank of Commerce ("NBOC") of
Portland, Oregon. NBOC operates as a branch of Cowlitz Bank, doing business as
Northern Bank of Commerce, and serves customers in the Portland, Oregon market
area.
Principles of consolidation - The accompanying consolidated financial statements
include the accounts of the Company and its subsidiaries. All significant
intercompany transactions and balances have been eliminated.
Use of estimates in preparation of the financial statements - Preparation of the
consolidated financial statements in conformity with generally accepted
accounting principles requires management to make certain estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Cash and cash equivalents - For the purpose of presentation in the statements of
cash flows, cash and cash equivalents include cash on hand, amounts due from
banks, and federal funds sold. Federal funds sold generally mature the day
following purchase.
Investment securities - Investment securities are classified as trading,
available-for-sale, or held-to-maturity. Securities are classified as
held-to-maturity when the Company has the positive intent and ability to hold
those securities to maturity. Held-to-maturity securities are carried at
amortized cost. Securities that are bought and held principally for the purpose
of selling them in the near-term are classified as trading securities. Trading
securities are carried at fair value. Net unrealized gains and losses on trading
securities are included in the consolidated statements of income. Securities not
classified as either held-to-maturity or trading are classified as
available-for-sale. Available-for-sale securities are carried at fair value with
unrealized gains and losses, net of tax effect, added to or deducted from
shareholders' equity. All investment securities have been designated as either
available-for-sale or held-to-maturity at December 31, 2001 and 2000.
Declines in the fair value of individual held-to-maturity and available-for-sale
securities below their cost that are other than temporary are recognized by
write-downs of the individual securities to their fair value. Such write-downs
would be included in earnings as realized losses.
Federal Home Loan Bank stock - The Company's investment in Federal Home Loan
Bank (FHLB) stock is a restricted investment carried at cost ($100 per share)
which approximates fair value. As a member of the FHLB system, the Company is
required to maintain a minimum level of investment in FHLB stock based on its
outstanding FHLB advances. The Company may request redemption of any stock in
excess of the amount required. Stock redemptions are made at the discretion of
the FHLB.
42
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)
Loans held-for-sale - Loans held-for-sale are carried at the lower of cost or
market value. Market value is determined in aggregate. Net unrealized losses are
recognized as changes to income through a valuation allowance.
Loans - Interest income on simple interest loans is accrued daily on the
principal balance outstanding. Generally, no interest is accrued on loans when
factors indicate that collection of interest is doubtful or when principal or
interest payments become 90 days past due, unless collection of principal and
interest is anticipated within a reasonable period of time and the loans are
well secured. For such loans, previously accrued but uncollected interest is
charged against current earnings, and income is only recognized to the extent
that payments are subsequently received and collection of the remaining recorded
investment is probable. Non-accrual loans are returned to accrual status when
the loans are paid current as to principal and interest and future payments are
expected to be made in accordance with the contractual terms of the loan. Loan
fees are offset against operating expenses to the extent that these fees cover
the direct expense of originating loans. Fees in excess of origination costs are
deferred and amortized to income over the related loan period.
Allowance for loan losses - The allowance for loan losses is based on
management's estimates. Management determines the adequacy of the allowance
based upon reviews of individual loans, delinquencies, recent loss experience,
current economic conditions, the risk characteristics of the various categories
of loans, and other pertinent factors. Actual losses may vary from current
estimates. These estimates are reviewed periodically and are adjusted as deemed
necessary. Loans deemed uncollectible are charged to the allowance. Provisions
for loan losses and recoveries on loans previously charged off are added to the
allowance.
A loan is impaired when, based on current information and events, it is probable
that the Company will be unable to collect all amounts due according to the
contractual terms of the loan agreement. The Company's policy is to include in
impaired loans all loans that are past due 90 days or more as to either
principal or interest and any loans that the Company believes collection of
principal or interest is doubtful, except for loans that are currently measured
at fair value or at the lower of cost or fair value, and credit card
receivables, which are considered large groups of smaller balance homogeneous
loans that are collectively evaluated for impairment. The Company measures
impairment based on the present value of expected future cash flows discounted
at the loan's effective interest rate or, as a practical expedient, impairment
is measured based on the loan's observable market price or the fair value of the
collateral if the loan is collateral dependent. Impaired loans are charged to
the allowance when management believes, after considering economic and business
conditions, collection efforts, and collateral position, that the borrower's
financial condition is such that collection of principal is not probable.
Stock-based compensation - Statement of Financial Accounting Standards (SFAS)
No. 123, "Accounting for Stock-Based Compensation," requires disclosure about
stock-based compensation arrangements regardless of the method used to account
for them. As permitted by SFAS No. 123, the Company has decided to apply the
accounting provisions of Accounting Principles Board (APB) Opinion No. 25, and
therefore discloses the difference between compensation cost included in net
income and the related cost measured by the fair value-based method defined by
SFAS No. 123, including tax effects, that would have been recognized in the
income statement if the fair value method had been used.
Other real estate owned - Other real estate owned (OREO), acquired through
foreclosure, is carried at the lower of cost or estimated fair value, less
estimated costs to sell. Prior to foreclosure, the balance of the underlying
loan is adjusted to equal the estimated fair value of the real estate to be
acquired, less estimated costs to sell, by a charge to the allowance for loan
losses. Any subsequent adjustments are recorded as a valuation allowance with a
charge to non-interest expense. Other real estate owned is included in other
assets on the consolidated statements of condition.
Premises and equipment - Premises and equipment are stated at cost less
accumulated depreciation. The provision for depreciation and amortization is
computed by the straight-line method over the estimated useful lives for the
majority of the assets, which range from 3 to 39.5 years.
43
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)
Improvements are capitalized and depreciated over the lesser of their estimated
useful lives or the life of a related lease. When property is replaced or
otherwise disposed of, the cost of such assets and the related accumulated
depreciation are removed from their respective accounts.
Intangible assets - Intangible assets include deposit premiums of $767,000 and
$1.0 million (net of accumulated amortization) at December 31, 2001 and 2000,
respectively. The deposit premiums are amortized using an accelerated method
over a ten-year life. Intangible assets at December 31, 2001 and 2000, also
include goodwill of $3.6 million and $4.4 million, respectively (net of
accumulated amortization). Goodwill represents the excess of acquisition costs
over the fair value of net assets that arose in connection with the acquisitions
of Business Finance Corporation (BFC), Bay Mortgage of Bellevue, Washington, Bay
Mortgage of Seattle, Washington, Bay Escrow, and Northern Bank of Commerce of
Portland, Oregon.
Goodwill related to the acquisition of BFC was considered impaired at December
31, 2001 and the balance of $1.2 million was charged against earnings at that
time. The impairment loss was measured based upon an assessment of BFC's net
tangible assets relative to the entity's fair value as determined by a sale in
process as of December 31, 2001. Also in 2001, an estimate of the final earn-out
payment related to the purchase of Bay Mortgage of Bellevue, Washington was
recognized and resulted in an increase to goodwill by $772,000. Prior to the
adoption of SFAS No. 142, as further discussed below, goodwill had been
amortized on a straight-line basis over a 15-year period.
Income taxes - Income taxes are accounted for using the asset and liability
method. Under this method, a deferred tax asset or liability is determined based
on enacted tax rates, which will be in effect when the differences between the
financial statement carrying amounts and tax bases of existing assets and
liabilities are expected to be reported in the Company's income tax returns. The
deferred tax provision or benefit for the year is equal to the net change in the
deferred tax asset or liability from the beginning to the end of the year. The
effect on deferred taxes of a change in tax rates is recognized in income in the
period that includes the enactment date.
Earnings per share - Earnings per share computations are computed using the
weighted average number of common and dilutive common equivalent shares (stock
options) assumed to be outstanding during the period using the treasury stock
method.
