Item 1. Business
General
Rainier Pacific Financial Group, Inc. ("Rainier Pacific Financial Group" or the "Company"), a Washington corporation, was organized on May 23, 2003 for the purpose of becoming the holding company for Rainier Pacific Savings Bank ("Rainier Pacific Bank" or the "Bank") upon the Bank's conversion from a mutual to a stock savings bank ("Conversion"). The Conversion was completed on October 20, 2003 through the sale and issuance of 8,442,840 shares of common stock by the Company. At December 31, 2007, we had total assets of $878.9 million, total deposits of $461.5 million and total shareholders' equity of $86.8 million. The Company's business activities generally are limited to passive investment activities and oversight of its investment in the Bank. Accordingly, the information set forth in this report, including consolidated financial statements and related data, relates primarily to the Bank.
The Bank is a well-established financial institution with a 75 year history of meeting the financial needs of its customers, who are primarily located in our local markets of Tacoma-Pierce County and the City of Federal Way in Washington State. We offer consumers a broad array of deposit and loan services through Rainier Pacific Bank and offer automobile and homeowners' insurance, financial planning, and non-federally insured mutual fund and investment services through two operating units of the Bank doing business as Rainier Pacific Insurance Services and Rainier Pacific Financial Services. We also provide deposit and loan services to small businesses, and local builders of single-family residential homes in our local community. Our customers’ deposits are insured by the Federal Deposit Insurance Corporation ("FDIC") up to applicable legal limits. Our primary regulators are the Washington State Department of Financial Institutions and the FDIC.
We began operations as a credit union in 1932, when we were formed as Tacoma Teachers Credit Union to serve the financial needs of Tacoma School District employees. In 1973, the Credit Union's name was changed to Educational Employees Credit Union, and we expanded our field of membership to encompass all employees in the field of education within the greater Tacoma and Pierce County area. The membership base was further expanded in 1988 by a merger with Health Care Credit Union which extended membership eligibility to all health care employees in Pierce County.
During 1993, 1994 and 1995, we obtained approval from the State of Washington's Department of Financial Institutions to extend credit union membership eligibility to all residents and employees of businesses in most communities in the Tacoma-Pierce County and City of Federal Way (in King County) geographical market. On October 16, 1995, we changed our name to Rainier Pacific, A Community Credit Union to reflect our change from an employer-based credit union to an inclusive community-based financial services provider.
On January 1, 2001, we converted from a credit union to a state-chartered mutual savings bank. The savings bank charter afforded us the opportunity to expand our offering of residential mortgage loans, multi-family and commercial real estate loans, real estate construction and land loans, and the ability to more broadly offer small business banking services. In addition, this savings bank charter enabled the expansion of our property and casualty insurance services beyond that available under our credit union charter.
On October 20, 2003, we completed our conversion from a state-chartered mutual savings bank to a state-chartered stock savings bank. In connection with the conversion, the Company sold 7,935,000 shares of its common stock and received $77.4 million in net proceeds after deducting expenses, and issued an additional 507,840 shares to the Rainier Pacific Foundation, a private foundation focused on supporting educational, healthcare, and community development services in our local markets. Since the completion of our conversion through December 31, 2007, the Company has repurchased 2,304,107 shares of its common stock.
As of December 31, 2007, the Company and the Bank operated a retail network of 14 branches throughout the Tacoma-Pierce County market and the City of Federal Way, with its corporate office located in the central business district of downtown Tacoma.
Market Area
We focus our efforts on serving residents and businesses in Pierce County and the City of Federal Way. Pierce County is the second most populous metropolitan area in Washington State, covering 1,794 square miles, with approximately 772,000 residents, a median household income of approximately $53,500 and an average household income of $66,100. The City of Federal Way is located in South King County, just north of the Pierce County border, with a population of approximately 81,000, a median household income of approximately $52,000, and an average household income of $64,500.
Our local economy possesses a blend of regional, national and international economic factors. The local economy has changed from an economy dependent upon aerospace, manufacturing, and natural resources, to one that is more focused on the service industry and international trade. The professional and technical service sectors today represent approximately 30% of the jobs in Pierce County, up from 15% ten years ago.
Since 2003, the local economy has experienced a sustained recovery and has been relatively strong compared to the rest of the nation. The Pierce County unemployment rate, which was among the highest in the country in 2003 at 6.9%, declined to 4.8% in 2007.
The local economy is expected to continue to benefit by the strength of the global economy as import/export activity continues to expand, and as growth in the high technology and health care sectors accelerate. The ports of Tacoma and Seattle are among the fastest growing ports with capacity for future growth on the west coast of the United States in terms of container volume. The presence of Fort Lewis Army Base and McChord Air Force Base, with planned expansion of their facilities and expected growth in the number of civilians and military employees, also provides additional stability for our local economy. Population growth has averaged 2.2% per year during the past decade supporting the housing market. Residential housing values were stable in the Pierce County market, with a median home price of $275,000 in December 2007, which were relatively unchanged on an annual basis. Home sales, however, slowed appreciably in 2007 and were 27% lower compared to 2006. Apartment vacancies remained low as rates were below 5% for the Puget Sound region, with vacancies for office properties at 7.3% at year-end 2007.
The City of Tacoma continues to experience strong revitalization of its downtown central business district with the addition of the Museum of Glass, the Tacoma Art Museum, a new convention center, a new hotel, new restaurants, new residential housing, and the continued expansion of the University of Washington Tacoma campus. In addition, numerous additional residential and commercial development projects are planned over the next five to ten years in the central business district.
Delivery Methods
We provide a high level of convenient access for our customers in a variety of ways, having adopted an integrated "bricks, clicks and mortar" delivery systems strategy within a community financial institution setting. This strategy focuses on giving consumers integrated, yet flexible, options and choices as to how they wish to transact business with us. Therefore, we focus upon developing each of the delivery systems within the three elements of our "bricks, clicks, and mortar" strategy. Our three-pronged delivery systems strategy allows customers to decide how they want to access our services through an appropriate blend of high-touch and high-tech service.
The "bricks" element of our strategy relates specifically to the branch facilities where in-person interactions occur. As a local community-based financial institution, we are committed to providing a network of branch offices that enables consumers to access services in person, within 15 minutes from essentially anywhere in Pierce County or the City of Federal Way. As of December 31, 2007, our retail network consisted of 11 branches in Pierce County
and three branches in the City of Federal Way. Our branch office hours are 9:00 a.m. to 5:30 p.m. Monday through Thursday, 9:00 a.m. to 6:00 p.m. on Fridays, and 9:00 a.m. to 3:00 p.m. on Saturdays.
The core components of the "clicks" element of our delivery channel strategy are internet banking and automated teller machines, along with automatic payment vehicles and debit and credit card services. We have expanded our on-line banking capabilities to enable customers to perform essentially any type of transaction that can be conducted in a branch setting, such as review account balances and statements, make funds transfers, apply for a mortgage or consumer loan, and even pay bills. To accommodate 24 hour, seven day a week availability to cash, we provide automated teller machines at each of our 14 full-service branch offices and an additional eight stand-alone automated teller machines throughout Pierce County.
The "mortar" element of our "bricks, clicks and mortar" strategy is our Call Center. The Call Center completes what we need to provide an integrated delivery solution for our customers. We continue to focus on improving the speed in which all telephone calls are answered, the level of customer service provided, and the ability to handle virtually all of our customers' banking requests over the phone. In addition to the employee-staffed Call Center that is available to customers during the week from 7:00 a.m. to 7:00 p.m. weekdays, and 9:00 a.m. to 3:00 p.m. on Saturdays, we also provide 24-hour, seven days a week telephone banking through an automated voice response system.
Lending Activities
General. We focus our lending activities primarily on generating five or more family residential (“multi-family”) and commercial real estate loans, real estate construction and land loans, loans secured by owner occupied one- to four-family residences, consumer loans and commercial loans for small businesses. We offer a wide variety of secured and unsecured consumer loan products, including direct and indirect auto loans, deposit secured loans, unsecured personal loans, VISA lines of credit, and home equity loans and lines of credit. We focus on originating multi-family and commercial real estate loans on properties located primarily in the Puget Sound region of Western Washington. In September 2002, we began offering real estate construction and land loans on single-family residential properties to consumers and local builders. In January 2005, we introduced small business banking services, originating a blend of unsecured and secured lines/loans and owner-occupied real estate loans. As of December 31, 2007, the loan portfolio totaled $637.0 million and represented 72.5% of our total assets. As of December 31, 2007, the loan portfolio was comprised of 33.4% commercial real estate loans, 23.4% multi-family real estate loans, 15.2% consumer loans (including our VISA credit card portfolio and home equity loans), 12.4% real estate construction and land loans, 12.1% one- to four-family home loans, and 3.6% commercial business loans.
Our loan policy limits the maximum amount of loans that we can lend to any one borrower to 15% of the Bank's capital. As of December 31, 2007, the policy limit amounted to $12.9 million. The loans outstanding to our five largest borrowing relationships as of December 31, 2007 were comprised of multi-family, commercial real estate, and real estate construction and land loans. The largest single borrower relationship is for $12.1 million, comprised of ten loans which are made to limited liability companies for multi-family properties located in King and Pierce counties. The second largest borrower relationship involved a construction company representing four loans totaling $11.8 million, secured primarily by properties located in Pierce County. The third largest borrower relationship totaling $10.7 million involves two loans to limited liability companies secured by real estate land development and multi-family properties located in King County. The fourth largest borrower relationship totals $10.6 million and involves four loans to four separate limited liability companies. One of these loans is secured by an office building, and the other three loans are for residential construction and land acquisition and development projects. The fifth largest borrower is a limited liability company with aggregate loans of $9.6 million, comprised of one loan for a multi-family property located in King County. All of the loans mentioned above have personal guarantees in place as an additional source of repayment, including those made to partnerships and corporations. All of the properties securing the loans discussed above were in the Puget Sound region and were performing according to their terms as of December 31, 2007.
Lending authorities are established under the guidelines provided by the Board of Directors. The President/CEO, or his designee, establishes individual loan authorities and limits. In some instances, two or more individuals combined can approve a higher loan amount than their individual loan limits. Loan authorities are categorized by various loan types, such as: (1) consumer, (2) residential real estate mortgages, (3) multi-family and commercial real estate, (4) real estate construction and land loans, and (5) commercial and industrial loans. Loans in excess of the individual or combined lending limits, generally in excess of $750,000 aggregate, are approved by the Management Loan Committee, which consists of the President/CEO, Senior Vice President, Vice President/Chief Lending Officer, Vice President Business Banking, and the Real Estate Loan Manager. Loans in excess of $5.0 million, individual or aggregate, are approved by the Loan and Investment Committee, comprised of members of the Board of Directors.
Subject to market conditions, we plan to continue to concentrate on originating multi-family and commercial real estate loans and real estate construction and land loans within the Puget Sound region in Washington State. We will also continue to pursue the expansion of our small business lending activities which involve greater risks of default and delinquency than other types of lending that we have historically engaged in.
Loan Portfolio Analysis. The following table sets forth the composition of Rainier Pacific Bank's loan portfolio by type of loan at the dates indicated.
The following table shows the composition of Rainier Pacific Bank's loan portfolio by fixed- and adjustable-rate loans at the dates indicated.
Residential One- to Four-Family Lending. As of December 31, 2007, $76.9 million, or 12.1% of our total loan portfolio consisted of loans secured by one- to four-family residences.
Our residential first mortgages are generally originated in accordance with guidelines established by Freddie Mac and Fannie Mae, except in certain circumstances such as our community development loans to low or moderate income borrowers. All of our one- to four-family residential mortgage loans, whether fixed or adjustable, require both monthly principal and interest payments and have no prepayment penalties. We have not originated or have in our loan portfolio any option ARMs, subprime, or single-family mortgage loans with more than a 30-year final maturity term.
Most of our residential loan originations are in connection with the refinance of an existing loan rather than the purchase of a home, and most of these customers prefer fixed rather than adjustable rate loans. We originated $32.1 million of fixed-rate one- to four-family residential loans and did not originate any adjustable rate one-to-four family residential loans during fiscal 2007. Residential mortgage loans are primarily made on owner-occupied properties within the Pierce and South King County markets. As of December 31, 2007, $70.0 million, or 91.1%, of our one- to four-family residential mortgage loan portfolio was comprised of fixed-rate loans.
As of December 31, 2007, we had $6.9 million, or 8.9% of our one- to four-family loans in adjustable-rate mortgages. The adjustable-rate mortgage products generally are underwritten to be saleable in the secondary market. The adjustable-rate mortgage products adjust annually after an initial fixed interest rate period ranging from one to ten years. Contractual annual adjustments generally are limited to increases or decreases of no more than 2%, subject to a maximum increase of no more than 6% from the initial interest rate. At the time of rate adjustment, the loan rate is usually modified to reflect the average yield on U.S. Treasury securities adjusted to a constant maturity of one year Treasury securities plus a margin of 2.5% to 2.875%. Borrower demand for adjustable-rate mortgage loans versus fixed-rate mortgage loans is primarily related to the interest rate environment and the anticipated changes in the interest rate over time, as well as the fees being charged on mortgage products within the market.
We have offered a fixed-rate ten-year term mortgage loan program since 1993 and introduced a fixed-rate seven-year program in November 2003 on owner-occupied one- to four-family residential properties. These loans are an attractive alternative to borrowers with lower loan amount needs and a greater level of equity in their homes. These loans are written consistent with secondary market standards and have an average loan balance of $43,580 with an average loan-to-value ratio of less than 25%. As of December 31, 2007, we had $9.4 million, or 12.2% of the fixed one- to four-family residential loan portfolio in seven- and ten-year mortgage products. We also offer special community development loans to low to moderate income borrowers at a loan-to-value ratio of up to 100%. As of December 31, 2007, we had $4.4 million in special community development loans in our residential loan portfolio. All loans under these special loan programs were performing in accordance with their terms as of December 31, 2007.
We originate a limited number of jumbo fixed- and adjustable-rate single-family loans that we retain for our portfolio. Jumbo loans have balances that are greater than $417,000. The jumbo loan portfolio, comprised of seven loans, totaled $4.3 million as of December 31, 2007. The loans in this portfolio have been generally priced at rates of 0.25% to 0.75% higher than the standard secondary market rates on conventional loans. As of December 31, 2007, all loans in the jumbo loan portfolio were performing in accordance with their terms.
Our fixed-rate, single-family residential mortgage loans are predominantly originated with 15 to 30 year terms, although these loans typically remain outstanding for substantially shorter periods. In addition, substantially all residential mortgage loans in our loan portfolio contain due-on-sale clauses providing that we declare the unpaid amount due and payable upon the sale of the property securing the loan. Typically, we enforce these due-on-sale clauses to the extent permitted by law and as a standard course of business. The average loan maturity is a function of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans.
Our lending policies generally limit the maximum loan-to-value ratio on mortgage loans secured by owner-occupied properties to 95% of the lesser of the appraised value or the purchase price. We usually obtain private mortgage insurance on the portion of the principal amount that exceeds 80% of the appraised value of the secured property. The maximum loan-to-value ratio on mortgage loans secured by non-owner occupied properties is generally 70% on purchases and up to 80% on no cash out refinances for loans originated for sale in the secondary market to Freddie Mac. Properties securing our one- to four-family loans are appraised by independent appraisers approved by us. We require the borrowers to obtain title, hazard, and, if necessary, flood insurance. We generally do not require earthquake insurance because of competitive market factors.
Multi-Family and Commercial Real Estate Lending. We have originated multi-family and commercial real estate loans since November 1995. Loans are underwritten by designated lending staff or the respective loan committee depending on the size of the loan. As of December 31, 2007, $362.0 million, or 56.8% of our total loan portfolio was secured by multi-family and commercial real estate property.
We actively pursue multi-family and commercial real estate loans located in the Puget Sound region of Washington State. Commercial and multi-family real estate loans include investment or owner-occupied office and medical buildings, retail shopping centers, mini-storage facilities, warehouse facilities, and apartment buildings and complexes. Multi-family and commercial real estate loans contain a higher risk of default and loss than one- to four-family residential loans, particularly if the local economy experiences a downturn and because these loans generally are priced at a higher rate of interest than one- to four-family residential loans. Typically, these loans have higher loan balances, are more difficult to evaluate and monitor, and involve a higher degree of risk than one- to four-family residential loans. Payments on loans secured by multi-family or commercial properties are usually dependent on the successful operation and management of the property; therefore, repayment of these loans may be affected by adverse conditions in the real estate market or the economy. We generally obtain loan guarantees from financially capable parties as determined by our review of personal financial statements. If the borrower is a corporation, we generally obtain personal guarantees from the corporate principals based upon a review of their personal financial statements and individual credit reports.
The average size loan in our multi-family and commercial real estate loan portfolios was $1.5 million as of December 31, 2007. These loans are primarily secured by properties located in the Puget Sound region of Western Washington. As of that date, $212.9 million, or 33.4% of our total loan portfolio was secured by commercial real estate properties while $149.1 million, or 23.4% of our total loan portfolio was secured by multi-family dwellings in our market area. We target individual multi-family and commercial real estate loans between $500,000 and $5.0 million; however, by policy we can originate loans to one borrower up to 15% of the Bank's capital. The largest non-residential commercial real estate loan as of December 31, 2007 was an $8.7 million loan secured by an industrial business park located in Thurston County, Washington. The largest multi-family loan as of December 31, 2007 was a $9.6 million loan secured by a 46-unit residential apartment building located in King County, Washington. Both of these loans were performing according to their loan terms, as were all of our multi-family and commercial real estate loans as of December 31, 2007.
We offer both fixed- and adjustable-rate loan options on multi-family and commercial real estate loans. Loans originated on a fixed-rate basis generally are originated with final maturities up to ten years, and with amortization terms up to 30 years. Interest rates on fixed-rate loans are generally established utilizing the Federal Home Loan Bank of Seattle's advance rate for an equivalent period plus a margin ranging from 1.50% to 2.50%, depending upon the prepayment penalty option selected by the borrower. We have established floor rates on these loans, although from time to time we may offer promotional rates below the established floor rates. As of December 31, 2007, we had $26.3 million of fixed-rate multi-family loans and $113.7 million of fixed-rate commercial real estate loans.
Adjustable-rate multi-family and commercial real estate loans are originated with variable rates that generally adjust after an initial fixed-rate period ranging from three to five years. Contractual annual adjustments predominantly have a 1.50% maximum annual rate increase and are generally subject to a lifetime cap rate of 13.0%. These loans have been originated with floor rates of 5.0% to 7.75%. Adjustable-rate multi-family and commercial
real estate loans are generally priced utilizing the 11th District Cost of Funds Index plus a margin of 3.00% to 3.50%, with principal and interest payments fully amortizing over terms up to 30 years, and anaccompanying prepayment penalty. As of December 31, 2007, we had $122.8 million in adjustable-rate multi-family loans and $99.2 million in adjustable-rate commercial real estate loans inclusive of owner occupied loans. Both adjustable-rate mortgages and fixed-rate mortgages contain provisions for the assumption of the loan by another borrower, subject to our approval and a 1% assumption fee.
The maximum loan-to-value ratio for multi-family loans is generally 80% of appraised value on purchases and 75% of appraised value on refinances. The maximum loan-to-value ratio for commercial real estate loans is generally 75% of appraised value for both purchases and refinances. We require appraisals of all properties securing multi-family and commercial real estate loans. Appraisals are performed by independent appraisers approved by us. We require our multi-family and commercial real estate loan borrowers with outstanding balances in excess of $500,000 to submit annual financial statements and rent rolls on the subject property. We also inspect the subject property at least once every two years if the loan balance exceeds $500,000. We generally require a minimum pro forma debt coverage ratio of 1.20 times for loans secured by multi-family and commercial properties.
Real Estate Construction and Land Loans. As of December 31, 2007, real estate construction and land loans represented $78.8 million, or 12.4% of our total loan portfolio. We began originating real estate construction and land loans in September 2002 and have focused our efforts primarily in the Pierce, Thurston, and King County market areas with custom residential construction all-in-one, residential speculative construction, single-family land acquisition and development, and lot inventory loans. The custom residential construction all-in-one loans are priced in accordance with the terms and conditions available in the secondary market for this product and are underwritten to be saleable in the secondary market upon completion of the home. Other construction loan programs will be originated with terms up to 18 months, with a variable interest rate tied to the prime rate as published in The Wall Street Journal, plus a margin ranging from 0.50% to 1.75%, with a loan-to-value ratio that is generally no more than 80% of the appraised value of the property at completion.
Our construction loans to individuals to build their personal residences typically are structured as construction/permanent loans whereby there is one closing for both the construction loan and the permanent financing. During the construction phase, which typically lasts for six months, our construction loan officers or an approved fee inspector makes periodic inspections of the construction site and loan proceeds are disbursed directly to the contractors or borrowers as construction progresses. Typically, disbursements are made in eight draws during the construction period. Construction loans require payment of interest only during the construction phase and are structured to be converted to fixed-rate permanent loans at the end of the construction phase. Prior to making a commitment to fund a construction loan, we require an appraisal of the property by an independent appraiser.
During the year ended December 31, 2007, we originated $85.8 million of short-term land development, lot inventory, and construction loans to 22 experienced local builders and developers to fund the construction of primarily one- to four-family residential properties primarily for homes within the price range of $200,000 to $600,000. Most loans are written with maturities of 12 to 24 months, have interest rates that are tied to the prime rate plus a margin, and are subject to rate adjustment with the movement of the prime rate. All builder/borrowers are underwritten to pre-established standards that include established cash reserves to carry projects through completion and sale of the project. The maximum loan-to-value ratio on both pre-sold and speculative projects is generally 80% or less. Construction loan proceeds are disbursed periodically in increments as construction progresses and as inspection by our approved inspectors warrant. Although there were no default or foreclosure actions involving land or construction loans during the year ended December 31, 2007 and all land and construction loans were performing according to their terms, two of our smaller builders submitted deeds in lieu of foreclosure for three completed homes and one lot in late January 2008.
At December 31, 2007, our largest construction and land development loan was a land development loan that had an outstanding principal balance of $8.9 million and was secured by a first mortgage lien. This loan was performing according to its original terms at December 31, 2007. At December 31, 2007, the average outstanding principal balance of land development loans to contractors and developers was $2.5 million.
We also make construction loans for commercial development projects. As of December 31, 2007, we had $5.7 million of loans outstanding for these types of projects. These projects include multi-family, apartment, retail, office/warehouse and office buildings. These loans generally have an interest-only phase during construction, and generally convert to permanent financing when construction is completed. Disbursement of funds is at our discretion and is based on the progress of construction. The maximum loan-to-value limit applicable to these loans is 75% of the as-completed appraised value.
We originate land loans to local contractors and developers for the purpose of holding the land for future development. As of December 31, 2007, we had $42.8 million of loans outstanding for residential land or lot projects. These loans are secured by a first lien on the property, are limited to 75% of the discounted appraised value of the land, and generally have a term of up to 24 months with a variable interest rate tied to the prime rate as published in The Wall Street Journal plus a margin. Our land loans are generally secured by property in our primary market area. We require title insurance and, if applicable, a hazardous waste survey reporting that the land is free of hazardous or toxic waste.
Although construction lending affords us the opportunity to achieve higher interest rates and fees with shorter terms to maturity than one- to four-family mortgage lending, construction lending is considered to involve a higher degree of risk. It is more difficult to evaluate construction loans than permanent loans. As of December 31, 2007, we had $30.3 million of loans outstanding for residential construction projects. At the time the loan is made, the value of the collateral securing the loan must be estimated based on the projected selling price at the time the residence is completed, typically six to 12 months later, and on estimated building and other costs (including interest costs). Changes in the demand for new housing in the area and higher than anticipated building costs may cause actual results to vary significantly from those estimated. Accordingly, we may be confronted, at the time the residence is completed, with a loan balance exceeding the value of the collateral. Because construction loans require active monitoring of the building process, including cost comparisons and on-site inspections, these loans are more difficult and costly to monitor. Increases in market rates of interest may have a more pronounced effect on construction loans by rapidly increasing the end-purchasers' borrowing costs, thereby reducing the overall demand for new housing. The fact that homes under construction are often difficult to sell and typically must be completed in order to be successfully sold also complicates the process of working out problem construction loans. This may require us to advance additional funds and/or contract with another builder to complete the residence. Furthermore, in the case of speculative construction loans, there is the added risk associated with identifying an end-purchaser for the finished home.
We attempt to minimize the foregoing risks by, among other things, limiting our construction lending to properties located primarily in Pierce, Thurston or King Counties, and limiting our speculative loans to a small number of experienced local builders. All of our land development, lot inventory, and construction loans were performing in accordance with their terms as of December 31, 2007.
New home sales slowed appreciably in our local market area and were 27% lower in 2007 compared to 2006. The unsold inventory of newly constructed homes has increased causing many builders and developers to reduce their offering prices and also causing lot prices to decline in value as inventory of unsold homes increased to 9.5 months and 5.7 months in Pierce and Thurston Counties, respectively, as of December 31, 2007, indicating a market that favors buyers as opposed to sellers.
Consumer Lending. Consumer loans entail greater risk than one- to four-family residential loans, particularly in the case of unsecured or loans secured by assets that decline in value over time. Therefore, interest rates on these loans are generally higher than residential real estate loans. In the event of default on a secured consumer loan, any repossessed collateral may not provide an adequate source of repayment of the outstanding balance as a result of the assets' decline in value over time, damage or loss. Often, the remaining deficiency balance does not warrant further substantial collection efforts against the borrower beyond sending the account to an outside collection agency, as these borrowers often file bankruptcy once the collateral has been repossessed. Consumer loan collections depend on the borrower's financial stability, and may be adversely impacted by job loss, divorce,
personal bankruptcy, or medical issues. Various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.
Our consumer installment loans, such as auto, boats, recreational, home equity and personal loans, are generally offered on a fixed-rate basis, while our VISA, unsecured personal lines of credit, and home equity lines of credit are principally offered on a variable rate basis. Our installment loans are offered using a risk-based pricing model based upon the creditworthiness of the customer and the available collateral. Our consumer lending programs do not specifically target borrowers with lower credit scores, however, they do allow for the underwriting of loans to individuals with negative credit information under certain defined guidelines. Management routinely monitors all loan programs and underwriting is adjusted when there is evidence of deterioration in individual consumer lending portfolios. Interest rates are offered on a multi-tiered basis, with the best "A" credits receiving the lowest loan rates. Loans made to borrowers with lower credit scores have a higher likelihood of becoming delinquent or defaulting on their loans, and therefore generally receive a higher interest rate. As of December 31, 2007, our consumer loans, including our home equity line/loan portfolio, totaled $96.7 million, or 15.2% of our total loan portfolio.
The home equity loan portfolio was the largest component of the consumer loan portfolio as of December 31, 2007 totaling $45.3 million, or 7.1% of our total loan portfolio. These loans include both adjustable-rate lines of credit and fixed-rate loan products. These loans are made on owner-occupied properties. The loan-to-value ratio is generally 90% or less, when taking into account both the first and the second mortgage loans, although it can be as high as 110% in some cases. Home equity loans generally carry fixed interest rates with a fixed payment over a term up to 15 years. Home equity lines of credit allow for a ten year draw period, which is renewable, and the interest rate is tied to the prime rate as published in The Wall Street Journal, plus or minus a margin.
