Item 1 - Business
General
Banner Corporation (the Company or BANR), a Washington corporation, is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly owned subsidiaries, Banner Bank (BB) and Banner Bank of Oregon (BBO). Prior to the consolidation and name change described in "Consolidation of Banking Operations", which occurred on October 30, 2000, the Company's subsidiaries included First Savings Bank of Washington (FSBW), Inland Empire Bank (IEB) and Towne Bank (TB) (together, the Banks). As of December 31, 2000, Banner Bank is a Washington-chartered commercial bank the deposits of which are insured by the Federal Deposit Insurance Corporation (FDIC) under the Savings Association Insurance Fund (SAIF). As of December 31, 2000, BB conducted business from its main office in Walla Walla, Washington, and its 32 branch offices and four loan production offices located in Washington, Idaho and Oregon. Banner Bank of Oregon is an Oregon-chartered commercial bank and its deposits are insured by the FDIC under the Bank Insurance Fund (BIF). BBO conducts business from its main office in Hermiston, Oregon, and its six branch offices and one loan production office located in northeast Oregon. Prior to merging with FSBW on October 30, 2000, TB was a Washington-chartered commercial bank whose deposits were insured by the FDIC under BIF. As of October 30, 2000, TB conducted business from seven full service branches in the Seattle, Washington, metropolitan area. An eighth Seattle area office opened in November 2000 following the merger of TB with FSBW.
The operating results of the Company depend substantially on its net interest income, which is the difference between interest income on interest-earning assets, consisting of loans and securities, and interest expense on interest-bearing liabilities, composed primarily of deposits and borrowings. Net interest income is a function of the Company's interest rate spread, which is the difference between the yield earned on interest-earning assets and the rate paid on interest-bearing liabilities, as well as a function of the average balance of interest-earning assets as compared to the average balance of interest-bearing liabilities. The Company's net income also is affected by provisions for loan losses and the level of its other income, including deposit service charges, loan servicing fees, and gains and losses on the sale of loans and securities, as well as its non-interest operating expenses and income tax provisions.
BB is a community oriented bank which has traditionally offered a wide variety of deposit products to its retail customers while concentrating its lending activities on real estate loans. Lending activities historically have been focused on the origination of loans secured by one- to four-family residential dwellings, including significant emphasis on loans for construction of residential dwellings. To an increasing extent in recent years, lending activities also have included the origination of multifamily, commercial real estate and consumer loans. BB's primary business has been that of a traditional banking institution, originating loans for portfolio in its primary market area. BB has also been an active participant in the secondary market, originating residential loans for sale and on occasion acquiring loans for portfolio. More recently, BB has begun making non-mortgage commercial and agribusiness loans to small businesses and farmers. For the past three years non-mortgage lending, especially commercial lending, has received significant attention and has become an increasingly important part of BB's operations. The acquisitions of TB, WSB and SCB have added substantially to the amount of non-mortgage loans held and being originated by BB. In addition to loans, BB has maintained a significant portion of its assets in marketable securities. The securities portfolio has been weighted toward mortgage-backed securities secured by one- to four-family residential properties. This portfolio also has included a significant amount of tax exempt municipal securities, primarily issued by entities located in the State of Washington. In addition to interest income on loans and investment securities, BB receives other income from deposit service charges, loan servicing fees and from the sale of loans and investments. On April 1, 2000, BB opened a new mortgage lending subsidiary, Community Financial Corporation (CFC), located in the Lake Oswego area of Portland, Oregon. CFC is an Oregon corporation and is a wholly owned subsidiary of BB. CFC's primary lending activities are in the area of construction and permanent financing for one- to four-family residential dwellings. BB also has a wholly owned subsidiary, Northwest Financial Corporation, which serves as the trustee under BB's mortgage loan documents and receives commissions from the sale of annuities.
Prior to being merged into BB, TB was a community oriented commercial bank chartered in the State of Washington. TB's lending activities consisted of granting commercial loans, including commercial real estate, land development and construction loans, and consumer loans to customers throughout King and Snohomish counties in western Washington. TB was a "Preferred Lender" with the Small Business Administration (SBA) and generated SBA guaranteed loans for portfolio and for resale. TB also offered a wide variety of deposit products to its consumer and commercial customers.
BBO is a community oriented commercial bank which historically has offered a wide variety of deposits and loan products to its consumer and commercial customers. Lending activities have included origination of consumer, commercial, agribusiness and real estate loans. BBO also has engaged in mortgage banking activity with respect to residential lending within its local markets, originating loans for sale generally on a servicing released basis. Additionally, BBO has maintained a significant portion of its
assets in marketable securities, particularly U.S. Treasury and government agency securities as well as tax exempt municipal securities issued primarily by entities located in the State of Oregon. BBO operates a division, Inland Financial Services, which offers insurance and brokerage services to its customers. BBO has two wholly owned subsidiaries: Pioneer American Property Company, which owns a building that is leased to BBO, and Inland Securities Corporation, which is currently inactive.
The Company and the Banks are subject to regulation by the Federal Reserve Board (FRB) and the FDIC, the State of Washington Department of Financial Institutions, Division of Banks (Division), the State of Oregon Department of Consumer and Business Services and the State of Idaho, Department of Finance.
During May 1999, the Company announced its decision to change its fiscal year from April 1 through March 31 to January 1 through December 31. For discussion and analysis purposes, the year ended December 31, 2000 is compared to the unaudited year ended December 31, 1999 and the nine months ended December 31, 1999 are compared to the unaudited nine-month period ended December 31, 1998.
Acquisitions and Mergers
Acquisition of Seaport Citizens Bank: - ------------------------------------- On April 1, 1999, the Company and FSBW (now operating as BB) completed the acquisition of Seaport Citizens Bank (SCB). FSBW paid $10.1 million in cash for all the outstanding common shares of SCB, which was headquartered in Lewiston, Idaho. As a result of the merger of SCB into FSBW, SCB became a division of FSBW. The acquisition was accounted for as a purchase and resulted in the recording of $6.1 million of costs in excess of the fair value of SCB's net assets acquired (goodwill). Goodwill assets are being amortized over a 14-year period and resulted in a current charge to earnings of $108,100 per quarter, beginning in the quarter ended June 30, 1999, or $433,000 per year. Founded in 1979, SCB was a commercial bank which had, before recording of purchase accounting adjustments, approximately $45 million in total assets, $41 million in deposits, $27 million in loans, and $4.1 million in shareholders' equity at March 31, 1999. SCB operated two full service branches in Lewiston, Idaho. SCB's results of operations are included in the Company's consolidated results of operations and financial statements for all periods subsequent to April 1, 1999.
Acquisition of Whatcom State Bancorp, Inc.: - ------------------------------------------- On January 1, 1999 the Company completed the acquisition of Whatcom State Bancorp, Inc. The Company paid $12.1 million in common stock for all the outstanding common shares and stock options of Whatcom State Bancorp, Inc., which was the holding company for Whatcom State Bank (WSB), headquartered in Bellingham, Washington. As a result of the merger of Whatcom State Bancorp, Inc. into the Company, WSB became a division of FSBW (now operating as BB). The acquisition was accounted for as a purchase and resulted in the recording of approximately $6.0 million of costs in excess of the fair value of Whatcom State Bancorp, Inc. net assets acquired (goodwill). Goodwill assets are being amortized over a 14-year period resulting in a current charge to earnings of approximately $105,200 per quarter or $421,000 per year. Founded in 1980, WSB was a community commercial bank which had, before recording of purchase accounting adjustments, approximately $99 million in total assets, $85 million in deposits, $79 million in loans, and $5.4 million in shareholders' equity at December 31, 1998. WSB operated five branches in the Bellingham, Washington, area Bellingham, Ferndale, Lynden, Blaine and Point Roberts. WSB's results of operations are included in the Company's consolidated results of operations and financial statements for all periods subsequent to January 1, 1999.
Acquisition of Towne Bancorp, Inc.: - ----------------------------------- On April 1, 1998 the Company completed the acquisition of Towne Bancorp, Inc. The Company paid $28.2 million in cash and common stock for all of the outstanding common shares and stock options of Towne Bancorp, Inc., which was the holding company for Towne Bank (TB), headquartered in Woodinville, Washington, a Seattle suburb. As a result of the merger of Towne Bancorp, Inc. into the Company, TB initially became a wholly owned subsidiary of the Company. As noted, TB was subsequently merged with FSBW (now known as BB) on October 30, 2000. The acquisition was accounted for as a purchase and resulted in the recording of $19.2 million of costs in excess of the fair value of Towne Bancorp, Inc. net assets acquired (goodwill). Goodwill assets are being amortized over a 14-year period resulting in a current charge to earnings of $343,800 per quarter or $1,375,000 per year. Founded in 1991, TB was a community business bank which had, before recording of goodwill, approximately $146 million in total assets, $134 million in deposits, $120 million in loans and $9.3 million in shareholders' equity at March 31, 1998.
Mortgage Lending Subsidiary: - ---------------------------- On April 1, 2000, FSBW (now Banner Bank) opened a new mortgage lending subsidiary, Community Financial Corporation (CFC), located in the Lake Oswego area of Portland, Oregon, with John Satterberg as President. Primary lending activities for CFC are in the area of construction and permanent financing for one- to four-family residential dwellings. CFC, an Oregon corporation, functions as a wholly owned subsidiary of Banner Bank. BB has capitalized CFC with $2 million of equity capital and provides funding support for CFC's lending operations.
Consolidation of Banking Operations
On October 30, 2000 the Company changed its name from First Washington Bancorp, Inc. (FWWB) to Banner Corporation in conjunction with a consolidation of banking operations affecting its banking subsidiaries. Towne Bank merged with First Savings Bank, First Savings Bank converted from a Washington state-chartered savings bank to a Washington state-chartered commercial bank, and First Savings Bank changed its name, along with the names of its divisions, Whatcom State Bank and Seaport Citizens Bank, to Banner Bank. At the same time, Inland Empire Bank changed its name to Banner Bank of Oregon.
The combination was designed to strengthen the Company's commitment to community banking by more effectively sharing the resources of the existing subsidiaries, improving operating efficiency and developing a broader regional brand identity. Final integration of all data processing into a common system is scheduled for completion by December 31, 2001. In light of the new Gramm-Leach-Bliley financial modernization legislation, the Company chose to retain a separate charter for Banner Bank of Oregon (formerly IEB) and to operate two banking subsidiaries. That recent legislation enacts Federal Home Loan Bank System reforms that impact community financial institutions. A community financial institution is defined as a "member of the Federal Home Loan Bank (FHLB) System, the deposits of which are insured by the FDIC and that has average total assets (over the preceding three years) of less than $500 million." One provision of the reforms provides community financial institutions with the ability to obtain long-term FHLB advances to fund small business, small farm and small agribusiness loans. In addition, community financial institutions are able to offer these loans as collateral for such borrowings. This provision, which represents a change in policy from the previous requirement that these funds be securitized primarily by residential mortgage loans, will be available only to community financial institutions. As an independent subsidiary, Banner Bank of Oregon currently qualifies as a community financial institution. Merging BBO into BB would disqualify it and remove this favorable status. On the other hand, consolidation of support operations continues and the Company expects to receive long-term benefits from the proposed efficiencies. The Banks use one name, Banner Bank, and are united under the leadership of an experienced management team. The same ten individuals serve as members of the Board of Directors of Banner Corporation and each of the Banks.
Lending Activities
General: The Banks have offered a wide range of loan products to meet the demands of their customers. The Banks originate loans for both their own loan portfolios and for sale in the secondary market. Management's strategy has been to maintain a significant percentage of assets in these loan portfolios in loans with more frequent interest rate repricing terms or shorter maturities than traditional long-term fixed-rate mortgage loans. As part of this effort, the Banks have developed a variety of floating or adjustable interest rate products that correlate closer with the Banks' cost of funds. However, in response to customer demand, the Banks continue to originate fixed-rate loans including fixed interest rate mortgage loans with terms up to 30 years. The relative amount of fixed-rate loans and adjustable-rate loans that can be originated at any time is largely determined by the demand for each in a competitive environment.
Historically, Banner Bank's primary lending focus has been on the origination of loans secured by first mortgages on owner-occupied, one- to four-family residences and loans for the construction of one- to four-family residences. BB also has originated, to a lesser degree, consumer, commercial real estate and multifamily real estate (including construction loans) and land loans. More recently, BB has begun marketing non-mortgage commercial and agribusiness loans to small businesses and farmers. The acquisitions of TB, WSB and SCB have added significantly to the amount of non-real estate loan activity at BB. Management expects this type of lending to continue to increase at BB subject to market conditions. At December 31, 2000, BB's net loan portfolio totaled $1.3 billion.
The aggregate amount of loans that BB is permitted to make under applicable federal regulations to any one borrower, including related entities, is 20% of the aggregate paid up and unimpaired capital and surplus. At December 31, 2000, the maximum amount which BB could have lent to any one borrower and the borrower's related entities was $30.2 million. At December 31, 2000, BB had no loans to one borrower with an aggregate outstanding balance in excess of this amount. BB had 53 borrowers with total loans outstanding in excess of $2.0 million at December 31, 2000. At that date, the largest amount outstanding to any one borrower and the borrower's related entities totaled $13.0 million, which consisted of a medical facility located in Bellingham, Washington other properties and a line of credit and as of December 31, 2000 the loans were performing in accordance with their terms.
Lending activities at Banner Bank of Oregon have included origination of consumer, commercial, agribusiness and commercial real estate loans. In particular, BBO has developed significant expertise and market share with respect to small business and agricultural loans within its local markets. In addition, BBO has originated one- to four-family residential real estate loans for sale in the secondary market.
At December 31, 2000, BBO's net loan portfolio totaled $166.8 million. The aggregate amount of loans that BBO is permitted to make under applicable state and federal regulations to any one borrower, including related entities, is 15% of the aggregate paid-up and unimpaired capital and surplus. At December 31, 2000, the maximum amount BBO could have lent to any one borrower and the borrower's related entities was $3.1 million ($5.0 million if secured by real estate). At that date, the largest amount outstanding to any one borrower of BBO totaled $3.5 million and was secured by an alfalfa grower, real property and a processing facility located in Hermiston, Oregon.