Off-balance-sheet financial instruments - The Company holds no derivative
financial instruments. However, in the ordinary course of business, the Company
has entered into off-balance-sheet financial instruments consisting of
commitments to extend credit, commitments under credit card arrangements, and
standby letters of credit. Such financial instruments are recorded in the
financial statements when they become payable.
Impact of new accounting issues - During 2001, the Financial Accounting
Standards Board issued the following accounting standards:
Standard of Financial Accounting Standard (SFAS) NO. 141 - Business Combinations
addresses financial accounting and reporting for business combinations and
supersedes APB Opinion No. 16, "Business Combinations," and FASB Statement No.
38, "Accounting for Preacquisition Contingencies of Purchased Enterprises." All
business combinations in the scope of this Statement are to be accounted for
using the purchase method. The provisions of this Statement apply to all
business combinations initiated after June 30, 2001. This Statement also applies
to all business combinations accounted for using the purchase method for which
the date of acquisition is July 1, 2001, or later.
44
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)
Statement of Financial Accounting Standard (SFAS) No. 142 - Goodwill and Other
Intangible Assets, addresses financial accounting and reporting for acquired
goodwill and other intangible assets and supersedes APB Opinion No. 17,
"Intangible Assets." It addresses how intangible assets that are acquired
individually or with a group of other assets (but not those acquired in a
business combination) should be accounted for in financial statements upon their
acquisition. This Statement also addresses how goodwill and other intangible
assets should be accounted for after they have been initially recognized in the
financial statements. The provisions of this Statement are required to be
applied starting with fiscal years beginning after December 15, 2001. Under the
new rules, goodwill (and intangible assets deemed to have indefinite lives) will
no longer be amortized but will be subject to annual impairment tests in
accordance with the Statement. Other intangible assets will continue to be
amortized over their useful lives.
The Company will apply the new rules on accounting for goodwill and other
intangible assets beginning in 2002. Application of the non-amortization
provisions of the Statement is expected to result in an increase in net income
of $325,000 per year. During 2002, the Company will perform the first of the
required impairment tests of goodwill and indefinite lived intangible assets,
but has not yet determined what the effect of these tests will be on the
earnings and financial position of the Company.
Statement of Financial Accounting Standard (SFAS) No. 143 - Accounting for Asset
Retirement Obligations, addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. This Statement applies to all entities. It
applies to legal obligations associated with the retirement of long-lived assets
that result from the acquisition, construction, development, and/or the normal
operation of a long-lived asset, except for certain obligations of lessees. As
used in this Statement, a legal obligation is an obligation that a party is
required to settle as a result of an existing or enacted law, statute,
ordinance, or written or oral contract or by legal construction of a contract
under the doctrine of promissory estoppel. This Statement amends FASB Statement
No. 19, "Financial Accounting and Reporting by Oil and Gas Producing Companies."
This Statement is effective for financial statements issued for fiscal years
beginning after June 15, 2002.
Statement of Financial Accounting Standard (SFAS) No. 144 - Accounting for the
Impairment or Disposal of Long-Lived Assets addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. This Statement
supersedes FASB Statement No. 122, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of," and the accounting and
reporting provisions of APB Opinion No. 30.
Comprehensive income - Comprehensive income includes net income reported on the
statements of income and changes in the fair value of available-for-sale
investments reported as a component of shareholders' equity.
The components of comprehensive income for the years ended December 31 are as
follows:
2001 2000 1999
------ ------ ------
(dollars in thousands)
Unrealized gain (loss) arising during the
period, net of tax $ 31 $ 77 $ (86)
Reclassification adjustment for net realized
gains (losses) on securities available-
for-sale included in net income during
the year, net of tax (59) (1) 2
------ ------ ------
Net unrealized gain (loss) included in other
comprehensive income $ (28) $ 76 $ (84)
====== ====== ======
Prior year reclassifications - Certain prior year amounts have been reclassified
to conform with the current year presentation.
45
NOTE 2 - BUSINESS ACQUISITIONS AND SALES
On July 1, 2000, the Company acquired Northern Bank of Commerce (NBOC) of
Portland, Oregon for approximately $3.8 million in cash, including acquisition
costs. The Company has accounted for the transaction using the purchase method
of accounting. Under the terms of the agreement, the shareholders of NBOC
received $2.48 in cash in exchange for each share of NBOC common stock.
The following table summarizes the acquisition of NBOC. As part of the
transaction, goodwill of $946,000 was recorded.
(dollars in thousands)
Fair value of assets acquired, including goodwill $ 47,192
Less liabilities assumed 43,357
--------
Cash paid for acquisition (3,835)
Less cash acquired 7,023
--------
Net cash received in acquisition $ 3,188
========
The following unaudited pro forma financial information for the Company gives
effect to the acquisition of NBOC, as if it had occurred on January 1, 2000.
These pro forma results have been prepared for comparative purposes only and do
not purport to be indicative of the results of operations which actually would
have resulted had the acquisition occurred on the dates indicated, or which may
result in the future for the combined companies under the ownership and
management of the Company. The pro forma results include certain adjustments,
such as additional expense, as a result of goodwill amortization.
Years Ended December 31,
-------------------------------------
2001 2000
-------------- ---------------
(Pro forma)
(dollars in thousands)
Net interest income $ 13,845 $ 14,326
============== ==============
Net loss $ (1,450) $ (279)
============== ==============
Net interest income per share $ 3.72 $ 4.49
============== ==============
Loss per share $ (0.39) $ (0.20)
============== ==============
During 1999, the Company acquired Bay Mortgage of Bellevue, Washington, Bay
Mortgage of Seattle, Washington and Bay Escrow of Seattle, Washington. The
acquisitions were accounted for using the purchase method of accounting and
included cash payments of $1.8 million and issuance of common stock with a value
of $977,000. During 2001, additional payments totaling $772,000 were recorded in
connection with the acquisitions, pursuant to a performance earn-out agreement.
The additional acquisition costs have been recorded as goodwill associated with
the purchase.
46
NOTE 2 - BUSINESS ACQUISTIONS AND SALES - (continued)
Subsequent to December 31, 2001, the Company sold BFC for a pre-tax gain of
$421,000. The following table summarizes the sale:
(dollars in thousands)
Net finance receivables sold $2,511
Other assets sold 121
------
2,632
------
Loan assumed 2,800
Other liabilities assumed 212
Due from purchaser 41
------
3,053
------
Pre-tax gain on sale $ 421
======
NOTE 3 - BALANCE WITH THE FEDERAL RESERVE BANK
The Bank is required to maintain reserves in cash or with the Federal Reserve
Bank equal to a percentage of its reservable deposits. Required reserves were
approximately $5.0 million and $1.7 million as of December 31, 2001 and 2000,
respectively.
NOTE 4 - INVESTMENT SECURITIES
The amortized cost and estimated fair values of investment securities at
December 31 are shown below (dollars in thousands):
Available-for-Sale
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
December 31, 2001:
U.S. Government and agency securities $ 19,566 $ 143 $ (65) $ 19,644
Mortgage-backed securities 10,606 13 (75) 10,544
--------- --------- --------- ---------
$ 30,172 $ 156 $ (140) $ 30,188
========= ========= ========= =========
47
NOTE 4 - INVESTMENT SECURITIES - (continued)
Held-to-Maturity
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
December 31, 2001:
Municipal Bonds $ 200 $ 3 $ -- $ 203
U.S. Government and agency securities 1,016 39 -- 1,055
Certificates of deposit 2,899 -- -- 2,899
--------- --------- --------- ---------
$ 4,115 $ 42 $ -- $ 4,157
========= ========= ========= =========
Available-for-Sale
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
December 31, 2000:
U.S. Government and agency securities $ 7,441 $ 58 $ -- $ 7,499
========= ========= ========= =========
Held-to-Maturity
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
Municipal Bonds $ 200 $ -- $ (2) $ 198
U.S. Government and agency securities 1,007 -- (1) 1,006
Certificates of deposit 3,365 -- -- 3,365
--------- --------- --------- ---------
$ 4,572 $ -- $ (3) $ 4,569
========= ========= ========= =========
Gross gains of $89,000 and gross losses of $4,000, and $2,000 in 2001, 2000, and
1999, respectively, were realized on maturities and sales of available-for-sales
securities.