The VISA credit card portfolio was the second largest component of our consumer loan portfolio totaling $23.2 million, or 3.6% of our total loan portfolio at December 31, 2007. We have been offering credit cards for more than 20 years and offer over 15 credit card products, the majority of which are on an adjustable-rate basis, with the interest rate tied to prime rate as published in The Wall Street Journal, plus a margin. Interest rates and credit limits are determined based upon product type and creditworthiness of the borrower. We use credit bureau scores, in addition to other criteria such as income, in our underwriting decision process on these loans.
As of December 31, 2007, the third largest component of the consumer portfolio was our auto loan portfolio totaling $20.8 million, or 3.3% of our total loan portfolio. This loan portfolio is primarily comprised of loans with terms up to seven years. We have offered indirect auto loans since 1994 and at December 31, 2007 the loans originated through our indirect dealer program were $18.6 million, or 89.5% of our total auto loan portfolio. These loans consist primarily of indirect auto loans and to a much lesser extent include indirect loans on recreational vehicles and boats. The majority of these loans have been originated through approximately 25 dealers located in our market area.
The interest rate charged to an indirect loan borrower is generally one to two percentage points higher than the "buy rate" or the rate we earn. The difference between the two rates is referred to as the "spread." At loan inception, we pay a portion of the dollar value of the spread over the contractual term of the loan to the auto dealer in accordance with the established loan programs, or in some cases, we pay flat origination fees to dealers on loans without a rate spread. Dealers are required to reimburse us for the amount paid to them if the loan pays off or the vehicle is repossessed within 90 days from the date of funding. Dealers are billed monthly for any interest spread or origination fee reimbursements and are given ten days after billing to pay us. In the event we are not reimbursed within ten days, the amount owed to us is deducted from the next payment we make to the dealer.
Borrowers may be more likely to become delinquent on an automobile loan than on a residential mortgage loan secured by their primary residence. Moreover, automobiles depreciate rapidly and in the event of default, principal loss as a percent of the loan balance depends upon several factors, such as the mileage and condition of the vehicle at the time of repossession, over which we have no control. In 2007, we significantly curtailed our origination of indirect auto loans and implemented more stringent underwriting standards in response to increasing price competition and compression of risk-adjusted profit margins in this line of business. As a result, new indirect
auto loan originations totaled $3.0 million in 2007, compared to $10.4 million in 2006 and $10.5 million in 2005. Effective February 1, 2008, we no longer originate indirect auto loans.
Commercial Business Lending. At December 31, 2007, we had $22.7 million, or 3.6% of our total loan portfolio in commercial business loans. Of the $22.7 million, $15.4 million is secured by equipment, receivables, or other assets, while the remaining $7.3 million is unsecured. Prior to 2004, we provided commercial business loans only on an accommodative basis to businesses owned by our retail customers. In 2004, we hired an experienced banking executive with 30 years of commercial banking experience to lead our business banking program, which officially commenced in March 2005. We intend to increase our commercial lending activities to take advantage of local lending opportunities in extending credit to small- and medium-sized businesses, to provide for potentially higher asset yields, and to position Rainier Pacific Bank as a full-service financial institution.
Commercial business lending generally involves risks that are different from, and often greater than, those associated with residential, commercial and multi-family real estate lending. Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral values and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default. Although commercial business loans often have equipment, inventory, accounts receivable or other business assets as collateral, the liquidation of collateral in the event of a borrower default is often not a sufficient source of repayment because accounts receivable may be uncollectible and inventories and equipment may be obsolete or of limited use, among other things. Accordingly, the repayment of a commercial business loan depends primarily on the creditworthiness of the borrower (and any guarantors), while liquidation of collateral is a secondary and often insufficient source of repayment.
As a relatively new program, our ability to originate commercial business loans is highly dependent upon favorable market conditions and our ability to hire qualified commercial banking personnel. Accordingly, there can be no assurance that we will continue to be successful in these efforts.
Loan Maturity and Repricing. The following table sets forth certain information at December 31, 2007 regarding the dollar amount of loans maturing in Rainier Pacific Bank's portfolio based on their contractual terms to maturity, but does not include scheduled payments or potential prepayments. Demand loans, loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.
The following table sets forth the dollar amount of all loans due one year or more after December 31, 2007, which have fixed interest rates, and which have floating or adjustable interest rates.
Loan Solicitation and Processing. The majority of the one- to four-family residential mortgage and consumer loan originations are generated through our retail branch network. We originate multi-family and commercial real estate loans using income property loan officers employed by us. In addition, approximately 20% of our multi-family and commercial real estate loans have been originated by an outside broker and underwritten by us within our policies and guidelines. Construction loans are generated by construction loan officers who work for us. Business loans are generally originated by our business banking officers, and approved by designated underwriters for this type of lending.
Upon receipt of a loan application from a prospective borrower, we obtain a credit report and other data to verify specific information relating to the loan applicant's employment, income, and credit standing. All real estate loans requiring an appraisal are done by an independent appraiser. All appraisers are approved by us, and their credentials are reviewed annually, as is the quality of their appraisals.
We use a multi-tier lending matrix depending on the type and size of the consumer credit to be approved. We approve loans based upon automated approvals, individual lending authorities, joint lending authorities, management loan committee authority, and the lending authority of the loan and investment committee of the Bank’s board of directors.
We require title insurance on all real estate loans. In addition, property and casualty insurance is required on all secured loans in excess of $2,500.
Loan Originations, Servicing, Purchases and Sales. Home equity lines of credit and loans, as well as our consumer loans, are originated utilizing an in-house system and are underwritten through either an automated decision matrix or by designated underwriting staff depending upon the size of the loan. These loans are also serviced on an in-house loan servicing system.
One- to four-family residential loans are generally originated in accordance with the guidelines established by Freddie Mac and Fannie Mae, with the exception of seven- and ten-year fixed-rate mortgage loans and our special community development loans. We originate residential first mortgages and service them using an in-house mortgage system. We utilize the Freddie Mac Loan Prospector Automated Loan System to underwrite approximately 95% of our residential first mortgage loans (excluding our seven- and ten-year loans and community development loans). The remaining loans are underwritten internally by designated real estate loan underwriters in accordance with standards as established by management.
We also sell residential first mortgage loans to the secondary market. Our primary secondary market relationship has been with Freddie Mac. We also maintained secondary market relationships with Fannie Mae and previously with the Federal Home Loan Bank of Seattle, prior to their discontinuation of their mortgage purchase program in 2005, and generally retain the servicing on all loans sold into the secondary market. As of December 31, 2007, our portfolio of mortgage loans serviced for others was $114.6 million.
We have originated multi-family and commercial real estate loans since November 1995. Loans are underwritten by designated lending staff or the respective loan committee depending on the size of the loan, and are serviced on an in-house real estate loan servicing system.
In addition we have five commercial real estate and multi-family participation loans secured by properties located in the Puget Sound region, which were originated and underwritten to our standards. As of December 31, 2007, the balance of the participation loans totaled $8.6 million. All of these loans were performing in accordance with their contractual terms and were current as of December 31, 2007.
We purchased 67 single-family loans to low income borrowers from Habitat for Humanity of Tacoma/Pierce County in early 2007. The loans were purchased for $2.1 million and are expected to generate an acceptable return to the Bank. The loans were purchased with recourse rights and will be serviced similar to other single-family loans.
One- to four-family residential construction loans are underwritten by designated lending staff or the respective loan committee, depending on the size of the loan and are serviced on our in-house loan servicing system. Loan documents are provided by a third-party specializing in commercial and construction lending documentation.
The following table shows total loans originated, purchased, sold and repaid during the periods indicated.
____________
(1)
The amounts reported for this item include all personal, home equity, and business lines of credit and credit cards at their net change for the year.
Loan Origination and Other Fees. In some instances, we receive loan origination fees on real estate related products. Loan fees generally represent a percentage of the principal amount of the loan and are paid by the borrower. The amount of fees we charge to the borrower on one- to four-family residential loans and on multi-family and commercial real estate loans can range up to 2.00%, but are generally 1.00% or lower. In addition, one- to four-family home loan borrowers may have to pay additional secondary market delivery fees on the loan based upon the borrower's creditworthiness and/or loan-to-value ratio, which are determined when the loan is underwritten by the Loan Prospector System through Freddie Mac. Accounting standards require that certain fees received, net of
certain origination costs, be deferred and amortized over the contractual life of the loan. Net deferred fees or costs associated with loans that are prepaid or sold are generally recognized as income at the time of prepayment or sale. We had $1.6 million of net deferred loan fees as of December 31, 2007, principally relating to deferred loan fees and origination costs associated with real estate loans, and deferred origination costs associated with consumer loans.
One- to four-family residential loans are generally originated without a prepayment penalty. The majority of multi-family and commercial real estate loans, however, have prepayment penalties associated with the loans ranging from 1% to 3%. We offer a variety of prepayment penalty options ranging from three to ten years from the loan funding date depending upon the loan type and the interest rate of the loan.
In addition, some consumer line of credit products, such as VISA credit cards, home equity lines of credit, and personal lines of credit, are assessed an annual fee or an early-closure fee depending upon product type and customer relationship. Annual fees for these lines of credit can range up to $75, while early-closure fees range up to $500.
Asset Quality
We categorize our delinquency ratio into three primary loan categories: consumer loans, real estate loans and commercial loans. Our consumer loan portfolio traditionally experiences the highest delinquency rate within our total loan portfolio. As of December 31, 2007, we had $2.1 million, or 0.33% of total loans 30 days or more delinquent, and $2.0 million were consumer loans which represented 2.1% of our $96.7 million consumer loan portfolio. For delinquency reporting purposes, the consumer loan portfolio includes new and used auto loans, VISA loans, home equity lines and loans, and other consumer secured and unsecured loans. In addition to the delinquency within our consumer loan portfolio, we had one one- to four-family loan that was 30 days or more delinquent totaling $171,000 as of December 31, 2007. There were no multi-family, commercial real estate, land, residential construction and land development, commercial business loans delinquent 30 days or more at December 31, 2007. However, the portfolio of multi-family and commercial real estate loans, and real estate construction and land loans has grown rapidly having increased from $190.3 million at year-end 2003 to $440.8 million as of December 31, 2007 without any corresponding increase in delinquent loans, and if a single large loan became delinquent, it could significantly affect the Bank's delinquency ratio.
We generally assess late fees or penalty charges on delinquent loans of 5% of the monthly payment. Substantially all fixed- and adjustable-rate mortgage loans are due on the first day of the month; however, the borrower is given a 15 day grace period to make the loan payment. When a one- to four-family residential loan payment is delinquent beyond the 15 day grace period, we handle the collection of the loan in accordance with the secondary market established collection procedures.
We generally send delinquent consumer loan borrowers three consecutive written notices when the loan becomes 10, 20, and 30 days past due. Late charges are incurred when the loan becomes 10 to 15 days past due depending upon the loan product, except for VISA loans which will incur the late charges on the statement cycle date. Our collection department actively attempts to collect on delinquent loans when they become 10 days past due. If the loan is not brought current, we continually try to contact the borrower both by telephone and in writing until the account is brought current. When the loan is 30 days past due, our collectors will attempt to interview the borrower to determine the cause of the delinquency, and to obtain a mutually satisfactory arrangement to bring the loan current.
If the borrower is chronically delinquent and all reasonable means of obtaining payments have been exercised, we will seek to recover the collateral securing the loan according to the terms of the security instrument and applicable law. In the event of an unsecured loan, we will either seek legal action against the borrower or refer the loan to an outside collection agency.
The following table shows our delinquent loans by the type of loan and number of days delinquent as of December 31, 2007:
When a loan becomes 90 days delinquent, we generally place the loan on non-accrual status. As of December 31, 2007, non-accrual loans and loans 90 days or more past due (referred to as non-performing loans) as a percentage of total loans were 0.08%, and as a percentage of total assets were 0.06%.
Non-performing Assets. The following table sets forth information with respect to our non-performing loans (non-accrual loans and loans 90 days or more past due) and restructured loans within the meaning of Statement of Financial Accounting Standards No. 15, Accounting by Debtors and Creditors for Troubled Debt Restructurings, ("SFAS 15") for the periods indicated. At the dates presented there were no accruing loans which were contractually past due 90 days or more, nor any loans restructured in accordance with SFAS 15.
___________
(1) Total loans are net of deferred fees and costs.
(2)
If interest on the loans classified as non-accrual had been accrued, interest income in these amounts would have been recorded on non-accrual loans.
Real Estate Owned and Other Repossessed Assets. Real estate acquired by us as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until it is sold. When the property is acquired, it is recorded at the lower of its cost, which is the unpaid principal balance of the related loan plus foreclosure costs, or the estimated fair market value of the property less selling costs. Other repossessed collateral, including autos, are also recorded at the lower of cost (i.e., the unpaid principal balance plus repossession costs) or estimated fair market value. As of December 31, 2007, we had repossessed vehicles from secured consumer loans of $49,000 and no repossessed real estate properties.
Restructured Loans. According to generally accepted accounting principles, we are required to account for certain loan modifications or restructuring as a "troubled debt restructuring" as specified in SFAS 15. In general, the modification or restructuring of a debt is considered a troubled debt restructuring if we, for economic or legal reasons related to the borrower's financial difficulties, grant a concession to the borrowers that we would not otherwise consider in the normal course of the loan. We had no restructured loans as of December 31, 2007.
Classified Assets. Federal regulations provide for the classification of lower quality loans and other assets, such as debt and equity securities, as substandard, doubtful or loss. An asset is considered substandard if it is inadequately protected by the current net worth and payment capacity of the borrower or of any collateral pledged. Substandard assets include those characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make collection or liquidation in full highly questionable and improbable, on the basis of currently existing facts, conditions and values. When we classify loans as either substandard or doubtful, we may establish a specific loss reserve, or in the case of loans, may allocate a portion of the allowance for loan losses in an amount we deem prudent to address the risk specifically. Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. When an insured institution classifies problem assets as a loss, it is required to charge off such assets in the period in which they are deemed uncollectible. Assets which do not currently expose us to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated as special mention. Our determination as to the classification of our assets and the amount of our valuation allowances is subject to review by the FDIC and the Washington State Department of Financial Institutions, which can order the establishment of additional loss allowances.
In connection with the filing of periodic reports with the FDIC and in accordance with our classification of assets policy, we regularly review the problem assets in our portfolio to determine whether any assets require classification in accordance with applicable regulations. On the basis of our review of our assets, as of December 31, 2007, we had classified $622,000 of our loans as substandard, $186,000 as doubtful, and no loan amounts were classified as a loss. There were three loans classified as special mention totaling $1.7 million, one was a multi-family residential real estate loan, one was a residential land and construction loan, and one was a commercial business loan. All of these special mention loans have performed according to their contractual loan terms and no significant losses are anticipated. Special mention loans are loans that are monitored by management on a consistent basis to help avoid any deterioration of credit quality. In addition, we held $49,000 in repossessed vehicles classified as substandard. The total classified assets of $2.5 million represented 2.8% of total equity and 0.3% of total assets as of December 31, 2007. Our allowance for loan losses of $8.1 million at December 31, 2007 adequately covers the potential losses from the classified loans, and no significant losses are anticipated on the repossessed vehicles.
The aggregate amounts of Rainier Pacific Bank's classified assets at the dates indicated (as determined by Rainier Pacific Bank), were as follows:
Allowance for Loan Losses. We maintain an allowance for loan losses to absorb credit losses inherent in the loan portfolio. In connection with our allowance, we have established a methodology for the determination of provisions for loan losses that takes into consideration the need for an adequate allowance for loan losses. When originating loans, we recognize that losses will ultimately be incurred and that the risk of loss varies with the type of loan being made, the creditworthiness of the borrower, economic conditions and in the case of a secured loan, the quality of the collateral.
Management recognizes that loan losses occur over the life of a loan and that losses may occur in the future on loans that are currently performing and unimpaired. Management also recognizes that certain loans in the portfolio may be impaired even though the performance of the loan indicates otherwise. In addition, management believes that deteriorating economic conditions and changing business cycles in our market area can result in weakened loan performance and increased losses across the loan portfolio. Management further believes that significant new growth in loan portfolios, new loan products, and the refinancing of existing loans can result in new portfolios of unseasoned loans that may not perform in a historical or projected manner.
Our asset liability management committee, primarily consisting of senior management, reviews the adequacy of the allowance for loan losses quarterly. Our methodology for analyzing the allowance for loan losses consists of two main elements: a formula element and a specific element, and establishes an acceptable range in which the allowance should fall. The establishment of an acceptable range also addresses estimation risk and helps ensure that the allowance is adequate for the risk inherent in the loan portfolio.
The formula element of the allowance is the combination of two different components: actual historical loss ratios and economic and other factors. While historical loss ratios are known amounts, economic and other factors are based on estimates by management, which considers factors such as delinquency ratios, loss trends, changes in underwriting, local and regional economic data, and other factors. These quantitative and qualitative factors are reviewed by management and applied against each loan pool in determining the formula element. In addition, an estimated loss ratio is applied to newly originated loan categories that may not have generated any historical losses. Prudent lending and accounting practices necessitate that the allowance address the risk associated with the loans in these newly originated loan categories in order to account for future losses that are probable and can be reasonably estimated.
The specific element of the allowance is created for large loans (e.g., a commercial, construction, or business loan) in accordance with SFAS No. 114, Accounting for Creditors for Impairment of Loans, when management believes that a specific large loan is impaired based on current information and events. In summary, a specific large loan would be impaired when it is probable the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. As part of the credit monitoring and allowance process, management uses its normal loan review process to identify loans that are to be evaluated for collectibility. Management’s normal loan review process includes reviewing various reports, analysis, and other information,
including the delinquency report, credit risk monitoring report, and individual credit file reviews. As of December 31, 2007 and 2006, we had no impaired loans which required a specific allowance.
Upon determining the combined balance of the formula and specific elements of the allowance, management determines an acceptable range considering the estimation risk involved in determining the two primary elements of the allowance. The acceptable range is determined by calculating an exact amount (for the formula and specific elements combined) and then establishing a range of plus or minus 10 percent of the allowance to total loans ratio resulting from the combined amount. Management believes establishing a range is necessary since there are unknown variables that will impact the projected amount or type of future loan originations and actual charge-offs. Market changes, shifts in customer preference, management judgments/projections, or other unforeseen issues make a range more reliable. Furthermore, a range more appropriately conveys management’s estimate of the level of credit risk in the loan portfolio, and that the allowance is a significant estimate and not a known amount.
The provision for loan losses was $600,000 for the year ended December 31, 2007, unchanged from the prior year. The allowance for loan losses was $8.1 million, or 1.27% of total loans at December 31, 2007, compared to $8.3 million, or 1.30% of total loans at December 31, 2006. The 2007 provision was consistent with 2006 as a result of continued low charge-offs, low delinquencies, and few non-performing loans. For the years ended December 31, 2005, 2004, and 2003, the provision for loan losses was $750,000, $2.7 million and $4.5 million, respectively.
We became a mutual savings bank in 2001, which subsequently resulted in very strong growth in multi-family, commercial real estate, and real estate construction and land loans. During 2001 and 2002, the relatively weaker economy was evidenced by high unemployment, particularly in our market area. In 2001, our charge-off ratio was 0.90%. By 2002, both the local and national economies had deteriorated further, and unemployment in our market area increased. Even though weaker economic conditions existed during 2002, charge-offs declined to 0.65% of loans and loan growth remained strong as we continued to add unseasoned multi-family and commercial real estate loans to our portfolio. From 2003 through 2006, the state and local economy improved along with the national economy, and the national unemployment rate dropped to 4.6% in December 2006, and our loan charge-offs declined to 0.15% of average outstanding loans in 2006. The improved economic conditions, accompanied by lower net charge-offs and the improved credit quality of our loan portfolio, also resulted in reduced provisions for loan losses in 2006 and 2005. During the later half of 2007, the state and local economy began to slow along with the national economy as rising concerns and tighter credit conditions significantly reduced sales and purchase activity for one- to four-family homes. Despite these conditions, the credit quality of the loan portfolio remained relatively stable with net charge-offs declining to $804,000, or 0.13% of average loans in 2007 compared to $914,000, or 0.15% of average loans in 2006. Management will continue to review the adequacy of the allowance for loan losses and make adjustments to the provision for loan losses accordingly, based on loan growth, portfolio composition, charge-offs, delinquencies, and state and local economic conditions.
The following table summarizes the distribution of the allowance for loan losses by loan category.
While management believes the estimates and assumptions used in its determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provision that may be required will not adversely impact our financial condition and results of operations. In addition, the determination of the amount of our allowance for loan losses is subject to review by bank regulators, as part of the routine examination process, which may result in the establishment of additional reserves based upon their judgment of information available to them at the time of their examination. Beginning in 2006, management allocated 100% of the allowance for loan losses to individual categories. Management believes this method is most representative of the probable loss estimates by loan category.
The following table sets forth an analysis of our allowance for loan losses at the dates and for the periods indicated.
___________
(1)
Total loans are net of deferred fees and costs.
We held, at December 31, 2007, $362.0 million of multi-family and commercial real estate loans and $78.8 million in real estate construction and land loans as compared to $181.9 million of multi-family and commercial real estate loans and $8.4 million in real estate construction and land loans at December 31, 2003. We have not historically experienced any losses in these portfolios. However, management believes that the increased loan growth in the multi-family and commercial real estate loan portfolios and the nature of real estate construction and land loans could result in higher losses than our historical experience.
At December 31, 2007, our loan portfolio of $637.0 million consisted of $438.9 million of real estate loans (68.9%); $96.7 million of consumer loans (15.2%); $78.8 million of real estate construction and land loans (12.4%); and $22.7 million of commercial loans (3.6%). While the consumer loan portfolio contributes favorably to our net interest margins, it also accounts for substantially all of our charge-offs and a significant portion of the allocated allowance. The consumer loan portfolio can result in significant fluctuations in year to year charge-offs depending on changes in the consumer loan portfolio, loan quality, and the effects of the economic environment on consumers.
Investment Activities
General. Under Washington State law, savings banks are permitted to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, banker's acceptances, repurchase agreements, federal funds, commercial paper, investment grade corporate securities, and obligations of states and their political subdivisions.
The loan and investment committee, consisting of board members, has the authority and responsibility to administer our investment policy, monitor portfolio strategies, and recommend appropriate changes to policy and strategies to the board and management. On a monthly basis, management reports to the board the investment holdings with respective market values, and all purchases and sales of investment securities. The Chief Financial Officer has the primary responsibility for the management of the investment portfolio. The Chief Financial Officer considers various factors when making decisions, including the marketability, maturity and tax consequences of proposed investments. The maturity structure of investments will be affected by various market conditions, including the current and anticipated slope of the yield curve, the level of interest rates, the trend of new deposit inflows and the anticipated demand for funds via deposit withdrawals and loan originations and purchases.
The general objectives of the investment portfolio are to provide liquidity when loan demand is high, to assist in maintaining earnings when loan demand is low, and to maximize earnings while satisfactorily managing risk, including credit risk, reinvestment risk, liquidity risk and interest rate risk.
At December 31, 2007, our investment portfolio, excluding Federal Home Loan Bank stock, totaled $177.0 million and consisted principally of trust preferred securities, mortgage-backed securities, U.S. Government agencies, corporate securities and municipal bonds. From time to time, investment levels may increase or decrease
depending upon yields available on investment alternatives and management's projected demand for funds for loan originations, deposits and other activities.
Trust Preferred Securities. Our trust preferred securities had a fair value of $102.4 million and a $109.0 million amortized cost at December 31, 2007. At December 31, 2007, the portfolio had a weighted-average-coupon rate of 6.47% and a weighted-average-yield of 6.28%. The portfolio consists of pooled bank trust preferred securities and are generally rated "A-2" by Moody's or "A" by Standard and Poor's. These securities either have a fixed interest rate for a three to five year period and then adjust to a floating three-month Libor rate plus a specified margin, or currently have a floating rate which adjusts to a three-month Libor rate plus a specified margin every three months. At December 31, 2007, $89.1 million of these securities were repricing every three months. These securities can be called in part or in whole by the issuer after five years, have an expected initial life of 10 years, and an initial term of 30 years. The trust preferred securities had an estimated average term to reprice of three months.
Mortgage-Backed Securities. Our mortgage-backed securities had a fair value of $50.9 million and a $51.4 million amortized cost at December 31, 2007. The mortgage-backed securities were comprised of Freddie Mac, Fannie Mae, and Ginnie Mae mortgage-backed securities. At December 31, 2007, the portfolio had a weighted-average-coupon rate of 4.92% and an estimated weighted-average-yield of 4.37%. These securities had an estimated average term to reprice or maturity of 3.5 years and an estimated average life of 3.7 years at December 31, 2007.
U.S. Government Agencies. Our portfolio, which consists of a single U.S. Government agency obligation had a fair value of $5.7 million and a $5.8 million amortized cost at December 31, 2007. At December 31, 2007, this security had a weighted-average-coupon rate of 2.83% and a weighted-average-yield of 2.83%. As of December 31, 2007, this security had an estimated average life of six months.
Municipal Bonds. Our tax exempt municipal bond portfolio had a fair value of $12.9 million and a $12.8 million amortized cost at December 31, 2007. The municipal bond portfolio was comprised of general obligation bonds (i.e., backed by the general credit of the issuer) and revenue bonds (i.e., backed by revenues from the specific project being financed) issued by various municipal corporations. At December 31, 2007, the portfolio had a weighted-average-coupon rate of 4.01% and a weighted-average-yield of 4.06%. Our municipal bonds have an estimated weighted average life of 3.0 years.
Corporate Securities. Our corporate bond portfolio consisted of a single bond with a fair value of $5.0 million and a $5.1 million amortized cost at December 31, 2007. The corporate bond portfolio was comprised of a short-term fixed-rate bond rated "Aa3" by Moody's and "A" by Standard and Poor's. At December 31, 2007, the bond had a weighted-average-coupon rate of 6.40% and a weighted-average-yield of 3.07%. This bond has an estimated average life of six months.
Federal Home Loan Bank Stock. As a member of the Federal Home Loan Bank of Seattle, we are required to own capital stock in the Federal Home Loan Bank of Seattle. The amount of stock we hold is based on percentages specified by the Federal Home Loan Bank of Seattle on our outstanding advances and other requirements. The redemption of any excess stock we hold is subject to certain time period limitations and at the discretion of the Federal Home Loan Bank of Seattle. The carrying value of Federal Home Loan Bank of Seattle stock totaled $13.7 million and produced a weighted-average-yield of 0.60% for the year ended December 31, 2007. The yield on the Federal Home Loan Bank of Seattle stock was historically paid through stock dividends, was subject to the discretion of the board of directors of the Federal Home Loan Bank of Seattle, and was negatively affected by the Federal Home Loan Bank of Seattle’s suspension of dividends on its capital stock from the fourth quarter of 2004 through the third quarter of 2006. The Federal Home Loan Bank of Seattle resumed the payment of dividends during the fourth quarter of 2006, with the announcement of a $0.10 per share cash dividend. In 2007, the Federal Home Loan Bank of Seattle paid a cumulative $0.60 per share in cash dividends. Our stock ownership in the Federal Home Loan Bank of Seattle is expected to remain stable or increase in response to the Bank’s borrowing needs.