One- to Four-Family Residential Real Estate Lending: The Banks originate loans secured by first mortgages on owner-occupied, one- to four-family residences and loans for the construction of one- to four-family residences in the communities where they have established full service branches. In addition, the Banks operate loan production offices in Bellevue, Puyallup, Oak Harbor and Spokane, Washington. In April 2000, BB formed a new mortgage lending subsidiary, CFC, to provide residential and construction lending in the Portland, Oregon area, complimenting the previous relationship BB has had with a mortgage loan broker in the Portland area market. At December 31, 2000, $408.6 million, or 27.5% of the Company's loan portfolio, consisted of permanent loans on one- to four-family residences.
Historically, BB has originated both fixed-rate loans and adjustable-rate residential loans for its portfolio. Fixed-rate residential loans generally have been sold into the secondary market; however, a portion of the fixed-rate loans originated by BB have been retained in the loan portfolio to meet asset/liability management objectives.
Historically, BBO has sold most of its residential loan originations into the secondary market. Generally BBO has sold loans on a servicing-released basis such that no revenue is realized by BBO after the sale.
In the loan approval process, the Banks assess the borrower's ability to repay the loan, the adequacy of the proposed security, the employment stability of the borrower and the credit worthiness of the borrower. As part of the loan application process, qualified independent appraisers inspect and appraise the security property. All appraisals are subsequently reviewed by a loan underwriter and, if necessary, by the Banks' chief appraiser.
The Banks' residential loans are generally underwritten and documented in accordance with the guidelines established by Freddie Mac and Fannie Mae. Government insured loans are generally underwritten and documented in accordance with the guidelines established by the Department of Housing and Urban Development (HUD) and the Veterans Administration (VA). The Banks' loan underwriters are approved as underwriters under HUD's delegated underwriter program.
The Banks and CFC sell whole loans on either a servicing-retained or servicing-released basis. All loans are sold without recourse. Occasionally, the Banks will sell a participation interest in a loan or pool of loans to an investor. In these instances, the Banks retain a small percentage of the loan(s) and pass through a net yield to the investor on the percentage sold. The decision to hold or sell loans is based on asset/liability management goals and policies and market conditions. Recently, BB has sold a significant portion of its conventional fixed-rate mortgage originations and all of its government insured loans into the secondary market. BBO has continued to sell most of its residential loan originations.
The Banks offer adjustable-rate mortgages (ARMs) at rates and terms competitive with market conditions. The Banks offer several ARM products which adjust annually after an initial period ranging from one to five years subject to a limitation on the annual increase of 1.0% to 2.0% and an overall limitation of 5.0% to 6.0%. Certain ARM loans are originated with an option to convert the loan to a 30-year fixed-rate loan at the then prevailing market interest rate. Generally these ARM products utilize the weekly average yield on one-year U.S. Treasury securities adjusted to a constant maturity of one year plus a margin of 2.75% to 3.25%. ARM loans held in the Banks' portfolios do not permit negative amortization of principal and carry no prepayment restrictions. The retention of ARM loans in the Banks' loan portfolios can help reduce the Company's exposure to changes in interest rates. However, borrower demand for ARM loans versus fixed-rate mortgage loans is a function of the level of interest rates, the expectations of changes in the level of interest rates and the difference between the initial interest rates and fees charged for each type of loan. In recent years borrower demand for ARM loans has been limited and the Banks have chosen not to aggressively pursue ARM loans by offering minimally profitable deeply discounted teaser rates. As a result ARM loans have represented only a very small portion of loans originated during this period.
Generally the Banks' lend up to 95% of the lesser of the appraised value of the property or purchase price of the property on conventional loans, although ARM loans are normally restricted to not more than 90%. Higher loan-to-value ratios are available on certain government insured programs. The Banks generally require private mortgage insurance on residential loans with a loan-to-value ratio at origination exceeding 80%.
Construction and Land Lending: BB invests a significant proportion of its loan portfolio in residential construction loans to professional home builders. This activity has resulted from favorable economic conditions in the Northwest, lower long-term interest rates and an increased demand for housing units as a result of the migration of people from other parts of the country to the Northwest. To a lesser extent, BB also originates land loans and construction loans for commercial and multifamily real estate. BBO also originates construction and land loans although to a much smaller degree than BB. At December 31, 2000, construction and land loans totaled $271.3 million, (including $79.9 million of land or land development loans and $44.4 million of commercial and multifamily real estate construction loans) or 18.2% of total loans of the Company.
Construction loans made by the Banks include both those with a sale contract or permanent loan in place for the finished homes and those for which purchasers for the finished homes may be identified either during or following the construction period. The Banks monitor the number of unsold homes in their construction loan portfolios, and generally maintain the portfolios so approximately 25% of their construction loans are secured by homes for which there is a sale contract in place.
Construction and land lending affords the Banks the opportunity to achieve higher interest rates and fees with shorter terms to maturity than does single-family permanent mortgage lending. Construction and land lending, however, is generally considered to involve a higher degree of risk than single-family permanent mortgage lending because of the inherent difficulty in estimating both a property's value at completion of the project and the estimated cost of the project. The nature of these loans is such that they are generally more difficult to evaluate and monitor. If the estimate of construction cost proves to be inaccurate, the Banks may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value upon completion proves to be inaccurate, the Banks may be confronted at, or prior to, the maturity of the loan with a project whose value is insufficient to assure full repayment. Projects may also be jeopardized by disagreements between borrowers and builders and by the failure of builders to pay subcontractors. Loans to builders to construct homes for which no purchaser has been identified carry more risk because the payoff for the loan is dependent on the builder's ability to sell the property prior to the time that the construction loan is due. The Banks have sought to address these risks by adhering to strict underwriting policies, disbursement procedures, and monitoring practices.
The maximum number of speculative loans approved for each builder is based on a combination of factors, including the financial capacity of the builder, the market demand for the finished product, and the ratio of sold to unsold inventory the builder maintains. The Banks have chosen to diversify the risk associated with speculative construction lending by doing business with a large number of smaller builders spread over a relatively large geographic area.
Loans for the construction of one- to four-family residences are generally made for a term of 12 months. The Banks' loan policies include maximum loan-to-value ratios of up to 80% for speculative loans. Each individual speculative loan request is supported by an independent appraisal of the property and the loan file includes a set of plans, a cost breakdown and a completed specifications form. All speculative construction loans must be approved by senior loan officers. At December 31, 2000, the Company's speculative construction portfolio included loans to 324 individual builders in 110 separate communities. At December 31, 2000, the Company had 75 builders who, individually, in the aggregate, had construction loans outstanding with balances exceeding $1.0 million. The largest builder had two loans totaling commitments of $12.6 million with $5.2 million outstanding at December 31, 2000. The loans were for the construction of an apartment complex in Everett, Washington and an office complex in Kirkland, Washington and both loans were current at December 31, 2000.
The Company regularly monitors the construction loan portfolio and the economic conditions and housing inventory in each of its markets and will decrease construction lending if it perceives there are unfavorable market conditions. The Company believes that the internal monitoring system in place mitigates many of the risks inherent in its construction lending.
To a lesser extent, the Banks make land loans to developers, builders and individuals to finance the acquisition and/or development of improved lots or unimproved land. In making land loans the Banks follow underwriting policies and disbursement procedures similar to those for construction loans. The initial term on land loans is typically one to three years with interest only payments, payable monthly, and provisions for principal reduction as lots are sold and released.
Commercial and Multifamily Real Estate Lending: The Banks also originate loans secured by multifamily and commercial real estate. At December 31, 2000, the Company's loan portfolio included $100.7 million in multifamily and $394.0 million in commercial real estate loans (including $44.4 million of commercial and multifamily real estate construction lending). Multifamily and commercial real estate lending affords the Banks an opportunity to receive interest at rates higher than those generally available from one- to four-family residential lending. However, loans secured by such properties are generally greater in amount, more difficult to evaluate and monitor and, therefore, involve a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by multifamily and commercial properties are often dependent on the successful operation and management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy.
In all multifamily and commercial real estate lending, the Banks consider the location, marketability and overall attractiveness of the properties. The Banks' current underwriting guidelines for commercial real estate loans require an appraisal from a qualified independent appraiser and an economic analysis of each property with regard to the annual revenue and expenses, debt service coverage and fair value to determine the maximum loan amount. In the approval process the Banks assess the borrowers willingness and ability to repay and the adequacy of the collateral.
Multifamily and commercial real estate loans originated by the Banks are predominately fixed rate loans with intermediate terms of ten years. More recently originated multifamily and commercial loans are linked to various constant maturity U.S. Treasury indices or certain prime rates. Rates on these ARM loans generally adjust annually after an initial period ranging from one to ten years. Rate adjustments for the more seasoned ARM loans in the portfolio predominantly reflect changes in the Federal Home Loan Bank (FHLB) National Monthly Median Cost of Funds index. The Banks' commercial real estate portfolios consist of loans on a variety of property types including motels, nursing homes, office buildings, and mini-warehouses. Multifamily loans generally are secured by small to medium sized projects.
At December 31, 2000, the Banks' loan portfolio included 181 multifamily loans, the average loan balance of which was $556,000. At December 31, 2000, the Banks had 97 multifamily or commercial real estate loans with balances over $1.0 million, the largest of which was a $15.2 million with BB and BBO being joint participants/lenders. Most of the properties securing these multifamily and commercial real estate loans are located in the Northwest; however, the Company has acquired some participation loans on properties located in California.
Commercial Lending: BB and BBO have been very active in small business lending. BBO has also been active in agricultural lending; however, BB has not engaged in agricultural lending to a significant extent. Historically, the Company has sold most of its small business administration guaranteed loans into the secondary market on a servicing retained basis. BB and BBO's officers have devoted a great deal of effort to developing customer relationships and the ability to serve this type of borrower. It is management's belief that many very large banks have in the past neglected small business lending, thus contributing to BB and BBO's success. BB and BBO will continue to emphasize this segment of lending in their market areas. Management intends to leverage their past success and local decision making ability to continue to expand this market niche. In addition to providing higher yielding assets, it is anticipated that this type of lending will increase the deposit base. Expanding commercial lending is currently an area of significant effort at BB. Following the October 30 consolidation all of FSBW, TB, WSB and SCB commercial lending operations have been integrated at BB.
Commercial loans may entail greater risk than do residential mortgage loans. Commercial loans may be unsecured or secured by special purpose or rapidly depreciating assets, such as equipment, inventory and receivables which may not provide an adequate source of repayment on defaulted loans. In addition, commercial loans are dependent on the borrower's continuing financial strength and management ability as well as market conditions for various products, services and commodities. For these reasons, commercial loans generally provide higher yields than residential loans but also require more administrative and management attention. Interest rates on commercial loans may be either fixed or adjustable. Loan terms including the fixed or adjustable interest rate, the loan maturity and the collateral considerations vary significantly and are negotiated on an individual loan basis. At December 31, 2000, commercial loans totaled $228.7 million, or 15.4% of total loans of the Company.
The Banks underwrite their commercial business loans on the basis of the borrower's cash flow and ability to service the debt from earnings rather than on the basis of the underlying collateral value. The Banks seek to structure such loans to have more than one source of repayment. The borrower is required to provide the Banks with sufficient information to allow the Banks to make their lending determination. In most instances, this information consists of at least three years of financial statements, tax returns, a statement of projected cash flows, current financial information on any guarantor and any additional information on the collateral. All closely held business borrowers typically require personal guarantees by the principals.
The Banks commercial business loans may be structured as term loans or as lines of credit. Commercial business term loans are generally made to finance the purchase of fixed assets and have maturities of five years or less. Commercial business lines of credit are typically made for the purpose of providing working capital and are usually approved with a term of one year.
Agricultural Lending: Agriculture is a major industry in BBO's market area as well as much of BB's Eastern Washington locations. Subject to market conditions, the Bank intends to continue to make agricultural loans to borrowers with a strong capital base, sufficient management depth, proven ability to operate through agricultural cycles, reliable cash flows and adequate financial reporting to the bank on a regular basis. At December 31, 2000 agricultural loans totaled $67.8 million, or 4.6% of the loan portfolio.
Agricultural operating loans generally are made as a percentage of the borrower's anticipated income to support budgeted operating expenses. These loans generally are secured by a blanket lien on all crops, livestock, equipment, accounts and products and proceeds thereof. In the case of crops, consideration is given to projected yields and prices from each commodity. The interest rate is normally fully floating based on the prime rate as published in the Wall Street journal, plus a negotiated margin of up to 2%. Because such loans are made to finance a farm or ranch's annual operations, they are written on a one-year review and renewable basis. The renewal is dependent upon prior year's performance and the forthcoming year's projections as well as overall financial strength of the borrower. The Bank carefully monitors these loans and prepares monthly variance reports on income and expenses. To meet the seasonal operating needs of a farm, borrowers may qualify for single payment notes, revolving lines of credit and/or non-revolving lines of credit.
In underwriting agricultural operating loans, the Banks considers the cash flow of the borrower based upon the expected income stream as well as the value of collateral used to secure the loans. Collateral generally consists of cattle or cash crops produced by the farm, such as grains, grass seed, peas, sugar beets, mint, onions, potatoes, corn and alfalfa. In addition to considering cash flow and obtaining a blanket security interest in the farm's cash crop, the Banks may also collateralize an operating loan with the farm's operating equipment, breeding stock, real estate, and federal agricultural program payments to the borrower.
The Banks also originate loans to finance the purchase of farm equipment and will continue to pursue this type of lending in the future. Loans to purchase farm equipment are made for terms of up to seven years. Agricultural real estate loans primarily are secured by first liens on farmland and improvements thereon located in the Bank's market area, to service the needs of the Bank's existing customers. Loans are generally written in amounts up to 50% to 75% of the tax assessed or appraised value of the property at terms ranging from 10 to 20 years. Such loans have interest rates that generally adjust at least every five years based typically upon a Treasury Index plus a negotiated margin. Fixed rate loans are granted on terms generally not to exceed five years with rates established at inception based on margins set above the current five year Treasury Note or another generally accepted index. In originating an agricultural real estate loans, the Bank's consider the debt service converge of the borrowers' cash flow, the appraised value of the underlying property, the experience and knowledge of the borrower, and the borrower's past performance with the Bank's and/or market area.