48
NOTE 4 - INVESTMENT SECURITIES - (continued)
saturity of investments - The amortized cost and estimated fair value of
investment securities by contractual maturity at December 31, 2001, are shown
below. Expected maturities may differ from contractual maturities because
borrowers may have the right to call or prepay the obligation.
Available-for-Sale Held-to-Maturity
-----------------------------------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- --------- --------- ---------
(dollars in thousands)
Due in one year or less $ 225 $ 232 $ 4,015 $ 4,056
Due after one year through five years 28,484 28,501 100 101
Due after five years through ten years 1,463 1,455 -- --
--------- --------- --------- ---------
$ 30,172 $ 30,188 $ 4,115 $ 4,157
========= ========= ========= =========
For the purposes of the maturity schedule, mortgage-backed securities, which are
not due at a single maturity date, have been allocated over maturity groupings
based on the expected maturity of the underlying collateral. Mortgage-backed
securities mature earlier than their stated contractual maturities because of
accelerated principal repayments of the underlying loans.
At December 31, 2001 and 2000, securities in the amounts of $8.3 million and
$4.1 million, respectively, were pledged as collateral for long-term borrowings.
NOTE 5 - LOANS AND ALLOWANCE FOR LOAN LOSSES
The loan portfolio as of December 31 consists of the following:
2001 2000
--------- ---------
(dollars in thousands)
Commercial loans $ 50,152 $ 46,738
Real estate:
Construction 26,520 10,744
Residential 36,190 34,402
Commercial 111,437 130,272
Installment and other consumer 11,650 12,247
--------- ---------
235,949 234,403
Less allowance for loan losses (5,997) (4,561)
Deferred loan fees (737) (764)
--------- ---------
Loans, net $ 229,215 $ 229,078
========= =========
49
NOTE 5 - LOANS AND ALLOWANCE FOR LOAN LOSSES - (continued)
An analysis of the change in the allowance for loan losses for the years ended
December 31 is as follows:
2001 2000 1999
---------- ---------- ----------
(dollars in thousands)
BALANCE, beginning of year $ 4,561 $ 2,281 $ 1,814
Provision for loan losses 5,262 1,155 1,349
Loans charged to the allowance (4,611) (2,070) (1,025)
Recoveries credited to the allowance 785 1,207 143
Adjustment incident to acquisition -- 1,988 --
---------- ---------- ----------
BALANCE, end of year $ 5,997 $ 4,561 $ 2,281
========== ========== ==========
Loans on which the accrual of interest has been discontinued amounted to
approximately $4.8 million, $5.1 million, and $2.4 million at December 31, 2001,
2000, and 1999, respectively. Interest forgone on non-accrual loans was
approximately $826,000, $753,000, and $424,000 in 2001, 2000, and 1999,
respectively.
At December 31, 2001 and 2000, the Company's recorded investment in certain
loans that were considered to be impaired was $7.3 million and $6.7 million,
respectively. Of these impaired loans, $2.5 million and $2.1 million have
related specific reserves of $792,000 and $1.3 million, respectively, while $4.8
million and $4.6 million, respectively, did not require specific reserves. The
balance of the allowance for loan losses in excess of these specific reserves is
available to absorb losses from all loans. The average recorded investment in
impaired loans for the years ended December 31, 2001, 2000, and 1999, was
approximately $6.0 million, $4.9 million, and $3.7 million, respectively.
Interest payments received on impaired loans are recorded as interest income,
unless collection of the remaining recorded investment is not probable, in which
case payments received are recorded as a reduction of principal. For the years
ended December 31, 2001, 2000, and 1999 interest income recognized on impaired
loans totaled $324,000, $159,000, and $153,000, respectively, all of which was
recognized on a cash basis.
NOTE 6 - PREMISES AND EQUIPMENT
Premises and equipment consist of the following at December 31:
2001 2000
------- -------
(dollars in thousands)
Land $ 839 $ 839
Buildings and improvements 4,519 4,445
Furniture and equipment 3,906 3,579
------- -------
9,264 8,863
Accumulated depreciation (4,029) (3,238)
------- -------
$ 5,235 $ 5,625
======= =======
50
NOTE 6 - PREMISES AND EQUIPMENT - (continued)
Depreciation expense amounted to $826,000 $759,000, and $654,000 for the years
ended December 31, 2001, 2000, and 1999, respectively.
NOTE 7 - CERTIFICATES OF DEPOSIT
Included in certificates of deposit are certificates in denominations of
$100,000 or greater totaling $95.0 million and $46.4 million at December 31,
2001 and 2000, respectively. Interest expense relating to certificates of
deposit in denominations of $100,000 or greater was $4.0 million, $2.3 million,
and $858,000 for the years ended December 31, 2001, 2000, and 1999,
respectively.
At December 31, 2001, the scheduled time remaining to repricing or maturity for
all time deposits is as follows:
(dollars in thousands)
Three months or less $ 48,425
Over three through six months 49,139
Over six months through 12 months 43,796
Over 12 months 34,318
--------
$175,678
========
NOTE 8 - OTHER BORROWINGS
Short-term borrowings consist of unsecured overnight federal funds purchased of
$2.8 million and $1.3 million at December 31, 2001 and 2000, respectively.
Long-term borrowings consist of the following at December 31:
2001 2000
---------- ----------
(dollars in thousands)
Notes payable to Federal Home Loan Bank; interest
from 2.0% to 8.62% and 6.02% to 8.80% at December
31, 2001 and 2000, respectively, payable in monthly
installments plus interest; due 2002 to 2009;
secured by certain investment securities and
mortgage loans totaling $35.4 million and $20.1
million at December 31, 2001 and 2000, respectively 16,013 18,293
51
NOTE 8 - OTHER BORROWINGS - (continued)
2001 2000
---------- ----------
Notes payable to a correspondent bank; interest at
8.00% at December 31, 2001 and 2000, payable in
monthly principal and interest installments of
$30,000, final payment of $2.1 million due in
December 31, 2007; secured by Bank stock 2,945 3,000
Contract payable to a private party; interest at
9.0%, payable in monthly installments plus
interest through October 2010 51 55
---------- ----------
$ 19,009 $ 21,348
========== ==========
Certain of the Company's long-term borrowings have restrictive covenants that
require the Company to maintain minimum levels of net income to required annual
debt-service payments. The Company was in violation of certain of these
covenants as of December 31, 2001.
However, a waiver of the covenant violation was received from the Company's
lender.
The scheduled repayment of other borrowings subsequent to December 31, 2001, is
as follows:
(dollars in thousands)
Years ending December 31, 2002 $ 10,126
2003 137
2004 5,148
2005 319
2006 227
Thereafter 3,052
----------
$ 19,009
==========
The FHLB borrowing agreements require the Bank to deliver collateral to the FHLB
in Seattle, Washington and are limited to 15% of total assets. The FHLB has also
issued standby letters of credit totaling $6.2 million at December 31, 2001, on
behalf of the Bank to support the Bank's public deposits and certain standby
letters of credit issued by the Bank.