The following table sets forth the composition of Rainier Pacific Bank's investment securities portfolio at the dates indicated. The amortized cost of the available-for-sale investments and mortgage-backed securities is their net book value before the mark-to-market fair value adjustment. Rainier Pacific Bank's investment in Federal Home Loan Bank of Seattle stock is presented for reference purposes.
The table below sets forth certain information regarding the amortized cost, weighted average yields, and maturities or periods to repricing of Rainier Pacific Bank's investment and mortgage-backed securities at December 31, 2007. The Bank's investment in Federal Home Loan Bank of Seattle stock is presented for reference purposes.
____________
(1)
Yields on tax exempt obligations are not computed on a tax equivalent basis.
The following table sets forth certain information with respect to each category of securities which had an aggregate amortized cost value in excess of 10% of Rainier Pacific Bank's equity at the date indicated.
Deposit Activities and Other Sources of Funds
General. Deposits, borrowed funds and loan repayments are the major sources of our funds for lending and other investment purposes. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are influenced significantly by general interest rates and market conditions. Borrowed funds from the Federal Home Loan Bank of Seattle are used to supplement the availability of funds from other sources and also as a source of term funds to assist in the management of interest rate risk.
Our deposit composition reflects certificates of deposit accounting for 51.8% of the total deposits at December 31, 2007, while interest- and non-interest-bearing checking, savings and money market accounts comprise the balance of total deposits. We rely on marketing activities, convenience, customer service and the availability of a broad range of deposit products and services to attract and retain customer deposits.
Deposits. Substantially all of our depositors are residents of Washington State, however, we do supplement local deposits with certificates of deposit generated nationally by a select number of brokers. Deposits are attracted from within our market area through the offering of a broad selection of deposit instruments, including checking accounts, money market accounts, savings accounts and certificates of deposit with a variety of rates. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of our deposit accounts, we consider the development of long term profitable customer relationships, current market interest rates, current maturity structure and deposit mix, customer preferences and the profitability of acquiring customer deposits compared to alternative sources.
At December 31, 2007, we had $127.9 million of jumbo ($100,000 or more) certificates of deposit, which represented 27.7% of total deposits at that date. This amount is inclusive of $60.9 million of certificates of deposit placed through the Bank’s brokered certificate program.
Deposit Activities. The following table sets forth the total deposit activities of Rainier Pacific Bank for the periods indicated.
Time Deposits by Rates. The following table sets forth time deposits classified by rates as of the dates indicated.
Time Deposits by Maturities. The following table sets forth the amount and maturities of time deposits at December 31, 2007.
The following table sets forth information concerning Rainier Pacific Bank's time deposits and other deposits at December 31, 2007.
The following table indicates the amount of Rainier Pacific Bank's jumbo certificates of deposit by time remaining until maturity as of December 31, 2007. Jumbo certificates of deposit are certificates in amounts of $100,000 or more and include $60.9 million of brokered certificates of deposit.
Deposit Composition and Changes. The following table sets forth the balances of deposits in the various types of accounts offered by Rainier Pacific Bank at the dates indicated.
Borrowed Funds. Customer deposits are the primary source of funds for our lending and investment activities. We do, however, use advances from the Federal Home Loan Bank of Seattle and short-term borrowing arrangements with others to increase lendable funds, to meet short-term deposit withdrawal requirements, and also to provide longer term funding to better match the duration of selected loan and investment assets.
As one of our capital management strategies, we have used borrowed funds from the Federal Home Loan Bank of Seattle to fund the purchase of investment securities and loans in order to increase our net interest income when attractive opportunities exist. Depending upon the retail banking activity and our available capital, we will consider and undertake leverage strategies within applicable regulatory requirements or restrictions. We expect that borrowed funds used in connection with our leverage strategies would primarily consist of Federal Home Loan Bank of Seattle advances. We use intermediate and longer-term borrowings which do not readily reprice and structured advances which may extend duration in different interest rate environments. See “Asset and Liability Management and Market Risk” contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this report for more information.
As a member of the Federal Home Loan Bank of Seattle, we are required to own capital stock in the Federal Home Loan Bank of Seattle and are authorized to apply for advances on the security of that stock and certain of our mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the U.S. Government) provided certain creditworthiness standards have been met. Advances are individually made under various terms pursuant to several different advance programs, each with its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based on the financial condition of the member institution and the adequacy of collateral pledged to secure the credit. We maintain a collateralized credit facility with the Federal Home Loan Bank of Seattle that provides for immediately available advances up to an aggregate of 50.0% of Rainier Pacific Bank’s total assets, or $440.3 million if sufficient eligible collateral exists. At December 31, 2007, outstanding advances to Rainier Pacific Bank from the Federal Home Loan Bank of Seattle totaled $320.5 million. See “Liquidity and Commitments” contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this report for more information.
The following table sets forth information regarding borrowed funds at the end of and during the periods indicated. The table includes both long- and short-term borrowings.
How We Are Regulated
The following is a brief description of certain laws and regulations which are applicable to Rainier Pacific Financial Group and Rainier Pacific Bank. The description of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, is not complete and is qualified in its entirety by reference to the applicable laws and regulations.
Legislation is introduced from time to time in the U.S. Congress and the Washington State Legislature that may affect the operations of Rainier Pacific Financial Group and Rainier Pacific Bank. In addition, the regulations governing us may be amended from time to time by the respective regulators. Any such legislation or regulatory changes in the future could adversely affect us. We cannot predict whether any such changes may occur.
Regulation and Supervision of Rainier Pacific Financial Group
General. Rainier Pacific Financial Group, as the sole shareholder of Rainier Pacific Bank, is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to comprehensive regulation by the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve. As a bank holding company, Rainier Pacific Financial Group is required to file quarterly reports with the Federal Reserve and any additional information required by the Federal Reserve and is subject to regular examinations by the Federal Reserve. The Federal Reserve also has extensive enforcement authority over bank holding companies, including the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices.
The Bank Holding Company Act. Under the Bank Holding Company Act, Rainier Pacific Financial Group is supervised by the Federal Reserve. The Federal Reserve has a policy that a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, the Federal Reserve provides that bank holding companies should serve as a source of strength to its subsidiary banks by being prepared to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity, and should maintain the financial flexibility and capital raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligation to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve to be an unsafe and unsound banking practice or a violation of the Federal Reserve's regulations or both.
We are required to file quarterly and periodic reports with the Federal Reserve and provide additional information as the Federal Reserve may require. The Federal Reserve may examine us, and any of our subsidiaries, and charge us for the cost of the examination.
Rainier Pacific Financial Group and any subsidiaries that it may control are considered "affiliates" within the meaning of the Federal Reserve Act, and transactions between our bank subsidiary and affiliates are subject to numerous restrictions. With some exceptions, we, and our subsidiaries, are prohibited from tying the provision of various services, such as extensions of credit, to other services offered by us, or our affiliates.
Sarbanes-Oxley Act of 2002. As a public company, Rainier Pacific Financial Group, is subject to the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act"), which implements a broad range of corporate governance and accounting measures for public companies designed to promote honesty and transparency in corporate America and better protect investors from corporate wrongdoing. The Sarbanes-Oxley Act was signed into law on July 30, 2002 in response to public concerns regarding corporate accountability in connection with various accounting scandals. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws.
The Sarbanes-Oxley Act includes very specific additional disclosure requirements and new corporate governance rules and required the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees. Our policies and procedures have been updated to comply with the requirements of the Sarbanes-Oxley Act.
Acquisitions. The Bank Holding Company Act prohibits a bank holding company, with certain exceptions, from acquiring ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company and from engaging in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. Under the Bank Holding Company Act, the Federal Reserve may approve the ownership of shares by a bank holding company in any company, the activities of which the Federal Reserve has determined to be so closely related to the business of banking or managing or controlling banks as to be a proper incident thereto. These activities include: operating a savings institution, mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing certain investment and financial advice; underwriting and acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, non-operating basis; selling money orders, travelers' checks and U.S. Savings Bonds; real estate and personal property appraising; providing tax planning and preparation services; and, subject to certain limitations, providing securities brokerage services for customers.
Interstate Banking. The Federal Reserve must approve an application of a bank holding company to acquire control of, or acquire all or substantially all of the assets of, a bank located in a state other than the holding company's home state, without regard to whether the transaction is prohibited by the laws of any state. The Federal Reserve may not approve the acquisition of a bank that has not been in existence for the minimum time period, not exceeding five years, specified by the law of the host state. Nor may the Federal Reserve approve an application if the applicant controls or would control more than 10% of the insured deposits in the United States or 30% or more of the deposits in the target bank's home state or in any state in which the target bank maintains a branch. Federal law does not affect the authority of states to limit the percentage of total insured deposits in the state that may be held or controlled by a bank holding company to the extent such limitation does not discriminate against out-of-state banks or bank holding companies. Individual states may also waive the 30% state-wide concentration limit contained in the federal law.
The federal banking agencies are authorized to approve interstate merger transactions without regard to whether the transaction is prohibited by the law of any state, unless the home state of one of the banks adopted a law prior to June 1, 1997 which applies equally to all out-of-state banks and expressly prohibits merger transactions involving out-of-state banks. Interstate acquisitions of branches will be permitted only if the law of the state in which the branch is located permits such acquisitions. Interstate mergers and branch acquisitions will also be subject to the nationwide and statewide insured deposit concentration amounts described above.
Dividends. The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses its view that although there are no specific regulations restricting dividend payments by bank holding companies other than state corporate laws, a bank holding company must maintain an adequate capital position and generally should not pay cash dividends unless the company's net income for the past year is sufficient to fully fund the cash dividends and that the prospective rate of earnings appears consistent with the company's capital needs, asset quality, and overall financial condition. The Federal Reserve policy statement also indicates that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends.
Stock Repurchases. Bank holding companies, except for certain "well-capitalized" and highly rated bank holding companies, are required to give the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of
their consolidated net worth. The Federal Reserve may disapprove a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve order, or any condition imposed by, or written agreement with, the Federal Reserve.
Capital Requirements. The Federal Reserve has established capital adequacy guidelines for bank holding companies that generally parallel the capital requirements of the FDIC for banks. The Federal Reserve regulations provide that capital standards will be applied on a consolidated basis in the case of a bank holding company with $150 million or more in total consolidated assets. Rainier Pacific Financial Group's total risk-based capital must equal 8% of risk-weighted assets and one half of the 8%, or 4%, must consist of Tier 1 (core) capital. At December 31, 2007, Rainier Pacific Financial Group's capital position was in excess of these requirements with Tier 1 (core) capital to average assets of 9.80%, Tier 1 (core) capital to risk-weighted assets of 11.78%, and total capital to risk-weighted assets of 12.88%.
Regulation and Supervision of Rainier Pacific Bank
General. As a state-chartered, federally insured financial institution, Rainier Pacific Bank is subject to extensive regulation. Lending activities and other investments must comply with various statutory and regulatory requirements, including prescribed minimum capital standards. Rainier Pacific Bank is regularly examined by the FDIC and state banking regulators and files quarterly and periodic reports concerning its activities and financial condition with its regulators. Rainier Pacific Bank's relationship with depositors and borrowers also is regulated to a great extent by both federal and state law, especially in such matters as to the ownership and handling of deposit accounts, and the form and content of mortgage documents.
Federal and state banking laws and regulations govern all areas of the operation of Rainier Pacific Bank, including reserves, loans, mortgages, capital, issuance of securities, payment of dividends and establishment of branches. Federal and state bank regulatory agencies also have the general authority to limit the dividends paid by insured banks and bank holding companies if such payments should be deemed to constitute an unsafe and unsound practice. The respective primary federal regulators of Rainier Pacific Financial Group and Rainier Pacific Bank have authority to impose penalties, initiate civil and administrative actions and take other steps intended to prevent banks from engaging in unsafe or unsound practices.
State Regulation and Supervision. As a state-chartered savings bank, Rainier Pacific Bank is subject to applicable provisions of Washington State law and regulations of the Washington State Department of Financial Institutions. State law and regulations govern Rainier Pacific Bank's ability to take deposits and pay interest, to make loans on or invest in residential and other real estate, to make consumer loans, to invest in securities, to offer various banking services to its customers, and to establish branch offices. Under state law, savings banks in Washington also generally have all of the powers that federal savings banks have under federal laws and regulations. Rainier Pacific Bank is subject to periodic examination and reporting requirements by and of the Washington State Department of Financial Institutions.
Insurance of Accounts and Regulation by the FDIC. Rainier Pacific Bank’s deposit are insured up to applicable limits by the Deposit Insurance Fund, or DIF, which is administered by the FDIC. The FDIC insures deposits up to the applicable limits and this insurance is backed by the full faith and credit of the United States government. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by institutions insured by the FDIC. It also may prohibit any institution insured by the FDIC from engaging in any activity determined by regulation or order to pose a serious risk to the institution. The FDIC also has the authority to initiate enforcement actions against savings institutions and may terminate the deposit insurance if it determines that an institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.
Under regulations effective January 1, 2007, the FDIC adopted a new risk-based premium system that provides for quarterly assessments based on an insured institution’s ranking in one of four risk categories based upon supervisory and capital evaluations. Well-capitalized institutions (generally those with capital adequacy, asset
quality, management, earnings and liquidity, or “CAMELS” composite ratings of 1 or 2) are grouped in Risk Category I and assessed for deposit insurance at an annual rate of between five and seven basis points. The assessment rate for an individual institution is determined according to a formula based on a weighted average of the institution’s individual CAMEL component ratings plus either five financial ratios or, in the case of an institution with assets of $10.0 billion or more, the average ratings of its long-term debt. Institutions in Risk Categories II, III and IV are assessed at annual rates of 10, 28 and 43 basis points, respectively. Our expense related to this assessment for the year ended December 31, 2007 was $258,000.
Deposit Insurance Fund-insured institutions are required to pay a Financing Corporation assessment, in order to fund the interest on bonds issued to resolve thrift failures in the 1980s. For the semi-annual period ended December 31, 2007, the Financing Corporation assessment equaled 1.14 basis points for each $100 in domestic deposits. These assessments, which may be revised based upon the level of DIF deposits, will continue until the bonds mature in the years 2017 through 2019. For 2007, Rainier Pacific Bank incurred $55,000 in FICO assessments.
The FDIC may terminate the deposit insurance of any insured depository institution, including Rainier Pacific Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is aware of no existing circumstances which would result in termination of Rainier Pacific Bank’s deposit insurance.
Capital Requirements. FDIC regulations recognize two types, or tiers, of capital: core ("Tier 1") capital and supplementary ("Tier 2") capital. Tier 1 capital generally includes common shareholders' equity and non-cumulative perpetual preferred stock, less most intangible assets. Tier 2 capital, includes Tier 1 capital, and such items as qualifying general loan loss reserves, cumulative perpetual preferred stock, mandatory convertible debt, term subordinated debt and limited life preferred stock; however, the amount of term subordinated debt and intermediate term preferred stock (original maturity of at least five years but less than 20 years) that may be included in Tier 2 capital is limited to 50% of Tier 1 capital.
The FDIC currently measures an institution's capital using a leverage limit together with certain risk-based ratios. The FDIC's minimum capital requirement specifies a minimum ratio of Tier 1 capital to average total assets (i.e., the leverage ratio). Most banks are required to maintain a minimum leverage ratio of at least 4% to 5% of total assets. At December 31, 2007, Rainier Pacific Bank had a Tier 1 capital leverage ratio of 9.79%. The FDIC retains the right to require an institution to maintain a higher capital level based on the institution’s particular risk profile.
FDIC regulations also establish a measure of capital adequacy based on ratios of qualifying capital to risk-weighted assets. Assets are placed in one of four categories and given a percentage weight based on the relative risk of the assets assigned to that category. In addition, certain off-balance-sheet items are converted to balance-sheet asset equivalent amounts, and each amount is then assigned to one of the four categories. Under the guidelines, the ratio of Tier 1 capital to risk-weighted assets must be at least 4%, and the ratio of total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets must be at least 8%. In evaluating the adequacy of a bank's capital, the FDIC may also consider other factors that may affect a bank's financial condition, such as interest rate risk exposure, liquidity, funding and market risks, the quality and level of earnings, concentration of credit risk, risks arising from non-traditional activities, loan and investment quality, the effectiveness of loan and investment policies, and management's ability to monitor and control financial and operating risks. At December 31, 2007, Rainier Pacific Bank had a Tier 1 risk-based capital ratio of 11.75% and a total risk-based capital ratio of 12.85%.
The Washington State Department of Financial Institutions requires that net worth equal at least 5% of total assets. Intangible assets must be deducted from net worth and assets when computing compliance with this
requirement. At December 31, 2007, Rainier Pacific Bank had a net worth, adjusted for intangible assets, of 9.36% of total assets.
The table below sets forth the Bank's capital position relative to its FDIC capital requirements at December 31, 2007. The definitions of the terms used in the table are those provided in the FDIC's capital regulations, and the Bank has not been notified by the FDIC of any higher capital requirements specifically applicable to it.
__________
(1)
For the Tier 1 (leverage) capital calculations, total average assets were $882.5 million. For the Tier 1 risk-based capital and total risk-based capital calculations, total risk-weighted assets were $735.2 million.
Rainier Pacific Bank's management believes that, under the current regulations, Rainier Pacific Bank will continue to meet its minimum capital requirements in the foreseeable future. However, events beyond the control of Rainier Pacific Bank, such as a downturn in the economy in areas where Rainier Pacific Bank has most of its loans, could adversely affect future earnings and, consequently, the ability of Rainier Pacific Bank to meet its capital requirements.
Prompt Corrective Action. The FDIC is required to take certain supervisory actions against undercapitalized savings institutions, the severity of which depends upon the institution's degree of undercapitalization. Generally, an institution that has a ratio of total capital to risk-weighted assets of less than 8%, a ratio of Tier 1 (core) capital to risk-weighted assets of less than 4%, or a ratio of Tier 1 (leverage) capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be undercapitalized. An institution that has a total risk-based capital ratio less than 6%, a core capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be significantly undercapitalized and an institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be critically undercapitalized. In most instances, the FDIC is required to appoint a receiver or conservator for a savings institution that is critically undercapitalized. FDIC regulations also require that a capital restoration plan be filed with the FDIC within 45 days of the date a savings institution receives notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. Compliance with the plan must be guaranteed by any parent holding company in an amount of up to the lesser of 5% of the institution's assets or the amount which would bring the institution into compliance with all capital standards. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The FDIC also could take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. At December 31, 2007, Rainier Pacific Bank was categorized as "well capitalized" under the prompt corrective action regulations of the FDIC.
Standards for Safety and Soundness. The federal banking regulatory agencies have prescribed, by regulation, guidelines for all insured depository institutions relating to: internal controls, information systems and internal audit systems; loan documentation; credit underwriting; interest rate risk exposure; asset growth; asset quality; earnings and compensation, fees and benefits. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the FDIC determines that Rainier Pacific Bank fails to meet any standard prescribed by the guidelines, it may require Rainier Pacific Bank to submit an acceptable plan to achieve compliance with the standard. FDIC regulations establish deadlines for the submission and review of safety and soundness compliance plans.
Activities and Investments of Insured State-Chartered Financial Institutions. Federal law generally limits the activities and equity investments of FDIC insured state-chartered banks to those that are permissible for national banks. An insured state bank is not prohibited from, among other things, (1) acquiring or retaining a majority interest in a subsidiary, (2) investing as a limited partner in a partnership the sole purpose of which is direct or indirect investment in the acquisition, rehabilitation or new construction of a qualified housing project, provided that such limited partnership investments may not exceed 2% of the bank's total assets, (3) acquiring up to 10% of the voting stock of a company that solely provides or reinsures directors', trustees' and officers' liability insurance coverage or bankers' blanket bond group insurance coverage for insured depository institutions, and (4) acquiring or retaining the voting shares of a depository institution if certain requirements are met.
Washington State has enacted a law regarding financial institution parity. Primarily, the law affords Washington-chartered commercial banks the same powers as Washington-chartered savings banks. In order for a bank to exercise these powers, it must provide 30 days notice to the Director of the Washington State Department of Financial Institutions and the Director must authorize the requested activity. In addition, the law provides that Washington-chartered commercial banks may exercise any of the powers that the Federal Reserve has determined to be closely related to the business of banking and the powers of national banks, subject to the approval of the Director in certain situations. The law also provides that Washington-chartered savings banks may exercise any of the powers of Washington-chartered commercial banks, national banks and federally-chartered savings banks, subject to the approval of the Director in certain situations. Finally, the law provides additional flexibility for Washington-chartered commercial and savings banks with respect to interest rates on loans and other extensions of credit. Specifically, they may charge the maximum interest rate allowable for loans and other extensions of credit by federally-chartered financial institutions to Washington residents.
Environmental Issues Associated With Real Estate Lending. The Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), a federal statute, generally imposes strict liability on all prior and present "owners and operators" of sites containing hazardous waste. However, Congress created a safe harbor provision to protect secured creditors by providing that the term "owner and operator" excludes a person whose ownership is limited to protecting its security interest in the site. Since the enactment of the CERCLA, this "secured creditor exemption" has been the subject of judicial interpretations which have left open the possibility that lenders could be liable for cleanup costs on contaminated property that they hold as collateral for a loan.
To the extent that legal uncertainty exists in this area, all creditors, including Rainier Pacific Bank, that have made loans secured by properties with potential hazardous waste contamination (such as petroleum contamination) could be subject to liability for cleanup costs, which costs often substantially exceed the value of the collateral property.
Federal Reserve System. The Federal Reserve Board requires that all depository institutions maintain reserves on transaction accounts or non-personal time deposits. These reserves may be in the form of cash or non-interest-bearing deposits with the regional Federal Reserve Bank. Negotiable order of withdrawal accounts and other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to the reserve requirements, as are any non-personal time deposits at a savings bank. As of December 31, 2007, Rainier Pacific Bank's deposit with the Federal Reserve Bank and vault cash exceeded its reserve requirements.
Affiliate Transactions. Rainier Pacific Financial Group and Rainier Pacific Bank are separate and distinct legal entities. Various legal limitations restrict Rainier Pacific Bank from lending or otherwise supplying funds to Rainier Pacific Financial Group (an "affiliate"), generally limiting any single transaction to 10% of Rainier Pacific Bank's capital and surplus and limiting all such transactions to 20% of Rainier Pacific Bank's capital and surplus and requiring eligible collateral to secure a loan to an affiliate. These transactions, including extensions of credit, sales of securities or assets and provision of services, also must be on terms and conditions consistent with safe and sound banking practices that are substantially the same as those prevailing at the time for transactions with unaffiliated companies.
Federally insured banks are subject, with certain exceptions, to certain restrictions on extensions of credit to their parent holding companies or other affiliates, on investments in the stock or other securities of affiliates and on the taking of such stock or securities as collateral from any borrower. In addition, these banks are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or the providing of any property or service.
Community Reinvestment Act. Banks are subject to the provisions of the Community Reinvestment Act of 1977, which requires the appropriate federal bank regulatory agency to assess the bank's record in meeting the credit needs of the community serviced by the bank, including low and moderate income neighborhoods. The regulatory agency's assessment of the bank's record is made available to the public. Further, a bank’s performance under the Community Reinvestment Act must be considered in connection a bank’s application to establish a new branch office that will accept deposits, relocate an existing office or merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution. Rainier Pacific Bank received a "Satisfactory" rating during its most recent examination.
Dividends. Dividends from Rainier Pacific Bank constitute a major source of funds for dividends which may be paid by Rainier Pacific Financial Group to its shareholders. The amount of dividends payable by Rainier Pacific Bank to Rainier Pacific Financial Group depends upon Rainier Pacific Bank's earnings and capital position, and is limited by federal and state laws. According to Washington law, Rainier Pacific Bank may not declare or pay a cash dividend on its capital stock if it would cause its net worth to be reduced below (1) the amount required for its liquidation account or (2) the net worth requirements, if any, imposed by the Director of the Washington State Department of Financial Institutions. In addition, dividends on Rainier Pacific Bank's capital stock may not be paid in an amount greater than one-half of the greater of (1) net income for the current fiscal year, or (2) the average net income for the current fiscal year and not more than two of the immediately preceding fiscal years. Furthermore, dividends may not be paid on Rainier Pacific Bank's capital stock in an aggregate amount greater than the aggregate retained earnings of Rainier Pacific Bank, without the approval of the Director of the Washington State Department of Financial Institutions.
The amount of dividends actually paid during any one period will be strongly affected by Rainier Pacific Bank's policy of maintaining a strong capital position. Federal law further provides that no insured depository institution may pay a cash dividend if it would cause the institution to be "undercapitalized," as defined in the prompt corrective action regulations. Moreover, the federal bank regulatory agencies also have the general authority to limit the dividends paid by insured banks if such payments are deemed to constitute an unsafe and unsound practice.
Privacy Standards. The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 ("GLBA"), which was enacted in 1999, modernized the financial services industry by establishing a comprehensive framework
to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers. The Bank is subject to FDIC regulations implementing the privacy protection provisions of the GLBA. These regulations require the Bank to disclose its privacy policy, including identifying with whom it shares "non-public personal information," to customers at the time of establishing the customer relationship and annually thereafter.
Anti-Money Laundering and Customer Identification. Congress enacted the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "USA Patriot Act") on October 26, 2001 in response to the terrorist events of September 11, 2001. The USA Patriot Act gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing, and broadened anti-money laundering requirements. In March 2006, Congress re-enacted certain expiring provisions of the USA Patriot Act.
Taxation
Federal Taxation
General. Rainier Pacific Financial Group and Rainier Pacific Bank are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to Rainier Pacific Financial Group or Rainier Pacific Bank. Rainier Pacific Financial Group’s or Rainier Pacific Bank's federal income tax returns have never been audited. Prior to January 1, 2001, Rainier Pacific Bank was a credit union, not generally subject to corporate income tax. Although we believe that we have properly recognized the tax consequences of the conversion to a taxable corporate entity, and in our accounting and reporting of subsequent tax matters, there can be no assurance that the Internal Revenue Service will not take a position contrary to the positions we have taken.
Rainier Pacific Financial Group files a consolidated federal income tax return with Rainier Pacific Bank. It is anticipated that any cash distributions made by Rainier Pacific Financial Group to its shareholders would be considered to be taxable dividends and not as a non-taxable return of capital to shareholders for federal and state tax purposes.
Method of Accounting. For federal income tax purposes, Rainier Pacific Financial Group and Rainier Pacific Bank report its income and expenses on the accrual method of accounting and use a fiscal year ending on December 31 for filing its federal income tax return.
Corporate Alternative Minimum Tax. The Internal Revenue Code imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences, called alternative minimum taxable income. The alternative minimum tax is payable to the extent the alternative minimum taxable income is in excess of an exemption amount. Net operating losses can offset no more than 90% of alternative minimum taxable income. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. Rainier Pacific Financial Group has not been subject to the alternative minimum tax, nor does it have any such amounts available as credits for carryover.
Net Operating Loss Carryovers. A financial institution may carry back net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years. This provision applies to losses incurred in taxable years beginning after August 6, 1997. At December 31, 2007, Rainier Pacific Financial Group had no net operating loss carryovers for federal income tax purposes.