Payments on an agricultural real estate loans depend, to a large degree, on the results of operation of the related farm entity. The repayment is also subject to bother economic and weather conditions as well as market prices for agricultural products, which can be highly volatile at times. Such loans are not made to start up businesses but are generally reserved for profitable operations with substantial equity and proven history.
Among the greatest and more common risks to agricultural lending can be weather conditions and disease. This risk can be mitigated through multi-peril crop insurance. Commodity prices also present a risk, which may be reduced by the use of set price contracts. Required beginning and projected operating margins provide for reasonable reserves to offset unexpected yield and price deficiencies.
In addition to the above mentioned risks, the Bank's also consider management succession, life insurance and business continuation plans.
Consumer and Other Lending: The Banks originate a variety of consumer loans, including secured second mortgage loans, automobile loans and loans secured by deposit accounts. Consumer and other lending has traditionally been a small part of BB's business. However, recent efforts at BB have led to a modest increase in consumer loans primarily to its existing customer base. BBO, on the other hand, has been an active originator of consumer loans. At December 31, 2000, the Company had $60.4 million, or 4.1% of its loans receivable, in outstanding consumer and other loans.
Similar to commercial loans, consumer loans often entail greater risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. Such loans may also give rise to claims and defenses by a consumer loan borrower against an assignee of such loans such as the Banks, and a borrower may be able to assert against such assignee claims and defenses that it has against the seller of the underlying collateral.
Loan Solicitation and Processing: The Banks originate real estate loans by direct solicitation of real estate brokers, builders, depositors, and walk-in customers. Loan applications are taken by the Banks' loan officers and are processed in each branch location. Most underwriting and all audit functions are performed by loan administration personnel at central locations. Applications for fixed-rate and adjustable-rate mortgages on one- to four-family properties are generally underwritten and closed based on Freddie Mac/Fannie Mae standards, and other loan applications are underwritten and closed based on the Banks' own written guidelines.
Commercial and agricultural loans are solicited by loan officers of each Bank by means of call programs focused on local businesses and farmers. While commercial loan officers are delegated reasonable commitment authority based upon their qualifications, credit decisions on significant commercial and agricultural loans are made by senior loan officers or in certain instances by the Board of Directors of each Bank or the Company.
Consumer loans are originated through various marketing efforts directed primarily toward existing deposit and loan customers of the Banks. Consumer loan applications may be processed at branch locations or by administrative personnel at the Banks' main offices.
Loan Originations, Sales and Purchases
While the Banks originate a variety of loans, their ability to originate loans and their ability to originate each type of loan is dependent upon the relative customer demand and competition in each market. For the year ended December 31, 2000, the nine months ended December 31, 1999 and the year ended March 31, 1999, the Banks originated and disbursed $880.8 million, $759.6 million and $717.0 million of loans, respectively. The Company's net loan portfolio grew $163.6 million or 12.5% during the year ended December 31, 2000 compared to $205.5 million of growth during the nine months ended December 31, 1999 ($178.5 million excluding acquisitions) and $345.8 million of growth in the year ended March 31, 1999 ($146.4 million excluding acquisitions).
In recent years prior to 1996 the Company generally sold most of its 30-year fixed-rate one- to four-family residential mortgage loans to secondary market purchasers. For the years ended March 31, 1996 and 1997 the Company sold a smaller portion of its fixed-rate loan originations choosing to retain loans in response to its capital deployment and growth objectives. Beginning in the second half of fiscal year 1998 the Company increased the amount of new fixed-rate residential loans sold as part of its interest rate risk management strategy. Proceeds from sales of loans by the Company for the year ended December 31, 2000, nine months ended December 31, 1999 and the year ended March 31, 1999 totaled $135.7 million, $99.3 million and $127.5 million, respectively.
Sales of whole loans generally are beneficial to the Company since these sales may generate income at the time of sale, provide funds for additional lending and other investments and increase liquidity. The Company sells loans on both a servicing-retained and a servicing-released basis. See "Loan Servicing Loan Servicing Portfolio." At December 31, 2000, the Company had $7.9 million in loans held for sale.
The Banks purchase whole loans and loan participation interests primarily during periods of reduced loan demand in their primary market. Any such purchases are made consistent with the Banks' underwriting standards; however, the loans may be located outside of the Banks' normal lending area. During the year ended December 31, 2000 the nine months ended December 31, 1999 and the year ended March 31, 1999, the Company purchased $12.0 million, $13.2 million and $86.2 million, respectively, of loans and loan participation interests.
Loan Servicing
General: The Banks receive fees from a variety of institutional owners in return for performing the traditional services of collecting individual payments and managing portfolios of sold loans. At December 31, 2000, the Banks were servicing $284.6 million of loans for others. Loan servicing includes processing payments, accounting for loan funds and collecting and paying real estate taxes, hazard insurance and other loan-related items such as private mortgage insurance. When the Banks receive the gross loan payment from individual borrowers, they remit to the investor a predetermined net amount based on the yield on that loan. The difference between the coupon on the underlying loan and the predetermined net amount paid to the investor is the gross loan servicing fee. In addition, the Banks retain certain amounts in escrow for the benefit of the lender for which the Banks incur no interest expense but are able to invest the funds into earning assets. At December 31, 2000, the Banks held $2.5 million in escrow for their portfolios of loans serviced for others.
Loan Servicing Portfolio: The loan servicing portfolio at December 31, 2000 was composed primarily of $18.6 million of Fannie Mae mortgage loans and $203.4 million of Freddie Mac mortgage loans. The remaining balance of the loan servicing portfolio at December 31, 2000, consisted of loans serviced for a variety of private investors. At December 31, 2000, the portfolio included loans secured by property located primarily in the states of Washington or Oregon. For the year ended December 31, 2000, $1.1 million of loan servicing fees, net of $251,000 of servicing rights amortization, were recognized in operations.
Mortgage Servicing Rights: In addition to the origination of mortgage servicing rights (MSRs) on the loans that BANR originates and sells in the secondary market on a servicing retained basis, BANR has also purchased mortgage-servicing rights. The cost of MSRs is capitalized and amortized in proportion to, and over the period of, the estimated future net servicing income. For the year ended December 31, 2000, the nine months ending December 31, 1999 and the year ending March 31, 1999, BANR capitalized $395,000, $128,000 and $981,000, respectively, of MSRs relating to loans sold with servicing retained. No MSRs were purchased in the year ended December 31, 2000, the nine months ending December 31, 1999 and the fiscal year ended March 31, 1999. Amortization of MSRs for the year ended December 31, 2000, the nine months ended December 31, 1999 and the fiscal year ended March 31, 1999 was $251,000, $215,000 and $277,000, respectively. Management periodically evaluates the estimates and assumptions used to determine the carrying values of MSRs and the amortization of MSRs. These carrying values are adjusted when the valuation indicates the carrying value is impaired. At December 31, 2000, MSRs were carried by BANR at a value, net of amortization, of $1,728,000, and no valuation allowance for impairment was considered necessary. MSRs generally are adversely affected by current and anticipated prepayments resulting from decreasing interest rates.
Asset Quality
Each Bank's asset classification committee meets at least monthly to review all classified assets, to approve action plans developed to resolve the problems associated with the assets and to review recommendations for new classifications, any changes in classifications and recommendations for reserves. The committee reports to the Board of Directors quarterly as to the current status of classified assets and action taken in the preceding quarter.
State and Federal regulations require that the Banks review and classify their problem assets on a regular basis. In addition, in connection with examinations of insured institutions, state and federal examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. Substandard assets must have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a significant possibility of loss. An asset classified loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. The regulations have also created a special mention category, described as assets which do not currently expose an insured institution to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving management's close attention. If an asset or portion thereof is classified loss, the insured institution establishes specific allowances for loan losses for the full amount of the portion of the asset classified loss. A portion of general loan loss allowances established to cover possible losses related to assets classified substandard or doubtful may be included in determining an institution's regulatory capital, while specific valuation allowances for loan losses generally do not qualify as regulatory capital.
At December 31, 2000 and 1999 and March 31, 1999, the aggregate amounts of the Banks' classified assets (as determined by the Banks) were as follows (in thousands):
December 31 At March 31 2000 1999 1999 ---- ---- ----
Loss $ -- $ -- $ 60 Doubtful 61 -- 58 Substandard assets 12,166 6,637 8,302 Special mention 9,936 1,762 3,008
Non-performing Assets and Delinquencies.
Real Estate Loans: When a borrower fails to make a required payment when due, the Banks follow established collection procedures. The first notice is mailed to the borrower within 10 to 17 days after the payment due date and attempts to contact the borrower by telephone begin within five to ten days after the late notice is mailed to the borrower. If the loan is not brought current by 30 days after the payment due date, the Banks will mail a second written notice to the borrower. If a satisfactory response is not obtained, continuous follow-up contacts are attempted until the loan has been brought current. Generally, for residential loans within 30 to 45 days into the delinquency procedure, the Banks notify the borrower that home ownership counseling is available. In most cases, delinquencies are cured promptly; however, if after 90 days of delinquency no response has been received nor an approved reinstatement plan established, foreclosure according to the terms of the security instrument and applicable law is initiated. Interest income on loans after 90 days of delinquency is no longer accrued and the full amount of accrued and uncollected interest is reversed.
Commercial/Agricultural and Consumer Loans: When a borrower fails to make payments as required, a late notice is sent to the borrower. If payment is still not made the responsible loan officer is advised and contact is made by telephone or letter. Continuous follow-up contacts are attempted until the loan has been brought current. Generally, if the loan is not current within 45 to 60 days, action is initiated to take possession of the security. A small claims or lawsuit is normally filed on unsecured loans or deficiency balances at 90 to 120 days. Loans over 90 days delinquent, repossessions, loans in foreclosure and bankruptcy no longer accrue interest unless a satisfactory repayment plan has been agreed upon, the loan is a full recourse contract or fully secured by a deposit account.
The following table sets forth information with respect to the Banks' non-performing assets and restructured loans within the meaning of SFAS No. 15, Accounting by Debtors and Creditors for Troubled Debt Restructuring, at the dates indicated (dollars in thousands).
At December 31 At March 31 -------------- ---------------------- 2000 1999 1999 1998 1997 ---- ---- ---- ---- ---- Nonaccrual loans: Loans secured by real estate: One- to four-family $ 873 $ 623 $3,564 $ 448 $1,644 Commercial 1,741 129 351 -- 187 Multifamily -- -- -- -- -- Construction/land 2,937 2,514 767 367 -- Commercial business 1,734 1,203 1,392 410 206 Agricultural business 529 -- 47 4 -- Consumer, credit card and other 18 9 17 41 45 ------- ------ ------ ------ ------ Total loans outstanding 7,832 4,478 6,138 1,270 2,082 ------- ------ ------ ------ ------ Loans more than 90 days delinquent, still on accrual: Loans secured by real estate: One- to four family real 20 155 20 52 -- Commercial -- -- 384 33 -- Multifamily -- -- -- -- -- Construction/land -- -- -- 32 -- Commercial business 1 25 -- -- -- Agricultural business 467 334 1,052 -- -- Consumer, credit card and other 54 79 82 33 30 ------- ------ ------ ------ ------ Total loans outstanding 542 593 1,538 150 30 ------- ------ ------ ------ -----
Total non-performing loans 8,374 5,071 7,676 1,420 2,112
Real estate/repossessed assets held for sale 3,287 3,576 1,644 882 1,057 ------- ------ ------ ------ ------ Total non-performing assets $11,661 $8,647 $9,320 $2,302 $3,169 ======= ====== ====== ====== ======
Restructured loans (1) $ 337 $ 369 $ 380 $ 305 $ 238
Total non-performing loans to net loans before allowance for loan losses 0.56% 0.38% 0.69% 0.19% 0.32% Total non-performing loans to total assets 0.42% 0.28% 0.47% 0.12% 0.21% Total non-performing assets to total assets 0.59% 0.48% 0.57% 0.20% 0.31%
(1) These loans are performing under their restructured terms but are classified substandard.
For the year ended December 31, 2000, $510,000 in interest income would have been recorded had nonaccrual loans been current, and no interest income on such loans was included in net income for such period.
Real Estate/Repossessed Assets, Held for Sale: Real estate acquired by the Company as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate held for sale until it is sold. When property is acquired it is recorded at the lower of its cost (the unpaid principal balance of the related loan plus foreclosure costs), or net realizable value. Subsequent to foreclosure, the property is carried at the lower of the foreclosed amount or net realizable value. Upon receipt of a new appraisal and market analysis, the carrying value is written down through the establishment of a specific reserve to the anticipated sales price less selling and holding costs. At December 31, 2000, the Company had $3.3 million of real estate owned and no other repossessed assets.
Allowance for Loan Losses
General: In originating loans, the Banks recognize that losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the credit worthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the security for the loan. As a result, the Banks maintain an allowance for loan losses consistent with the generally acceptable accounting principles (GAAP) guidelines outlined in SFAS No. 5, Accounting for Contingencies. The Banks have established systematic methodologies for the determination of the adequacy of their allowance for loan losses. The methodologies are set forth in a formal policy and take into consideration the need for an overall general valuation allowance as well as specific allowances that are tied to individual problem loans. The Banks increase their allowance for loan losses by charging provisions for possible loan losses against the Banks' income.
On April 1, 1995, the Company and its subsidiary Banks adopted SFAS No. 114, Accounting by Creditors for Impairment of a Loan, and SFAS No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures, an amendment of SFAS No. 114. These statements require that impaired loans that are within their scope be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of collateral if the loan is collateral dependent. Subsequent changes in the measurement of impaired loans shall be included within the provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the provision that would otherwise be reported. As of December 31, 2000, the Company and its subsidiary Banks had identified $3.9 million of impaired loans as defined by the statement and had established $133,000 of specific reserves for these loans. The statements also apply to all loans that are restructured in a troubled debt restructuring, subsequent to the adoption of SFAS No. 114, as defined by SFAS No. 15. A troubled debt restructuring is a restructuring in which the creditor grants a concession to the borrower that it would not otherwise consider. At December 31, 2000, the Company had $337,000 of restructured loans that, though performing, were classified substandard.