52
NOTE 9 - INCOME TAXES
Components of the provision for income taxes for the years ended December 31
were as follows:
2001 2000 1999
----- ------- -----
(dollars in thousands)
Current $ 355 $ 1,777 $ 631
Deferred benefit (205) (1,166) (211)
----- ------- -----
Provision for income taxes $ 150 $ 611 $ 420
===== ======= =====
The tax effect of temporary differences that give rise to deferred tax assets
and deferred tax liabilities at December 31 was as follows:
2001 2000
------- -------
(dollars in thousands)
Deferred tax assets:
Allowance for loan losses $ 1,613 $ 1,285
Loan origination fees -- 7
Amortization of intangible assets 215 167
Deferred compensation 23 106
Net operating loss carryforward 530 565
Other 27 22
------- -------
2,408 2,152
------- -------
Deferred tax liabilities:
Accumulated depreciation (36) (77)
Federal Home Loan Bank stock dividends (725) (624)
Accrual to cash adjustment (20) (29)
------- -------
(781) (730)
------- -------
Net deferred tax $ 1,627 $ 1,422
======= =======
The above table does not include deferred tax assets or liabilities relating to
the unrealized gain or loss on available-for-sale securities. Deferred tax
liabilities of $5,000 in 2001 and $20,000 in 2000, were recorded in conjunction
with unrealized gains and losses on available-for-sale securities.
53
NOTE 9 - INCOME TAXES - (continued)
A reconciliation between the statutory federal income tax rate and the effective
tax rate is as follows:
2001 2000 1999
-------- -------- --------
Federal income taxes at statutory rate $ (442) $ 503 $ 366
Effect of non-deductible goodwill amortization 465 45 34
Effect of non-deductible officers' life insurance 79 37 13
Other 48 26 7
-------- -------- --------
$ 150 $ 611 $ 420
======== ======== ========
N/A 44.3% 39.0%
======== ======== ========
At December 31, 2001, the Company had a $1.5 million net operating loss
carryforward that was acquired with the purchase of Northern Bank of Commerce.
The federal and state net operating loss carryforward will offset future taxable
income by approximately $100,000 each year. The carryforwards will expire in
2020.
Management believes, based upon the Company's historical performance, that the
deferred tax assets will be realized in the normal course of operations and,
accordingly, management has not reduced deferred tax assets by a valuation
allowance.
NOTE 10 - EARNINGS PER SHARE
The following table reconciles the numerator and denominator of the basic and
diluted earnings per share computations:
Weighted Per
Net Income Average Share
(Loss) Shares Amount
------------ ------------ ------------
(dollars in thousands)
For the year ended December 31, 2001
Basic loss per share $ (1,450) 3,691,728 $ (0.39)
Stock options 39,591
----------
Diluted loss per share $ (1,450) 3,731,319 $ (0.39)
==========
54
NOTE 10 - EARNINGS PER SHARE - (continued)
Weighted Per
Net Income Average Share
(Loss) Shares Amount
------------ ------------ ------------
For the year ended December 31, 2000
Basic earnings per share $ 869 3,885,946 $ 0.22
Stock options 14,819
----------
Diluted earnings per share $ 869 3,900,765 $ 0.22
==========
For the year ended December 31, 1999
Basic earnings per share $ 656 4,054,657 $ 0.16
Stock options 42,591
----------
Diluted earnings per share $ 656 4,097,248 $ 0.16
==========
For the periods reported the Company had no reconciling items between net income
and income available to common shareholders.
Options to purchase 538,866 shares with exercise prices ranging from $5.71 to
$12.00 were not included in diluted earnings per share due to the exercise price
being greater than the average market price for the year ended December 31,
2001. The options expire from 2008 to 2010. At December 31, 2000, there were
602,166 shares with exercise prices ranging from $4.94 to $12.00 not included in
diluted earnings per share due to the exercise price being greater than the
average market price. The options expire from 2008 to 2010. Options to purchase
96,000 shares of common stock at a price ranging from $5.55 to $6.42 were
outstanding at December 31, 1999 but were not included in the computation of
diluted earnings per share because the options' exercise price was greater than
the average market price of the common shares. These options expire in 2008 and
2009.
NOTE 11 - SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL
Dividends are paid by the Company from its retained earnings, which are
principally provided through dividends and income from its subsidiaries.
However, state agencies restrict the amount of funds the Bank may transfer to
the Company in the form of cash dividends, loans, or advances. Transfers are
limited by the Bank's retained earnings, which for the Bank were $13.6 million
at December 31, 2001.
The Company and the Bank are subject to various regulatory capital requirements
as established by applicable federal and state banking regulatory authorities.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company and the Bank must meet specific capital
guidelines that involve quantitative measures of their assets, liabilities and
certain off-balance-sheet items. The quantitative measures for capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios of Total
and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average
assets (leverage). The Company's and the Bank's capital components,
classifications, risk weightings, and other factors are also subject to
qualitative judgments by regulators. Failure to meet minimum capital
requirements can initiate certain actions by regulators that, if undertaken,
could have a material effect on the Company's financial statements.
Management believes that as of December 31, 2001, the Company and the Bank meet
all minimum capital adequacy requirements to which they are subject. The most
recent notification, based on June 30, 2001 reporting, from the Federal Deposit
Insurance Corporation categorized the Bank as adequately capitalized under the
regulatory framework for prompt correction actions. Management believes that
changes in conditions have occurred subsequent to such notification to change
the Bank's category to well capitalized as of December 31, 2001.
55
NOTE 11 - SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL - (continued)
The following table presents selected capital information for the Company
(consolidated) and the Bank as of December 31, 2001 and 2000:
To Be Well Capitalized
Under Prompt
For Capital Adequacy Correct Action
Actual Purposes Provisions
----------------------- ----------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
---------- ---------- ---------- ---------- ---------- ----------
December 31, 2001 Total risk-based capital:
Consolidated $ 27,358 10.10% $ 21,661 >/=8.00% $ 27,076 >/=10.00%
Bank $ 28,898 10.72% $ 21,564 >/=8.00% $ 26,956 >/=10.00%
Tier 1 risk-based capital:
Consolidated $ 23,941 8.84% $ 10,830 >/=4.00% $ 16,245 >/=6.00%
Bank $ 25,499 9.46% $ 10,782 >/=4.00% $ 16,173 >/=6.00%
Tier 1 (leverage) capital:
Consolidated $ 23,941 6.51% $ 14,717 >/=4.00% N/A N/A
Bank $ 25,499 6.99% $ 14,594 >/=4.00% $ 18,242 >/=5.00%
December 31, 2000 Total risk-based capital:
Consolidated $ 27,717 10.99% $ 20,170 >/=8.00% $ 25,213 >/=10.00%
Bank $ 26,408 10.62% $ 19,887 >/=8.00% $ 24,859 >/=10.00%
Tier 1 risk-based capital:
Consolidated $ 24,548 9.74% $ 10,085 >/=4.00% $ 15,128 >/=6.00%
Bank $ 23,278 9.37% $ 9,944 >/=4.00% $ 14,915 >/=6.00%
Tier 1 (leverage) capital:
Consolidated $ 24,548 8.48% $ 11,583 >/=4.00% N/A N/A
Bank $ 23,278 8.19% $ 11,366 >/=4.00% $ 14,208 >/=5.00%
NOTE 12 - STOCK OPTION AND EMPLOYEE STOCK PURCHASE PLANS
During 1997, the Company adopted the 1997 Stock Option Plan (the 1997 Plan)
which, together with subsequent amendments, authorizes up to 625,000 shares of
common stock for issuance thereunder. Under the 1997 Plan, options may be
granted to the Company's employees, directors, and consultants. The exercise
price of incentive stock options under the 1997 Plan must be at least equal to
the fair value of the common stock on the date of grant. Options granted under
the 1997 Plan generally vest over a five-year period, at the discretion of the
compensation committee. All incentive stock options granted under the 1997 Plan
will expire ten years from the date of grant unless terminated sooner pursuant
to the provisions of the 1997 Plan. At December 31, 2001 and 2000, options to
purchase a total of 476,180 and 479,900 shares, respectively, are outstanding
under the 1997 Plan. All stock options granted under the 1997 Plan were made
with exercise prices equal to the fair market value of the underlying stock on
the date of grant.