Corporate Dividends-Received Deduction. Rainier Pacific Financial Group may eliminate from its income dividends received from Rainier Pacific Bank as a wholly-owned subsidiary of Rainier Pacific Financial Group because it files a consolidated return with Rainier Pacific Bank. The corporate dividends-received deduction is 100% or 80%, in the case of dividends received from corporations with which a corporate recipient does not file a
consolidated tax return, depending on the level of stock ownership held in the payor of the dividend. Corporations which own less than 20% of the stock of a corporation distributing a dividend may deduct 70% of dividends received or accrued on their behalf.
Charitable Contribution Deduction. Rainier Pacific Financial Group is authorized by state statute and federal law to make charitable contributions. In this regard, Washington law provides that a charitable gift must be within reasonable limits to be valid. Under the Internal Revenue Code, Rainier Pacific Financial Group is generally allowed a deduction for charitable contributions made to qualifying donees within the taxable year of up to 10% of the taxable income of the consolidated group of corporations (with certain modifications) for that year. Charitable contributions made by Rainier Pacific Financial Group in excess of the annual deductible amount will be deductible over each of the five succeeding taxable years, subject to certain limitations, including the sufficiency of taxable income to allow the full deduction.
In connection with Rainier Pacific Bank's mutual to stock conversion in October 2003, Rainier Pacific Financial Group pledged to make a $6.3 million contribution to the newly formed Rainier Pacific Foundation, consisting of a combination of 507,840 shares of its common stock and $1.3 million in cash. Rainier Pacific Financial Group made its stock contribution in October 2003 and its cash contribution in January 2004. The Rainier Pacific Foundation filed its application for recognition of tax-exempt status as a private foundation under Section 501 of the Internal Revenue Code, and in March 2004 the Internal Revenue Service approved the application. The effective date of the foundation's status as a Section 501(c) organization was the date of its organization in July 2003.
Upon review of the charitable contribution carry-forward remaining at December 31, 2007, Rainier Pacific Financial Group has determined that it is more likely than not that the Company may not be able to fully realize all the benefit of the 2003 and 2004 charitable contributions based upon the nature and timing of the items listed. In order to fully realize the charitable contribution carry-forward, the Bank will need to generate sufficient future taxable income. As of December 31, 2007, the deferred tax asset relating to the charitable contribution was $1.2 million, of which $787,000 and $432,000 are set to expire in 2008 and 2009, respectively. Management expects that the Bank may not generate sufficient taxable income to utilize the entire net deferred tax asset, including the deferred tax asset relating to the charitable contribution, and has established a valuation allowance in the amount of $550,000 in the deferred tax asset.
Washington Taxation
Rainier Pacific Bank is subject to a business and occupation tax imposed under Washington law at the rate of 1.50% of gross receipts. In addition, various municipalities also assess business and occupation taxes at differing rates. Interest received on loans secured by mortgages or deeds of trust on residential properties, rental income from properties, and certain investment securities are exempt from this tax.
Competition
We face intense competition in originating loans and in attracting deposits within our targeted geographic market. We compete by leveraging our full service delivery capability, comprised of convenient branch locations, internet banking and other automated methods, and our call center, as well by consistently delivering high-quality, high-touch service to our customers that result in a high level of customer satisfaction.
We ranked eighth in terms of deposits with a 4.4% market share of deposits, among the 46 federally-insured depository institutions in Pierce County, our primary market, as of June 30, 2007. Our key competitors are Columbia Bank, Key Bank, Bank of America, Washington Mutual, Wells Fargo and US Bank. These competitors control approximately 60.3% of the Pierce County deposit market with deposits of $6.0 billion, out of the $10.0 billion in total deposits in Pierce County as of June 30, 2007. Aside from these traditional competitors, credit unions, insurance companies and brokerage firms are increasingly competing for consumer deposit relationships. In addition, we also compete for deposits with three branch offices in the City of Federal Way, in King County,
Washington. We have $23.8 million in deposits with a 2.2% market share of deposits among the 19 federally-insured depository institutions in Federal Way as of June 30, 2007.
Our competition for loans comes principally from mortgage bankers and brokers, commercial banks, savings institutions, credit unions and finance companies operating in Pierce County and the City of Federal Way. Several other financial institutions, including those previously mentioned, have greater resources than we do and compete with us for banking business in our targeted market area. Among the advantages of some of these institutions are their ability to make larger loans, finance extensive advertising campaigns, access lower cost funding sources and allocate their investment assets to regions with higher yields and demand. Competition for the origination of loans may limit our future growth and earnings prospects.
In addition to traditional banking services, we offer commercial and personal lines of property and casualty insurance, as well as accidental death and dismemberment insurance, collateral protection insurance, life insurance and long-term care insurance. We offer these products through our insurance services unit of the Bank doing business as Rainier Pacific Insurance Services. We compete with other insurance agents and brokers in our primary local market area and are the fifth largest agency in Pierce County based upon total property and casualty insurance premiums. We also provide alternative financial products and services to our customers through Rainier Pacific Financial Services. Rainier Pacific Financial Services is the operating unit of the Bank that provides financial planning and non-federally insured investment products such as mutual funds, debt, equity, and government securities, retirement accounts, life insurance, and fixed and variable annuities.
Personnel
At December 31, 2007, we had 187 full-time employees and 46 part-time employees. Our employees are not represented by any collective bargaining group and we consider our employee relations to be good.
Executive Officers of the Registrant
The following table sets forth certain information with respect to the executive officers of the Company and the Bank.
Executive Officers of the Company and the Bank
Biographical Information
Edward J. Brooks is the Chairman of the Board at Rainier Pacific Financial Group and Rainier Pacific Bank. He has served as Chairman of the Bank and its predecessor since 1992. Mr. Brooks is the President and Chief Executive Officer of Sunset Pacific General Contractors, Inc., a local commercial construction and general contracting firm. He is past president of the Tacoma Narrows Rotary Club, and has served on the Board of Directors of Associated General Contractors of Washington and is actively involved with several local community organizations.
John A. Hall is President and Chief Executive Officer of Rainier Pacific Financial Group and Rainier Pacific Bank. Mr. Hall joined Rainier Pacific Bank's predecessor in 1991 serving as its Executive Vice President and Chief Financial Officer and became its President and Chief Executive Officer in 1995. He obtained his Bachelor of Arts in Business Administration from the University of Puget Sound, is a certified pubic accountant (CPA) and a member of the Washington Society of CPAs and the American Institute of CPAs. After working for the national accounting firm of Ernst & Young, Mr. Hall began his career in the financial services industry in 1987. His financial institution experience prior to joining Rainier Pacific Bank's predecessor included a controllership and financial reporting position of a $650 million savings bank and also served as corporate audit manager of a $4.6 billion regional bank holding company. He is a board member of Tacoma Goodwill Industries, the Economic Development Board for Tacoma-Pierce County, the Tacoma-Pierce County Chamber of Commerce, the Washington Financial League, the Business Advisory Board of the University of Washington-Tacoma, and the Executive Council for a Greater Tacoma. Mr. Hall is a past board member and treasurer of the United Way of Pierce County, and serves on various citizen committees of the Tacoma School District. He is also the Chairman of the Board of Trustees of the Rainier Pacific Foundation.
Victor J. Toy is Senior Vice President and Corporate Secretary of Rainier Pacific Financial Group and Senior Vice President of Rainier Pacific Bank. Mr. Toy joined Rainier Pacific Bank's predecessor in 1991. Mr. Toy holds a Bachelor of Arts degree in Social Welfare from the University of California at Berkeley. He has over 25 years of financial services experience. Prior to joining Rainier Pacific Bank, he was a principal and partner of a management consulting firm serving financial institutions, and held positions as vice president responsible for marketing, sales, strategic planning and shareholder relations for two separate publicly traded savings banks with assets of $650 million to $750 million located in Washington State. Mr. Toy's primary areas of responsibility at Rainier Pacific Financial Group and Rainier Pacific Bank include strategic planning and development, shareholder relations, and marketing. Mr. Toy serves as the Treasurer and as Trustee of the Rainier Pacific Foundation.
Joel G. Edwards is Vice President, Chief Financial Officer and Treasurer of Rainier Pacific Financial Group, and Vice President, Chief Financial Officer, Treasurer, and Secretary of Rainier Pacific Bank. Mr. Edwards joined Rainier Pacific Bank's predecessor in 1996. He has 22 years of financial services experience. He holds a Bachelor of Arts degree in Business and Economics and a Masters of Business Administration from Eastern Washington University, is an inactive certified public accountant (CPA), and is a member of the Washington Society of CPAs and the American Institute of CPAs. Prior to joining Rainier Pacific Bank, Mr. Edwards was the president of the Washington Credit Union Share Guaranty Association. He also served the Farm Credit System for eight years including positions as vice president responsible for administration, budget and policy. Mr. Edwards's primary areas of responsibility at Rainier Pacific Financial Group and Rainier Pacific Bank include finance, accounting, facilities, and purchasing.
Carolyn S. Middleton is Vice President and Chief Lending Officer of Rainier Pacific Bank. Ms. Middleton joined Rainier Pacific Bank's predecessor in 1991. Ms. Middleton has worked in the lending arena for 33 years specializing in mortgage and consumer lending. She holds a Certified Credit & Collection Executive designation from the International Credit Association and a Certified Commercial Real Estate Underwriter designation from the Mortgage Banker's Association. Prior to joining Rainier Pacific Bank, Ms. Middleton was the director of loan services and security officer for the largest credit union in the State of Oregon, and worked in the collection and legal departments of a national consumer products retailer. Ms. Middleton is an active member of the Washington Community Reinvestment Association and Society of Certified Credit Executives. Ms. Middleton is
also an active member and past president of the Northwest Fraud Investigators Association. Ms. Middleton's primary areas of responsibility at Rainier Pacific Bank include credit administration, loan underwriting and servicing, and collections.
Dalen D. Harrison is a Vice President of Rainier Pacific Bank. Ms. Harrison joined Rainier Pacific Bank's predecessor in 1994. Ms. Harrison holds a Bachelor of Arts degree in Business Administration from St. Mary's College. Ms. Harrison has over 26 years of financial services experience. Prior to joining Rainier Pacific Bank, she held positions as vice president responsible for administration and member services at a $550 million credit union. Ms. Harrison is active in local chambers of commerce and the Gig Harbor Rotary Club and served on the board of a local not-for-profit organization. Ms. Harrison's primary areas of responsibility at Rainier Pacific Bank include the sales and service activities of the 14 branch retail network, consumer banking support, and Internet and call center delivery channels. Ms. Harrison is also a Trustee of the Rainier Pacific Foundation and a Trustee of the Gig Harbor Rotary Foundation.
Waylin L. McCurley is a Vice President of Rainier Pacific Bank. Mr. McCurley joined Rainier Pacific in 1999, and was promoted to Vice President of Human Resources and Development in 2004. In 2006, he became Vice President of Corporate Services, and his primary areas of responsibility include Human Resources, Development, Training, Compliance, and Security. He has over eight years of financial services experience, and holds a Bachelor of Arts degree in Chemistry from New York University (NYU). Prior to joining Rainier Pacific Bank, Mr. McCurley worked in an executive recruiting firm. Mr. McCurley is a board member for the United Way of Pierce County and is a Fire Commissioner for the City of Lakewood.
Richard D. Pickett joined Rainier Pacific Bank as a Vice President responsible for the Bank's business banking services in 2004. Mr. Pickett has 34 years of experience in the financial services industry, concentrated in the business banking field and executive bank management. Mr. Pickett holds a Bachelor of Arts degree in Business Administration from Washington State University, and graduated with honors from the Pacific Coast Banking School at the University of Washington. Prior to joining Rainier Pacific Bank, he was employed by Valley Bank in Auburn, Washington, as its President and Chief Executive Officer. Prior to joining Valley Bank in 1999, Mr. Pickett was employed by Bank of America (and its regional predecessor, Seattle First National Bank) since 1974, as a Commercial Underwriting Team Leader and Credit Administrator.
Sandra K. Steffeney is a Vice President of Rainier Pacific Bank. Ms. Steffeney joined Rainier Pacific Bank's predecessor in 2000. Ms. Steffeney has over 32 years of experience in the financial services industry, concentrated in the insurance and investment securities business. She is a Chartered Life Underwriter (CLU); Certified Financial Planner (CFP); and holds National Association of Securities Dealers (NASD) investment advisor (Series 65), securities principal (Series 24), securities agent (Series 63) and securities representative (Series 7) licenses. Ms. Steffeney is also a member of several professional associations relative to her certifications and licenses. Prior to joining Rainier Pacific Bank, she was district manager of an insurance company subsidiary and vice president of a broker-dealer subsidiary of a national financial services holding company. Ms. Steffeney was also co-owner of a local financial planning practice. Ms. Steffeney's primary area of responsibility at Rainier Pacific Bank is to manage the operations of Rainier Pacific Insurance Services and Rainier Pacific Financial Services, which are principally engaged in insurance and investment services.
David R. Webb is a Vice President of Rainier Pacific Bank. Mr. Webb joined Rainier Pacific in 2004, and was promoted to Vice President of Information Services in 2006. He has 29 years of experience in data processing and information services, most of those in the financial services industry. Prior to joining Rainier Pacific Bank, Mr. Webb worked at the Frank Russell Company for 19 years in positions ranging from programmer-analyst to manager of technical services, where he was responsible for the design, deployment and operations of the Russell Company’s global information technology infrastructure and network. He holds a Bachelor of Science in Psychology from the University of Kentucky. He is responsible for managing the Bank’s day-to-day operations of information services and for delivering reliable computing resources to internal and external customers.
Item 1A.
Item 1A. Risk Factors.
Ownership of Rainier Pacific Financial Group’s common stock involves risk and investors should consider the following risk factors. In assessing these risks you should also refer to the other information set forth herein, including Rainier Pacific Financial Group’s financial statements and related notes.
Our loan portfolio possesses increased risk due to the high level of outstanding balances of multi-family and commercial real estate loans, real estate construction and land loans, and a portfolio of indirect auto and consumer loans.
Our multi-family and commercial real estate loans, real estate construction and land loans, and commercial business loans accounted for approximately 72.8% of our total loan portfolio as of December 31, 2007. We have increased our emphasis on multi-family and commercial real estate lending and residential construction and land loans, and consider these types of loans to involve a higher degree of risk compared to first mortgage loans on one- to four-family, owner-occupied residential properties. We have traditionally focused on consumer lending, using a risk-based pricing model. As of December 31, 2007, consumer loans, including our home equity loans, totaled $96.7 million or 15.2% of our total loan portfolio, including a $23.2 million credit card portfolio. The aforementioned loan types are more likely to become delinquent or default than first mortgage one- to four-family real estate secured loans, and therefore may cause higher future loan losses. Accordingly, as a result of the inherent risks associated with these types of loans, and the recent slowdown in general economic conditions, it may become necessary for us to increase the level of our provision for loan losses which would result in a reduction in our net income.
From December 31, 2004, through December 31, 2007, our total loans have grown by $134.3 million, or 26.7%. In connection with this rapid expansion, the growth in our multi-family and commercial real estate, and residential construction and land loan portfolios was $155.1 million, which may be subject to a higher magnitude of potential losses in an economic slowdown or recession.
At December 31, 2007, $18.6 million, or 89.5%, of our total auto loan portfolio were loans that we originated indirectly through a network of automobile dealers. Because these loans are originated through auto dealers and not directly by us and are secured by automobiles that depreciate rapidly in value, they present greater risks than other types of lending activities.
For further information concerning the risks associated with multi-family and commercial real estate loans, construction and land loans, and consumer loans, see “Item 1. Business - Lending Activities.”
We may be subject to additional regulatory scrutiny because of the level of our commercial real estate loan portfolio.
The FDIC, along with the Federal Reserve and the Office of the Comptroller of the Currency, has issued final guidance for financial institutions with concentrations in commercial real estate lending. The guidance provides that a bank has a concentration in commercial real estate lending if (i) total reported loans for construction, land development, and other land represent 100% or more of total capital or (ii) total reported loans secured by multi-family and non-farm residential properties and loans for construction, land development, and other land represent 300% or more of total capital and its construction loan portfolio has increased 50% or more during the prior 36 months. If a concentration is present, management must employ heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, and increasing capital requirements. Based on the Bank’s commercial real estate lending levels, it has a concentration in commercial real estate lending and must implement the practices outlined in the final guidance, including maintaining a higher capital ratio.
Our real estate construction and land lending presents greater risk than one- to four-family and consumer lending.
Construction lending is generally considered to involve a higher level of risk as compared to one- to four-family residential or consumer lending, as a result of the concentration of principal in a limited number of loans and borrowers, and the effects of general economic conditions on developers and builders. Moreover, a construction loan can involve additional risks because of the inherent difficulty in estimating both a property’s value at completion of the project and the estimated cost (including interest) of the project. The nature of these loans is such that they are generally more difficult to evaluate and monitor. In addition, speculative construction loans to a builder are often associated with homes that are not pre-sold, and thus pose a greater potential risk to us than construction loans to individuals on their personal residences. Loans on land under development or held for future construction also poses additional risk because of the lack of income being produced by the property and the potential illiquid nature of the collateral. With home sales having declined by 27% in 2007 as compared to 2006, a higher rate of foreclosures may occur as developers and builders experience difficulty in servicing their debt.
Our commercial business lending activities involves greater risk than other types of lending.
Our commercial business lending has increased $19.9 million since 2004 and we intend to continue to offer commercial business loans to small and medium sized businesses. Our ability to originate commercial business loans is determined by the demand for these loans and our ability to attract and retain qualified commercial lending personnel. Because payments on commercial business loans generally depend on the successful operation of the business involved, repayment of commercial business loans may be subject to a greater extent to adverse conditions in the economy than other types of lending. Although commercial business loans often have equipment, inventory, accounts receivable or other business assets as collateral, the sale of the collateral in the event the borrower does not repay the loan is often not sufficient to repay the loan because the collateral may be uncollectible and inventories and equipment may be obsolete or of limited use, among other things. Consequently, there can be no assurance that we will be successful in our commercial business lending efforts.
A significant decline or rise in interest rates may hurt our profits, market value and equity.
If short-term interest rates were to rapidly rise, the Bank will not be able to increase the rates it earns on its loans and investments in the same proportion or as rapidly as the increase it would experience in its cost of deposits and other interest-bearing liabilities. The difference between the rates received on interest-earning assets and the rates paid on interest-bearing liabilities is referred to as our interest rate spread. When our interest rate spread decreases, so does our profitability. When short-term interest rates rise, our net interest income and the value of our assets could be significantly reduced if interest paid on interest-bearing liabilities, such as deposits and borrowings, increases more quickly than interest received on interest-earning assets, such as loans, investment securities and mortgage-backed securities. If long-term rates rise rapidly, a large portion of our relatively low rate structured term borrowings may be called that can cause the costs of our interest-bearing liabilities to rise. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management and Market Risk” for further information.
The economy in our local market area may adversely affect our operations.
Our financial results may be adversely affected by changes in prevailing economic conditions, including: decreases in real estate values, changes in interest rates, and adverse employment conditions; the monetary and fiscal policies of the federal government; and other significant external events. Because we hold a significant amount of real estate loans, decreases in real estate values could adversely affect the value of property used as collateral for these loans. Adverse changes in the economy may also have a negative effect on the ability of our borrowers to make timely repayments of their loans, which may increase credit losses and have an adverse impact on our earnings.
During 2007, the housing market in the United States began to experience significant adverse trends, including accelerated price depreciation in some markets and rising delinquency and default rates. As a result of
these trends, we are now seeing increases in delinquency and default rates particularly on construction loans in our primary area. These trends, if they continue, or worsen, could cause further credit losses and loan loss provisioning and could adversely affect our earnings and financial condition.
Our operating expenses are higher than our peers and can negatively impact our future profitability if revenue growth slows or declines.
In order to execute upon our operating strategy of being a full-service financial solutions provider and in deepening customer relationships, we offer a broad array of retail banking, insurance and investment products and services. Our consumer products and services have relatively lower average account balances and require more servicing. Our operating strategy and our retail banking environment require a diverse infrastructure and multiple delivery channels, including 14 branch locations, in a community bank environment. Consequently, our operating costs and efficiency ratio are higher than our peers. Given the volume of our retail banking operations in proportion to the infrastructure, we anticipate continuing to have a relatively higher cost operation than our peers. If we cannot grow our customer relationships and increase revenue, our net income could decline.
If our allowance for loan losses is not sufficient to cover future loan losses, our earnings could decrease.
We make various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, we review several factors including our loan loss and delinquency experience, underwriting practices, and economic conditions. If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover future losses in the loan portfolio, resulting in the need for greater additions to our allowance. Material additions to the allowance could materially decrease our net income. Our allowance for loan losses was 1.27% of total loans and 1,625.55% of non-performing loans at December 31, 2007.
In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize additional loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities may have a material adverse effect on our financial condition and results of operations.
Strong competition within our market area may limit our growth and profitability.
Competition in the banking and financial services industry is intense. In our market area, we compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual fund companies, insurance companies, and investment brokerage and financial planning firms operating locally and elsewhere. Many of these competitors have substantially greater resources and lending limits than we do and may offer certain services that we do not or cannot provide. Our profitability depends upon our continued ability to successfully compete in our market.
Loss of key personnel may hurt our operations because it may be difficult to hire qualified replacements.
The loss of the President and Chief Executive Officer or other executive officers could have a material adverse impact on our operations since they have been instrumental in managing the business affairs of the Company. If we were to lose these executive officers, the board of directors would most likely have to search outside of the Company for qualified, permanent replacements. This search may be prolonged and there can be no assurance that we will be able to locate and hire qualified replacements in a timely manner. For a discussion of Rainier Pacific Financial Group’s management, see “Item 1. Business - Personnel - Executive Officers of the Registrant.”
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud, and as a result, investors and depositors could lose confidence in our financial reporting, which could adversely affect our business, the trading price of our stock, and our ability to attract additional deposits.
In connection with the enactment of the Sarbanes-Oxley Act of 2002 (“Act”) and the implementation of the rules and regulations promulgated by the SEC, we document and evaluate the Company’s internal control over financial reporting in order to satisfy the requirements of Section 404 of the Act. This requires us to prepare an annual management report on our internal control over financial reporting, including among other matters, management’s assessment of the effectiveness of internal control over financial reporting. If we fail to identify and correct any significant deficiencies in the design or operating effectiveness of our internal control over financial reporting or fail to prevent fraud, current and potential shareholders and depositors could lose confidence in our internal controls and financial reporting, which could adversely affect our business, financial condition and results of operations, the trading price of our stock, and our ability to attract additional deposits.
If external funds were not available, this could adversely impact our growth and future prospects.
We rely on deposits, brokered deposits, advances from the Federal Home Loan Bank of Seattle, and other borrowings to fund our operations. Although we have historically been able to replace maturing deposits when desired, no assurance can be given that we will be able to replace such funds in the future if our financial condition or market conditions were to change. Although we consider the sources of existing funds adequate for our current liquidity needs, we may seek additional brokered deposits or debt in the future to achieve our long-term business objectives. There can be no assurance additional funds, if sought, would be available to us or, if available, would be on favorable terms. If additional financing sources are unavailable or are not available on reasonable terms, our growth and future prospects could be adversely affected.
We are subject to extensive government regulation and supervision.
We are subject to extensive federal and state regulation and supervision primarily through the Bank. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not shareholders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the Company in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer, and/or increase the ability of non-bank enterprises to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur. See Item 1. "Business - How We Are Regulated."
Our information systems may experience an interruption or breach in security.
We rely heavily on communications and information technology systems to conduct our business. Any failure, interruption, or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of potential failure, interruption or security breach of our systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
We rely on dividends from our subsidiary for most of our holding company’s cash flow.
Rainier Pacific Financial Group is a separate and distinct legal entity from its subsidiary, Rainier Pacific Bank. Rainier Pacific Financial Group receives substantially all of its cash flow from dividends from its subsidiary. These dividends are the principal source of funds to pay dividends on our common stock and our operating expenses. Various federal and/or state laws and regulations limit the amount of dividends that the Bank may pay to us. Also, our right to participate in a distribution of assets upon our subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. In the event the Bank is unable to pay dividends to us, we may not be able to pay our obligations or pay dividends on our common stock. The inability to receive dividends from the Bank could have a material adverse effect on our business, financial condition and results of operations. See Item 1., "Business - How We Are Regulated."
Item 1B.
Item 1B. Unresolved Staff Comments
Not applicable. Rainier Pacific Financial Group has not received any written comments from the SEC regarding its periodic or current reports under the Exchange Act that are unresolved.
Item 2.
Item 2. Properties
At December 31, 2007, we had 14 full service branch offices, all of which we own except for our Gig Harbor North branch, our Proctor branch, and our 320th Street branch in the City of Federal Way. On December 6, 2004, we moved to our new administrative offices located in the central business district of downtown Tacoma, Washington. The new corporate office building was completed in December 2004 and contains approximately 60,000 square feet of mixed-use office and retail space, with the Bank occupying approximately 60% of the space for administrative offices and our downtown branch, with the remaining 40% leased to other unaffiliated organizations. See Notes 5 and 10 of the Notes to Consolidated Financial Statements included in Item 8 of this report for additional information. The net book value of our investment in premises, equipment, and leaseholds, excluding computer equipment and construction in process, was $32.9 million at December 31, 2007. The net book value of the data processing and computer equipment utilized by us at December 31, 2007 was approximately $952,000.
The following table provides a list of our main and branch offices and indicates whether the properties are owned or leased:
________________
* Drive-up ATM available.
Item 3.
Item 3. Legal Proceedings
From time to time, we are involved as plaintiff or defendant in various legal actions arising in the normal course of business. As of December 31, 2007, we were not involved in any significant litigation and do not anticipate incurring any material liability as a result of any such litigation.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2007.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on The Nasdaq Stock Market LLC’s Global Market, under the symbol "RPFG." As of December 31, 2007, there were 6,466,633 shares of common stock issued and we had approximately 1,100 shareholders of record, excluding persons or entities who hold stock in nominee or "street name" accounts with brokers.
Dividends
Dividend payments by Rainier Pacific Financial Group depend primarily on dividends it receives from Rainier Pacific Bank. Under federal regulations, the dollar amount of dividends Rainier Pacific Bank may pay depends upon its capital position and recent net income. Generally, if Rainier Pacific Bank satisfies its regulatory capital requirements, it may make dividend payments up to the limits prescribed in the state law and FDIC regulations. However, institutions that have converted to a stock form of ownership may not declare or pay a dividend on, or repurchase any of, its common stock if the effect thereof would cause the regulatory capital of the institution to be reduced below the amount required for the liquidation account which was established in connection with the conversion. Under Washington law, Rainier Pacific Financial Group is prohibited from paying a dividend if, as a result of its payment, it would be unable to pay its debts as they become due in the normal course of business, or if Rainier Pacific Financial Group's total liabilities would exceed its total assets. For additional information, see Item 1, "Business - How We Are Regulated - Regulation and Supervision of Rainier Pacific Financial Group - Dividends."
The following table sets forth the market price range of, and dividends paid on, the Company's common stock for the years ended December 31, 2007 and 2006. The Company began trading on The Nasdaq Stock Market LLC on October 21, 2003. The following information was provided by The Nasdaq Stock Market LLC.