The allowance for losses on loans is maintained at a level sufficient to provide for estimated losses based on evaluating known and inherent risks in the loan portfolio and upon management's continuing analysis of the factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, delinquency rates, actual loan loss experience, current economic conditions, detailed analysis of individual loans for which full collectibility may not be assured, and determination of the existence and realizable value of the collateral and guarantees securing the loans. Additions to these allowances are charged to earnings. Realized losses and charge-offs that are related to specific loans are applied as a reduction of the carrying value of the assets and charged immediately against the allowance for losses. Recoveries on previously charged off loans are credited to the allowance. The reserve is based upon factors and trends identified by management at the time financial statements are prepared. The Company's methodology for assessing the appropriateness of the allowance consists of several key elements, which include specific allowances, an allocated formula allowance, and an unallocated allowance. Losses on specific loans are provided for when the losses are probable and estimable. The formula allowance is calculated by applying loss factors to outstanding loans, excluding loans with specific allowances. Loss factors are based on the Company's historical loss experience adjusted for significant factors including the experience of other banking organizations that, in management's judgment, affect the collectibility of the portfolio as of the evaluation date. The unallocated allowance is based upon management's evaluation of various factors that are not directly measured in the determination of the formula and specific allowances. Although management uses the best information available, future adjustments to the allowance may be necessary due to economic, operating, regulatory and other conditions beyond the Banks' control.
At December 31, 2000, the Company had an allowance for loan losses of $15.3 million which represented 1.03% of net loans and 183% of non-performing loans compared to 1.02% and 267%, respectively, at December 31, 1999. The increase in the provision for losses reflects the amount required to maintain the allowance for losses at an appropriate level based upon management's evaluation of the adequacy of general and specific loss reserves. The higher provision in the current year reflects changes in the portfolio mix and a higher level of non-performing loans, although the amount of net charge-offs declined modestly from that which occurred in the prior year. Net charge-offs decreased from $1.2 million for the year ended December 31, 1999, to $920,000 for the year ended December 31, 2000. Non-performing loans increased to $8.4 million at December 31, 2000, compared to $5.1 million at December 31, 1999. A comparison of the allowance for loan losses at December 31, 2000 and 1999 shows an increase of $1.8 million to $15.3 million at December 31, 2000 from $13.5 million at December 31, 1999 (see Notes 7 and 8 to the Consolidated Financial Statements for further analysis of the loan portfolio mix and allowance for loan losses).
While the Company believes that the Banks have established their existing allowance for loan losses in accordance with Generally Accepted Accounting Principles (GAAP), there can be no assurance that regulators, in reviewing the Banks' loan portfolio, will not request the Banks to increase significantly their allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that substantial increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect the Company's financial condition and results of operations.
The following table sets forth an analysis of the Company's gross allowance for possible loan losses for the periods indicated (dollars in thousands).
Nine Months Year Ended Ended December 31 December 31 Years Ended March 31 ----------- ----------- ------------------------ 2000 1999 1999 1998 1997 ---- ---- ---- ---- ----
Balance, beginning of period $ 13,541 $12,261 $ 7,857 $ 6,748 $ 4,051 Allowances added through business combinations -- 477 2,693 -- 1,416 Sale of credit card portfolio (174) -- -- -- -- Provision 2,867 1,885 2,841 1,628 1,423
Recoveries of loans previously charged off: Secured by real estate: One- to four-family 2 -- -- 6 38 Commercial 2 1 60 29 -- Multifamily -- -- -- -- -- Construction and land -- -- -- -- -- Commercial business 40 450 143 -- -- Agricultural business 1 6 1 -- -- Consumer, credit card and other 66 11 21 16 16 ------ ------ ------ ------ ------ 111 468 225 51 54 ------ ------ ------ ------ ------ Loans charged off: Secured by real estate One- to four-family (90) (532) (25) (359) (127) Commercial (31) -- (35) - -- Multifamily -- -- -- -- -- Construction and land (12) (24) (69) (11) -- Commercial business (403) (841) (911) (19) (3) Agricultural business (16) (19) (5) -- -- Consumer, credit card and other (479) (134) (310) (181) (66) -------- ------- ------- ------- ------- (1,031) (1,550) (1,355) (570) (196) -------- ------- ------- ------- ------- Net charge-offs (920) (1,082) (1,130) (519) (142) -------- ------- ------- ------- -------
Balance, end of period $15,314 $13,541 $12,261 $ 7,857 $ 6,748 ======= ======= ======= ======= =======
Ratio of allowance to net loans before allowance for loan losses 1.03% 1.02% 1.10% 1.03% 1.03%
Ratio of net loan charge-offs to the average net book value of loans outstanding during the period 0.06% 0.09% 0.14% 0.08% 0.04%
Investment Activities
Under Washington and Oregon state law, banks are permitted to invest in various types of marketable securities. Authorized securities include but are not limited to U.S. Treasury obligations, securities of various federal agencies, mortgage-backed securities, certain certificates of deposit of insured banks and savings institutions, banker's acceptances, repurchase agreements, federal funds, commercial paper, corporate debt and equity securities and obligations of states and their political sub-divisions. The investment policies of the Banks are designed to provide and maintain adequate liquidity and to generate favorable rates of return without incurring undue interest rate or credit risk. The Banks' policies generally limit investments to U.S. Government and agency securities, municipal bonds, certificates of deposit, marketable corporate debt obligations and mortgage-backed securities. Investment in mortgage-backed securities includes those issued or guaranteed by Freddie Mac (FHLMC), Fannie Mae (FNMA), Government National Mortgage Association (GNMA) and privately-issued collateralized mortgage-backed securities that have an AA credit rating or higher. A high credit rating indicates only that the rating agency believes there is a low risk of loss or default. However, all of the Banks' investment securities, including those that have high credit ratings, are subject to market risk in so far as a change in market rates of interest or other conditions may cause a change in an investment's market value.
At December 31, 2000, the Company's consolidated investment portfolio totaled $326.5 million and consisted principally of U.S. Government and agency obligations, mortgage-backed securities, municipal bonds, corporate debt obligations, and stock of FNMA and FHLMC. From time to time, investment levels may be increased or decreased depending upon yields available on investment alternatives, and management's projections as to the demand for funds to be used in the Banks' loan originations, deposits and other activities. During the year ended December 31, 2000 investments and securities decreased by $35.6 million. Holdings of mortgage-backed securities decreased $35.9 million and U.S. Treasury and agency obligations increased $2.6 million. Ownership of corporate and other securities increased $1.5 million. Municipal bonds decreased $3.7 million.
Mortgage-Backed and Mortgage-Related Securities: The Company purchases mortgage-backed securities in order to: (i) generate positive interest rate spreads on large principal balances with minimal administrative expense; (ii) lower the credit risk of the Company as a result of the guarantees provided by FHLMC, FNMA, and GNMA or credit enhancements provided by other entities or the structure of the securities; (iii) enable the Company to use mortgage-backed securities as collateral for financing; and (iv) increase liquidity. The Company invests primarily in federal agency issued or guaranteed mortgage-backed and mortgage-related securities, principally FNMA, FHLMC and GNMA. The Company also invests in privately issued collateralized mortgage obligations (CMOs) including real estate mortgage investment conduits (REMICs). At December 31, 2000, net mortgage-backed securities totaled $194.1 million, or 9.8% of total assets. At December 31, 2000, 44.0% of the mortgage-backed securities were adjustable-rate and 56.0% were fixed-rate. The estimated fair value of the Company's mortgage-backed securities at December 31, 2000, was $194.1 million, which is $3.5 million less than the amortized cost of $197.6 million. At December 31, 2000, the Company's portfolio of mortgage-backed securities had a weighted average coupon rate of 6.76%. The estimated weighted average remaining life of the portfolio was 8.6 years based on the last 3 months' "constant prepayment rate" (CPR) or the most recent CPR if less than 3 months history is available.
Mortgage-backed securities known as PCs or mortgage pass-through certificates generally represent a participation interest in a pool of single-family mortgage loans. The principal and interest payments on these loans are passed from the mortgage originators, through intermediaries (generally U.S. Government agencies and government sponsored enterprises) that pool and resell the participation interests in the form of securities, to investors such as the Company. Mortgage participation certificates generally yield less than the loans that underlie such securities because of the cost of payment guarantees and credit enhancements. In addition, PCs are usually more liquid than individual mortgage loans and may be used to collateralize certain liabilities and obligations of the Company. These types of securities also permit the Company to optimize its regulatory capital because of their low risk weighting.
CMOs and REMICs are mortgage-related obligations and may be considered as derivative financial instruments because they are created by redirecting the cash flows from the pool of mortgage loans or mortgage-backed securities underlying these securities into two or more classes (or tranches) with different maturity or risk characteristics. Management believes these securities may represent attractive alternatives relative to other investments due to the wide variety of maturity, repayment and interest rate options available; however, the complex structure of certain CMOs increases the difficulty in assessing the portfolio's risk and its fair value. Yields on privately issued CMOs generally exceed the yield on similarly structured agency CMOs because they expose the Company to certain risks not inherent in agency CMOs, such as credit risk and liquidity risk. Neither the U.S. government nor any of its agencies guarantees these assets generally because the loan size, credit underwriting or underlying collateral do not meet certain industry standards. Consequently, the potential for loss of principal is higher for privately issued securities. In addition, because the universe of potential investors for privately issued CMOs is smaller, these securities are
somewhat less liquid than are agency issued or guaranteed securities. At December 31, 2000 the Company held CMOs and REMICs with a net carrying value of $167.0 million, including $55.1 million of privately issued CMOs.
Of the Company's $194.1 million mortgage-backed securities portfolio at December 31, 2000, $92.3 million with a weighted average yield of 6.79% had contractual maturities or period to repricing within ten years and $99.8 million with a weighted average yield of 6.74% had contractual maturities or period to repricing over ten years. However, the actual maturity of a mortgage-backed security is usually less than its stated maturity due to prepayments of the underlying mortgages. Prepayments that are faster than anticipated may shorten the life of the security and may result in rapid amortization of premiums or discounts and thereby affect the net yield on such securities. Although prepayments of underlying mortgages depend on many factors, including the type of mortgages, the coupon rate, the age of mortgages, the geographical location of the underlying real estate collateralizing the mortgages and general levels of market interest rates, the difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates generally is the most significant determinant of the rate of prepayments. During periods of declining mortgage interest rates, if the coupon rate of the underlying mortgage loans exceeds the prevailing market interest rates offered for mortgage loans, refinancing generally increases and accelerates the prepayment of the underlying mortgage loans and the related security. Under such circumstances, the Company may be subject to reinvestment risk because, to the extent that the Company's mortgage-backed securities amortize or prepay faster than anticipated, the Company may not be able to reinvest the proceeds of such repayments and prepayments at a comparable rate. In contrast to mortgage-backed securities in which cash flow is received (and hence, prepayment risk is shared) pro rata by all securities holders, the cash flow from the mortgage loans or mortgage-backed securities underlying REMICs or CMOs is segmented and paid in accordance with a predetermined priority to investors holding various tranches of such securities or obligations. A particular tranche of REMICs and CMOs may therefore carry prepayment risk that differs from that of both the underlying collateral and other tranches.
Municipal Bonds: The Company's tax exempt municipal bond portfolio, which at December 31, 2000, totaled $28.2 million at estimated fair value ($27.8 million at amortized cost), 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 authorities, hospitals, water and sanitation districts located in the states of Washington, Oregon and Idaho. At December 31, 2000, general obligation bonds and revenue bonds had total estimated fair values of $17.5 million and $8.9 million, respectively. The Company also has taxable revenue bonds as of December 31, 2000 totaling $3.6 million at estimated fair value ($3.9 million at amortized cost). Many bank qualifying municipal bonds are not rated by a nationally recognized credit rating agency (e.g., Moody's or Standard and Poor's) due to their smaller size. At December 31, 2000, the Company's municipal bond portfolio had a weighted average maturity of approximately 10.6 years and an average coupon rate of 6.27%. The largest security in the portfolio was an industrial revenue bond issued by the City of Kent, Washington, with an amortized cost of $3.4 million and a fair value of $3.4 million.
Corporate Bonds: The Company's corporate bond portfolio, which totaled $27.9 million at fair value ($28.4 million at amortized cost) at December 31, 2000, was composed of short and long-term fixed-rate and adjustable-rate securities. At December 31, 2000, the portfolio had a weighted average maturity of 22.1 years and a weighted average coupon rate of 8.05%. The longest term security has an amortized cost of $3.0 million and a term to maturity of 29.2 years.
U.S. Government and Agency Obligations: The Company's portfolio of U.S. Government and agency obligations had a fair value of $61.4 million ($61.5 million at amortized cost) at December 31, 2000. The Company's subsidiary, BB, has invested a small portion of its securities portfolio in structured notes. The structured notes in which BB has invested provide for periodic adjustments in coupon rates or prepayments based on various indices and formulae. At December 31, 2000, structured notes which totaled $4.7 million at fair value ($4.7 million at amortized cost), consisted of U.S. Government agency obligations with a fair value of $2.0 million which mature in 2004 and 2005 and a privately issued obligation with a fair value of $2.7 million which matures in 2005. In addition, most of the U.S. Government agency obligations owned by the Company include call features which allow the issuing agency the right to call the securities at various dates prior to the final maturity.
Asset-backed Securities: The Company's subsidiary, BB, has invested a small portion of its investment portfolio in asset-backed securities collateralized by equipment lease contracts. At December 31, 2000 the investment totaled $5.3 million at fair value ($5.3 at amortized cost), was yielding 8.66%, and matures in 2004.
Off Balance Sheet Derivatives: Derivatives include "off balance sheet" financial products whose value is dependent on the value of an underlying financial asset, such as a stock, bond, foreign currency, or a reference rate or index. Such derivatives include "forwards," "futures," "options" or "swaps." The Company generally has not invested in "off balance sheet" derivative instruments, although investment policies authorize such investments. On December 31, 2000 the Company had no off balance sheet derivatives and no outstanding commitments to purchase or sell securities.