56
NOTE 12 - STOCK OPTION AND EMPLOYEE STOCK PURCHASE PLANS - (continued)
In connection with the acquisition of Northern Bank of Commerce during 2000, the
Company issued 231,466 incentive stock options to former Directors of NBOC.
These options vest equally over five years and expire 10 years after the date of
grant. The exercise prices of the options range from $11.09 to $12.00 per share
and were granted outside of the 1997 Plan. Also in 2000, the Company granted
17,000 incentive stock options to employees, which vest equally over five years
and expire ten years after the date of grant. The exercise price of these
options is equal to the fair value of the underlying common stock at the date of
grant.
During 1999, the Company granted incentive stock options to purchase 20,000
shares of common stock to certain officers of Bay Mortgage and Bay Bank. These
options vest equally over a five-year period and expire 10 years after the grant
dates. The exercise prices are equal to the fair value of the underlying common
stock. These options were granted by the Company outside of the 1997 Plan.
Also during 1999, the Company authorized up to 69,000 performance-based stock
options to be granted to an officer of Bay Bank. The number of performance-based
stock options actually to be issued varies depending on Bay Bank's achievement
of certain earnings targets over a three-year period. The exercise price for
54,000 of these performance-based stock options was equal to the fair market
value of the underlying common stock on the grant date. The Company accrues
compensation expense for these performance-based stock options over the
performance period based on changes in the fair market value of the underlying
common stock and estimates of the number of stock options to be issued based on
the performance targets. There was no compensation expense charged against
(credited to) income for these performance-based stock options in 2001 or 2000,
respectively. The exercise price of the remaining 15,000 options will be equal
to the fair value of the underlying common stock of the Company on the date the
earnings targets are achieved.
The Company adopted an employee stock purchase plan during 1996 and may sell up
to 175,000 shares of common stock to its eligible employees under the plan.
During 2001 and 2000, the Company sold 3,233 and 8,207 shares of stock,
respectively, under the plan. Each employee is granted the right to purchase
stock at a price equal to the fair value of the common stock at the date of
grant, as determined by the Board of Directors. These grants are made to
qualified employees each quarter and expire within the month they are granted.
A summary of option activity for the years ended December 31, 2001, 2000, and
1999 is as follows:
2001 2000 1999
------------------------ -------------------------- --------------------------
Weighted Weighted Weighted
Common Average Common Average Common Average
Shares Price Shares Price Shares Price
---------- ----------- ---------- ----------- ----------- -------------
(dollars in thousands)
BALANCE, beginning of year 769,866 $ 7.29 598,000 $ 5.92 454,092 $ 6.08
Granted 57,233 $ 5.96 458,166 $ 8.20 224,041 $ 5.90
Exercised (3,233) $ 4.92 (8,207) $ 4.75 (5,778) $ 6.09
Forfeited (22,320) $ 4.78 (278,093) $ 5.80 (74,355) $ 6.73
-------- --------- --------
BALANCE, end of year 801,546 $ 7.25 769,866 $ 7.29 598,000 $ 5.92
======== ========== ========= ========== ======== ==========
Exercisable, end of year 460,124 $ 6.87 302,113 $ 6.63 284,500 $ 5.89
======== ========== ========= ========== ======== ==========
Fair value of options granted $ 1.33 $ 1.00 $ 4.02
========== ========== ==========
57
NOTE 12 - STOCK OPTION AND EMPLOYEE STOCK PURCHASE PLANS - (continued)
At December 31, 2001, exercise prices for outstanding options ranged from $4.44
to $12.00. For the options outstanding at December 31, 2001, the weighted
average contractual life is 7.8 years.
As of December 31, 2001, outstanding stock options consist of the following:
Weighted Weighted Weighted
Average Average Average
Options Exercise Remaining Options Exercise
Exercise Price Range Outstanding Price Life Exercisable Price
---------- ---------- ---------- ----------- ----------
$4.00 - $5.00 262,680 $ 4.57 8.80 99,698 $ 4.99
$5.00 - $6.00 192,500 5.71 5.75 192,500 5.71
$6.00 - $7.00 72,900 6.49 7.57 32,940 6.51
$7.00 - $8.00 42,000 7.94 7.00 33,600 7.94
$11.00 - $12.00 231,466 11.68 8.50 92,586 11.68
------- ---------- ---- ------- --------
801,546 $ 7.25 7.80 451,324 $ 6.87
======= ========== ==== ======= ========
The Company accounts for the 1997 Plan, options granted outside of the 1997
Plan, and the Employee Stock Purchase Plan under APB Opinion No. 25, under which
no compensation cost has been recognized. Had compensation cost for these plans
been determined consistent with SFAS No. 123 and recognized over the vesting
period, the Company's net income (loss) and earnings (loss) per share would have
been reduced to the following pro forma amounts:
2001 2000 1999
--------- --------- ---------
(dollars in thousands, except per share amounts)
Net income (loss):
As reported $ (1,450) $ 869 $ 656
Pro forma $ (1,639) $ 688 $ 501
Basic earnings (loss) per share:
As reported $ (0.39) $ 0.22 $ 0.16
Pro forma $ (0.44) $ 0.18 $ 0.12
Diluted earnings (loss) per share:
As reported $ (0.39) $ 0.22 $ 0.16
Pro forma $ (0.44) $ 0.18 $ 0.12
The fair value of each option granted is estimated on the date of grant using
the Black-Scholes option-pricing model, with the following weighted-average
assumptions used for grants in 2001, 2000, and 1999: risk-free average interest
rate of 3.50%, 5.50%, and 5.10%, respectively; expected dividend yields of
0.93%, 1.40%, and 1.08%, respectively; and an expected volatility of 16.70%,
10.84%, and 63.61%, respectively. Expected lives for options granted were
between five and seven years. Due to the discretionary nature of stock option
grants, the compensation cost included in the 2001, 2000, and 1999, pro forma
net income per SFAS No. 123 may not be representative of that expected in future
years.
58
NOTE 13 - CONTINGENT LIABILITIES AND COMMITMENTS WITH OFF- BALANCE-SHEET RISK
The Company's consolidated financial statements do not reflect various
commitments and contingent liabilities of its subsidiary bank that arise in the
normal course of business and that involve elements of credit risk, interest
rate risk and liquidity risk. These commitments and contingent liabilities are
commitments to extend credit, credit card arrangements, and standby letters of
credit.
A summary of the Bank's undisbursed commitments and contingent liabilities at
December 31, 2001, is as follows:
Fixed Variable Total
Rate Rate 2001
------- ------- -------
(dollars in thousands)
Commitments to extend credit $ 8,861 $34,064 $42,925
Credit card commitments 5,892 -- 5,892
Standby letters of credit 175 4,674 4,849
------- ------- -------
$14,928 $38,738 $53,666
======= ======= =======
Commitments to extend credit, credit card arrangements, and standby letters of
credit all include exposure to some credit loss in the event of non-performance
of the customer. The Bank's credit policies and procedures for credit
commitments and financial guarantees are the same as those for extension of
credit that are recorded in the consolidated statements of condition. Because
these instruments have fixed maturity dates and many of them expire without
being drawn upon, they do not generally present a significant liquidity risk to
the Bank.
The Company and its subsidiaries are also party to several noncancellable lease
agreements for premises and equipment. Future rental payments on these
noncancellable leases are as follows:
(dollars in thousands)
Years ending December 31, 2002 $ 890
2003 840
2004 475
2005 161
2006 79
Thereafter 488
-------
$ 2,933
=======
This payment schedule reflects actual liability on lease agreements in which the
Company is currently involved, and does not include potential additional
payments relating to possible lease extensions.
Rent expense under noncancellable lease agreements amounted to $1.1 million,
$909,000, and $397,000 for the years ending December 31, 2001, 2000, and 1999,
respectively.