Stock Purchases
On May 17, 2004, the Company announced a plan to repurchase 4%, or 337,714 shares, of Rainier Pacific Financial Group’s common stock to fund the 2004 Management Recognition Plan, which was completed on June 22, 2004 with the purchase of these shares at an average price of $16.21 per share. On July 21, 2004, we announced our first general stock repurchase program to purchase 390,701 shares, which was completed on October 15, 2004 with the purchase of these shares at an average price of $17.04. During the remainder of the year ended December 31, 2004, we completed one additional stock repurchase program. For the year ended December 31, 2005, we completed two additional stock repurchase programs. We completed one additional stock repurchase program during the year ended December 31, 2006. As of December 31, 2007, we had purchased a total of 2,304,107 of Rainier Pacific Financial Group shares at an average price of $17.08 per share, which represents 27.3% of the 8,442,840 shares that were issued when Rainier Pacific Financial Group went public in October 2003. At December 31, 2007, we had a remaining authorization to purchase 114,483 shares under our February 22, 2006 repurchase plan.
The following table sets forth our purchases of Rainier Pacific Financial Group outstanding common stock during the fourth quarter of the year ended December 31, 2007.
We purchased 12,600 shares of Rainier Pacific Financial Group stock between January 1, 2008 and February 25, 2008. On January 15, 2008, the Board of Directors authorized a 12-month extension of our February 22, 2006 repurchase program of 307,000 shares, which allows us to purchase an additional 101,883 shares of common stock through February 22, 2009.
Equity Compensation Plan Information
The equity compensation plan information presented under subparagraph (d) in Part III, Item 12 of this report is incorporated herein by reference.
Performance Graph. The following graph compares the cumulative total shareholder return on the Company’s Common Stock with the cumulative total return on the Russell 2000 Index, the Nasdaq Bank Index, and the SNL Thrift Index, a peer group index. The graph assumes that total return includes the reinvestment of all dividends, and that the value of the investment in the Company’s Common Stock and each index was $100 on December 31, 2003, and is the base amount used in the graph. The closing price of the Company’s Common Stock on December 31, 2003, 2004, 2005, 2006 and 2007, was $15.92, $17.90, $16.01, $19.83 and $14.81, respectively.
*Source: Bloomberg, SNL Services
Item 6.
Item 6. Selected Financial Data
The following table sets forth certain information concerning our consolidated financial position and results of operations at and for the dates indicated. Certain reclassifications have been made to prior periods’ consolidated financial statements and/or schedules to conform to the current periods’ presentation. Certain information for prior years has been restated in accordance with the SEC’s Staff Accounting Bulletin No. 108 which addresses how the effects of prior year uncorrected misstatements should be considered when quantifying misstatements in current year financial statements. See Note 1 to the Consolidated Financial Statements and accompanying Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K. The effects of these changes are considered immaterial for any individual period. The consolidated data is derived in part from, and should be read in conjunction with, our consolidated financial statements and related notes contained in Item 8 herein.
(1) Net income divided by average total assets.
(2)
Net income divided by average total equity.
(footnotes continued on following page)
(3) Average equity divided by average total assets.
(4)
Total equity divided by total assets.
(5)
Difference between weighted average yield on interest-earning assets and weighted average rate on interest-bearing liabilities.
(6)
Net interest margin, otherwise known as net yield on interest-earning assets, is calculated as net interest income divided by average interest-earning assets.
(7)
The efficiency ratio represents the ratio of non-interest expense divided by the sum of net interest income and non-interest income.
(8)
Total loans are net of deferred fees and costs.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This Form 10-K contains certain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may be identified by the use of words such as "believe," "expect," "anticipate," "should," "planned," "estimated," and "potential." These forward-looking statements relate to, among other things, expectations of the business environment in which the Company operates, projections of future performance, perceived opportunities in the market, potential future credit experience, and statements regarding the Company’s strategies. These forward-looking statements are based upon current management expectations and may, therefore, involve risks and uncertainties. The Company’s actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide variety or range of factors including, but not limited to: interest rate fluctuations; economic conditions in the Company’s primary market area; deposit flows; demand for residential, commercial real estate, consumer, and other types of loans; levels of our non-performing assets and other loans of concern; real estate values; success of new products; competitive conditions between banks and non-bank financial service providers; regulatory and accounting changes; success of new technology; technological factors affecting operations; costs of technology; pricing of products and services; costs of constructing new buildings; time to lease excess space in Company-owned buildings; and other risks detailed from time to time in our filings with the Securities and Exchange Commission. Accordingly, these factors should be considered in evaluating forward-looking statements, and undue reliance should not be placed on such statements. The Company undertakes no responsibility to update or revise any forward-looking statements. These risks could cause our actual results beyond 2007 to differ materially from those expressed in any financial statements made by or on behalf of the Company.
General
Our results of operations depend primarily on revenue generated as a result of our net interest income and non-interest income. Net interest income is the difference between the interest income we earn on our interest-earning assets (consisting primarily of loans and investment securities) and the interest we pay on our interest-bearing liabilities (consisting primarily of customer savings and money market accounts, time deposits and borrowed funds). Non-interest income consists primarily of service charges on deposit and loan accounts, gains on the sale of loans and investments, loan servicing fees, real estate lease income, and investment and insurance commissions. Our results of operations are also affected by our provisions for loan losses and non-interest expenses. Non-interest expenses consist primarily of compensation and benefits, occupancy, office operations and supplies, equipment, data processing, marketing, and, when applicable, deposit insurance premiums. Our results of operations are also affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities.
Business Strategy
As a financial service provider, we serve more than 25,000 households in our primary market area of Tacoma-Pierce County and the neighboring City of Federal Way in Washington State. We principally focus on growing and expanding customer relationships in this geographical market area and provide our services primarily
through 14 full-service retail locations, 22 automated teller machines, and our Call Center. In addition, we offer customers 24-hour access through our internet banking services and automated voice response telephone banking system. Our strategy of delivering services through the combined availability of branches, the internet, and our call center provides customers with personalized options on how they want to access our services.
Our traditional banking services consist of attracting retail checking, money market, and certificates of deposit from the general public and small businesses; which we invest primarily in commercial real estate loans, multi-family real estate loans, real estate construction and land loans, one- to four-family real estate loans, a variety of consumer loans (e.g., credit cards, home equity, automobile), and commercial business loans. We are a member of the Federal Home Loan Bank of Seattle and use borrowed funds as a funding source to supplement customer deposits for funding loans and investments and to assist us in managing liquidity and our interest rate risk.
We also focus on building and deepening customer relationships by offering financial planning and investment services, as well as property and casualty insurance products to our customers and the local community. We provide financial planning and non-insured investment products and conduct business under the name of Rainier Pacific Financial Services. We offer property and casualty and life insurance products and conduct business under the name of Rainier Pacific Insurance Services.
We plan to continue growing our market share of local insured deposits and increasing our portfolio of commercial and multi-family real estate loans, construction loans, and commercial business loans over the next few years. In addition, we will continue to seek acquisitions of small property and casualty insurance agencies in our local market area to grow and diversify our revenue base.
Operating Strategy
Our mission is to build profitable relationships by providing valuable financial solutions for our customers. Service quality, broad product selection, and convenient access are all primary attributes of our brand and business strategy. We focus on providing exceptional service and quality products and services, as well as convenient access to generate a high level of customer satisfaction. We are committed to providing a network of branch offices and proprietary automated teller machines that enable our customers to access our services within 15 minutes from essentially anywhere in Pierce County and the City of Federal Way.
Our operating strategy is focused on continuing to build the value of our Company by profitably offering a broad array of financial products and services to residents and businesses located in our primary geographical market area of operation. We plan to grow existing retail customer relationships, by gaining an increased proportion of their deposits, loans and investments, increasing our commercial and multi-family real estate loans, real estate construction and land loans, and small business loans that offer the greatest potential for future profits. In addition, we intend to focus on the expansion and growth of products and services that provide the greatest potential for the generation of future recurring non-interest income, including property and casualty insurance services and growth of customer investment assets under administration. We will seek to maintain favorable asset quality by using prudent underwriting standards, maintaining a low level of non-performing assets, and adequate loan loss reserves.
We have established strategic objectives that guide our actions. Our primary strategic objectives are: (1) being a full-service financial solutions provider delivering a high degree of value to our customers and community; and (2) actively managing Rainier Pacific Financial Group to produce a financially stable organization that consistently grows its market value.
Critical Accounting Estimate
Management recognizes that loan losses occur over the life of a loan, and that the allowance for loan losses must be maintained at a level sufficient to absorb probable losses inherent in the loan portfolio. Management's determination of the allowance is based on a number of factors, including the level of non-performing loans, loan loss experience, credit concentrations, a review of the quality of the loan portfolio, underwriting practices, collateral
values and economic conditions. The allowance is increased by the provision for loan losses, which is charged against current period operating results and decreased by the amount of actual loan charge-offs, net of recoveries.
We believe that the accounting estimate related to the allowance for loan losses is a "critical accounting estimate" because: (1) it is highly susceptible to change from period to period because it requires company management to make assumptions about future losses on loans; and (2) the impact of a sudden large loss could significantly reduce the allowance and potentially require increased provisions to replenish the allowance, which would negatively affect earnings.
Our methodology for assessing the appropriateness of the allowance consists of two key elements: a formula element and a specific element
We review the consumer and residential loan portfolios as pools of loans since no single loan is individually significant. The formula element is calculated by applying a loss percentage factor to the various loan types based on past due ratios, historical loss experience, regulatory and internal credit grading and classification systems, and changes in underwriting practices that could affect the collectibility of the portfolio. Additionally, we consider economic and other factors, including loan volumes and concentrations, seasoning of the loan portfolio, and local employment data. These factors may be adjusted for events that are significant in management's judgment as of the evaluation date.
We determine the specific element through the evaluation of commercial real estate and commercial business on an individual basis once a loan is deemed impaired. A loan is considered impaired when, based on current information, management determines it is probable that the Company will be unable to collect all amounts due according to the terms of the loan agreement. Impairment is measured by the difference between the recorded investment in the loan (including accrued interest and net deferred loan fees or costs) and the estimated present value of total expected future cash flows, discounted at the loan's effective rate, or the fair value of the collateral, if the loan is collateral dependent. The amount by which the recorded investment in the loan exceeds either the present value of expected future cash flows or the value of the impaired loan's collateral, when applicable, would be a specifically allocated portion of the allowance for loan losses. Any portion of an impaired loan classified as loss under regulatory guidelines is charged off.
Our asset liability management committee (primarily consisting of senior management) reviews and analyzes the loan portfolio, charge-offs, and allowance on a quarterly basis. Management then discusses the development and calculation of this critical accounting estimate with the loan and investment committee of our board of directors. The audit committee of our board of directors also reviews the Company's disclosures including this critical accounting estimate.
We reviewed and evaluated the loan portfolio and the adequacy of the allowance at December 31, 2007 and believe that the allowance is adequate for the risk inherent in the loan portfolio considering the current economic environment. In 2007, the total loan portfolio decreased 0.4% to $637.0 million at December 31, 2007 from $639.4 million at December 31, 2006. The recent weakness in one- to four-family home sales, slowdown in the economic environment, and portfolio growth during the last few years in our real estate construction and land, multi-family, and commercial real estate loans has increased our exposure to loan losses. In September 2002, the Bank started making one- to four-family real estate construction and land loans. As of December 31, 2007, real estate construction and land loans were 12.4% of the loan portfolio and totaled $78.8 million, a decrease of $908,000, or 1.1%, from $79.7 million in fiscal 2006. This was, however, $62.6 million higher compared to $16.2 million for the year ended December 31, 2004. In addition, the loan portfolio has experienced substantial growth especially in multi-family and commercial real estate loans. At December 31, 2007, the multi-family and commercial real estate portfolios totaled $362.0 million, up from $358.9 million, $325.2 million, and $269.5 million for the years ended December 31, 2006, 2005, and 2004, respectively. In the December 31, 2007 allowance for loan loss review, we determined that the allowance was adequate at 1.27% of total loans, or $8.1 million compared to 1.30% of total loans or $8.3 million at December 31, 2006. The decrease in the allowance is primarily a result of the changing
composition of the loan portfolio with increased real estate secured loans and decreased consumer loans, lower historical loss experience, and improved credit quality.
The Bank recorded net charge-offs of $804,000, $914,000, $1.1 million, $2.0 million and $2.3 million during the years ended December 31, 2007, 2006, 2005, 2004 and 2003, respectively. Consumer loans (including home equity) totaled $96.7 million, $106.1 million, $102.6 million, $116.8 million, and $129.9 million or 15.2%, 16.6%, 17.6%, 23.2%, and 29.0% of the loan portfolio at December 31, 2007, 2006, 2005, 2004, and 2003, respectively. Consumer loans, including home equity loans, account for essentially all of the Bank's charge-offs.
The provision for loan losses has fluctuated based upon the growth of the loan portfolio, the changing characteristics and composition of the portfolio, and the level of charge-offs and with consideration to the current economic environment. The provision for loan losses was $600,000, $600,000, $750,000, $2.7 million and $4.5 million for the years ended 2007, 2006, 2005, 2004 and 2003, respectively. If management's estimate of the allowance deviated by plus or minus 20% then the $8.1 million allowance at December 31, 2007 could either decrease to $6.6 million or increase to $9.9 million. The provision for loan losses would then subsequently increase or decrease by $1.6 million, with net income correspondently increasing or decreasing by $1.1 million after federal income taxes.
Critical Accounting Policies
The Company's significant accounting principles are described in Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this report and are essential to understanding Management's Discussion and Analysis of Financial Condition and Results of Operations. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions which affect the reported amounts and disclosures. Actual results may differ from these estimates under different assumptions or conditions. The following policies involve a higher degree of judgment than do our other significant accounting policies detailed in Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this report.
Allowance for Loan Losses. The Company reviews historical origination and charge-off relationships, charge-off experience factors, collection data, delinquency reports, estimates of the value of the underlying collateral, economic conditions and trends and other information in order to make the necessary judgments as to the appropriateness of the provision for loan losses and the allowance for loan losses. Loans are charged off to the allowance for loan losses when the Company repossesses the collateral or the account is otherwise deemed uncollectible. The Company believes that the allowance for loan losses is adequate to cover probable losses inherent in its loan portfolio; however, because the allowance for loan losses is based on estimates, there can be no assurance that the ultimate charge-off amount will not exceed the estimates.
Investments. The Company classifies its investments as either available-for-sale or held-to-maturity. Available-for-sale securities are reported at their fair value, which is determined by obtaining quoted market prices. Unrealized gains and losses on available-for-sale securities are included in other comprehensive income and excluded from earnings. Realized gains and losses and declines in fair value judged to be other than temporary are included in earnings. The fair value of financial instruments is discussed in more detail in Note 16 of the Notes to Consolidated Financial Statements included in Item 8 of this report.
Long-Lived Assets and Intangibles. The Company periodically assesses the impairment of its long-lived assets and intangibles using judgment as to the effects of external factors, including market conditions. Judgment is also required in projecting future operating results. If actual external conditions and future operating results differ from the Company's judgments, impairment charges may be necessary to reduce the carrying value of these assets to the appropriate market value.
Accrued Taxes. The Company estimates tax expense based on the amount it expects to owe various tax authorities. Taxes are discussed in more detail in Note 9 of the Notes to Consolidated Financial Statements included
in Item 8 of this report. Accrued taxes represent the net estimated amount due or to be received from taxing authorities. In estimating accrued taxes, management assesses the relative merits and risks of the appropriate tax treatment of transactions taking into account statutory, judicial and regulatory guidance in the context of our tax position.
Comparison of Financial Condition at December 31, 2007 and December 31, 2006
The following table sets forth certain information concerning our consolidated financial condition at the dates indicated (dollars in thousands):
____________
(1) Includes mortgage-backed securities.
Total assets decreased by $23.8 million, or 2.6%, to $878.9 million at December 31, 2007 from $902.7 million at December 31, 2006. This decrease reflects a $20.7 million decline in the investment securities portfolio and a $2.2 million decline in the loan portfolio. The decline in investments was primarily due to principal payments made on mortgage-backed securities, as well as partial calls and a temporary decline in the market value of our trust preferred securities. The decline in loans reflected a lower level of loan originations compared to prior year, a continued high level of commercial real estate and multi-family loan prepayments, and increased one- to four-family mortgage loan sales. Deposits increased $4.1 million to $461.5 million from $457.4 million, resulting from increases in interest-bearing customer deposits, primarily money market accounts. Shareholders' equity decreased $1.0 million to $86.8 million at December 31, 2007 from $87.8 million at December 31, 2006, primarily due to the temporary decline in market value of our trust preferred securities, partially offset by the net income earned for the year ended December 31, 2007.
Loans. The following table sets forth the composition of our loan portfolio by type of loan at the dates indicated (dollars in thousands):
Our net loan portfolio decreased $2.2 million, or 0.3%, to $628.9 million at December 31, 2007 from $631.1 million at December 31, 2006. This decrease was primarily attributable to a $14.0 million, or 8.6% decline in our multi-family residential loans and lower automobile loan portfolio balances, which decreased $11.1 million, or 34.8%. Additionally, one- to four-family loans decreased $4.7 million, or 5.7% as a result of $23.7 million in sales during the year in this category. The decline in multi-family real estate loans was largely due to $34.5 million in prepayments while the decline in our auto loan portfolio was the result of our decision to reduce the origination volume of higher risk indirect auto loans during 2007. Partially offsetting these decreases were commercial real estate loans, which increased $17.0 million, commercial business loans, which increased $9.6 million, and home equity loans, which increased $2.6 million. Total loans secured by real estate were relatively unchanged at $562.9 million at year-end December 31, 2007 and 2006. Subject to market conditions, we will continue to focus on growing our real estate secured loans, primarily multi-family and commercial real estate loans.
Investments. The following table sets forth the composition of our investment securities portfolio at the dates indicated. Available-for-sale investments are presented at net book value after a mark-to-market fair value adjustment, while the held-to-maturity securities are presented at amortized cost. Our investment in the Federal Home Loan Bank of Seattle's common stock is presented at cost and for reference purposes only (dollars in thousands):
Our investment securities portfolio decreased by $20.7 million, or 10.5%, to $177.0 million at December 31, 2007 from $197.8 million at December 31, 2006. The decrease was primarily attributable to $11.9 million in principal payments on mortgage-backed securities and $2.5 million in partial calls on trust preferred securities. Additionally, the mark-to-market value adjustment on available-for-sale securities experienced a temporary decline of $5.7 million primarily as the result of market valuation changes, not investment grade changes, on our trust preferred securities portfolio. The decline in value on the trust preferred securities is a result of spreads increasing in response to the credit markets tightening during the fourth quarter.
Deposits. The following table sets forth the composition of our deposits at the dates indicated (dollars in thousands):
Our deposits increased $4.1 million, or 0.9%, to $461.5 million at December 31, 2007 from $457.4 million at December 31, 2006. Interest-bearing deposits increased by $3.9 million, or 0.9% and non-interest bearing deposits were up $202,000. Our deposit mix at the end of the year included 49.1% of relatively low-cost checking, savings, money market, and individual retirement accounts. Certificates of deposit at December 31, 2007 included $60.9 million of brokered certificates of deposit, an increase of $10.0 million from the $50.9 million of brokered certificates of deposit at December 31, 2006.
Borrowings. The Federal Home Loan Bank of Seattle advances decreased $24.9 million, or 7.2%, to $320.5 million at December, 2007 from $345.4 million at December 31, 2006. We used the borrowed funds as part of our capital and interest rate risk management strategies for both short- and long-term funding of loans and investment securities. We also utilize borrowings from the Federal Home Loan Bank of Seattle to fund attractive
loan and investment opportunities and to enhance earnings in connection with leveraging the Company's capital to increase our net interest income.
Capital. Total shareholders' equity decreased $1.0 million, or 1.1%, to $86.8 million at December 31, 2007 from $87.8 million at December 31, 2006. This decrease in equity was the result of a $3.8 million unrealized loss, net of tax, for a temporary decline in the market value of our available-for-sale securities, $2.1 million in common stock repurchases, and $1.7 million in cash dividends paid to shareholders. Partially offsetting these decreases was net income of $3.9 million and $2.7 million in positive equity adjustments related to stock compensation and benefits. As a result of these factors, and the $23.8 million decrease in assets, our capital-to-assets ratio under accounting principles generally accepted in the United States increased to 9.88% for December 31, 2007, compared to 9.73% for December 31, 2006.
Comparison of Operating Results for the Years Ended December 31, 2007 and 2006
The following table sets forth certain information concerning our results of operations for the periods indicated (dollars in thousands):
Net Interest Income. The following table sets forth detailed information concerning our net interest income for the periods indicated (dollars in thousands):
Our net interest income increased to $26.3 million for the year ended December 31, 2007, compared to $25.0 million for the year ended December 31, 2006. The $1.3 million increase in net interest income resulted from increased interest income of $3.5 million, which was partially offset by the increase in our interest expense of $2.2 million. Our interest rate spread increased 11 basis points to 2.69% for the year ended December 31, 2007, from
2.58% for the year ended December 31, 2006, primarily due to yield increases in our loan and investment portfolios, which was greater than the increase in our cost of deposits.
Interest Income. Our interest income increased $3.5 million, or 6.5%, to $57.7 million for the year ended December 31, 2007 from $54.2 million for the year ended December 31, 2006. Interest earned on loans for the year ended December 31, 2007 and 2006 was $47.2 million and $43.0 million, respectively. The average yield on total loans was 7.35% for the year ended December 31, 2007 compared to 7.03% for the year ended December 31, 2006. The average balance of total loans also increased by $30.4 million to $642.1 million for the year ended December 31, 2007 from $611.7 million for the year ended December 31, 2006. A significant portion of the loan portfolio consists of real estate secured loans which do not immediately re-price when interest rates change. Real estate construction and land loans, home equity lines of credit, credit card loans, and a large portion of our commercial business loans, however, readily re-price when short-term interest rates change. The increase in yield on these loan products, combined with the increase in average balance of loans, primarily contributed to the increased interest income on loans.
Interest income on investment securities (including mortgage-backed securities) decreased only $524,000, or 4.8%, to $10.4 million for the year ended December 31, 2007 despite a $28.0 million decrease in the average balance of investment securities. The average balance of investment securities (including mortgage-backed securities) for the years ended December 31, 2007 and 2006 was $190.4 million and $218.5 million, respectively. The average yield on investment securities increased to 5.43% for the year ended December 31, 2007 from 4.98% for the year ended December 31, 2006, primarily as a result of floating rate trust preferred securities repricing upwards due to the increases in short-term interest rates during most of 2007.
Interest Expense. Our interest expense increased $2.2 million, or 7.5%, to $31.4 million for the year ended December 31, 2007 from $29.2 million for the year ended December 31, 2006. In addition to an increase in the average balances of our deposits, rising market rates increased our deposit and borrowing costs.
Interest expense on deposits increased $2.0 million, or 14.1%, to $16.2 million for the year ended December 31, 2007 from $14.2 million for the year ended December 31, 2006. The average cost of deposits increased 39 basis points to 3.82% for the year ended December 31, 2007 from 3.43% for the year ended December 31, 2006. This increase in deposit costs for the year ended December 31, 2007 was primarily a result of an average balance increase of $25.2 million in higher cost money market deposit accounts, partially offset by an average balance decrease of $13.8 million in higher cost certificates of deposits.
Interest expense on borrowed funds increased $196,000, or 1.3%, to $15.2 million for the year ended December 31, 2007 from $15.0 million for the year ended December 31, 2006. The increase was solely due to a cost increase as average balances of Federal Home Loan Bank of Seattle advances decreased $16.2 million to $339.6 million for the year ended December 31, 2007 from $355.8 million for the year ended December 31, 2006. The cost of borrowed funds increased 26 basis points to 4.48% for the year ended December 31, 2007 from 4.22% for the year ended December 31, 2006 as lower rate fixed-rate advances matured.
Provision for Loan Losses. The following table sets forth an analysis of our allowance for loan losses at the dates and for the periods indicated (dollars in thousands):
Our provision for loan losses was unchanged at $600,000 for the years ended December 31, 2007 and December 31, 2006. The provision was recorded at a level considered appropriate to ensure that the allowance for loan losses was adequate to address the inherent credit risk in the loan portfolio. The allowance for loan losses as a percent of total loans decreased to 1.27% at December 31, 2007 from 1.30% at December 31, 2006. The decrease in the allowance ratio and total allowance was largely the result of good credit quality as our loan portfolio contained more real estate secured loans, which have historically experienced a very low level of losses, and a decrease in non-real estate-secured consumer loans, which have historically experienced higher losses. At December 31, 2007, the allowance for loan losses totaled $8.1 million compared to $8.3 million at December 31, 2006.
Management believes our allowance for loan losses as of December 31, 2007 was adequate to absorb the known and inherent risks of loss in the loan portfolio at that date. While management believes the estimates and assumptions used in its determination of the adequacy of the allowance were reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. In addition, the determination of the amount of our allowance for loan losses is subject to review by bank regulators, as part of the routine examination process, which may result in the establishment of additional reserves based upon their judgment of information available to them at the time of their examination.
Non-interest Income. The following table sets forth information regarding our non-interest income for the periods indicated (dollars in thousands):
Our non-interest income for the year ended December 31, 2007 increased $746,000, or 8.4%, to $9.6 million from $8.9 million for the year ended December 31, 2006, primarily a result of increases in other operating income of $313,000, insurance service fees of $234,000, loan service fees of $126,000, and net gain on sale of loans of $101,000. Excluding a $325,000 non-recurring settlement of a claim against one of our software vendors, non-interest income for 2007 was $9.3 million, up 4.7% compared to 2006. Insurance services fees increased primarily due to the purchase of two small property and casualty insurance books of business in 2007. Loan service fees increased $126,000 to $1.3 million in 2007 as a result of a $114,000 increase in loan modification and extension fees. Gain on sale of loans, net increased $101,000 to $379,000 for year ended December 31, 2007 as a result of increased one- to four-family fixed rate loans sales during the year. Partially offsetting these increases was real estate lease income, which declined $27,000 as two of our tenants’ leases ended in the later half of 2007. Additionally, deposit services fees decreased $24,000 due to a lower incidence rate of overdraft and return item fees. All other categories of non-interest income reflected a net increase of $23,000.
Non-interest Expense. The following table sets forth information regarding our non-interest expense for the periods indicated (dollars in thousands):
Non-interest expense increased $303,000, or 1.1%, to $29.0 million for the year ended December 31, 2007 from $28.7 million for the year ended December 31, 2006. The increase in the current year was primarily attributable to increases in other operating expense of $863,000 and compensation and benefits of $557,000, partially offset by a $1.2 million decrease in office operations expense.
The $863,000 increase in other operating expense was primarily attributable to higher expenses in five areas. We incurred a $173,000 non-recurring expense related to our share of litigation settlements between VISA USA Inc. and its member banks and American Express and Discover Financial Services. Deposit insurance expense totaled $258,000 as the Bank was subject to FDIC deposit insurance premiums in 2007. Additionally, business and occupation tax expense increased $131,000 for the year ended December 31, 2007, due to increased revenue, while safety and soundness examination fees increased $91,000 as a result of a bi-annual state examination. The fifth other major operating expense increase for 2007 was $70,000 in operational losses, which included the charge-off of uncollectible items related to overdrafts from VISA debit/check cards, fraud, and checks.