Deposit Activities and Other Sources of Funds
General: Deposits, FHLB advances (or borrowings) and loan repayments are the major sources of the Banks' 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 money market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds from other sources. They may also be used on a longer-term basis for general business purposes.
Deposit Accounts: Deposits are attracted from within the Banks' primary market areas through the offering of a broad selection of deposit instruments, including demand checking accounts, NOW accounts, money market deposit accounts, regular savings accounts, certificates of deposit and retirement savings plans. 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 their deposit accounts, the Banks consider current market interest rates, profitability to the Banks, matching deposit and loan products and their customer preferences and concerns. The Banks generally review their deposit mix and pricing weekly.
The Banks compete with other financial institutions and financial intermediaries in attracting deposits. Competition from mutual funds has been particularly strong in recent years due to the performance of the stock market. In addition, there is strong competition for savings dollars from commercial banks, credit unions, and nonbank corporations, such as securities brokerage companies and other diversified companies, some of which have nationwide networks of offices.
The Banks, especially BB, have been most successful in attracting a broad range of retail time deposits and, at December 31, 2000, the Banks had a total of $798.7 million in retail time deposits, of which $491.9 million had original maturities of one year or longer.
As illustrated in the following table, certificates of deposit have accounted for a larger percentage of the deposit portfolio than have transaction accounts. However, as reflected in the balances and percentages for December 31, 2000 and 1999 and March 31, 1999, the acquisitions of IEB, TB, WSB and SCB have added significantly to demand, NOW and Money Market accounts for the Company.
Borrowings: Deposits are the primary source of funds for the Banks' lending and investment activities and for their general business purposes. The Banks also use borrowings to supplement their supply of lendable funds, to meet deposit withdrawal requirements and to more effectively leverage their capital position. The FHLB-Seattle serves as the Banks' primary borrowing source. At December 31, 2000, the Banks had $507.1 million of combined borrowings from FHLB-Seattle at a weighted average rate of 6.27%. At December 31, 2000 the Banks, on a combined basis, have been authorized by the FHLB-Seattle to borrow up to $557.0 million under a blanket floating lien security agreement. Additional short-term funds are also obtained through $12.6 million in commercial banking credit lines. At December 31, 2000 the Banks had no short-term funds outstanding.
The FHLB-Seattle functions as a central reserve bank providing credit for member financial institutions. As a member, the Banks are required to own capital stock in the FHLB-Seattle and are authorized to apply for advances on the security of such stock and certain of its mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the U.S. Government) provided certain credit worthiness standards have been met. Advances are made pursuant to several different credit and underwriting programs. Each program has its own interest rate, maturity and collateral requirements. 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.
BB also uses retail repurchase agreements due generally within 90 days as a source of funds. At December 31, 2000, retail repurchase agreements totaling $11.3 million with interest rates from 3.54% to 7.20% were secured by a pledge of certain FNMA, GNMA and FHLMC mortgage-backed securities with a market value of $12.2 million.
BB also borrows funds through the use of secured wholesale repurchase agreements with securities brokers. The broker holds BB's securities while BB continues to receive the principal and interest payments from the security. BB's outstanding borrowings at December 31, 2000, under wholesale repurchase agreements totaled $63.4 million and were collateralized by mortgage-backed securities with a fair value of $66.4 million.
(See "Management's Discussion and Analysis of Financial Position and Results of Operations - Liquidity and Capital Resources" and Notes 11 and 12 of the Consolidated Financial Statements)
Personnel
As of December 31, 2000, the Company had 513 full-time and 78 part-time employees. The employees are not represented by a collective bargaining unit. The Company believes its relationship with its employees is good.
Taxation Federal Taxation
General. For tax reporting purposes, the Company and the Banks report their income on a calendar year basis using the accrual method of accounting. The Company and the Banks are subject to federal income taxation in the same manner as other corporations with some exceptions including particularly the reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Company and the Banks. Reference is made to Note 13 of the Notes to the Consolidated Financial Statements contained in Item 7 of this Form 10-K for additional information concerning the income taxes payable by the Banks.
Provisions of the Small Business Job Protection Act of 1996 (the "Job Protection Act") significantly altered the Company's tax bad debt deduction method and the circumstances that would require a tax bad debt reserve recapture. Prior to enactment of the Job Protection Act, savings institutions were permitted to compute their tax bad debt deduction through use of either the reserve method or the percentage of taxable income method. The Job Protection Act repealed both of these methods for large savings institutions and allows bad debt deductions based only on actual current losses. While repealing the reserve method for computing tax bad debt deductions, the Job Protection Act allows thrifts to retain their existing base year bad debt reserves but requires that reserves in excess of the balance at December 31, 1987, be recaptured into taxable income. The tax liability for this recapture is included in the accompanying Consolidated Financial Statements.
The base year reserve is recaptured into taxable income only in limited situations, such as in the event of certain excess distributions, complete liquidation or disqualification as a bank. None of the limited circumstances requiring recapture are contemplated by the Company. The amount of the Company's tax bad debt reserves subject to recapture in these circumstances approximates $5,318,000 at December 31, 2000. Due to the remote nature of events that may trigger the recapture provisions, no tax liability has been established in the accompanying consolidated financial statements.
In addition, as a result of certain acquisitions, the Company is required to recapture certain tax bad debt reserves of the acquiree. The Company has elected to recapture these reserves into income over a four-year period using the deferral method. The recapture does not result in a charge to earnings as the Company provided for this liability on the acquisition date.
Corporate Alternative Minimum Tax. The Code imposes a tax on alternative minimum taxable income ("AMTI") at a rate of 20%. AMTI is increased by an amount equal to 75% of the amount by which the corporation's adjusted current earnings exceeds its AMTI (determined without regard to this preference and prior to reduction for net operating losses). For taxable years beginning after December 31, 1986, and before January 1, 1996, an environmental tax of .12% of the excess of AMTI (with certain modification) over $2.0 million was imposed on corporations, including the Banks, whether or not an Alternative Minimum Tax ("AMT") is paid.
Dividends-Received Deduction and Other Matters.. The Company may exclude from its income 100% of dividends received from the Banks as a member of the same affiliated group of corporations. The corporate dividends-received deduction is generally 70% in the case of dividends received from unaffiliated corporations with which the Company and the Banks will not file a consolidated tax return, except that if the Company or the Banks own more than 20% of the stock of a corporation distributing a dividend, then 80% of any dividends received may be deducted.
There have not been any IRS audits of the Company's or the Banks' federal income tax returns during the past five years.
State Taxation
Washington Taxation. Banner Bank is subject to a business and occupation tax which is imposed under Washington law at the rate of 1.50% of gross receipts; however, interest received on loans secured by mortgages or deeds of trust on residential properties is not subject to such tax. Banner Bank's business and occupation tax returns through December 1996 were audited in October 1997.
Oregon and Idaho Taxation Corporations with nexus to the states of Oregon and Idaho are subject to a corporate level income tax. The Company's operations in those states resulted in corporate income taxes of approximately $281,000 (net of federal tax benefit). As the Company's operations in these states increase the state income tax provision will have an increasing effect on the Company's effective tax rate and results of operations.
Environmental Regulation
The business of the Company is affected from time to time by federal and state laws and regulations relating to hazardous substances. Under the federal Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), owners and operators of properties containing hazardous substances may be liable for the costs of cleaning up the substances. CERCLA and similar state laws can affect the Company both as an owner of branches and other properties used in its business and as a lender holding a security interest in property which is found to contain hazardous substances. While CERCLA contains an exemption for holders of security interests, the exemption is not available if the holder participates in the management of a property, and some courts have broadly defined what constitutes participation in management of property. Moreover, CERCLA and similar state statutes can affect the Company's decision of whether or not to foreclose on a property. Before foreclosing on commercial real estate, it is the Company's general policy to obtain an environmental report, thereby increasing the costs of foreclosure. In addition, the existence of hazardous substances on a property securing a troubled loan may cause the Company to elect not to foreclose on the property, thereby reducing the Company's flexibility in handling the loan.
Competition
The Banks encounter significant competition both in attracting deposits and in originating real estate loans. Their most direct competition for deposits has come historically from other commercial and savings banks, savings associations and credit unions in their market areas. More recently, the Banks have experienced an increased level of competition from securities firms, insurance companies, money market and mutual funds, and other investment vehicles. The Banks expect continued strong competition from such financial institutions and investment vehicles in the foreseeable future. The ability of the Banks to attract and retain deposits depends on their ability to provide investment opportunities that satisfy the requirements of investors as to rate of return, liquidity, risk of loss of principal, convenience of locations and other factors. The Banks compete for deposits by offering depositors a variety of deposit accounts and financial services at competitive rates, convenient business hours, and a high level of personal service and expertise.
The competition for loans comes principally from commercial banks, loan brokers, mortgage banking companies, other savings banks and credit unions. The competition for loans has increased substantially in recent years as a result of the large number of institutions competing in the Banks' market areas as well as the increased efforts by commercial banks and credit unions to expand mortgage loan originations.
The Banks compete for loans primarily through offering competitive rates and fees and providing excellent services to borrowers and home builders. Factors that affect competition include general and local economic conditions, current interest rate levels and the volatility of the mortgage markets.
Regulation The Banks
General: As state-chartered, federally insured financial institutions, the Banks are subject to extensive regulation. Lending activities and other investments must comply with various statutory and regulatory requirements, including prescribed minimum capital standards. The Banks are regularly examined by the FDIC and their state banking regulators and file periodic reports concerning their activities and financial condition with their regulators. The Banks' relationship with depositors and borrowers also is regulated to a great extent by both federal and state law, especially in such matters as the ownership of savings accounts and the form and content of mortgage documents.
Federal and state banking laws and regulations govern all areas of the operation of the Banks, 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 the Company and the Banks 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 state-chartered commercial Banks, Banner Bank and Banner Bank of Oregon are subject to the applicable provisions of Washington law and Oregon law, respectively, and each state's regulations. State law and regulations govern the Banks' ability to take deposits and pay interest thereon, 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. The Banks are subject to periodic examination and reporting requirements by and of their state banking regulators.
Deposit Insurance: The FDIC is an independent federal agency that insures the deposits, up to prescribed statutory limits, of depository institutions. The FDIC currently maintains two separate insurance funds: the BIF and the SAIF. As insurer of the Banks' deposits, the FDIC has examination, supervisory and enforcement authority over the Banks.
Banner Bank's accounts are insured by both the BIF and the SAIF and Banner Bank of Oregon's accounts are insured by the BIF to the maximum extent permitted by law. The Banks pay deposit insurance premiums based on a risk-based assessment system established by the FDIC. Under applicable regulations, institutions are assigned to one of three capital groups that are based solely on the level of an institution's capital "well capitalized," "adequately capitalized," and "undercapitalized" which are defined in the same manner as the regulations establishing the prompt corrective action system, as discussed below. These three groups are then divided into three subgroups which reflect varying levels of supervisory concern, from those which are considered to be healthy to those which are considered to be of substantial supervisory concern. The matrix so created results in nine assessment risk classifications.
Effective January 1, 1997, the premium schedule for BIF and SAIF insured institutions ranged from 0 to 27 basis points. However, SAIF insured institutions and BIF 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 BB this amount is currently equal to about 1.90 basis points for each $100 in domestic deposits and BBO pays an assessment of about 1.50 basis points. These assessments, which may be revised based upon the level of BIF and SAIF deposits, will continue until the bonds mature in the year 2015.
The FDIC may terminate the deposit insurance of any insured depository institution 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 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 that could result in termination of the deposit insurance of the Banks.
Prompt Corrective Action: Federal statutes establish a supervisory framework based on five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. An institution's category depends upon where its capital levels are in relation to relevant capital measures, which include a risk- based capital measure, a leverage ratio capital measure, and certain other factors. The federal banking agencies have adopted regulations that implement this statutory framework. Under these regulations, an institution is treated as well capitalized if its ratio of total capital to risk-weighted assets is 10% or more, its ratio of core capital to risk-weighted assets is 6% or more, its ratio of core capital to adjusted total assets is 5% or more, and it is not subject to any federal supervisory order or directive to meet a specific capital level. In order to be adequately capitalized, an institution must have a total risk-based capital ratio of not less than 8%, a Tier 1 risk-based capital ratio of not less than 4%, and a leverage ratio of not less than 4%. Any institution which is neither well capitalized nor adequately capitalized will be considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls and restrictions which become more extensive as an institution becomes more severely undercapitalized. Failure by the Banks to comply with applicable capital requirements would, if unremedied, result in restrictions on their activities and lead to enforcement actions, including, but not limited to, the issuance of a capital directive to ensure the maintenance of required capital levels. Banking regulators will take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. Additionally, approval of any regulatory application filed for their review may be dependent on compliance with capital requirements.
At December 31, 2000, all the Banks were 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, standards for all insured depository institutions relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v) asset growth; (vi) asset quality; (vii) earnings and (viii) compensation, fees and benefits (Guidelines). 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 either Bank fails to meet any standard prescribed by the Guidelines, the agency may require the Bank to submit to the agency an acceptable plan to achieve compliance with the standard.
Capital Requirements: The FDIC's minimum capital standards applicable to FDIC-regulated banks and savings banks require the most highly-rated institutions to meet a "Tier 1" leverage capital ratio of at least 3% of total assets. Tier 1 (or "core capital") consists of common stockholders' equity, noncumulative perpetual preferred stock and minority interests in consolidated subsidiaries minus all intangible assets other than limited amounts of purchased mortgage servicing rights and certain other accounting adjustments. All other banks must have a Tier 1 leverage ratio of at least 100-200 basis points above the 3% minimum. The FDIC capital regulations establish a minimum leverage ratio of not less than 4% for banks that are not highly rated or are anticipating or experiencing significant growth.
Any insured bank with a Tier 1 capital to total assets ratio of less than 2% is deemed to be operating in an unsafe and unsound condition unless the insured bank enters into a written agreement, to which the FDIC is a party, to correct its capital deficiency. Insured banks operating with Tier 1 capital levels below 2% (and which have not entered into a written agreement) are subject to an insurance removal action. Insured banks operating with lower than the prescribed minimum capital levels generally will not receive approval of applications submitted to the FDIC. Also, inadequately capitalized state nonmember banks will be subject to such administrative action as the FDIC deems necessary.