59
NOTE 14 - RELATED-PARTY TRANSACTIONS
Certain directors, executive officers and their spouses, associates and related
organizations, had banking transactions with the Bank in the ordinary course of
business. All loans and commitments to loan were made on substantially the same
terms and conditions, including collateral required, as comparable transactions
with unaffiliated parties. Directors and executive officers are charged the same
rates of interest and loan fees as are charged to employees of the Company, with
interest rates and fees slightly lower than those charged to non-employee
borrowers. The amounts of loans outstanding to directors, executive officers,
principal shareholders, and companies with which they are associated was as
follows:
2001 2000
-------- -------
(dollars in thousands)
Beginning balance $ 4,615 $ 2,059
Loans made 9,757 8,786
Loan repayments made (10,536) (6,024)
Other (334) (206)
-------- -------
Ending balance $ 3,502 $ 4,615
======== =======
Certain officers at December 31, 2000 were no longer officers at December 31,
2001. The balances outstanding to such persons are reflected in the "other"
category above.
The Chairman of the Company previously owned a securities brokerage franchise of
Raymond James Financial Services, Inc., which leases space from the Company.
Total income from the lease amounted to $24,000 for each of the years ending
December 31, 2001, 2000, and 1999. The franchise was sold to a third party in
2001.
NOTE 15 - EMPLOYEE BENEFIT PLANS
The Company has a contributory retirement savings plan covering substantially
all full-time and part-time employees who have completed three months of
service. The plan allows an employee to contribute a portion of his or her
annual wages subject to a maximum dollar limit which is set by law. In addition,
at the annual discretion of the Board of Directors, the Company may contribute
funds into the plan on behalf of each employee participant. Currently, the
Company will match the first 3% of the employee's contribution, up to $3,000 per
year. In addition, regardless of the employee's participation in the plan, the
Company currently contributes 3% of the employee's salary, up to a maximum of
$3,000. For this contribution, employees must be employed by the Company on the
last day of the plan year. The plan also requires completion of six months of
service to become eligible for the Company contributions. Any funds contributed
by the Company are subject to the following vesting schedule:
20% - after 2 years of service
40% - after 3 years of service
60% - after 4 years of service
80% - after 5 years of service
100% - after 6 years of service
The Company contributed $446,000, $292,000, and $236,000 into the plan for the
years ended December 31, 2001, 2000, and 1999, respectively.
60
NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS
A financial instrument is defined as cash, evidence of ownership interest in an
entity, or a contract that conveys or imposes the contractual right or
obligation to either receive or deliver cash or another financial instrument.
Examples of financial instruments included in the Company's statements of
condition are cash, federal funds sold or purchased; debt and equity securities;
loans; demand, savings, and other interest-bearing deposits; and notes and
debentures. Examples of financial instruments, which are not included in the
Company's statements of condition, are commitments to extend credit and standby
letters of credit.
Fair value is defined as the amount at which a financial instrument could be
exchanged in a current transaction between willing parties, other than in a
forced sale or liquidation, and is best evidenced by a quoted market price if
one exists.
The fair value of deposit liabilities with no stated maturity, such as demand
deposits, NOW, and money market accounts is equal to the carrying value of these
financial instruments and does not recognize the inherent value of core deposit
relationships when determining fair value. Disclosure of the fair value of
non-financial instruments, such as the Company's premises and equipment, its
banking and trust franchises, and its core deposit relationships is not
required. The Company believes that these non-financial instruments have
significant fair value.
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
Cash and due from banks - For these short-term instruments, the carrying amount
is a reasonable estimate of fair value.
Investment securities - For securities held for investment purposes, fair values
are based on quoted market prices or dealer quotes. For other securities, fair
value equals quoted market prices, if available. If a quoted market price is not
available, fair value is estimated using quoted market prices for similar
securities.
Loans - For certain variable rate loans, fair value is estimated at carrying
value, as these loans reprice to market frequently. The fair value of other
types of loans is estimated by discounting the future cash flows, using the
current rates at which similar loans would be made to borrowers with similar
credit ratings and for the same remaining maturities.
Deposit liabilities - The fair value of demand deposits, savings accounts, and
certain money market deposits is the amount payable on demand at the reporting
date. The fair value of fixed-maturity certificates of deposit is estimated by
discounting future cash flows, using the rates currently offered for deposits of
similar remaining maturities.
Short-term borrowing -The carrying amounts of borrowings under repurchase
agreements and short-term borrowings approximate their fair values.
Long-term borrowing - Rates currently available to the Bank for debt with
similar terms and remaining maturities are used to estimate the fair value of
existing debt.
Commitments to extend credit, credit card commitments, and standby letters of
credit - The fair values of commitments to extend credit, credit card
commitments, and standby letters of credit were not material as of December 31,
2001 and 2000.
61
NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS - (continued)
The estimated fair values of the Company's financial instruments at December 31
were as follows:
2001 2000
-----------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- -------- -------- --------
(dollars in thousands)
Financial assets:
Cash and cash equivalents $ 50,177 $ 50,177 $ 25,589 $ 25,589
Investment securities $ 34,303 $ 34,345 $ 12,071 $ 12,068
Federal Home Loan Bank stock $ 3,531 $ 3,531 $ 3,302 $ 3,302
Loans, net of allowances for loan losses
and deferred loan fees $229,215 $229,400 $229,078 $226,000
Loans held-for-sale $ 37,322 $ 37,322 $ 10,013 $ 10,013
Financial liabilities:
Non-interest-bearing demand $ 43,225 $ 43,225 $ 40,201 $ 40,201
Savings and interest-bearing demand $ 96,587 $ 96,587 $ 73,770 $ 73,770
Certificates of deposit $175,678 $176,918 $127,245 $127,750
Short-term borrowings $ 2,750 $ 2,750 $ 1,275 $ 1,275
Long-term borrowings $ 19,009 $ 19,518 $ 21,348 $ 21,267
While estimates of fair value are based on management's judgment of the most
appropriate factors, there is no assurance that were the Company to have
disposed of such items at December 31, 2001 and 2000, the estimated fair values
would necessarily have been achieved at that date, since market values may
differ depending on various circumstances. The estimated fair values at December
31, 2001 and 2000, should not necessarily be considered to apply at subsequent
dates.
NOTE 17 - CONCENTRATIONS OF CREDIT RISK
All of the Bank's loans, commitments, and commercial and standby letters of
credit have been granted to customers in the Bank's market areas. The majority
of such customers are also depositors of the Bank. The concentrations of credit
by type of loan are set forth in Note 4. The distribution of commitments to
extend credit approximates the distribution of loans outstanding. Commercial and
standby letters of credit were granted primarily to commercial borrowers as of
December 31, 2001. The Bank's loan policies do not allow the extension of credit
to any single borrower or group of related borrowers in excess of $1.0 million
without approval from the Bank's respective loan committees.
62
NOTE 18 - SEGMENTS OF A BUSINESS AND RELATED INFORMATION
The Company is principally engaged in community banking activities through its
branches and corporate offices. Community banking activities include accepting
deposits, providing loans and lines of credit to local individuals, businesses
and governmental entities, investing in investment securities and money market
instruments, and holding or managing assets in a fiduciary agency capacity on
behalf of its customers and their beneficiaries. The Company's mortgage segment,
Bay Mortgage, specializes in all facets of residential lending including FHA and
VA loans, construction loans and bridge loans. Prior to the sale of Business
Finance Corporation in the first quarter of 2002, the Company provided
asset-based financing to companies throughout the western United States.
The community banking, asset-based financing activity, and mortgage banking
activities are monitored and reported by Company management as separate
operating segments. The asset-based financing segment does not meet the
prescribed aggregation or materiality criteria and, therefore, is reported as
"Other" in the table below.
The accounting policies for the Company's segment information provided below are
the same as those described in Note 1, except that some operating expenses are
not allocated to segments.