Compensation and benefits increased $557,000, or 3.5%, to $16.3 million for the year ended December 31, 2007 from $15.8 million for the year ended December 31, 2006. The increase was the result of increased base pay, primarily as a result of higher position values for 2007 compared to 2006, as well as an increase of full-time equivalent employees.
Partially offsetting the increases was a decrease in office operations expense of $1.2 million, or 23.1% to $4.0 million for the year ended December 31, 2007 from $5.2 million for the year ended December 31, 2006. The decrease was primarily attributable to a $1.3 million decrease in depreciation expense as our primary operating software became fully depreciated in November of 2006.
All other non-interest expenses increased by a net amount of $76,000 for the year ended December 31, 2007 compared to the year ended December 31, 2006.
Comparison of Financial Condition at December 31, 2006 and December 31, 2005
The following table sets forth certain information concerning our consolidated financial condition at the dates indicated (dollars in thousands):
Total assets increased by $31.9 million, or 3.7%, to $902.7 million at December 31, 2006 from $870.8 million at December 31, 2005. This increase reflects loan portfolio growth of $56.8 million to $631.1 million from $574.3 million, partially offset by a decrease of $27.9 million in investment securities. The growth in loans was primarily funded by maturing investment securities and increased customer deposits. Deposits increased $19.4 million to $457.4 million from $438.0 million, resulting from increases in interest-bearing customer deposits. Shareholders' equity increased $3.1 million to $87.8 million at December 31, 2006 from $84.7 million at December 31, 2005, primarily due to the net income earned during the year ended December 31, 2006.
Loans. The following table sets forth the composition of the Company's loan portfolio by type of loan at the dates indicated (dollars in thousands):
Our net loan portfolio increased $56.8 million, or 9.9%, to $631.1 million at December 31, 2006 from $574.3 million at December 31, 2005. This increase was primarily attributable to the growth of our commercial real estate loans, which increased $29.6 million or 17.8%; one- to four-family residential construction and land loans, which increased $22.3 million, or 41.8%; and home equity loans, which increased $10.8 million, or 33.7%. Additional growth in the loan portfolio was generated in multi-family real estate loans, which increased $4.1 million or 2.6%; commercial business loans, which increased $3.9 million, or 42.3%; and the Visa portfolio, which increased $1.3 million, or 5.8%. These increases were partially offset by declines in the automobile loan portfolio, which decreased $7.5 million, or 19.1% and commercial residential and non-residential construction loans, which decreased $3.5 million, or 45.4%. Additionally, one- to four-family residential loans decreased $3.4 million, or 4.0% primarily as a result of $19.6 million in sales in this category. Total loans secured by real estate increased $59.9 million, or 11.9%, to $562.9 million at December 31, 2006 from $503.0 million at December 31, 2005.
Investments. The following table sets forth the composition of our investment securities at the dates indicated. The available-for-sale investments are presented at net book value after a mark-to-market fair value adjustment, while the held-to-maturity securities are presented at amortized cost. Our investment in the Federal Home Loan Bank of Seattle's common stock is presented at cost and for reference purposes only (dollars in thousands):
Our investment securities portfolio decreased by $27.9 million, or 12.4%, to $197.8 million at December 31, 2006 from $225.7 million at December 31, 2005. The decrease was primarily attributable to the maturity of a $20.0 million held-to-maturity security and a decrease in mortgage-backed securities of $15.0 million, or 19.1% to $63.0 million from $78.0 million primarily as a result of prepayments. Partially offsetting these decreases was the purchase of $9.0 million of adjustable-rate trust preferred securities added to the portfolio during the first quarter of 2006.
Deposits. The following table sets forth the composition of our deposits at the dates indicated (dollars in thousands):
Our deposits increased $19.4 million, or 4.4%, to $457.4 million at December 31, 2006 from $438.0 million at December 31, 2005. Interest-bearing deposits increased by $16.7 million, or 4.1% and non-interest bearing deposits were up $2.7 million. Our deposit mix at the end of the year included 48.2% of relatively low-cost checking, savings, money market, and individual retirement accounts. Certificates of deposit at December 31, 2006 included $50.9 million of brokered certificates of deposit, a decline of $1.3 million from the $52.2 million of brokered certificates of deposit at December 31, 2005.
Borrowings. The Federal Home Loan Bank of Seattle advances increased $5.2 million, or 1.5%, to $345.4 million at December, 2006 from $340.2 million at December 31, 2005. We used the borrowed funds as part of our capital and interest rate risk management strategies for both short- and long-term funding of loans and investment securities. We utilize borrowings from the Federal Home Loan Bank of Seattle to fund attractive loan and investment opportunities and to enhance earnings in connection with leveraging the Company's capital to increase our net interest income.
Capital. Total shareholders' equity increased $3.1 million, or 3.7%, to $87.8 million at December 31, 2006 from $84.7 million at December 31, 2005. The increase in equity from December 31, 2005 to December 31, 2006 was the result of $2.8 million in net income, $3.0 million in positive equity adjustments related to stock compensation and benefits, and $635,000 in unrealized gains on securities. The $6.5 million of positive equity items were offset by $1.7 million of common stock repurchases and $1.6 million of dividends paid to shareholders. As a result of these factors, and the $31.9 million increase in assets, our capital-to-assets ratio under accounting principles generally accepted in the United States was relatively unchanged at 9.73% for December 31, 2006 and December 31, 2005.
Comparison of Operating Results for the Years Ended December 31, 2006 and 2005
The following table sets forth detailed information concerning the Company’s results of operations for the periods indicated (dollars in thousands):
Net Interest Income. The following table sets forth detailed information concerning our net interest income for the periods indicated (dollars in thousands):
Our net interest income increased to $25.0 million for the year ended December 31, 2006, compared to $24.4 million for the year ended December 31, 2005. The $572,000 increase in net interest income resulted from increased interest income of $11.1 million, which was largely offset by the higher increase in our interest expense. Our interest rate spread decreased to 2.58%, or 39 basis points, for the year ended December 31, 2006, from 2.97% for the year ended December 31, 2005, due to the impact of rising short-term rates and a slightly inverted yield curve that caused our liability costs to rise more rapidly than our yields on earning assets. A $108.9 million increase in the average balance of interest-earning assets for the year ended December 31, 2006 offset the impact of this margin compression and resulted in a $572,000 increase in net interest income for 2006 compared to 2005.
Interest Income. Our interest income increased $11.1 million, or 25.7%, to $54.2 million for the year ended December 31, 2006 from $43.1 million for the year ended December 31, 2005. Interest earned on loans for the year ended December 31, 2006 and 2005 was $43.0 million and $35.0 million, respectively. The average yield on total loans was 7.03% for the year ended December 31, 2006 compared to 6.66% for the year ended December 31, 2005. The average balance of total loans also increased by $85.7 million to $611.7 million for the year ended December 31, 2006 from $526.0 million for the year ended December 31, 2005. A significant portion of the loan portfolio consists of fixed-rate real estate secured loans which do not immediately re-price when interest rates change. Construction loans, home equity lines of credit, credit card loans, and our commercial loans, however,
readily re-price when short-term interest rates change. The increase in yield on these loan products, combined with the increase in average balance of loans, primarily contributed to the increased interest income on loans.
Interest income on investment securities (including mortgage-backed securities) increased $2.9 million, or 35.7%, to $10.9 million for the year ended December 31, 2006 from $8.0 million for the year ended December 31, 2005 as a result of a higher average balance and yields on investment securities. The average balance of investment securities for the year ended December 31, 2006 and 2005 was $218.5 million and $199.6 million, respectively. The average yield on investment securities increased to 4.98% for the year ended December 31, 2006 from 4.01% for the year ended December 31, 2005, primarily as a result of floating rate trust preferred securities repricing upward as short-term interest rates rose through mid-2006.
Interest Expense. Our interest expense increased $10.5 million, or 56.1%, to $29.2 million for the year ended December 31, 2006 from $18.7 million for the year ended December 31, 2005. In addition to an increase in the average balances of our deposits and borrowings, rising market rates increased our deposit and borrowing costs.
Interest expense on deposits increased $6.7 million, or 90.6%, to $14.2 million for the year ended December 31, 2006 from $7.5 million for the year ended December 31, 2005. The average cost of deposits increased 129 basis points to 3.43% for the year ended December 31, 2006 from 2.14% for the year ended December 31, 2005. This increase in deposit costs for the year ended December 31, 2006 was primarily a result of higher rates paid on money market and certificate of deposits and an increase in average balances of $44.5 million in certificates of deposit and brokered deposit accounts, $19.8 million in interest bearing checking accounts, and $6.8 million in money market accounts.
Interest expense on borrowed funds increased $3.7 million, or 33.2%, to $15.0 million for the year ended
December 31, 2006 from $11.3 million for the year ended December 31, 2005. The average balances of Federal Home Loan Bank of Seattle advances were $355.8 million for the year ended December 31, 2006, an increase of $46.9 million from $308.9 million for the year ended December 31, 2005. In addition to the increased balances, the cost of borrowed funds increased by 57 basis points to 4.22% during the year ended December 31, 2006 from 3.65% for the year ended December 31, 2005 as short-term market rates rose.
Provision for Loan Losses. The following table sets forth an analysis of our allowance for loan losses at the dates and for the periods indicated (dollars in thousands):
Our provision for loan losses decreased $150,000, or 20.0% to $600,000 for the year ended December 31, 2006 from $750,000 for the year ended December 31, 2005. The provision was recorded at a level considered appropriate to ensure that the allowance for loan losses was adequate to address the inherent credit risk in the loan portfolio. The allowance for loan losses as a percent of total loans decreased to 1.30% at December 31, 2006 from 1.47% at December 31, 2005. The decrease in the allowance ratio and total allowance was largely the result of the improved credit quality of the loan portfolio due primarily to growth in real estate secured loans, which have historically experienced a very low level of losses, and a decreased balance of consumer loans (excluding home equity loans), which have historically experienced higher losses, and improved credit quality of the loan portfolio. At December 31, 2006, the allowance for loan losses totaled $8.3 million compared to $8.6 million at December 31, 2005.
Management believes our allowance for loan losses as of December 31, 2006 was adequate to absorb the known and inherent risks of loss in the loan portfolio at that date. While management believes the estimates and assumptions used in its determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. In addition, the determination of the amount of our allowance for loan losses is subject to review by bank regulators, as part of the routine examination process, which may result in the establishment of additional reserves based upon their judgment of information available to them at the time of their examination.
Non-interest Income. The following table sets forth information regarding our non-interest income for the periods indicated (dollars in thousands):
Our non-interest income for the year ended December 31, 2006 increased $1.6 million, or 21.2%, to $8.9 million from $7.3 million for the year ended December 31, 2005, primarily a result of increases in insurance service fees of $1.5 million and real estate lease income of $510,000. The purchase of the Christopherson-Boze and Holman Insurance Agencies, completed on January 3, 2006, provided the primary contribution to the $1.5 million increase in insurance service fee income. The Bank's administrative office building was fully leased during the year ending December 31, 2006, which contributed $458,000 of the $510,000 increase in real estate lease income, as the administrative office was not fully leased until September 2005. Partially offsetting these increases was a $216,000 decline in the gain on sale of loans for the comparative periods as a result of a lower level of originations of one- to four-family residential real estate loans during the year ended December 31, 2006. The one- to four-family mortgages we originate are primarily refinanced mortgages. Based on the current interest rate environment, consumer demand for mortgage refinances declined during the year providing for a lower volume of one- to four-family loan origination and sales. Additionally, deposit services fees decreased $189,000 due to a lower incidence rate of overdraft and return item fees. All other categories of non-interest income reflected a net decrease of $32,000.
Non-interest Expense. The following table sets forth information regarding our non-interest expense for the periods indicated (dollars in thousands):
Non-interest expense increased $1.8 million, or 6.7%, to $28.7 million for the year ended December 31, 2006 from $26.9 million for the year ended December 31, 2005. The increase in the current year was primarily attributable to increases in compensation and benefits of $1.5 million, occupancy expense of $488,000, and other operating expenses of $243,000.
Compensation and benefits increased $1.5 million, or 10.6%, to $15.8 million for the year ended December 31, 2006 from $14.3 million for the year ended December 31, 2005, primarily as a result of $594,000 associated with additional employees hired in connection with the acquisition of the Christopherson-Boze and Holman Insurance Agencies in January 2006, $477,000 related to expensing previously granted stock options, and costs related to additional staff expense associated with the opening of a new branch in July 2006.
Occupancy expense increased $488,000, or 22.8%, primarily as a result of a $175,000 increase in the amortization of capitalized tenant and leasehold improvements, a $132,000 increase in utilities and building maintenance, and a $76,000 increase in rent expense related to the operations of the Christopherson-Boze and Holman Insurance Agencies.
The $243,000 increase in other operating expense was primarily attributable to a $226,000 increase in the amortization of our intangible assets as a result of acquiring two insurance agencies, and increases in various other operating expenses.
All other non-interest expenses decreased by a net amount of $435,000 for the year ended December 31, 2006 compared to year ended December 31, 2005.
Average Balances, Interest and Average Yields/Costs
The following table sets forth, for the periods indicated, information regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resultant yields, interest rate spread, net interest margin (otherwise known as net yield on interest-earning assets), and the ratio of average interest-earning assets to average interest-bearing liabilities. Average balances have been calculated using the average of daily balances during the period.
___________________________
(1)
Average total loans includes non-performing loans and is net of deferred fees and costs. Interest income does not include interest on loans 90 days or more past due.
(2)
The 2006 interest expense was reduced by a capitalized interest credit of $24,000 from the construction of a new branch in 2006.
(3)
Net interest margin, otherwise known as net yield on interest-earning assets, is calculated as net interest income divided by average interest-earning assets.
Yields Earned and Rates Paid
The following table sets forth, for the periods and at the dates indicated, the weighted average yields earned on Rainier Pacific Bank's assets, the weighted average interest rates paid on Rainier Pacific Bank's liabilities, together with the interest rate spread and net yield on interest-earning assets.
________________
(1)
Weighted average rate earned on loans at December 31, 2007 does not include a yield adjustment for deferred loan fees/costs. The weighted average rate earned on loans for the years ended December 31, 2007, 2006 and 2005 includes a yield adjustment for deferred loan fees from the actual amortization of net loan fees. Total loans net of deferred loan fees/costs were used to calculate the yield on total interest-earning assets.
(2)
Net interest margin, otherwise known as net yield on interest-earning assets, is calculated as net interest income divided by average interest-earning assets.
Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes on the net interest income of Rainier Pacific Bank. Information is provided with respect to effects on interest income and interest expense attributable to changes in volume (changes in volume multiplied by prior rate), effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume), and changes in rate/volume (changes attributable to the combined impact of volume and rate).
____________
(1)
Changes attributable to the combined impact of volume and rate have not been allocated to the specific changes due to volume and rate. If such changes were to be allocated, they would be done so proportionately to the specific changes due to volume and rate.
Asset and Liability Management and Market Risk
General. Rainier Pacific Bank's board of directors has established asset liability management policies to guide management in managing the differences in terms between interest-earning assets and interest-bearing liabilities while maintaining acceptable levels of liquidity, capital adequacy, interest rate sensitivity, credit risk, and profitability. The policy includes the use of an asset liability management committee whose members primarily consist of the members of senior management. The committee's purpose is to communicate, coordinate and manage our asset/liability positions consistent with our business plan and board-approved policies. The asset liability management committee meets twice a month to review various areas including:
•
economic conditions;
•
interest rate outlook;
•
current and projected liquidity needs;
•
asset/liability mix;
•
interest rate risk sensitivity;
•
current market opportunities to promote specific products;
•
loan and deposit product pricing;
•
historical financial results;
•
projected financial results; and
•
capital position.
In addition, the committee members frequently meet on an ad hoc basis in between regularly scheduled meetings particularly during periods of highly volatile economic conditions to discuss dynamic and timely tactical actions regarding loan portfolio allocations, investment securities positioning, borrowing opportunities, and product features and pricing changes. The tactical actions and related changes are generally taken in a very timely manner in order to enhance our competitive position in the marketplace, and are done so in the context of the long-term strategic direction of the Bank established by the board of directors.
Risks to Us When Interest Rates Change. One of our primary financial objectives is to generate ongoing profitability. The largest contributor to our profitability is net interest income. Net interest income is the difference between the income we receive on loans and investments and the expenses we incur on deposits and borrowed funds. Net interest income is affected by the amount of interest-earning assets and interest-bearing liabilities that Rainier Pacific Bank holds, as well as the associated yields and costs.
The asset liability management policy and the committee guide us in managing Rainier Pacific Bank's market risk. A summary of the asset and liability management committee activities is reported to our board of directors monthly and in more detail to the loan and investment committee of the board on a quarterly basis.
Some of the principal strategies that we employ to manage our interest rate sensitivity include: (1) selling long-term fixed-rate mortgage loans; (2) borrowing intermediate- to long-term funds at fixed rates; (3) originating consumer and income property loans with shorter maturities or at variable rates; (4) purchasing securities with shorter maturities or at variable rates; (5) appropriately modifying loan and deposit pricing to capitalize on the then current market opportunities; (6) increasing core deposits, such as savings, checking and money-market accounts, in order to reduce our reliance on the traditionally higher cost, more rate sensitive certificates of deposits; and (7) maintaining adequate capital levels for the level of interest rate risk inherent in the balance sheet.
How We Measure the Risk of Interest Rate Changes. We monitor the Bank’s profitability on a monthly basis through the use of income simulations using internally managed forecasting software and measure our interest rate sensitivity on a quarterly basis through internal simulations and a service offered by an outside provider. Management uses various assumptions to evaluate the sensitivity of our operations to changes in interest rates. Although management believes these assumptions are reasonable, the interest rate sensitivity of our assets and liabilities on net interest income and the market value of portfolio equity could vary substantially if different assumptions were used or actual experience differs from these assumptions. Although certain assets and liabilities may have similar maturities or periods of repricing, they may react differently to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities lag behind changes in market interest rates. Non-uniform changes and fluctuations in market interest rates across various maturities will also affect the results presented. In addition, certain assets, such as adjustable-rate mortgage loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. In the event of a significant change in interest rates, prepayment and early withdrawal levels would likely deviate from those assumed.
We use three primary measures to assess the level of interest rate risk associated with the Bank’s assets and liabilities: the change in net income, the change in net interest income, and the change in the net portfolio value of
equity. These measures provide guidance related to the level of capital the Bank will maintain. Our policies require the Bank hold more capital when higher levels of interest rate risk are identified in our measures and to develop a plan to reduce interest rate risk if certain policy parameters are exceeded as a result of pre-defined interest rate risk stress tests. At December 31, 2007, the change in net income, net interest income and net portfolio value of equity results were within policy. Based on the results of these measures, the Bank is maintaining a minimum 8.00% capital ratio (total equity divided by total assets under generally accepted accounting principles) and is taking actions consistent with its business plan to reduce interest rate risk and increase earnings. The percentage change or sensitivity in net income is heightened as a result of net income and net interest income being lower than industry averages. As net income increases, the effects of the stress tests on net income and net interest income are expected to decrease, and the Bank could potentially reduce its capital ratio requirements.
The assumptions we use in our analyses of market risk are based upon a combination of proprietary and market data that reflect historical results and current market conditions. These assumptions relate to interest rates, prepayments, deposit decay rates and the market value of certain assets under various interest rate scenarios. We use historical and market data from outside providers to determine prepayments and maturities of loans, investments and borrowings, and use our own assumptions on deposit decay rates except for time deposits. Time deposits are modeled to reprice to market rates upon their stated maturities. We also assume that non-maturity deposits can be maintained with rate adjustments not directly proportionate to the change in market interest rates, based upon our historical deposit decay rates which are substantially lower than market decay rates. We have demonstrated in the past that the tiering structure and related pricing tactics associated with our deposit accounts during changing rate environments results in relatively lower volatility and less than market rate changes in our interest expense for deposits. We tier our deposit accounts by balance and rate, whereby higher balances within an account earn higher rates of interest. Therefore, deposits that are not very rate sensitive (generally, lower balance tiers) are separated from deposits that are rate sensitive (generally, higher balance tiers). When interest rates rise, we do not have to raise interest rates proportionately on less rate sensitive accounts to retain these deposits. These assumptions are based upon our analysis of our customer base, competitive factors and historical experience.
The following tables illustrate the change in the Bank's net income, net interest income and net portfolio value of equity at December 31, 2007 that would occur in the event of an immediate change in interest rates equally across all maturities, with no effect given to any steps that we might take to counter the effect of that interest rate movement.
___________
(1)
Represents the increase (decrease) of the estimated net income at the indicated change in interest rates compared to net income assuming no change in interest rates.
___________
(1)
Represents the increase (decrease) of the estimated net interest income at the indicated change in interest rates compared to net interest income assuming no change in interest rates.
____________
(1)
The net portfolio value is calculated based upon the present value of the discounted cash flows from assets and liabilities. The difference between the present value of assets and liabilities is the net portfolio value and represents the market value of equity for the given interest rate scenario. Net portfolio value is useful for determining, on a market value basis, how much equity changes in response to various interest rate scenarios. Large changes in net portfolio value reflect increased interest rate sensitivity and generally more volatile earnings streams.
(2)
Represents the increase (decrease) in the estimated net portfolio value at the indicated change in interest rates compared to the net portfolio value assuming no change in interest rates.
(3)
Calculated as the net portfolio value divided by the market value of assets ("net portfolio value ratio").
(4)
Calculated as the increase (decrease) in the net portfolio value ratio assuming the indicated change in interest rates over the estimated net portfolio value assuming no change in interest rates.
(5)
Market value of assets is calculated based on the present value of the discounted cash flows from assets. The market value of assets represents the value of assets under the various interest rate scenarios and reflects the sensitivity of those assets to interest rate changes.
When interest rates decline by 100, 200 or 300 basis points, our net interest income and net income decrease because the rate we earn on our interest-earning assets decreases faster then the rate we pay on our interest-bearing liabilities (primarily borrowed funds). Interest income would also decrease on our interest-earning assets due to increased prepayments that would emerge. Interest expenses would not decrease proportional to the decline in interest income because our structured, intermediate-term, and longer-term borrowings from the Federal Home Loan Bank of Seattle do not reprice when interest rates decline. Furthermore, the rate we pay on some of our deposits and borrowed funds cannot decline 100, 200 or 300 basis points, in the event of an immediate change in market interest rates, since most of our interest-bearing liabilities possess some term structured or existing rates that are below the 100, 200 or 300 basis point level.
When interest rates rise by 100, 200 or 300 basis points, our net interest income and net income decrease because the rates we earn on our interest-earning assets do not increase as rapidly as the rates we would pay on our interest-bearing liabilities. Our interest-earning assets primarily consist of intermediate-term and longer-term loans that do not reprice quickly and investments with primarily intermediate-term structures. Prepayment risks on ourintermediate-term and longer-term loans would decrease since customers with lower rate loans would be less likely to prepay and refinance their loans. Our interest-bearing liabilities generally consist of short-term deposits (savings, money market, and certificates of deposits) and structured borrowings from the Federal Home Loan Bank of Seattle that would reprice more quickly than our interest-earning assets.
The net interest income, net income and net portfolio value tables presented above are predicated upon a stable balance sheet with no growth or change in asset or liability mix. In addition, the net portfolio value is based upon the present value of discounted cash flows using information from our outside providers and our estimates of current replacement rates to discount the cash flows. The effects of changes in interest rates in the net interest income table are based upon a cash flow simulation of our existing assets and liabilities and, for purposes of simplifying the analysis, assumes that delinquency rates would not change as a result of changes in interest rates, although there can be no assurance that this will be the case. Delinquency rates may change when interest rates change; as a result of changes in the loan portfolio mix, underwriting conditions, loan terms, or changes in economic conditions that have a delayed effect on the portfolio. The model we use does not change the delinquency rate for the various interest rate scenarios. Even if interest rates change in the designated amounts, there can be no assurance that our assets and liabilities would perform as set forth above. Also, a change in the U.S. Treasury rates in the designated amounts accompanied by a change in the shape of the Treasury yield curve would cause changes to the net portfolio value and net interest income other than those indicated above.
Liquidity and Commitments
We actively analyze and manage Rainier Pacific Bank's liquidity with the objectives of maintaining an adequate level of liquidity and to ensure the availability of sufficient cash flows to support loan growth, fund deposit withdrawals, fund operations and satisfy other financial commitments. See "Consolidated Statements of Cash Flows" contained in the Consolidated Financial Statements included in Item 8 of this report.
Our primary sources of funds are from customer and brokered deposits, loan repayments, loan sales, maturing investment securities, advances from the Federal Home Loan Bank of Seattle. These funds, together with retained earnings and equity, are used to make loans, acquire investment securities and other assets, and fund continuing operations. While maturities and the scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by the level of interest rates, economic conditions and competition. We believe that our current liquidity position and cash flows from our forecasted operating results are sufficient to fund all of our existing commitments.
The board of directors established liquidity requirements within our asset and liability management policy to guide management in maintaining adequate liquidity. Our policy requires Rainier Pacific Bank to maintain adequate lines of credit as set by our Asset/ Liability Management Committee. We can borrow for liquidity, loan and investment opportunities, or to manage our interest rate risk. Our policy requires Rainier Pacific Bank to maintain at least five percent of assets in cash and cash equivalents, interest-bearing deposits in other financial institutions, and immediately available unused lines of credit or borrowing/repurchase arrangements. Rainier Pacific Bank is also required to maintain 20% of assets consisting of Tier I liquidity, plus available-for-sale investment securities, and readily saleable loans. At December 31, 2007, we maintained a line of credit with the Federal Home Loan Bank of Seattle equal to 50% of total assets, with an unused portion of the line of credit amounting to 13.6% of total Bank assets. This line of credit depends on us having sufficient collateral to pledge to the Federal Home Loan Bank of Seattle. At December 31, 2007, we were in compliance with our collateral requirements, and 10.4% of our line of credit with the Federal Home Loan Bank of Seattle was available. In February 2008, Rainier Pacific Bank opened a $15.0 million fed funds line of credit with a national bank to increase liquidity sources. The Bank previously had maintained a credit facility with Fortis Securities, LLC, primarily as an emergency liquidity source and tested that source annually. Fortis Securities, LLC closed the Bank’s line, along with other customers’ lines,
to reduce their exposure to unfunded lines of credit/repurchase agreements. In addition, we had 25.3% of total assets available through the aggregate of cash and cash equivalents, unused lines of credit, interest-bearing deposits, available-for-sale investments, and readily saleable loans available for liquidity purposes, which is above our internal requirement of 20%.
At December 31, 2007, certificates of deposits amounted to $239.0 million, or 51.8% of total deposits, including $238.2 million that are scheduled to mature by December 31, 2008. Historically, we have been able to retain a significant amount of our deposits as they mature. At times, we have also elected to borrow from the Federal Home Loan Bank of Seattle and price certificates of deposit at below market rates to let these non-core deposits decline in order to reprice the non-core portion of the deposit portfolio quicker. Once the repricing objective has been met, we return our deposit pricing to market rates and recover the lost deposit volume. Management believes that we have adequate resources to fund all loan commitments through deposits, borrowings from the Federal Home Loan Bank of Seattle, and the sale of mortgage loans or investments. Management also believes that we can adjust the offering rates of savings, money market, and certificates of deposit to retain, increase, or decrease deposits in changing interest rate environments.