FDIC regulations also require that banks meet a risk-based capital standard. The risk-based capital standard requires the maintenance of total capital (which is defined as Tier 1 capital and Tier 2 or supplementary capital) to risk weighted assets of 8% and Tier 1 capital to risk-weighted assets of 4%. In determining the amount of risk-weighted assets, all assets, plus certain off balance sheet items, are multiplied by a risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in the type of asset or item. The components of Tier 1 capital are equivalent to those discussed above under the 3% leverage requirement. The components of supplementary capital currently include cumulative perpetual preferred stock, adjustable-rate perpetual preferred stock, mandatory convertible securities, term subordinated debt, intermediate-term preferred stock and allowance for possible loan and lease losses. Allowance for possible loan and lease losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of capital counted toward supplementary capital cannot exceed 100% of Tier 1 capital.
FDIC capital requirements are designated as the minimum acceptable standards for banks whose overall financial condition is fundamentally sound, which are well-managed and have no material or significant financial weaknesses. The FDIC capital regulations state that, where the FDIC determines that the financial history or condition, including off-balance sheet risk, managerial resources and/or the future earnings prospects of a bank are not adequate and/or a bank has a significant volume of assets classified substandard, doubtful or loss or otherwise criticized, the FDIC may determine that the minimum adequate amount of capital for that bank is greater than the minimum standards established in the regulation.
The Company believes that, under the current regulations, the Banks will continue to meet their minimum capital requirements in the foreseeable future. However, events beyond the control of the Banks, such as a downturn in the economy in areas where the Banks have most of their loans, could adversely affect future earnings and, consequently, the ability of the Banks to meet their capital requirements.
For additional information concerning the Bank's capital, see Note 17 of the Notes to the Consolidated Financial Statements contained in Item 7 of this Form 10-K.
Activities and Investments of Insured State-Chartered Banks: Federal law generally limits the activities and equity investments of FDIC-insured, state-chartered banks to those that are permissible for national banks. Under regulations dealing with equity investments, an insured state bank generally may not directly or indirectly acquire or retain any equity investment of a type, or in an amount, that is not permissible for a national bank. An insured state bank is not prohibited from, among other things, (i) acquiring or retaining a majority interest in a subsidiary, (ii) 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, (iii) 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 (iv) acquiring or retaining the voting shares of a depository institution if certain requirements are met.
Federal law provides that an insured state-chartered bank may not, directly or indirectly through a subsidiary, engage as "principal" in any activity that is not permissible for a national bank unless the FDIC has determined that such activities would pose no risk to the insurance fund of which it is a member and the bank is in compliance with applicable regulatory capital requirements. Any insured state-chartered bank directly or indirectly engaged in any activity that is not permitted for a national bank must cease the impermissible activity.
Federal Reserve System: The Federal Reserve Board requires, under Regulation D, reserves on all depository institutions that maintain transaction accounts or nonpersonal time deposits. These reserves may be in the form of cash or non-interest-bearing deposits with the regional Federal Reserve Bank. NOW accounts and other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to Regulation D reserve requirements, as are any nonpersonal time deposits at a bank. Under Regulation D, a bank must establish reserves equal to 3% of the first $47.8 million of transaction accounts, of which the first $4.4 million is exempt, and 10% on the remainder. The reserve requirement on nonpersonal time deposits with original maturities of less than 1-1/2 years is 0%. As of December 31, 2000, the Banks met their reserve requirements.
Affiliate Transactions: The Company and the Banks are legal entities separate and distinct. Various legal limitations restrict the Banks from lending or otherwise supplying funds to the Company (an "affiliate"), generally limiting such transactions with the affiliate to 10% of the Bank's capital and surplus and limiting all such transactions to 20% of the Bank's capital and surplus. Such 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, including credit standards, that are substantially the same or at least as favorable to the Banks 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, such 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 also subject to the provisions of the Community Reinvestment Act of 1977, which requires the appropriate federal bank regulatory agency, in connection with its regular examination of a bank, 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, such assessment is required of any bank which has applied, among other things, 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.
Dividends: Dividends from the Banks constitute the major source of funds for dividends paid by the Company. The amount of dividends payable by the Banks to the Company will depend upon the Banks' earnings and capital position, and is limited by federal and state laws, regulations and policies.
Federal law further provides that no insured depository institution may make any capital distribution (which would include a cash dividend) if, after making the distribution, the institution would 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 should be deemed to constitute an unsafe and unsound practice.
The Company
General: The Company, as sole shareholder of the Banks, 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 (BHCA), and the regulations of the Federal Reserve. The Company is required to file with the Federal Reserve annual reports and such additional information as the Federal Reserve may require and is subject to regular examinations by the Federal Reserve. The Federal Reserve also has extensive enforcement authority over bank holding companies, including, among other things, 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.
New Legislation. On November 12, 1999, the Gramm-Leach-Bliley Financial Services Modernization Act of 1999 was signed into law. The purpose of this legislation is to modernize the financial services industry by establishing a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers. Generally, the Act:
(a) repeals the historical restrictions and eliminates many federal and state law barriers to affiliations among banks, securities firms, insurance companies and other financial service providers;
(b) provides a uniform framework for the functional regulation of the activities of banks, savings institutions and their holding companies;
(c) broadens the activities that may be conducted by national banks, banking subsidiaries of bank holding companies and their financial subsidiaries;
(d) provides an enhanced framework for protecting the privacy of consumer information;
(e) adopts a number of provisions related to the capitalization, membership, corporate governance and other measures designed to modernize the FHLB system;
(f) modifies the laws governing the implementation of the Community Reinvestment Act; and
(g) addresses a variety of other legal and regulatory issues affecting day-to-day operations and long-term activities of financial institutions.
Acquisitions. Under the BHCA, a bank holding company must obtain Federal Reserve approval before: (1) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares); (2) acquiring all or substantially all of the assets of another bank or bank holding company; or (3) merging or consolidating with another bank holding company.
The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect 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 directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain nonbank activities which, by statute or by Federal Reserve regulation or order, have been identified as activities closely related to the business of banking or managing or controlling banks. The list of activities permitted by the Federal Reserve includes, among other things: 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 and Branching. The Federal Reserve must approve an application of an adequately capitalized and adequately managed 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 such 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 statutory law of the host state. Nor may the Federal Reserve approve an application if the applicant (and its depository institution affiliates) 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 which 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 such 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 the Federal Reserve's view that a bank holding company should pay cash dividends only to the extent that the company's net income for the past year is sufficient to cover both the cash dividends and a rate of earning retention that is consistent with the company's capital needs, asset quality and overall financial condition. The Federal Reserve also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends.
Capital Requirements: The Federal Reserve has established capital adequacy guidelines for bank holding companies that generally parallel the capital requirements of the FDIC for the 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.
The Company's total risk based capital must equal 8% of risk-weighted assets and one half of the 8% (4%) must consist of Tier 1 (core) capital. As of December 31, 2000 the Company's total risk based capital was 12.29% of risk-weighted assets and its risk based capital of Tier 1 (core) capital was 11.14% of risk-weighted assets.
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 gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of their consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve order, or any condition imposed by, or written agreement with, the Federal Reserve.
At its November, 2000 meeting, the Board of Directors authorized the repurchase of up to 5% (approximately 600,000 shares) of the Company's outstanding common stock over a 12 month period. Shares may be purchased from time to time depending upon market conditions, price and other management considerations. During the year ended December 31, 2000, the Company repurchased 393,673 shares of its common stock, compared to the repurchase of 693,148 shares of common stock under the prior plan during the comparable prior year period. As of December 31, 2000, the Company has repurchased a total of 3,287,923 shares.
MANAGEMENT PERSONNEL
Executive Officers
The following table sets forth information with respect to the executive officers of the Company as of December 31, 2000.
Name Age (1) Position with Company Position with Banks - ---- ------- --------------------- -------------------
Gary Sirmon 57 Chief Executive Officer, BB - Chief Executive President and Director Officer and Director BBO - Director
Lloyd Baker 52 Executive Vice President, BB, BBO - Executive Vice Chief Financial Officer President and Chief Financial Officer
Michael K. Larsen 58 Executive Vice President, BB - Executive Vice Chief Lending Officer President and Chief Lending Officer
Cynthia Purcell 43 Executive Vice President, BB, Executive Vice Chief Operating Officer President and Chief Operating Officer
Jesse G. Foster 62 Director BBO-Chief Executive Officer, President and Director
S. Rick Meikle 53 Director BB - President and Director, BBO- Director
(1) As of December 31, 2000.
Biographical Information
Set forth is certain information regarding the executive officers of the Company, directors or executive officers. There are no family relationships among or between the directors or executive officers.
Gary Sirmon is Chief Executive Officer, President and a Director of the Company; Chief Executive Officer of BB; and a Director of BB and BBO. He joined FSBW (now BB) in 1980 as an Executive Vice President and assumed his current position in 1982.
Lloyd Baker is Executive Vice President and Chief Financial Officer of the Company, BB and BBO. He joined FSBW in 1995 as a Vice President.
Michael K. Larsen is Executive Vice President and Chief Lending Officer of BB and is an Executive Vice President of the Company. He joined FSBW in 1981.
Cynthia Purcell is Executive Vice President and Chief Operating Officer of the Company and BB. She joined IEB(now BBO) in 1981.
Jesse G. Foster is the Chief Executive Officer, President and a Director of BBO and a Director of the Company. He joined IEB in 1962.
S. Rick Meikle is President and a Director of BB and a Director of the Company. He helped form TB (merged with BB) in 1991.
Item 2
Item 2 - Properties
The Company's home office, which is owned by the Company, is located in Walla Walla, Washington. FSBW has, in total, 23 branch offices including five WSB offices and two SCB offices, located in Washington and Idaho. These offices are located in the cities of Walla Walla (4), Kennewick (2), Richland, Clarkston, Sunnyside, Yakima (4), Selah, Wenatchee, Dayton, Bellingham, Ferndale, Lynden, Blaine, Point Roberts and the two SCB offices which are located in Lewiston, Idaho. Of these offices, 15 are owned by the Company and 8 are leased. The leases expire from 2000 through 2006. In addition to these, FSBW has five leased loan production offices in Bellevue, Spokane, Puyallup, Bellingham and Oak Harbor, Washington plus FSBW leases two administration offices in Walla Walla, Washington. The leases expire from 2000 through 2002. IEB's main office is located in Hermiston, Oregon and is owned by the Company. IEB has, in total, six branch offices and a drive-up facility, all of which are located in the State of Oregon. These offices, and the drive up facility, which are owned by the Company, are located in Hermiston, Pendleton, Umatilla, Boardman and Stanfield. IEB has two loan production offices, one in Condon, which is on a month-to-month lease and one in La Grande, which is on a lease which expires in 2003. IEB also leases a facility in Hermiston for its information systems and it leases a grocery branch in Pendleton. These leases expire in 2001 and 2004, respectively. Towne Bank operates from seven branch locations, all of which are leased under agreements which expire from 2000 to 2006. TB offices are located in Woodinville, Bellevue, Redmond, Bothell, Renton, Everett and Kirkland, Washington. The Company's net investment in its offices, premises, equipment and leaseholds was $16.6 million at December 31, 1999.
Item 3
Item 3 - Legal Proceedings
Periodically, there have been various claims and lawsuits involving the Banks, mainly as a defendant, such as claims to enforce liens, condemnation proceedings on properties in which the Banks hold security interests, claims involving the making and servicing of real property loans and other issues incident to the Banks' business. The Company and the Banks are not a party to any pending legal proceedings that it believes would have a material adverse effect on the financial condition or operations of the Company.
Item 4
Item 4 - Submission of Matters to a Vote of Security Holders
None.
Part II
Item 5
Item 5 - Market for Registrant's Common Equity and Related Stockholder Matters
Stock Listing
Banner Corporation common stock is traded over-the-counter on The Nasdaq Stock Market under the symbol "BANR." Newspaper stock tables list the company as "Banner Corp".. Stockholders of record at December 31, 2000 totaled 1,131. This total does not reflect the number of persons or entitles who hold stock in nominee or "street" name through various brokerage firms. The following tables show the reported high and low sale prices of the Company's common stock for the year ended December 31, 2000, nine months ended December 31, 1999 and the three year period ended March 31, 1999.
Cash Year Ended Dividends December 31, 2000 High Low Declared ----------------- ---- --- -------- First quarter(1) $16.59 $11.93 $0.127 Second quarter(1) 15.91 11.70 0.127 Third quarter(1) 14.87 11.99 0.127 Fourth quarter 15.25 12.94 0.140
Cash Nine Months Ended Dividends December 31, 1999(1) High Low Declared ----------------- ---- --- -------- First quarter $20.00 $16.42 $0.109 Second quarter 18.18 15.85 0.109 Third quarter 17.50 13.41 0.109
Cash Year Ended Dividends March 31, 1999(1) High Low Declared ----------------- ---- --- -------- First quarter(1) $23.04 $19.83 $0.074 Second quarter 21.49 17.61 0.082 Third quarter 21.82 18.07 0.082 Fourth quarter 21.82 16.70 0.109
(1) Restated to reflect 10% stock dividend granted in August 1998 and November, 2000 see Note 2 to Consolidated Financial Statements.
Item 6
Item 6 - Selected Consolidated Financial and Other Data
During May of 1999, the Company announced its decision to change its fiscal year end from March 31 to December 31 beginning with the period ended on December 31, 1999. The information presented for the nine months ended December 31, 1998 and for the twelve months ended December 31, 1999 is for comparative purposes only and has not been subjected to a financial audit. These tables set forth selected consolidated financial and other data of the Company at the dates and for the periods indicated. This information is derived from and is qualified in its entirety by reference to the detailed information and Consolidated Financial Statements and Notes thereto presented elsewhere in this or prior filings.