Summarized financial information for the years ended December 31, 2001, 2000,
and 1999 concerning the Company's reportable segments is shown in the following
tables.
2001
------------------------------------------------------------------------------------
Mortgage Holding
Banking Banking Company Other Intersegment Consolidated
---------- ---------- ---------- ---------- ------------ ------------
(dollars in thousands)
Interest income $ 24,523 $ 4,725 $ 86 $ 1,123 $ (3,230) $ 27,227
Interest expense 13,318 2,791 245 258 (3,230) 13,382
---------- ---------- ---------- ---------- ------------ ------------
Net interest income 11,205 1,934 (159) 865 -- 13,845
Provision for loan loss (2,779) (713) -- (1,770) -- (5,262)
Non-interest income 1,345 8,216 30 -- -- 9,591
Non-interest expense 10,153 6,674 717 1,930 -- 19,474
---------- ---------- ---------- ---------- ------------ ------------
Income (loss) before provision
for income taxes (382) 2,763 (846) (2,835) -- (1,300)
Provision for income taxes (62) 939 (208) (519) -- 150
---------- ---------- ---------- ---------- ------------ ------------
Net income (loss) $ (320) $ 1,824 $ (638) $ (2,316) $ -- $ (1,450)
========== ========== ========== ========== ============ ============
Depreciation and amortization $ 1,013 $ 288 $ -- $ 107 $ -- $ 1,408
========== ========== ========== ========== ============ ============
Total assets $ 362,811 $ 56,649 $ 31,718 $ 3,841 $ (84,359) $ 370,660
========== ========== ========== ========== ============ ============
63
NOTE 18 - SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION -
(continued)
2000
------------------------------------------------------------------------------------
Mortgage Holding
Banking Banking Company Other Intersegment Consolidated
---------- ---------- ---------- ---------- ------------ ------------
(dollars in thousands)
Interest income $ 21,114 $ 1,030 $ 416 $ 1,528 $ (1,240) $ 22,848
Interest expense 10,158 633 -- 389 (1,240) 9,940
---------- ---------- ---------- ---------- ------------ ------------
Net interest income 10,956 397 416 1,139 -- 12,908
Provision for loan loss (873) (147) 8 (143) -- (1,155)
Non-interest income 1,593 3,626 -- -- -- 5,219
Non-interest expense 9,380 4,593 764 755 -- 15,492
---------- ---------- ---------- ---------- ------------ ------------
Income (loss) before provision
for income taxes 2,296 (717) (340) 241 -- 1,480
Provision for income taxes 818 (244) (80) 117 -- 611
---------- ---------- ---------- ---------- ------------ ------------
Net income (loss) $ 1,478 $ (473) $ (260) $ 124 $ -- $ 869
========== ========== ========== ========== ============ ============
Depreciation and amortization $ 950 $ 252 $ -- $ 114 $ -- $ 1,316
========== ========== ========== ========== ============ ============
Total assets $ 289,520 $ 22,227 $ 33,485 $ 6,001 $ (54,334) $ 296,898
========== ========== ========== ========== ============ ============
64
NOTE 18 - SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION - (continued)
1999
------------------------------------------------------------------------------------
Mortgage Holding
Banking Banking Company Other Intersegment Consolidated
---------- ---------- ---------- ---------- ------------ ------------
(dollars in thousands)
Interest income $ 13,701 $ 161 $ 586 $ 1,482 $ (654) $ 15,276
Interest expense 5,638 -- -- 264 (654) 5,248
---------- ---------- ---------- ---------- ------------ ------------
Net interest income 8,063 161 586 1,218 -- 10,028
Provision for loan loss (963) -- (8) (378) -- (1,349)
Non-interest income 1,380 1,811 -- -- -- 3,191
Non-interest expense 6,812 2,279 900 803 -- 10,794
---------- ---------- ---------- ---------- ------------ ------------
Income before provision
for income taxes 1,668 (307) (322) 37 -- 1,076
Provision for income taxes 574 (104) (95) 45 -- 420
---------- ---------- ---------- ---------- ------------ ------------
Net income (loss) $ 1,094 $ (203) $ (227) $ (8) $ -- $ 656
========== ========== ========== ========== ============ ============
Depreciation and amortization $ 903 $ 83 $ -- $ 112 $ -- $ 1,098
========== ========== ========== ========== ============ ============
Total assets $ 186,811 $ 5,410 $ 31,594 $ 6,588 $ (31,908) $ 198,495
========== ========== ========== ========== ============ ============
65
NOTE 19 - PARENT COMPANY ONLY FINANCIAL DATA
The following sets forth condensed financial information of the Company on a
stand-alone basis:
Statements of Condition
(unconsolidated)
December 31,
--------------------
2001 2000
------- -------
(dollars in thousands)
ASSETS
Cash and cash equivalents $ 424 $ 1,365
Investment in bank subsidiary 30,306 27,830
Investment in non-bank subsidiary 194 2,510
Receivables due from non-bank subsidiary 450 1,400
Other assets 344 379
------- -------
Total assets $31,718 $33,484
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Long-term borrowings $ 2,945 $ 3,000
Other liabilities 25 75
------- -------
Total liabilities 2,970 3,075
SHAREHOLDERS' EQUITY 28,748 30,409
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY $31,718 $33,484
======= =======
66
NOTE 19 - PARENT COMPANY ONLY FINANCIAL DATA - (continued)
Statements of Operations
(unconsolidated)
Years Ended December 31,
---------------------------
2001 2000 1999
------- ------- -----
(dollars in thousands)
INCOME
Income from subsidiaries $ 86 $ 416 $ 571
Other income 30 -- 15
------- ------- -----
Total income 116 416 586
------- ------- -----
EXPENSES
Interest expense 245 -- --
Other expense 717 764 907
------- ------- -----
Total expense 962 764 907
------- ------- -----
Loss before income tax benefit and equity
in undistributed earnings of subsidiaries (846) (348) (321)
Income tax benefit 208 80 95
------- ------- -----
Net loss before equity in undistributed
earnings of subsidiaries (638) (268) (226)
Equity in undistributed earnings (losses) of
subsidiaries (812) 1,137 882
------- ------- -----
NET INCOME (LOSS) $(1,450) $ 869 $ 656
======= ======= =====
67
NOTE 19 - PARENT COMPANY ONLY FINANCIAL DATA - (continued)
Statements of Cash Flows
(unconsolidated)
Years Ended December 31,
--------------------------------
2001 2000 1999
-------- -------- --------
(dollars in thousands)
CASH FLOWS FROM OPERATING
ACTIVITIES
Net income (loss) $ (1,450) $ 869 $ 656
Adjustments to reconcile net income (loss)
to net cash from operating activities:
Undistributed earnings (losses) of
subsidiaries 812 (1,137) (882)
Decrease (increase) in other assets 35 302 (359)
Decrease in other liabilities (50) (29) (7)
-------- -------- --------
Net cash from operating activities (653) 5 (592)
-------- -------- --------
CASH FLOWS FROM INVESTING
ACTIVITIES
Decrease (increase) in loans -- 492 (500)
Acquisition of business, net of cash acquired -- -- (967)
Advances to subsidiaries (12,400) (32,925) (5,104)
Repayment of advances to subsidiaries 12,350 26,318 3,393
-------- -------- --------
Net cash from investing activities (50) (6,115) (3,178)
-------- -------- --------
CASH FLOWS FROM FINANCING
ACTIVITIES
Proceeds form issuance of long-term debt -- 3,000
Net repayments of long-term borrowings (55) -- --
Purchase of treasury stock -- (1,784) (732)
Proceeds from issuance of common stock 17 39 34
Dividends paid (200) (281) (281)
-------- -------- --------
Net cash from financing activities (238) 974 (979)
-------- -------- --------
NET DECREASE IN CASH AND CASH
EQUIVALENTS (941) (5,136) (4,749)
CASH AND CASH EQUIVALENTS,
beginning of year 1,365 6,501 11,250
-------- -------- --------
CASH AND CASH EQUIVALENTS,
end of year $ 424 $ 1,365 $ 6,501
======== ======== ========