At December 31, 2007, we had $6.9 million of net unrealized losses on securities classified as available-for-sale, or 5.0% of the $138.2 million carrying value of the related securities. Movements in market interest rates will affect the unrealized gains and losses on these securities. However, assuming that the securities are held to their individual dates of maturity, even in periods of increasing market interest rates, as the securities approach their dates of maturity, the unrealized gain or loss will begin to decrease and eventually be eliminated.
Capital Resources
Consistent with our objective to operate a financially stable organization that consistently grows its market value, we have maintained and will continue to focus on maintaining a "well capitalized" rating from regulatory authorities. As of December 31, 2007, the Bank was classified as a "well capitalized" institution under the criteria established by the FDIC and exceeded all capital requirements. Total equity for the Bank was $86.8 million at December 31, 2007, or 9.88% of total assets on that date. The Bank's regulatory capital ratios at December 31, 2007 were as follows: Tier 1 capital leverage of 9.79%; Tier 1 capital risk-based capital of 11.75%; and total risk-based capital of 12.85%.
Contractual Obligations
In the normal course of business, the Company enters into contractual obligations that meet various business needs. These contractual obligations include time deposits to customers, borrowings from the Federal Home Loan Bank of Seattle, lease obligations for facilities, and contracts or lease agreements to build facilities or construct tenant improvements. See Note 10 of the Notes to Consolidated Financial Statements included in Item 8 of this report for additional information. The following table summarizes the Company's long-term contractual obligations at December 31, 2007:
Off-Balance Sheet Arrangements
In the normal course of business, the Company makes off-balance sheet arrangements, including credit commitments to its customers to meet their financial needs. These arrangements involve, to varying degrees, elements of credit and interest rate risk not recognized in the consolidated statement of financial condition. The Bank makes personal, commercial, and real estate lines of credit available to customers but generally does not issue stand-by letters of credit or financial guarantees.
Commitments to extend credit to customers are subject to the Bank's normal credit policies and are essentially the same as those involved in extending loans to customers. See Note 10 of the Notes to Consolidated Financial Statements included in Item 8 of this report for additional information.
Impact of Inflation
The Consolidated Financial Statements and related financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America. These principles generally require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation.
Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. The primary impact of inflation is reflected in the increased cost of our operations. As a result, interest rates generally have a more significant impact on a financial institution's performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services. In a period of rapidly rising interest rates, the liquidity and maturities structures of our assets and liabilities are critical to the maintenance of acceptable performance levels.
The principal effect of inflation on earnings, as distinct from levels of interest rates, is in the area of non-interest expense. Expense items such as employee compensation, employee benefits and occupancy and equipment costs may be subject to increases as a result of inflation. An additional effect of inflation is the possible increase in dollar value of the collateral securing loans that we have made. Management is unable to determine the extent, if any, to which properties securing loans have appreciated in dollar value due to inflation.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). This standard clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing an asset or liability. Additionally, it establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and is not expected to have a material impact on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“SFAS 158”). This standard requires employers to recognize the underfunded or overfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through accumulated other comprehensive income. The new reporting requirements and related new footnote disclosure rules of SFAS 158 are effective for fiscal years ending after December 15, 2006, and did not have a material impact on our financial statements as the Company does not currently offer a defined benefit plan for its employees.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - including an amendment of FASB Statement 115 (“SFAS 159”). SFAS 159 permits entities to measure many financial instruments and certain other items at fair value. Most of the provisions of this statement apply only to entities that elect the fair value option. However, the amendment to FASB Statement No. 115,
Accounting for Certain Investments in Debt and Equity Securities, applies to all entities with available-for-sale and trading securities. SFAS 159 is effective for fiscal years beginning after November 15, 2007, and is not expected to have a material impact on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements - an amendment of ARB No. 51 (“SFAS 160”). SFAS 160 establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation. This statement applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding non-controlling interest in one or more subsidiaries or that deconsolidate a subsidiary. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008, and is not expected to have a material impact on our consolidated financial statements.
In December 2007, the FASB revised SFAS No. 141, Business Combinations (“SFAS 141(R)”). SFAS 141(R) improves the completeness of the information reported about a business combination by changing the requirements for recognizing assets acquired and liabilities assumed arising from contingencies. This statement requires an acquirer to recognize assets acquired and liabilities assumed arising from contractual contingencies as of the acquisition date. SFAS No. 141, Business Combinations permitted deferred recognition of preacquisition contingencies until the recognition criteria for SFAS No. 5, Accounting for Contingencies, were met. SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, and is not expected to have a material impact on our consolidated financial statements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information contained under "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management and Market Risk" of this Form 10-K is incorporated herein by reference.
Item 8.
Item 8. Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
Management’s Annual Report on Internal Control Over Financial Reporting
The management of Rainier Pacific Financial Group, Inc. (the “Company”) is responsible for the preparation, integrity, and fair presentation of the consolidated financial statements included in this annual report. The consolidated financial statements and notes included in this annual report have been prepared in conformity with accounting principles generally accepted in the United States of America and include, as necessary, some amounts that are based on management’s best estimates and judgments.
Management is also responsible for establishing and maintaining effective internal control over financial reporting, as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. This process includes policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation.
The Company’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007. Management’s assessment was based on criteria described in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on that assessment, the Company’s management concluded that the Company’s system of internal control over financial reporting was effective as of December 31, 2007.
Respectfully submitted,
/s/John A. Hall
/s/Joel G. Edwards
John A. Hall Joel G. Edwards
President and Vice President and
Chief Executive Officer
Chief Financial Officer
March 12, March 12,
Report of Independent Registered Public Accounting Firm
To the Board of Directors
Rainier Pacific Financial Group, Inc.
We have audited the accompanying consolidated statements of financial condition of Rainier Pacific Financial Group, Inc. and Subsidiary (the “Company”) as of December 31, 2007 and December 31, 2006, and the related consolidated statements of income, shareholders’ equity and cash flows for the each of the years in the three-year period ended December 31, 2007. We also have audited the Company’s internal control over financial reporting as of December 31, 2007, based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control - Integrated Framework. The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company's internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also include performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Rainier Pacific Financial Group, Inc. and Subsidiary, as of December 31, 2007, and December 31, 2006, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Rainier Pacific Financial Group, Inc. and Subsidiary maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria set forth by COSO in Internal Control - Integrated Framework.
As discussed in Note 1 to the consolidated financial statements, the Company restated its 2006 and 2005 consolidated financial statements.
/s/Moss Adams LLP
Everett, Washington
March 12,
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (dollars in thousands)
See accompanying notes.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME (dollars in thousands except per share data)
See accompanying notes.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (dollars in thousands)
See accompanying notes.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands)
See accompanying notes.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands)
See accompanying notes.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Description of Operations and Summary of Significant Accounting Policies
Organization - Effective January 1, 2001, Rainier Pacific, a Community Credit Union (the “Credit Union”) converted from a state chartered community credit union to a state chartered mutual savings bank and changed its name to Rainier Pacific Savings Bank (the “Bank”) doing business as Rainier Pacific Bank. On October 20, 2003, the Bank converted from a mutual savings bank to a stock savings bank. In connection with the conversion, the bank holding company, Rainier Pacific Financial Group, Inc. (the “Company”) was formed. The Company purchased 100% of the Bank’s common stock simultaneous with the Bank’s conversion to a stock form of organization and the Company’s offering and sale of common stock to the public.
The Bank provides a full range of banking services to consumers and small to medium-sized businesses and professionals through 14 banking offices located in Pierce and South King Counties of Washington State. The Bank also provides insurance and investment services through operating units of the Bank doing business as Rainier Pacific Insurance Services and Rainier Pacific Financial Services.
Principles of consolidation and basis of presentation - The consolidated financial statements include the accounts of the Company and the Bank. All significant intercompany transactions and balances have been eliminated. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and predominant practices followed by the financial services industry.
Use of estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities, as of the date of the Consolidated Statements of Financial Condition, as well as reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates.
Material estimates that are particularly susceptible to significant changes relate to the determination of the allowance for loan losses, the valuation of the deferred tax assets, and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowance for loan losses and the valuation of foreclosed assets held-for-sale, management obtains independent appraisals for significant properties.
Cash and cash equivalents - Cash and cash equivalents consist of vault and automated teller machine cash and non-interest bearing deposits in depository institutions, including the Federal Reserve and the Federal Home Loan Bank. Cash and cash equivalents have a maturity of three months or less. Cash and cash equivalents also include $1,354,000 and $1,358,000 of cash as of December 31, 2007 and 2006, respectively, which is restricted due to a contractual relationship with the Bank’s credit card transaction processing vendor.
Interest-bearing deposits with banks - Interest-bearing deposits with banks include interest-bearing deposits at various Federal Deposit Insurance Corporation (“FDIC”) insured financial institutions and the Federal Home Loan Bank of Seattle. At times throughout the year, the Bank has balances that exceed FDIC insured limits.
Securities available-for-sale - Securities available-for-sale represent securities that may be sold prior to maturity. These securities are stated at fair value, and any unrealized net gains or losses are reported as a separate component of equity until realized, net of any tax effect. Gains and losses on the sale of securities available-for-sale are determined using the specific identification method. Fair value is determined using published quotes as of the close of business. Premiums or discounts are recognized in interest income using the interest method.
Securities available-for-sale may be sold in response to changes in market interest rates, repayment rates, the need for liquidity, and changes in the availability and yield on alternative investments. Investments with fair values that are less than amortized cost are considered impaired. Impairment may result from either a decline in the financial condition of the issuing entity or, in the case of fixed interest rate investments, from rising interest rates. At each financial statement date, management assesses each investment to determine if impaired investments are temporarily impaired or if the impairment is other-than-temporary based upon the positive and negative evidence available. Evidence evaluated includes, but is not limited to, industry analyst reports, credit market conditions, ability and intent to hold until recovery, and interest rate trends. If negative evidence outweighs positive evidence that the carrying amount is not recoverable within a reasonable period of time, the impairment is deemed to be other-than-temporary and the security is written down in the period in which such determination is made.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Description of Operations and Summary of Significant Accounting Policies
(continued)
Securities held-to-maturity - Securities for which the Bank has the positive intent and ability to hold until maturity are classified as securities held-to-maturity and are recorded at cost, adjusted for unamortized premiums or discounts. Premiums or discounts are recognized in interest income using the interest method. Impairment for securities held-to-maturity and the accounting treatment of securities which are deemed to be other-than-temporary follows the same methodology as impaired securities available-for-sale.
Federal Home Loan Bank of Seattle stock - As a member of the FHLB, the Bank is required to maintain a minimum level of investment in FHLB stock based on specified percentages of its outstanding FHLB advances (i.e., borrowed funds) and requirements of the FHLB’s Mortgage Purchase Program. The Bank’s investment in FHLB stock is carried at par value ($100 per share), which reasonably approximates its fair value. The Bank may request redemption at par value of any stock in excess of the amount the Bank is required to hold. FHLB stock is restricted as to purchase, sale, and redemption.
Loans held-for-sale - Mortgage loans originated and designated as held-for-sale are carried at the lower of cost or estimated fair value, as determined by quoted market prices, under the aggregate method. Net unrealized losses are recognized in a valuation allowance by charges to income. Gains or losses on the sale of such loans are based on the specific identification method. The Bank held no loans classified as held-for-sale at December 31, 2007 or 2006.
Loans and allowance for loan losses - Loans that management has the intent and ability to hold for the foreseeable future, or until maturity or pay-off, are reported at their unpaid outstanding principal balance and are adjusted for the allowance for loan losses, unearned discounts and non-refundable fees and related direct loan origination costs. Interest income is accrued on the unpaid principal balance. Loan origination and commitment fees, net of certain direct loan origination costs, are deferred and amortized as an adjustment to the yield of the related loan using the interest method.
Interest on loans is recognized over the term of the loans and is calculated using the simple-interest method on principal amounts outstanding. Accrual of interest is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due or when the loan becomes past due 90 days as to either principal or interest. When the accrual of interest is discontinued, all accrued interest is reversed against current income. The accrual and recognition of interest is resumed when, in management's opinion, the collectibility of principal and interest is no longer in doubt.
The Bank maintains an allowance for loan losses to absorb credit losses inherent in the loan portfolio. The allowance is determined in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 5: Accounting for Contingencies and SFAS No. 114: Accounting by Creditors for Impairment of a Loan (“SFAS 114”). The allowance is based on ongoing assessments of probable estimated credit losses, and is evaluated by management on a quarterly basis. The allowance is increased by the provision for loan losses, which is charged against current operating results and decreased by the amount of loan charge-offs, net of recoveries.
The Bank’s methodology for analyzing the allowance for loan loss consists of two main elements: a formula element and a specific element, and establishes an acceptable range in which the allowance should fall. The establishment of an acceptable range addresses estimation risk and helps ensure that the allowance is adequate for the risk inherent in the loan portfolio.
The formula element of the allowance is the combination of two different components: actual historical loss ratios and economic and other factors. While historical loss ratios are known amounts, economic and other factors are based on estimates by management, which considers factors such as delinquency ratios, loss trends, changes in underwriting, local and regional economic data, and other factors. These quantitative and qualitative factors are reviewed by management and applied against each loan pool in the formula element. In addition, an estimated loss ratio is applied to newly originated loan categories that may not have generated any historical losses. Prudent lending and accounting practices necessitate that the allowance address the risk associated with the loans in these newly originated loan categories in order to account for future losses that are probable and can be reasonably estimated.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Description of Operations and Summary of Significant Accounting Policies
(continued)
The specific element of the allowance is created for large loans (e.g., commercial, construction, or business loan) in accordance with SFAS 114 when management believes that a specific large loan is impaired based on current information and events. A specific large loan would be impaired when it is probable the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. As part of the credit monitoring and allowance process, management uses its normal loan review process to identify loans that are to be evaluated for collectibility. Management’s normal loan review process includes reviewing various reports, analysis, and other information, including the delinquency report, credit risk monitoring report, and any individual credit review analysis.
Upon determining the combined balance of the formula and specific elements of the allowance, management determines an acceptable range therefrom, by considering the estimation risk involved in determining the two primary elements of the allowance. The acceptable range is determined by calculating an exact number (for the formula and specific components combined) and then establishing a range of plus or minus 10 percent of the allowance to total loans ratio resulting from the combined calculation. Management believes establishing a range is necessary since there are unknown variables that will impact the projected amount or type of future loan originations and actual charge-offs. Market changes, shifts in customer preference, management judgments/projections, or other unforeseen issues make a range more reliable. Furthermore, a range more appropriately conveys management’s estimate of the level of credit risk in the loan portfolio, and that the allowance is a significant estimate and not an exact number.
A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans may be collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.
Premises and equipment - Land is stated at cost. Land improvements, buildings, leasehold improvements and equipment are stated at cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the following estimated useful lives:
Buildings and improvements 5 - 40 years
Furniture, fixtures and equipment 3 - 12 years
Leasehold improvements are amortized over the term of the lease or the estimated useful life of the improvements, whichever is less. Gains and losses on dispositions of premises and equipment are reflected in current operations. Expenditures for major improvements are capitalized and ordinary maintenance and repairs are charged to operations, as incurred.
The Bank reviews premises and equipment for impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of specific assets may not be recoverable. Impairment is measured by comparing the carrying value of the long-lived assets to the estimated undiscounted future cash flows expected to
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Description of Operations and Summary of Significant Accounting Policies
(continued)
result from use of the assets and their ultimate disposition. In circumstances where impairment is determined to exist, the Bank will write down the assets to their fair value based on either the present value of estimated expected future cash flows or anticipated realizable market value. In circumstances where a long-lived asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life, depreciation estimates are revised to reflect the use of the asset over its shortened useful life.
Collateral in liquidation and other real estate owned - Collateral in liquidation and other real estate owned (obtained through repossession or foreclosure) is recorded at the lower of its acquisition cost or its net realizable value. The Bank held $49,000 and $33,000 of such assets at December 31, 2007 and 2006, respectively, which are included in “Other assets” in the Consolidated Statements of Financial Condition.
Transfers of financial assets - Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Mortgage servicing rights - Servicing assets are recognized when servicing rights are acquired and retained through the sale of mortgage loans. Servicing rights are reported in “Other assets” in the Consolidated Statements of Financial Condition, and are amortized to non-interest income over the estimated life of the underlying mortgage loans sold. Servicing assets are evaluated for impairment based upon the fair value of the assets as compared to amortized cost.
Mortgage loans serviced for others include whole loans sold to the Federal Home Loan Mortgage Corporation (“FHLMC”), the FHLB, and the Federal National Mortgage Association (“FNMA”). Loans being serviced for FHLMC, FHLB and FNMA totaled $114,629,000 and $110,297,000 at December 31, 2007 and 2006, respectively. Mortgage loans serviced for others are not included in “Loans” in the Consolidated Statements of Financial Condition.
Federal Income taxes - The Company and the Bank file a consolidated federal income tax return. The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Intangible assets - In December 2000, the Bank, through a previous wholly-owned subsidiary, acquired the rights to customers and policies of a local insurance agency for $350,000. In January 2006, the Bank acquired the rights to customers and policies of two other local insurance agencies for $3,500,000. The Bank finalized the purchase of two additional local agencies in 2007 for a combined total of $351,000. These purchase amounts were accounted for as intangible assets and are included in “Other assets” in the Consolidated Statements of Financial Condition. In accordance with the provisions of SFAS No. 142, Goodwill and Other Intangible Assets, the intangible assets are amortized under the straight-line method for up to 15 years and are periodically evaluated for impairment. The balance of the intangible assets was $3,486,000 and $3,299,000 as of December 31, 2007 and 2006, respectively.
Marketing - The Bank expenses marketing costs as they are incurred. Marketing expense was $1,036,000, $946,000, and $1,032,000 for the years ended December 31, 2007, 2006, and 2005, respectively.
Comprehensive income - Comprehensive income is comprised of net income and other comprehensive income. Other comprehensive income includes items previously recorded directly to equity, such as unrealized gains and losses on securities available-for-sale. Comprehensive income is presented in the Consolidated Statements of Shareholders’ Equity.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Description of Operations and Summary of Significant Accounting Policies
(continued)
The components of other comprehensive income and related tax effects are as follows (dollars in thousands):
Segment reporting - The Company’s operations are solely in the financial services industry and include providing to its customers traditional banking and other financial services. The Company operates primarily in the Puget Sound geographical region of Washington State. Management makes operating decisions and assesses performance based on an ongoing review of the Company’s consolidated financial results. The Company is considered a single operating segment for financial reporting purposes.
Employee stock ownership plan - The Bank sponsors a leveraged ESOP. Under Statement of Position No. 93-6, Employers’ Accounting for Employer Stock Ownership Plans, as shares are committed to be released, compensation expense is recorded equal to the market price of the shares, and the shares become outstanding for purposes of earnings per share calculations. Cash dividends on allocated shares (those credited to ESOP participants’ accounts) are recorded as a reduction of retained earnings and distributed directly to participants’ accounts. Cash dividends on unallocated shares (those held by the ESOP not yet credited to participants’ accounts) are used to pay administrative expenses and debt service requirements of the ESOP. At December 31, 2007, there were 390,263 unallocated shares in the plan (Note 11). Shares released on December 31, 2007 totaled 67,896 and were credited to plan participants’ accounts in February 2008.
Stock-based compensation - Prior to the adoption of the Financial Accounting Standards Board (“FASB”) SFAS No. 123(R), Share-Based Payment (“SFAS 123(R)”), the Company accounted for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and related interpretations. The Company adopted the pro forma disclosure-only provision of SFAS 123(R), Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation- Transition and Disclosure, an amendment of SFAS No. 123 and, as such did not recognize any compensation expense for employee stock options for all periods prior to January 1, 2006.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Description of Operations and Summary of Significant Accounting Policies
(continued)
If the Company had elected to recognize compensation cost based on the fair value at the grant dates for awards under its plan, consistent with the method described in SFAS No. 123, net income and earnings per share would have been reduced to the pro forma amounts indicated below for the year ended December 31, 2005 (dollars in thousands, except per share data):
On January 1, 2006 (the effective date of SFAS 123(R), the Company adopted the fair value recognition provision of SFAS 123(R), using the “modified prospective” method in which compensation cost is recognized for all share-based payments granted prior to the effective date of SFAS 123(R) that remained unvested on the effective date and for all awards granted to employees after the effective date. See Note 12 for additional information regarding stock-based compensation.
Earnings per share (“EPS”) data - The Company displays basic and diluted EPS in the Consolidated Statements of Income. Basic EPS is computed by dividing net income by the weighted average number of shares outstanding during the period. Unallocated shares related to the ESOP are deducted in the calculation of weighted average shares outstanding. Diluted EPS is computed by dividing net income by the diluted weighted average shares outstanding, which includes common stock equivalent shares outstanding using the treasury stock method, unless such shares are not dilutive. Common stock equivalent shares include the stock options and restricted stock awards under the 2004 Stock Option Plan and the 2004 Management Recognition Plan approved by the shareholders in April 2004.
Recent accounting pronouncements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). This standard clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing an asset or liability. Additionally, it establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and is not expected to have a material impact on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“SFAS 158”). This standard requires employers to recognize the underfunded or overfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through accumulated other comprehensive income. The new reporting requirements and related new footnote disclosure rules of SFAS 158 are effective for fiscal years ending after December 15, 2006, and did not have a material impact on our financial statements as the Company does not currently offer a defined benefit plan for its employees.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Description of Operations and Summary of Significant Accounting Policies
(continued)
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - including an amendment of FASB Statement 115 (“SFAS 159”). SFAS 159 permits entities to measure many financial instruments and certain other items at fair value. Most of the provisions of this statement apply only to entities that elect the fair value option. However, the amendment to FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all entities with available-for-sale and trading securities. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007, and is not expected to have a material impact on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements - an amendment of ARB No. 51 (“SFAS 160”). SFAS 160 establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation. This statement applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding non-controlling interest in one or more subsidiaries or that deconsolidate a subsidiary. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008, and is not expected to have a material impact on our consolidated financial statements.
In December 2007, the FASB revised SFAS No. 141, Business Combinations (“SFAS 141(R)”). SFAS 141(R) improves the completeness of the information reported about a business combination by changing the requirements for recognizing assets acquired and liabilities assumed arising from contingencies. This statement requires an acquirer to recognize assets acquired and liabilities assumed arising from contractual contingencies as of the acquisition date. SFAS No. 141, Business Combinations permitted deferred recognition of preacquisition contingencies until the recognition criteria for SFAS No. 5, Accounting for Contingencies, were met. SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, and is not expected to have a material impact on our consolidated financial statements.
Concentrations of credit risk - The Bank accepts deposits and grants credit primarily within its local service area of Pierce County and South King County, Washington. The Bank has a diversified loan portfolio and grants consumer, single-family residential, commercial, and real estate construction loans, and is not dependent on any industry or group of customers. Although the Bank has a diversified loan portfolio, a substantial portion of its loans are real estate related. The ability of the Bank’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in the area.
Reclassifications - Certain amounts in the prior years have been reclassified to conform to the 2007 presentation.
Restatements - During 2007, the Company identified an error in the application of SOP 93-6, Employers Accounting for Employee Stock Ownership Plans. Entries related to permanent tax differences were incorrectly applied against common stock instead of the provision for federal income tax. We concluded, in accordance with the SEC’s Staff Accounting Bulletin No. 108, that while the amounts related to individual years were immaterial, in the aggregate they resulted in cumulative adjustments that the Board of Directors and management felt required the restatement of previously released financial statements that are shown for comparative purposes in these financial statements. The impact of the adjustments to the Consolidated Statements of Income for fiscal 2006 and 2005 are shown in the following table:
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Description of Operations and Summary of Significant Accounting Policies
(continued)
Note 2 - Restricted Assets
Federal Reserve Board regulations require that the Bank maintain certain minimum reserve balances as either cash on hand, in the vault, or on deposit with the Federal Reserve Bank. The minimum reserve balances as of December 31, 2007 and 2006 were $3,447,000 and $3,870,000, respectively.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3 - Investment Securities
The following summarizes the amortized cost, gross unrealized gains and losses, and the estimated fair value of the Bank's investment securities at December 31 (dollars in thousands):
Certain investment securities shown above currently have fair values less than amortized cost and therefore contain unrealized losses. The Company has evaluated these securities and has determined that the decline in value is temporary and is related to the change in market interest rates and spreads since purchase. The decline in value on the trust preferred securities is a result of spreads increasing in response to the credit markets tightening in 2007. The trust preferred securities have maintained their credit quality and there have been no negative credit quality actions on these securities. There were 58 and 48 investment securities with unrealized losses at December 31, 2007 and 2006, respectively. The Company anticipates full recovery of amortized cost with respect to these securities at maturity or sooner in the event of a more favorable market interest rate environment. Management periodically evaluates each available-for-sale and held-to-maturity investment security in an unrealized loss position to determine if the impairment is temporary or other-than-temporary.
Management has determined that no investment security is other-than-temporarily impaired. The Company has the ability to hold all investment securities with temporary impairments to the earlier of the forecasted recovery or the maturity of the underlying investment security.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3 - Investment Securities (continued)
At December 31, 2007, the weighted average yield on corporate securities, U.S. Government agency securities, mortgage-backed securities, municipal obligations and trust preferred securities was 3.07%, 2.83%, 4.37%, 4.06%, and 6.28%, respectively. At December 31, 2006, the weighted average yield on corporate securities, U.S. Government agency securities, mortgage-backed securities, municipal obligations and trust preferred securities was 3.02%, 2.83%, 4.52%, 4.06% and 6.09%, respectively.
The amortized cost and the fair value of investment securities at December 31, 2007 by contractual maturity, are shown below (dollars in thousands).
Expected maturities may differ from contractual maturities, due to call provisions or the prepayment of principal.
Investment securities valued at $55,572,000 were pledged to the FHLB and $1,576,000 were pledged to secure deposits of certain public governmental entities as of December 31, 2007. Investment securities valued at $66,365,000 were pledged to the FHLB and $1,789,000 were pledged to secure deposits of certain public governmental entities as of December 31, 2006.
Gross gains from the sales of available-for-sale investment securities were $3,000, and $54,000 for the years ended December 31, 2006, and 2005, respectively. The Bank did not incur any gains for the year ended December 31, 2007. The Bank incurred gross losses of $56,000 for the year ended December 31, 2005. The Bank did not incur any gross losses for the years ended December 31, 2006 and 2007.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 4 - Loans
The major classifications of the Bank’s loans are summarized as follows at December 31 (dollars in thousands):
There were $497,000 and $241,000 of non-accrual loans at December 31, 2007 and 2006, respectively. The Bank does not accrue interest on loans past due 90 days or more, and appropriately discontinued accruing interest on these loans. There were no specific allowances established for non-accrual loans at December 31, 2007 and 2006. The average balance of non-accrual loans was approximately $247,000 and $150,000 during the years ended December 31, 2007 and 2006, respectively. If interest on these loans had been accrued, such interest income would have been approximately $21,000 and $13,000 for the years ended December 31, 2007 and 2006, respectively. As defined previously in Note 1, there were no impaired loans at December 31, 2007 or 2006. Additionally, at December 31, 2007, there were no commitments to lend additional funds to borrowers whose loans were classified as non-accrual or impaired and there were no troubled debt restructurings.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 4 - Loans (continued)
The following table sets forth the contractual maturities of the Bank’s loan portfolio at December 31, 2007 (dollars in thousands):
A summary of the changes in the allowance for loan losses is as follows for the years ended December 31 (dollars in thousands):
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 5 - Premises and Equipment
Premises and equipment are summarized as follows at December 31 (dollars in thousands):
Depreciation expense on premises and equipment totaled $2,333,000, $3,654,000, and $3,653,000 during the years ended December 31, 2007, 2006, and 2005, respectively.