(1) Includes securities available for sale and held to maturity. (2) Certain amounts in the prior periods' financial statements have been reclassified to conform to the current period's presentation. These reclassifications have affected certain ratios for the prior periods. The effect of such reclassifications is immaterial. (3) Per share data have been adjusted for the 10% stock dividend paid in August 1998 and November 2000. (4) Calculated using shares outstanding excluding unearned restricted shares held in ESOP. (5) Ratios are annualized. (6) Net income divided by average assets. (7) Net income divided by average equity. (8) Difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. (9) Net interest income before provision for loan losses as a percent of average interest-earning assets. (10)Other operating expenses divided by the total of net interest income before loan losses and other operating income (non-interest income). (11)Non-performing loans consist of nonaccrual and 90 days past due loans.
ITEM 7
ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations
Special Note Regarding Forward-Looking Statements
Management's Discussion and Analysis (MD&A) and other portions of this report contain certain "forward-looking statements" concerning the future operations of Banner Corporation. Management desires to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 and is including this statement for the express purpose of availing the Company of the protections of such safe harbor with respect to all "forward-looking statements" contained in this report and our Annual Report. We have used "forward-looking statements" to describe future plans and strategies, including our expectations of the Company's future financial results. Management's ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors which could affect actual results include interest rate trends, the general economic climate in the Company's market area and the country as a whole, the ability of the Company to control costs and expenses, the ability of the Company to efficiently incorporate acquisitions into its operations, competitive products and pricing, loan delinquency rates, and changes in federal and state regulation. These factors should be considered in evaluating the "forward-looking statements," and undue reliance should not be placed on such statements.
General
Banner Corporation (the Company or BANR), a Washington corporation, is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly owned subsidiaries, Banner Bank (BB) and Banner Bank of Oregon (BBO). Prior to the consolidation and name change, which occurred on October 30, 2000, the Company's subsidiaries included First Savings Bank of Washington (FSBW), Inland Empire Bank (IEB) and Towne Bank (TB) (together, the Banks). As of December 31, 2000, Banner Bank is a Washington-chartered commercial bank the deposits of which are insured by the Federal Deposit Insurance Corporation (FDIC) under the Savings Association Insurance Fund (SAIF). As of December 31, 2000, BB conducted business from its main office in Walla Walla, Washington, and its 32 branch offices and four loan production offices located in Washington, Idaho and Oregon. Banner Bank of Oregon is an Oregon-chartered commercial bank and its deposits are insured by the FDIC under the Bank Insurance Fund (BIF).. BBO conducts business from its main office in Hermiston, Oregon, and its six branch offices and one loan production office located in northeast Oregon. Prior to merging with FSBW on October 30, 2000, TB was a Washington-chartered commercial bank whose deposits were insured by the FDIC under BIF. As of October 30, 2000, TB conducted business from seven full service branches in the Seattle, Washington, metropolitan area. An eighth Seattle area office opened in November 2000.
During May 1999, the Company announced its decision to change its fiscal year from April 1 through March 31 to January 1 through December 31. For discussion and analysis purposes, the year ended December 31, 2000 is compared to the unaudited year ended December 31, 1999 and the nine months ended December 31, 1999 are compared to the unaudited nine-month period ended December 31, 1998.
The operating results of BANR depend primarily on its net interest income, which is the difference between interest income on interest-earning assets, consisting of loans and investment securities, and interest expense on interest-bearing liabilities, composed primarily of savings deposits and Federal Home Loan Bank (FHLB) advances. Net interest income is primarily a function of BANR's interest rate spread, which is the difference between the yield earned on interest-earning assets and the rate paid on interest-bearing liabilities, as well as a function of the average balance of interest-earning assets as compared to the average balance of interest-bearing liabilities. As more fully explained below, BANR's net interest income significantly increased for the year ended December 31, 2000, when compared to the year ended December 31, 1999. This increase in net interest income was due to the significant asset and liability growth which occurred at BANR. The increase in net interest income occurred despite a 14 basis point reduction of the interest rate spread for the year, which resulted from changes in the mix of assets and liabilities and changes in the levels of various market interest rates. The net interest margin also declined 13 basis points for the year reflecting the reduced interest rate spread and the increased use of interest-bearing liabilities relative to interest-earning assets as the Company continued to leverage its equity capital. BANR's net income also is affected by provisions for loan losses and the level of its other income, including deposit service charges, loan origination and servicing fees, and gains and losses on the sale of loans and securities, as well as its non-interest operating expenses and income tax provisions.
Management's discussion and analysis of results of operations is intended to assist in understanding the financial condition and results of operations of the Company. The information contained in this section should be read in conjunction with the Consolidated Financial Statements and accompanying Notes to the Consolidated Financial Statements.
Recent Developments and Significant Events
Consolidation of Banking Operations: - ----------------------------------- On October 30, 2000 the Company changed its name from First Washington Bancorp, Inc. (FWWB) to Banner Corporation in conjunction with a consolidation of banking operations affecting its banking subsidiaries. Towne Bank merged with First Savings Bank, First Savings Bank converted from a Washington state-chartered savings bank to a Washington state-chartered commercial bank, and First Savings Bank changed its name, along with the names of its divisions, Whatcom State Bank and Seaport Citizens Bank, to Banner Bank. At the same time, Inland Empire Bank changed its name to Banner Bank of Oregon.
The combination was designed to strengthen the Company's commitment to community banking by more effectively sharing the resources of the existing subsidiaries, improving operating efficiency and developing a broader regional brand identity. Final integration of all data processing into a common system is scheduled for completion by December 31, 2001. In light of the new Gramm-Leach-Bliley financial modernization legislation, the Company chose to retain a separate charter for Banner Bank of Oregon (formerly IEB) and to operate two banking subsidiaries. That recent legislation enacts Federal Home Loan Bank System reforms that impact community financial institutions. A community financial institution is defined as a "member of the Federal Home Loan Bank (FHLB) System, the deposits of which are insured by the FDIC and that has average total assets (over the preceding three years) of less than $500 million." One provision of the reforms provides community financial institutions with the ability to obtain long-term FHLB advances to fund small business, small farm and small agribusiness loans. In addition, community financial institutions are able to offer these loans as collateral for such borrowings. This provision, which represents a change in policy from the previous requirement that these funds be securitized primarily by residential mortgage loans, will be available only to community financial institutions. As an independent subsidiary, Banner Bank of Oregon currently qualifies as a community financial institution. Merging BBO into BB would disqualify it and remove this favorable status. On the other hand, consolidation of support operations continues and the Company expects to receive long-term benefits from the proposed efficiencies. The Banks use one name, Banner Bank, and are united under the leadership of an experienced management team. The same ten individuals serve as members of the Board of Directors of Banner Corporation and each of the Banks.
Declaration of 10% Stock Dividend: - --------------------------------- On October 19, 2000, BANR's Board of Directors declared a 10% stock dividend payable November 10, 2000 to shareholders of record on October 31, 2000. All earnings per share and share data have been adjusted to reflect the 10% stock dividend.
Mortgage Lending Subsidiary: - --------------------------- On April 1, 2000, FSBW (now Banner Bank) opened a new mortgage lending subsidiary, Community Financial Corporation (CFC), located in the Lake Oswego area of Portland, Oregon, with John Satterberg as President. Primary lending activities for CFC are in the area of construction and permanent financing for one- to four-family residential dwellings. CFC, an Oregon corporation, functions as a wholly owned subsidiary of Banner Bank. BB has capitalized CFC with $2 million of equity capital and provides funding support for CFC's lending operations.
Recent Accounting Standard: - -------------------------- Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, was issued in June 1998 and establishes accounting and reporting standards for derivative instruments, as amended by SFAS Nos. 137 and 138, including certain derivative instruments embedded in other contracts, and for hedging activities. BANR implemented this statement on January 1, 2001. The impact of the adoption of this statement on the results of operations and financial condition of BANR was considered to be immaterial.
Recent Accounting Standard Not Yet Adopted: - ------------------------------------------ In September 2000, FASB issued SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, which revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but carries over most of the provisions of SFAS No. 125 without reconsideration. SFAS No. 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. The provisions of this statement are not expected to have a material effect on the Company's financial position or results of operations.
Acquisition of Seaport Citizens Bank: - ------------------------------------ On April 1, 1999, the Company and FSBW ( now operating as BB ) completed the acquisition of Seaport Citizens Bank (SCB). FSBW paid $10.1 million in cash for all the outstanding common shares of SCB, which was headquartered in Lewiston, Idaho. As a result of the merger of SCB into FSBW, SCB became a division of FSBW. The acquisition was accounted for as a purchase and resulted in the recording of $6.1 million of costs in excess of the fair value of SCB's net assets acquired (goodwill). Goodwill assets are being amortized over a 14-year period and resulted in a current charge to earnings of $108,100 per quarter, beginning in the quarter ended June 30,1999, or $433,000 per year. Founded in 1979, SCB was a commercial bank which had, before recording of purchase accounting adjustments, approximately $45 million in total assets, $41 million in deposits, $27 million in loans, and $4.1 million in shareholders' equity at March 31, 1999. SCB operated two full service branches in Lewiston, Idaho. SCB's results of operations are included in the Company's consolidated results of operations and financial statements for all periods subsequent to April 1,1999.
Acquisition of Whatcom State Bancorp, Inc.: - ------------------------------------------ On January 1, 1999 the Company completed the acquisition of Whatcom State Bancorp, Inc. The Company paid $12.1 million in common stock for all the outstanding common shares and stock options of Whatcom State Bancorp, Inc., which was the holding company for Whatcom State Bank (WSB), headquartered in Bellingham, Washington. As a result of the merger of Whatcom State Bancorp, Inc. into the Company, WSB became a division of FSBW ( now operating as BB ). The acquisition was accounted for as a purchase and resulted in the recording of approximately $6.0 million of costs in excess of the fair value of Whatcom State Bancorp, Inc. net assets acquired (goodwill). Goodwill assets are being amortized over a 14-year period resulting in a current charge to earnings of approximately $105,200 per quarter or $421,000 per year. Founded in 1980, WSB was a community commercial bank which had, before recording of purchase accounting adjustments, approximately $99 million in total assets, $85 million in deposits, $79 million in loans, and $5.4 million in shareholders' equity at December 31, 1998. WSB operated five branches in the Bellingham, Washington, area Bellingham, Ferndale, Lynden, Blaine and Point Roberts. WSB's results of operations are included in the Company's consolidated results of operations and financial statements for all periods subsequent to January 1,1999.
Acquisition of Towne Bancorp, Inc.: - ---------------------------------- On April 1, 1998 the Company completed the acquisition of Towne Bancorp, Inc. the Company paid $28.2 million in cash and common stock for all of the outstanding common shares and stock options of Towne Bancorp, Inc., which was the holding company for Towne Bank (TB), headquartered in Woodinville, Washington, a Seattle suburb. As a result of the merger of Towne Bancorp, Inc. into the Company, TB initially became a wholly owned subsidiary of the Company. As noted above, TB was subsequently merged with FSBW (now known as BB) on October 30, 2000 with the name of the consolidated bank changed to Banner Bank. The acquisition was accounted for as a purchase and resulted in the recording of $19.2 million of costs in excess of the fair value of Towne Bancorp, Inc. net assets acquired (goodwill). Goodwill assets are being amortized over a 14-year period resulting in a current charge to earnings of $343,800 per quarter or $1,375,000 per year. Founded in 1991, TB was a community business bank which had, before recording of goodwill, approximately $146 million in total assets, $134 million in deposits, $120 million in loans and $9.3 million in shareholders' equity at March 31, 1998.
Comparison of Financial Condition at December 31, 2000 and 1999
Total assets increased $162.7 million, or 8.9%, from $1.820 billion at December 31, 1999, to $1.983 billion at December 31, 2000. The growth of $162.7 million occurred most significantly at BB and was funded primarily with deposit growth and advances from the FHLB. This growth represented a continuation of management's plans to further leverage BANR's capital and reflects the solid economic conditions in the markets where BANR operates. Net loans receivable (gross loans less loans in process, deferred fees and discounts, and allowance for loan losses) grew $163.6 million, or 12.5%, from $1.308 billion at December 31, 1999, to $1.472 billion at December 31, 2000. The increase in net loans included a $10.5 million decrease in residential mortgages, an increase of $53.8 million in mortgages secured by commercial and multifamily real estate, an increase of $76.6 million in construction and land loans and an increase of $45.4 million in non-mortgage loans such as commercial, agricultural and consumer loans. These increased balances reflect the Company's continuing effort to increase the portion of its assets invested in loans and more specifically the portion of loans invested in commercial real estate, construction and land development, and non-mortgage loans. While these loans are inherently of higher risk than residential mortgages, management believes they can produce higher credit-adjusted returns to the Company and provide better opportunities to develop comprehensive banking relationships with borrowers than most residential mortgages. The Company also had an increase of $10.3 million in bank owned life insurance as a result of the purchase of $10.0 million of new policies and the growth of cash surrender values on both new and existing policies. The majority of the increase in
assets was funded by a net increase of $148.0 million in deposits and borrowings. Asset growth was also funded by net income from operations. Deposits grew $114.6 million, or 10.6%, from $1.078 billion at December 31, 1999, to $1.193 billion at December 31, 2000. FHLB advances increased $40.6 million from $466.5 million at December 31, 1999, to $507.1 million at December 31, 2000. Other borrowings, primarily reverse repurchase agreements with securities dealers, decreased $7.1 million, from $81.7 million at December 31, 1999, to $74.5 million at December 31, 2000. Securities available for sale and held to maturity decreased $35.6 million, or 9.8%, from $362.1 million at December 31, 1999, to $326.5 million at December 31, 2000, as a result of principal repayments and the sale of certain securities. FHLB stock increased $4.3 million, as BANR was required to purchase more stock as a result of its increased use of FHLB advances.