68
NOTE 20 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following sets forth unaudited quarterly financial data for the years ended
December 31, 2001 and 2000:
March 31 June 30 September 30 December 31
------------ ------------ ------------ ------------
(dollars in thousands)
2001
Interest income $ 6,593 $ 7,063 $ 6,955 $ 6,616
Interest expense 3,220 3,622 3,540 3,000
------------ ------------ ------------ ------------
Net interest income 3,373 3,441 3,415 3,616
Provision for loan losses (252) (355) (2,125) (2,530)
Non-interest income 1,797 2,456 1,820 3,518
Non-interest expense 4,175 4,789 4,519 5,991
------------ ------------ ------------ ------------
Income (loss) before
provision (benefit)
for income taxes 743 753 (1,409) (1,387)
Provision (benefit)
for income
taxes 286 337 (457) (16)
------------ ------------ ------------ ------------
Net income (loss) $ 457 $ 416 $ (952) $ (1,371)
============ ============ ============ ============
Basic earnings (loss)
per share $ 0.12 $ 0.11 $ (0.26) $ (0.37)
============ ============ ============ ============
Diluted earnings
(loss) per share $ 0.12 $ 0.11 $ (0.25) $ (0.37)
============ ============ ============ ============
69
NOTE 20 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED) - (continued)
March 31 June 30 September 30 December 31
------------ ------------ ------------ ------------
(dollars in thousands)
2000
Interest income $ 4,597 $ 5,011 $ 6,594 $ 6,646
Interest expense 1,671 2,134 2,999 3,136
------------ ------------ ------------ ------------
Net interest income 2,926 2,877 3,595 3,510
Provision for loan
losses (370) (371) (214) (200)
Non-interest income 1,006 1,222 1,473 1,509
Non-interest expense 3,852 3,371 4,315 3,945
------------ ------------ ------------ ------------
Income (loss) before
provisions (benefit)
for income taxes (290) 357 539 874
Provision (benefit)
for income
taxes (80) 119 203 369
------------ ------------ ------------ ------------
Net income (loss) $ (210) $ 238 $ 336 $ 505
============ ============ ============ ============
Basic earnings (loss)
Per share $ (0.05) $ 0.06 $ 0.09 $ 0.13
============ ============ ============ ============
Diluted earnings
(loss) per share $ (0.05) $ 0.06 $ 0.09 $ 0.13
============ ============ ============ ============
70
Item 9. Changes in and disagreements with accountants on accounting and
financial disclosure
None.
PART III
Item 10. Directors and executive officers of the registrant
The response to this item is incorporated by reference to the sections
entitled "Security ownership of directors and executive officers, Election of
directors, Information regarding the board of directors and its committees," in
the Company's 2002 Proxy Statement.
Effective March 27, 2002, Harve E. Menkens has been replaced as
President and CEO of the Company and the Bank by Paul L. Campbell. Mr. Campbell
has 38 years of banking experience, including 18 years as President and CEO of
Pioneer National Bank of Yakima, Washington. Mr. Campbell attended the
University of Utah, and is a graduate of the Pacific Coast Banking School, The
National Commercial Lending School, and Bank Marketing School.
On March 25, 2002, the Bank hired Gary S. Hanson as an Executive Vice
President and Chief Credit Administrator. Mr. Hanson has 28 years of banking
experience, including 22 years with Kitsap Bank of Port Orchard, Washington
where he served as Executive Vice President, Chief Credit Officer, and Branch
Administrator. Mr. Hanson has a business degree from Central Washington State
College in Ellensburg, Washington, and is a graduate of the Pacific Coast
Banking School.
Item 11. Executive Compensation
The response to this item is incorporated by reference to the section
entitled "Executive Compensation" in the Company's 2002 Proxy Statement.
Item 12. Security ownership of certain beneficial owners and management
The response to this item is incorporated by reference entitled
"Security ownership of directors and executive officers" in the Company's 2002
Proxy Statement.
Item 13. Certain relationships and related transactions
The response to this item is incorporated by reference entitled
"Related-party transactions" in the Company's 2002 Proxy Statement.
PART IV
Item 14. Exhibits, Financial Statement schedules and reports on form 8-K
a. No Form 8-K's were filed during the fourth quarter.
b. The exhibit list is set forth on the Exhibit Index included herein.
71
SIGNATURES
Pursuant to the requirements of Section 13 or 159d) 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, on the 29th day of
March, 2002.
COWLITZ BANCORPORATION
(Registrant)
/s/ Benjamin Namatinia
Benjamin Namatinia
Chairman
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant in the capacities indicated on the 29th day of March 2002.
Principal Accounting Officer:
/s/ Don P. Kiser
Don P. Kiser
Vice President/Chief Financial Officer/Secretary
Accounting Officer
/s/ Donna P. Gardner
Donna P. Gardner
Vice-President/Treasurer
Remaining Directors:
/s/ Benjamin Namatinia
Benjamin Namatinia
Chairman
/s/ Mark F. Andrews, Jr.
Mark F. Andrews, Jr.
Director
/s/ E. Chris Searing
E. Chris Searing
Director
/s/ John S. Maring
John S. Maring
Director
72
EXHIBIT INDEX
3.1* Restated and Amended Articles of Incorporation of Registrant.
3.2* Bylaws of Registrant.
10.1* Advances Security and Deposit Agreement dated March 29, 1991 between
Federal Home Loan Bank of Seattle and Cowlitz Bank.
10.2* Federal Home Loan Bank of Seattle Form of Promissory Note (Credit Line
Fixed Rate Advance).
10.4* Lease Agreement dated October 7, 1963 between Twin City Development Co.
and Bank of Cowlitz County.
10.5* Assignment of Lease dated March 4, 1976 between Bank of the West and Old
National Bank of Washington.
10.6* Assignment of Lease dated March 30, 1979 between Old National Bank of
Washington and Pacific National Bank of Washington.
10.7* Extension of Lease dated April 1, 1989 between Triangle Development
Company and First Interstate Bank of Washington, N.A.
10.9* Employment Agreement dated January 1, 1998 between Cowlitz
Bancorporation and Ben Namatinia.
10.10* Cowlitz Bancorporation 1997 Stock Option Plan.
10.11* Form of Stock Option Agreement.
10.12* Cowlitz Bancorporation Employee Stock Purchase Plan.
11.1 Computation of Per Share Earnings. (Included in Note 1 to the
Consolidated Financial Statements included herein)
21 List of all Subsidiaries of the Registrant Cowlitz Bank Business Finance
Corporation Consent of Moss Adams LLP
23.2 Consent of Arthur Andersen LLP
* Incorporated by reference from Registration Statement on Form S-1, Reg.
No. 333-44355
73
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the
incorporation of our report included (or incorporated by reference) in the Form
10-K, into the Company's previously filed Registration Statement File No.
333-48607.
Portland, Oregon /s/ Moss Adams LLP
March 29, 2002
74
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the
incorporation of our report dated January 21, 2000, on the consolidated
statements of income, changes in shareholder's equity and cash flows of Cowlitz
Bancorporation and subsidiaries for the year ended December 31, 1999, included
in Cowlitz Bancorporation's Form 10-K for the year ended December 31, 2001, into
Cowlitz Bancorporation's previously filed Form S-8 Registration Statement File
No. 333-48607. It should be noted that we have not audited any financial
statements of Cowlitz Bancorporation subsequent to December 31, 1999 or
performed any audit procedures subsequent to the date of our report.
San Francisco, California /s/Arthur Andersen LLP
March 22, 2002
75