Note 6 - Mortgage Servicing Rights
The carrying value of capitalized mortgage servicing rights is reported in “Other assets” in the Consolidated Statements of Financial Condition. The following summarizes mortgage servicing rights activity for the years ended December 31 (dollars in thousands):
The Bank sells real estate loans to the FHLMC, FNMA, and formerly to the FHLB, while retaining the servicing rights to those loans. The fair value of mortgage servicing rights is determined by the use of a valuation model that evaluates the estimated discounted future cash flows of the servicing rights.
Assumptions used in the valuation model include the cost of servicing the loan, a discount rate, and anticipated prepayment speeds. The Bank assesses the impairment of the mortgage servicing rights based on the recalculation of the current market price of mortgage servicing rights, discounted for changes in actual prepayment speeds of the loans. Impairment is assessed on a pool-by-pool basis with any impairment recognized through a valuation allowance for the combined pools. Currently, the pools are combined as they all have similar interest rates, terms and risk characteristics. In the opinion of management, an impairment valuation allowance is not necessary, as the fair value of these mortgage serving rights exceeds the carrying value.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 7 - Deposits
Interest-bearing customer deposits at December 31 are summarized as follows (dollars in thousands):
A summary of certificates of deposit, by year of maturity, at December 31, 2007 is as follows (dollars in thousands):
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 7 - Deposits (continued)
Interest expense on deposit accounts for the years ended December 31 is summarized as follows (dollars in thousands):
The aggregate amount of time deposits in denominations of $100,000 or more was $127,895,000 and $116,914,000 at December 31, 2007 and 2006, respectively. The uninsured portion of all deposits totaled $68,890,000 and $64,955,000 at December 31, 2007 and 2006, respectively.
Note 8 - Borrowed Funds
At December 31, 2007, the Bank had credit facilities available from the FHLB of $440,285,000. The FHLB credit facility is subject to an existing Advances, Security and Deposit Agreement and borrowings are limited to the amount of qualifying collateral. Under the FHLB agreement, virtually all of the Bank’s assets, not otherwise encumbered, are pledged as collateral. The Bank had borrowed funds from the FHLB at December 31, 2007 and 2006 of $320,454,000 and $345,395,000, respectively.
During 2007, 2006, and 2005, the Bank also had a $100,000,000 credit facility with Fortis Securities, LLC that was subject to a repurchase agreement, wherein the Bank pledged securities it owned to collateralize the sale of securities that were subject to an obligation to repurchase the same or similar securities. The Bank maintained the Fortis Securities, LLC credit facility as an emergency liquidity source and tested the line annually. As a result of turmoil in the credit markets in 2007, Fortis Securities, LLC changed its collateral requirements and subsequently closed the Bank’s credit facility along with other customer’s credit facilities to reduce Fortis Securities, LLC’s exposure to unused lines of credit. The Bank did not have an outstanding obligation to Fortis Securities, LLC at December 31, 2007 or 2006.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 8 - Borrowed Funds (continued)
The Bank’s borrowed funds consisted of the following during the years ended December 31 (dollars in thousands):
The contractual maturities of borrowed funds at December 31, 2007 are as follows (dollars in thousands):
Expected maturities may differ from contractual maturities due to put provisions on $260,464,000 of the amount outstanding. Capitalized interest amounted to $24,000 for the year ended December 31, 2006. There was no interest that was capitalized during the years ended December 31, 2007 and 2005. Interest expense on borrowings is decreased by the amount of any capitalized interest.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 9 - Federal Income Tax
The components of the provision for federal income tax for the years ended December 31 are as follows (dollars in thousands):
A reconciliation of the tax expense based on statutory corporate tax rates on pre-tax income and the “Provision for federal income tax” shown in the accompanying Consolidated Statements of Income for the years ended December 31, is as follows (dollars in thousands):
The following tables show the nature and components of the Bank’s net deferred tax assets, recorded among “Other assets” in the Consolidated Statements of Financial Condition, established at an estimated tax rate of 34% at December 31 (dollars in thousands):
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 9 - Federal Income Tax (continued)
Prior to 2003, the Bank qualified under the provisions of the Internal Revenue Service Code to deduct from taxable income a reserve for bad debts based on the experience method. The experience method allowed the Bank to deduct bad debt expense (i.e., increases to the reserve for losses on loans) from taxable income in amounts greater than the actual losses incurred. Starting in 2003, the Bank became classified as a large bank and is now required to use the direct charge-off method. The Bank recaptured the excess reserves previously recorded that exceed actual losses for taxable income purposes over the four year period ended December 31, 2006. The recapture of the pre-2003 bad debt reserves recorded under the experience method did not result in a charge to earnings as these amounts are included in the deferred tax asset.
The Bank establishes a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion, or all, of the deferred tax asset will not be realized. Management has determined that it is more likely than not that it may not realize all the benefit of the deferred tax assets based upon the nature and timing of the items listed. In order to fully realize the net deferred tax asset related to the charitable contribution, the Bank will need to generate sufficient future taxable income. Management expects that the Bank may not generate sufficient taxable income to utilize the net deferred tax asset and has established a valuation allowance in the amount of $550,000. As of December 31, 2007, the deferred tax asset relating to the charitable contribution was $1.2 million, of which $787,000 and $432,000 are set to expire in 2008 and 2009, respectively.
The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. The Company had no unrecognized tax benefits which would require an adjustment to the January 1, 2007 beginning balance of retained earnings. The Company had no unrecognized tax benefits at January 1, 2007 and at December 31, 2007.
The Company recognizes interest and penalties related to taxes in tax expense. During the years ended December 31, 2007 and 2006, the Company recognized no interest and penalties.
The Company files a consolidated income tax return with its subsidiary. With few exceptions, the Company is no longer subject to U.S. federal or state/local income tax examinations for years before 2004.
Note 10 - Commitments and Contingent Liabilities
Loan commitments - The Bank is a party to financial instruments in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. These commitments involve, to varying degrees, elements of credit and interest rate risk not recognized in the Consolidated Statements of Financial Condition.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the agreement. Commitments generally have fixed expiration dates or termination clauses and may require payment of a fee. Since many of the commitments are expected to expire or be renewed without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank reviews customers’ creditworthiness on a case-by-case basis when renewing or increasing commitments. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's evaluation of the customer.
Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. Many of these lines of credit are uncollateralized and usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Company is committed.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 10 - Commitments and Contingent Liabilities (continued)
The Bank had outstanding commitments for the origination of loans and for unused lines of credit that are not reflected in the consolidated financial statements at December 31 as follows (dollars in thousands):
The Bank does not anticipate any material losses as a result of the commitments.
Loans sold to the FHLB - The Bank formerly sold mortgage loans to the FHLB and retained the servicing of all loans sold. Loans sold to the FHLB required a loan reserve account of 40 to 50 basis points to be established to offset any potential future charge-offs. There is no additional recourse to the Bank on the loans sold to the FHLB other than the reserve account. As of both December 31, 2007 and 2006, the reserve account totaled $98,000 and no portion of the loan reserve account was used to offset loan losses or was repaid to the Bank based upon satisfactory loan repayment.
Lease commitments (as lessee) - Rent expense under operating leases for branch premises for the year ended December 31, 2007 totaled $286,000. Rent expense under operating leases for administrative office space and branch premises for the years ended December 31, 2006 and 2005 totaled $319,000 and $214,000, respectively.
As of December 31, 2007, the future minimum rent payments under the terms of the leases for branch premises are as follows for future years ending December 31 (dollars in thousands):
Lease commitments (as lessor) - During the year ended December 31, 2007, the Bank leased office and retail space to others under non-cancelable operating leases requiring fixed monthly rentals over various terms, some of which contain escalation clauses providing for increased rents and excess operating expense reimbursements. As of December 31, 2007, the future minimum contractual lease rental receipts are as follows for future years ending December 31 (dollars in thousands):
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 10 - Commitments and Contingent Liabilities (continued)
Purchase obligations (insurance agencies) - On January 3, 2006, the Bank acquired the rights to customers and policies of two local insurance agencies for $3,500,000. The first payment of $1,200,000 was paid at closing on January 3, 2006. The second payment for those agencies, in the amount of $1,150,000, was made on January 3, 2007, and the final payment of $1,150,000 was made on January 3, 2008. At December 31, 2007, the $1,150,000 outstanding was included in “Other liabilities” in the Consolidated Statements of Financial Condition.
Restrictions on equity - The Company and the Bank are subject to certain restrictions on the amount of dividends that may be declared without prior regulatory approval. For example, at the time of the Bank’s conversion from a state chartered mutual savings bank to a state chartered stock savings bank, the Bank established a liquidation account in an amount equal to its equity of $43,493,000 as of June 30, 2003, the date of the latest statement of financial condition used in the final conversion prospectus. The liquidation account is maintained for the benefit of eligible account holders who maintain their deposit accounts in the Bank after conversion. The liquidation account will be reduced annually to the extent that eligible account holders have reduced their qualifying deposits. Subsequent increases will not restore an eligible account holder’s interest in the liquidation account. In the event of a complete liquidation of the Bank (and only in such an event), eligible depositors who have continued to maintain accounts will be entitled to receive a distribution from the liquidation account before any liquidation may be made with respect to the Bank’s common stock. The Bank may not declare or pay cash dividends if the effect thereof would reduce its regulatory capital below the amount required for the liquidation account. The balance of the liquidation account as of December 31, 2007 and 2006 was $8,172,000 and $9,323,000, respectively, and was part of shareholders’ equity.
Note 11 - Retirement Plans
Effective January 1, 2004, the Bank amended and restated its Profit Sharing 401(k) Plan into a 401(k) Employee Stock Ownership Plan (“ESOP”) in order to provide a 401(k) profit sharing plan with employee stock ownership features for employees of the Bank. The ESOP covers substantially all employees that meet certain age and service requirements. Under the plan, annual retirement expense is generally defined as a percentage of employee compensation, net of forfeitures from employees who have terminated employment.
The net expense related to the Bank’s retirement plans recognized for the years ended December 31, 2007, 2006, and 2005 was $1,329,000, $1,367,000, and $1,197,000, respectively.
In October 2003, the ESOP borrowed $6,754,000 from the Company to purchase common stock of the Company. The loan will be repaid principally from the Bank’s contributions to the ESOP over a period of ten years. The interest rate on the loan is fixed at 4.0% per annum.
For the year ended December 31, 2007, the ESOP was committed to release 67,896 shares of the Company’s common stock to participants. At December 31, 2007, the ESOP had 390,263 unallocated shares remaining to be released. The fair value of the 390,263 restricted shares held by the ESOP trust was $5,780,000 at December 31, 2007.
Note 12 - Stock Option and Restricted Stock Plans
Stock Option Plan - On April 26, 2004, the Company’s shareholders approved the Rainier Pacific Financial Group, Inc. 2004 Stock Option Plan (“SOP”). The Company implemented the SOP to promote the long-term interests of the Company and its shareholders by providing a retention and performance incentive to directors and key employees who are expected to significantly contribute to the operating success of the Company. The maximum number of options that may be issued under the SOP is 844,284. The options are granted using an exercise price of the then fair market value of the Company’s common stock on the date of grant, vest over five years, expire 10 years from the date of grant, and are subject to certain restrictions and limitations.
On June 7, 2004, the Company granted 351,750 non-qualified stock options and 328,250 incentive stock options to certain directors and employees. The fair market value of the Company’s common stock on the date of grant was
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 12 - Stock Option and Restricted Stock Plans (continued)
$16.26. On August 17, 2005, the Company granted 40,000 incentive stock options to certain employees. The fair market value of the Company’s common stock on the date of the August 17, 2005 grants was $16.72. There were no grants in 2006. On June 1, 2007, the Company granted 72,000 incentive stock options to certain employees. The fair market value of the Company’s common stock on the date of the June 1, 2007 grants was $20.40.
The fair value of options granted were estimated on the date of grants (August 17, 2005 and June 1, 2007) using a binomial option-pricing model with the following assumptions for the years ended December 31:
The following represents the stock option activity and option exercise price information for the years ended December 31 (in dollars):
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 12 - Stock Option and Restricted Stock Plans (continued)
Financial data pertaining to the stock options at December 31, 2007 is as follows:
Stock-based compensation expense of the SOP recognized by the Company in the Consolidated Statements of Income was $315,000 for the year ended December 31, 2007, compared to $477,000 for the year ended December 31, 2006 and the pro forma stock-based compensation expense of $850,000 for the years ended December 31, 2005. On an after-tax basis, stock-based compensation was $204,000 for the year ended December 31, 2007 compared to $310,000 for the year ended December 31, 2006 and the pro forma stock-based compensation expense of $561,000 for the year ended December 31, 2005.
The remaining unrecognized compensation expense for the fair value of stock options was approximately $449,000 and $518,000 at December 31, 2007 and 2006.
Management Recognition Plan - The purpose of the Rainier Pacific Financial Group, Inc. 2004 Management Recognition Plan (“MRP”) is to promote the long-term interests of the Company and its shareholders by providing restricted stock as a means for attracting and retaining directors and certain employees. The maximum number of shares of common stock that may be issued under the MRP is 337,714. The Company granted restricted stock awards of 336,800 shares of its common stock to its directors and certain employees on June 24, 2004. The fair market value of the restricted stock awards was $16.20 per share on June 24, 2004 and totaled $5,456,000. The Company granted restricted stock awards of 10,000 shares of its common stock to certain employees on June 1, 2007. The fair market value of the restricted stock awards was $20.40 per share on June 1, 2007 and totaled $204,000. These restricted stock awards vest over a five-year period, and therefore, the cost of such is accrued ratably over a five-year period as compensation expense. Compensation expense related to the MRP awards was $1,025,000, $1,032,000, and $1,083,000 for the years ended December 31, 2007, 2006, and 2005, respectively. Cash dividends are paid on all MRP shares granted and are treated as additional compensation expense for tax reporting purposes for the dividends earned on unvested shares. A total of 5,900 MRP shares were forfeited during the year ended December 31, 2007 while 63,260 shares were vested to the award recipients. There were 98,725 unvested restricted shares outstanding at year-end, net of current and prior period forfeitures.
The remaining unrecognized compensation expense for the MRP was approximately $1.6 million and $2.6 million at December 31, 2007 and 2006, respectively.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 13 - Shareholders’ Equity
The following table sets forth information about the Company’s purchases of its outstanding common stock during the years ended, and as of, December 31, 2007, 2006 and 2005:
Earnings per share - The following table presents the computation of basic and diluted earnings per share for the years ended December 31 (dollars in thousands, except the number of shares and per share data):
For the years ended December 31, 2007, 2006, and 2005, there were no non-dilutive securities included in the calculation for earnings per share.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 14 - Regulatory Capital Requirements
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank's financial results.
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 assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of Tier I capital to risk-weighted assets, and to average assets for leverage capital purposes, and total risk-based capital to total risk-based assets (set forth in the following table). Management believes that the Company and the Bank meet all capital adequacy requirements to which they are subject as of December 31, 2007 and 2006.
As of December 31, 2007, the Bank was categorized as “well capitalized” under the regulatory framework for prompt corrective action promulgated by the Federal Deposit Insurance Corporation (“FDIC”). To be categorized as “well capitalized”, the Bank must maintain minimum total Tier I leverage, Tier I risk-based, and total risk-based capital ratios as set forth in the table below. There are no subsequent conditions or events that management believes have changed the “well capitalized” categorizations.
The Company's and the Bank’s actual capital amounts and ratios are presented in the following table (dollars in thousands):
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 14 - Regulatory Capital Requirements (continued)
At periodic intervals, the FDIC and the Washington State Department of Financial Institutions (“DFI”) routinely examine the Bank as part of their legally prescribed oversight of the banking industry. Based on these examinations, the regulators can direct that the Bank’s financial statements be adjusted in accordance with their findings. A future examination by the FDIC or the DFI could include a review of certain transactions or other amounts reported in the Bank's 2007 financial statements. In view of the regulatory environment in which the Bank operates, the extent, if any, to which a forthcoming regulatory examination may ultimately result in adjustments to the accompanying financial statements cannot presently be determined.
Note 15 - Related Party Transactions
During the normal course of business, the Bank originates loans to directors, executive officers, and their affiliates. Such loans are granted with interest rates, terms and collateral requirements substantially the same as those for all other customers.
Loans to directors, executive officers and their affiliates are subject to regulatory limitations. Such loans were within regulatory limitations and had aggregate balances and activity as follows (dollars in thousands):
The Bank held approximately $1,177,000 and $1,121,000 in deposits from directors, executive officers, and their affiliates at December 31, 2007 and 2006, respectively.
Note 16 - Fair Value of Financial Instruments
The carrying amount and estimated fair values of financial instruments at December 31 are as follows (dollars in thousands):
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 16 - Fair Value of Financial Instruments (continued)
Fair value of financial instruments - The Bank has adopted SFAS No. 107, Disclosure About Fair Value of Financial Instruments, which requires disclosure of estimated fair values for financial instruments. Such estimates are subjective in nature and significant judgment is required regarding the risk characteristics of various financial instruments at a distinct point in time. Therefore, such estimates could vary significantly if assumptions regarding uncertain factors were to change. Major assumptions, methods and fair value estimates for the Bank’s significant financial instruments are set forth below.
Cash and cash equivalents, interest bearing deposit with banks, and corporate drafts payable - The recorded amount approximates fair value.
Securities and Federal Home Loan Bank stock - The fair value of securities is based on quoted market prices or dealer quotes. FHLB stock is valued based on the most recent redemption value.
Loans - The fair value of loans is estimated for portfolios of loans with similar financial characteristics. Fair value for fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers for the same remaining maturities. Prepayment estimates are based on the historic experience of the market. Fair values for adjustable rate loans are estimated at carrying amount due to their adjustability.
Deposits - The fair value of deposits with no stated maturity date is included at the amount payable on demand. The fair value of fixed maturity certificates of deposit is estimated by discounting future cash flows using the rates currently offered by the Bank for deposits of similar remaining maturities.
Borrowed funds - The fair value of borrowed funds is estimated by discounting the future cash flows of the borrowings at a rate which approximates the current offering rate of borrowings with a comparable remaining life.
Off-balance sheet financial instruments - Commitments to extend credit represent the principal categories of off-balance sheet financial instruments (see Note 10). The fair value of these commitments is not material since they are for a short period of time and subject to customary credit terms.
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 17 - Parent Company Only Financial Statements
The restatement disclosed in Note 1 also affected the parent company only financials. The effects were to decrease equity in the undistributed income of subsidiary, total income and income before provision for federal income tax by $122,000 and $93,000 in 2006 and 2005, respectively, and to decrease federal income tax benefit by $53,000 in both 2006 and 2005. As a result, net income was decreased by $175,000 and $146,000 in 2006 and 2005, respectively.
The following is a summary of condensed parent company financial information for Rainier Pacific Financial Group, Inc. (dollars in thousands):
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 17 - Parent Company Only Financial Statements (continued)
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 18 - Selected Quarterly Financial Data (Unaudited)
RAINIER PACIFIC FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 18 - Selected Quarterly Financial Data (Unaudited) (continued)
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company's disclosure controls and procedures (as defined in Section 13(a)-15(e) of the Securities Exchange Act of 1934 (the "Act")) was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and other members of the Company's management team as of the end of the period covered by this annual report. The Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures as currently in effect are effective, in all material respects, in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms.
(b) Changes in Internal Controls: There have been no changes in our internal control over financial reporting (as defined in 13a-15(f) of the Act) that occurred during the quarter ended December 31, 2007, that have materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. The Company continued, however, to implement suggestions from its internal auditor and independent auditor on ways to strengthen existing controls. The Company does not expect that its disclosure controls and procedures and internal controls over financial reporting will prevent all error and fraud. A control procedure, no matter how well designed and functioning, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgements in decision-making can be faulty, and that breakdowns in controls or procedures can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure is based in part upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in cost-effective control procedures, misstatements due to error or fraud may occur and not be detected.
Management’s Annual Report on Internal Control Over Financial Reporting is included in this Form 10-K under Part II, Item 8, “Financial Statements and Supplementary Data.”
Item 9B.
Item 9B. Other Information
There was no information to be disclosed by the Company in a report on Form 8-K during the fourth quarter of fiscal 2007 that was not so disclosed.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information contained under the section captioned "Proposal 1 -- Election of Directors" is included in the Company's Definitive Proxy Statement for the 2008 Annual Meeting of Stockholders ("Proxy Statement") and is incorporated herein by reference.
For information regarding the executive officers of the Company and the Bank, see the information contained herein under the section captioned "Item 1. Business - Personnel - Executive Officers of the Registrant."
Audit Committee Financial Expert
The Audit Committee of the Company is composed of Directors Charles E. Cuzzetto, CPA (Chairperson), Stephen M. Bader, CPA and Brian E. Knutson, CPA. Each member of the Audit Committee is "independent" as defined in listing standards of The Nasdaq Stock Market LLC. The Company's Board of Directors has designated Director Knutson as the Audit Committee financial expert, as defined in the SEC's Regulation S-K. Director Knutson is independent as that term is used in Item 7(d)(3)(iv) of Schedule 14A promulgated under the Exchange Act.
Code of Business Conduct and Ethics
The Board of Directors adopted a Code of Business Conduct and Ethics for the Company's officers (including its senior financial officers), directors, and employees. The Code of Business Conduct and Ethics requires the Company's officers, directors, and employees to maintain the highest standards of professional conduct. A copy of the Code of Business Conduct and Ethics is filed as an exhibit to this Form 10-K and also is available on the Company's website at www.rainierpac.com.
Compliance with Section 16(a) of the Exchange Act
The information contained under the section captioned "Section 16 (a) Beneficial Ownership Reporting
Compliance" is included in the Company’s Proxy Statement and is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
The information contained under the sections captioned "Executive Compensation" and "Directors’ Compensation" are included in the Company's Proxy Statement and are incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
(a)
Security Ownership of Certain Beneficial Owners.
The information contained under the section captioned "Security Ownership of Certain Beneficial Owners and Management" is included in the Company's Proxy Statement and is incorporated herein by reference.
(b)
Security Ownership of Management.
The information contained under the sections captioned "Security Ownership of Certain Beneficial Owners and Management" is included in the Company's Proxy Statement and is incorporated herein by reference.
(c) Changes In Control
The Company is not aware of any arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the Company.
(d) Equity Compensation Plan Information
The following table summarizes share and exercise price information about the Company's equity compensation plans as of December 31, 2007.
____________
(1)
The restricted shares granted under the 2004 Management Recognition Plan were purchased by the Company in open market transactions, and subsequently issued to the Company’s directors and certain employees on June 24, 2004. The fair market value of the restricted shares awarded was $16.20 per share on June 24, 2004, the award date. As of December 31, 2007, there were 326,900 restricted shares issued and outstanding pursuant to the 2004 Management Recognition Plan.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information contained under the sections captioned "Meetings and Committees of the Board of Directors and Corporate Governance -- Corporate Governance -- Related Party Transactions" and "Meetings and Committees of the Board of Directors and Corporate Governance Matters -- Corporate Governance -- Director Independence" are included in the Company's Proxy Statement and are incorporated herein by reference.
Item 14.
Item 14. Principal Accounting Fees and Services
The information contained under the section captioned "Independent Auditors and Related Fees" is included in the Company's Proxy Statement and is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) Exhibits
3.1
Articles of Incorporation of the Registrant (1)
3.2 Bylaws of the Registrant (1)
10.1
Form of Employment Agreement for President and Chief Executive Officer (1)
10.2
Amended and Restated Employment Agreement between the Company and the Bank and John A. Hall (2)
(continued on following page)
10.3
Employment Agreement between the Company and the Bank and Victor J. Toy (2)
10.4
Employment Agreement between the Company and the Bank and Joel G. Edwards (2)
10.5 Form of Rainier Pacific Savings Bank Employee Severance Compensation Plan (1)
10.6
Rainier Pacific 2004 Stock Option Plan (3)
10.7 Rainier Pacific 2004 Management Recognition Plan (3)
10.8
Form of Incentive Stock Option Agreement (4)
10.9
Form of Non-Qualified Stock Option Agreement (4)
10.10
Form of Restricted Stock Award Agreement (4)
Code of Business Conduct and Ethics (5)
Subsidiaries of the Registrant
Consent of Independent Registered Public Accounting Firm
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section
of the Sarbanes-Oxley Act
___________
(1)
Filed as an exhibit to the Registrant's Registration Statement on Form S-1 (333-106349).
(2)
Filed as an exhibit to the Registrant’s Current Report on Form 8-K dated December 20, 2005 and incorporated herein by reference.
(3)
Filed as an exhibit to the Registrant's Registration Statement on Form S-8 (333-117568) and incorporated herein by reference.
(4)
Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005 and incorporated herein by reference.
(5)
Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2006 and incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
RAINIER PACIFIC FINANCIAL GROUP, INC.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Exhibit Index
Exhibit No.
Description
Subsidiaries of the Registrant
Consent of Independent Registered Public Accounting Firm
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section
of the Sarbanes-Oxley Act
Exhibit
Subsidiaries of the Registrant
Exhibit
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Rainier Pacific Financial Group, Inc.
We consent to the incorporation by reference in Registration Statement No. 333-117568 on Form S-8 of Rainier Pacific Financial Group, Inc. and Subsidiary (Rainier Pacific Financial Group, Inc.) of our report dated March 12, 2008, with respect to the consolidated statement of financial position of Rainier Pacific Financial Group, Inc. as of December 31, 2007 and 2006, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2007, and in our same report, with respect to the effectiveness of internal control over financial reporting, which report is included in this annual report on Form 10-K of Rainier Pacific Financial Group, Inc. for the year ended December 31, 2007.
/s/Moss Adams LLP
Everett, Washington
March 12,
Exhibit 31.1
Certification Required
by Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934
I, John A. Hall, certify that:
1.
I have reviewed this annual report on Form 10-K of Rainier Pacific Financial Group, Inc.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c)
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d)
Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
5.
The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date: March 12, 2008
/s/John A. Hall
John A. Hall
Chief Executive Officer
Exhibit 31.2
Certification Required
by Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934
I, Joel G. Edwards, certify that:
1.
I have reviewed this annual report on Form 10-K of Rainier Pacific Financial Group, Inc.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c)
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d)
Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
5.
The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date: March 12, 2008
/s/Joel G. Edwards
Joel G. Edwards
Chief Financial Officer
Exhibit
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
OF RAINIER PACIFIC FINANCIAL GROUP, INC.
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The undersigned hereby certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and in connection with this Annual Report on Form 10-K, that:
1.
the report fully complies with the requirements of Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, and
2.
the information contained in the report fairly presents, in all material respects, the Company's financial condition and results of operations.
/s/John A. Hall
/s/Joel G. Edwards
John A. Hall Joel G. Edwards
Chief Executive Officer
Chief Financial Officer
Dated: March 12, 2008