Comparison of Results of Operations for the Years Ended December 31, 2000 and
General. Net income for the year ended December 31, 2000 was $18.3 million, or $1.60 per share (diluted), compared to net income of $16.9 million, or $1.41 per share (diluted), for the year ended December 31, 1999. BANR's improved operating results primarily reflect the significant growth of assets and liabilities which was offset somewhat by the decline in net interest margin, increased operating expenses and amortization of goodwill. Net interest margin declined 13 basis points for the year reflecting changes in the level of market rates and the increased use of interest-bearing liabilities relative to interest-earning assets as the Company continued to leverage its equity capital. Average equity was 9.58% of average assets for the year ended December 31, 2000, compared to 10.65% of average assets for the year ended December 31, 1999. The modest changes in net interest spread and net interest margin for the year are notable in light of the significant changes in the level of market interest rates over the past 18 months. However, margin compression was significant for the two most recent quarters, as liability costs increased 14 basis points more than asset yields during that period. Continued pressure on the net interest margin appears likely in the current market environment, with loan yields expected to decline more rapidly in the near term than deposit costs as a result of the more immediate impact of changes in the prime rate on loans and the fact that deposit cost declines tend to lag changes in market rates.
Interest Income. Interest income for the year ended December 31, 2000 was $158.3 million compared to $131.5 million for the year ended December 31, 1999, an increase of $26.8 million, or 14.4%. The increase in interest income was a result of a $229.7 million, or 14.4%, growth in average balances of interest-earning assets, and a 43 basis point increase in the average yield on those assets. The yield on average interest-earning assets increased to 8.68% for the year ended December 31, 2000 compared to 8.25% for the same period a year earlier. Average loans receivable for the year ended December 31, 2000 increased by $227.2 million, or 19.0%, when compared to the year ended December 31, 1999, reflecting the Banks' significant internal growth. Interest income on loans increased by $24.9 million, or 23.4%, compared to the prior year, reflecting the impact of the increase in average loan balances and a 33 basis point increase in the average loan yield. The increase in average loan yield largely resulted from the significant increase in market interest rates, including a 175 basis point increase in the prime rate from the second calendar quarter of 1999 to the end of the most recent period. Adding to this effect were changes in the mix of the loan portfolio and the impact on adjustable and floating rate loans and new loan originations at higher levels than other market interest rates over the past 18 months. Although certain market rates declined in the second half of 2000 they remained significantly higher than 12 to 18 months earlier. Subsequent to December 31, 2000, the Federal Reserve has engineered two 50 basis point reductions in the Fed Funds Target Rate which has resulted in a 100 basis point decline in the prime rate. Other market rates have also continued to decline in the first two months of 2001, although most intermediate and longer term interest rates have declined by much smaller amounts than the prime rate during this period. Loans yielded 9.23% for the year ended December 31, 2000, compared to 8.90% for the year ended December 31, 1999. The average balance of mortgage-backed securities, investment securities, daily interest-bearing deposits and FHLB stock increased by $2.5 million for the year ended December 31, 2000, and the interest and dividend income from those investments increased $1.9 million compared to the year ended December 31, 1999 reflecting a 43 basis point increase in yield. The average yield on mortgage-backed securities increased from 6.26% for the year ended December 31, 1999, to 6.80% for the comparable period in 2000. Yields on mortgage-backed securities were lower in the 1999 period reflecting the adverse impact of higher prepayments on the amortization of purchase premiums on those securities as well as the impact of lower market rates on the interest rates paid on the significant portion of those securities that have adjustable interest rates. In the year ended December 31, 2000, prepayments had diminished and market rates had increased reversing both of those effects on mortgage-backed securities yields. The average yield on investment securities and short term cash investments increased from 6.18% for the year ended December 31, 1999, to 6.65% for the current year, also reflecting the rise in interest rates during 1999 and early 2000. Earnings on FHLB stock increased by $17,000, resulting from an increase of $3.2 million in the average balance of FHLB stock for the year ended December 31, 2000, and despite an 87 basis point decrease in the dividend yield on that stock. Dividends on FHLB stock are established on a quarterly basis by vote of the Directors of the FHLB.
Interest Expense. Interest expense for the year ended December 31, 2000 was $89.6 million compared to $69.4 million for the year ended December 31, 1999, an increase of $20.2 million, or 29.2%. The increase in interest expense was due to the $226.0 million growth in average interest-bearing liabilities and the increase in the average cost of all interest-bearing liabilities from 4.62% to 5.19%. The $140.0 million increase in average interest-bearing deposits for the year ended December 31, 2000 reflects solid deposit growth throughout the Company over the past 12 months. Deposit interest expense increased $12.4 million for the year ended December 31, 2000. Average deposit balances increased from $1.001 billion for the year ended December 31, 1999, to $1.141 billion for the year ended December 31, 2000, while, at the same time, the average rate paid on deposit balances increased 58 basis points. The increase in the rate paid on deposits reflects the significant increase in market interest rates over the level that prevailed a year earlier. Average FHLB advances totaled $509.7 million during the year ended December 31, 2000, compared to $420.6 million during the year ended December 31, 1999, an increase of $89.0 million that, combined with a 42 basis point increase in the average cost of advances, resulted in a $7.3 million increase in related interest expense. The average rate paid on those advances increased to 6.19% for the year ended December 31, 2000 from 5.77% for the year ended December 31, 1999. Other borrowings consist of retail repurchase agreements with customers and repurchase agreements with investment banking firms secured by certain investment securities. The average balance for other borrowings decreased $3.0 million from $78.3 million for the year ended December 31, 1999, to $75.3 million for the same period in 2000, while the related interest expense increased $631,000 from $4.3 million to $4.9 million for the respective periods. The average rate paid on other borrowings was 6.52% in the year ended December 31, 2000, compared to 5.46% for the same period in 1999 also reflecting the increase in market interest rates.
Provision for Loan Losses. During the year ended December 31, 2000, the provision for loan losses was $2.9 million, compared to $2.5 million for the year ended December 31, 1999, an increase of $351,000. The increase in the provision for losses reflects the amount required to maintain the allowance for losses at an appropriate level based upon management's evaluation of the adequacy of general and specific loss reserves as more fully explained in the following paragraphs. The higher provision in the current year reflects changes in the portfolio mix and a higher level of non-performing loans, although the amount of net charge-offs declined modestly from what occurred in the prior year. Net charge-offs decreased from $1.2 million for the year ended December 31, 1999, to $920,000 for the year ended December 31, 2000. Non-performing loans increased to $8.4 million at December 31, 2000, compared to $5.1 million at December 31, 1999. A comparison of the allowance for loan losses at December 31, 2000 and 1999 shows an increase of $1.8 million to $15.3 million at December 31, 2000 from $13.5 million at December 31, 1999. The allowance for loan losses as a percentage of net loans (loans receivable excluding allowance for losses) was 1.03% and 1.02% at December 31, 2000 and 1999, respectively. The allowance for loan losses equaled 183% of non-performing loans at December 31, 2000 compared to 267% of non-performing loans at December 31, 1999.
The allowance for losses on loans is maintained at a level sufficient to provide for estimated losses based on evaluating known and inherent risks in the loan portfolio and upon management's continuing analysis of the factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, actual loan loss experience, current economic conditions, detailed analysis of individual loans for which full collectibility may not be assured, and determination of the existence and realizable value of the collateral and guarantees securing the loans. Additions to the allowance are charged to earnings. Recoveries on previously charged off loans are credited to the allowance. The reserve is based upon factors and trends identified by management at the time financial statements are prepared. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Banks' allowance for loan losses. Such agencies may require the Banks to provide additions to the allowance based upon judgments different from management. Although management uses the best information available, future adjustments to the allowance may be necessary due to economic, operating, regulatory and other conditions beyond the Banks' control. The adequacy of general and specific reserves is based on management's continuing evaluation of the pertinent factors underlying the quality of the loan portfolio, including changes in the size and composition of the loan portfolio, delinquency rates, actual loan loss experience and current economic conditions. Large groups of smaller-balance homogeneous loans are collectively evaluated for impairment. Loans that are collectively evaluated for impairment by the Banks include residential real estate and consumer loans. Smaller balance non-homogeneous loans also may be evaluated collectively for impairment. Larger balance non-homogeneous residential construction and land loans, commercial real estate loans, commercial business loans and unsecured loans are individually evaluated for impairment. Loans are considered impaired when, based on current information and events, management determines that it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. Factors involved in determining impairment include, but are not limited to, the financial condition of the borrower, value of the underlying collateral and current status of the economy. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical
expedient, at the loan's observable market price or the fair value of collateral if the loan is collateral dependent. Subsequent changes in the value of impaired loans are included within the provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the provision that would otherwise be reported.
The Company's methodology for assessing the appropriateness of the allowance consists of several key elements, which include specific allowances, an allocated formula allowance, and an unallocated allowance. Losses on specific loans are provided for when the losses are probable and estimable. General loan loss reserves are established to provide for inherent loan portfolio risks not specifically provided for. The level of general reserves is based on analysis of potential exposures existing in the Banks' loan portfolios including evaluation of historical trends, current market conditions and other relevant factors identified by management at the time the financial statements are prepared. The formula allowance is calculated by applying loss factors to outstanding loans, excluding loans with specific allowances. Loss factors are based on the Company's historical loss experience adjusted for significant factors including the experience of other banking organizations that, in management's judgment, affect the collectibility of the portfolio as of the evaluation date. The unallocated allowance is based upon management's evaluation of various factors that are not directly measured in the determination of the formula and specific allowances. This methodology may result in losses or recoveries differing significantly from those provided in the financial statements.
Other Operating Income. Other operating income for the year ended December 31, 2000, increased $1.6 million from the comparable period in 1999. The $528,000 increase in gains from the sale of loans and securities for the year ended December 31, 2000, occurred despite the adverse impact of the rising rate environment that occurred during the first few months of the year and a slight decline in loan sales from $143.8 million for the year ended December 31, 1999, to $135.7 million for the year ended December 31, 2000. Gains on loan sales increased significantly in the most recent quarter as the interest rate environment improved for mortgage banking activities. Gain on sale of loans also was augmented in the second half of 2000 by activity at CFC. In addition, the Company recorded $519,000 of gain on sale in the fourth quarter of the year as a result of a portfolio restructuring transaction which included the sale of approximately $27.5 million of slightly seasoned one- to four-family loans. Gain on sale of loans for the year ended December 31, 2000, also includes a $289,000 gain on the sale of all of the Company's $7.6 million credit card loans. Income from other fees and service charges increased by $853,000 primarily due to growth in customer relationships and deposits.
Other Operating Expenses. Other operating expenses increased $6.6 million from $39.9 million for the year ended December 31, 1999, to $46.5 million for the year ended December 31, 2000. Increases in other operating expenses reflect the growth in assets and liabilities, customer relationships and complexity of operations as BANR continues to expand. The increase in expenses reflects approximately $900,000 in non-recurring costs associated with reorganizing under the Banner name, as well as the addition of two new bank branches opened during this year. The increase also reflects expenses associated with the new lending subsidiary, CFC. The increase in other operating expenses was partially offset by a $257,000 increase in capitalized loan origination costs. The higher operating expenses associated with BANR's transition to more of a commercial bank profile, coupled with pressure on net interest margin, caused BANR's efficiency ratio, excluding the amortization of goodwill, to increase to 55.59% (59.65% including goodwill), for the year ended December 31, 2000, from 52.79% (57.16% including goodwill) for the year ended December 31, 1999. Other operating expenses as a percentage of average assets increased to 2.42% (2.30% excluding the amortization of goodwill) for the year ended December 31, 2000, compared to 2.36% (2.23% excluding the amortization of goodwill) for the year ended December 31, 1999.
Income Taxes. Income tax expense was $10.2 million for the year ended December 31, 2000, compared to $10.5 million for the comparable period in 1999. The $229,000 decrease in the provision for income taxes reflects a higher level of income being taxed at slightly lower effective rates. The lower effective rate is due to a reduction in future expected state tax liability; the declining relative contribution of BBO, which is subject to Oregon state income taxes; the fact that a declining relative portion of the expense recorded in the release of the Employee Stock Ownership Plan (ESOP) shares is not deductible for tax purposes; the decline in the relative amount of goodwill amortization which is also not deductible for tax purposes and the recovery of amounts previously accrued for certain tax matters relating to years now closed to audit. The Company's effective tax rates for the years ended December 31, 2000 and 1999, were 36% and 38%, respectively.
Comparison of Results of Operations for the Nine Months Ended December 31, 1999 and 1998
General. Net income for the nine-month period ended December 31, 1999 was $12.9 million, or $1.09 per share (diluted), compared to net income of $11.4 million, or $0.94 per share (diluted), for the nine months ended December 31, 1998. Net income for the nine months ended December 31, 1999 increased $1.5 million from the comparable nine-month period ended December 31, 1998. The Company's improved operating results for the 1999 period reflect the significant growth of assets and liabilities as well as improvements in net interest margin and non-interest revenues which were offset somewhat by increased operating expenses and amortization of goodwill. Compared to levels a year earlier, total assets increased 23.9% to $1.820 billion at December 31, 1999, total loans rose 34.0% to $1.308 billion, deposits grew 33.2% to $1.078 billion and borrowings increased 14.6% to $548.2 million. Net interest margin improved, despite the adverse effects of prepayment of certain higher yielding seasoned loans in late 1998 and early 1999 and rising market rates throughout most of 1999, reflecting the acquisitions of WSB and SCB, continuing changes in the asset and liability mix and the lagging impact of rising rates on deposit costs.
Interest Income. Interest income for the nine-month period ended December 31, 1999 was $101.0 million compared to $81.8 million for the nine months ended December 31, 1998, an increase of $19.2 million, or 23.5%. The increase in interest income was a result of a $317.6 million, or 24.3%, growth in average balances of interest-earning assets, moderated by a 6 basis point decrease in the average yield on those assets. The yield on average assets declined to 8.25% for the nine months ended December 31, 1999 compared to 8.31% for the same period a year earlier. Average loans receivable for the nine months ended December 31, 1999 increased by $284.6 million, or 30.1%, when compared to the nine months ended December 31, 1998, reflecting the previously discussed acquisitions and internal growth. Interest income on loans increased by $16.9 million, or 25.8%, compared to the prior year, reflecting the impact of the increase in average loan balances and despite a 30 basis point decrease in the average yield. The decline in average loan yield largely resulted from the significant decline in market interest rates, including a 75 basis point decline in the prime rate, in the third and fourth calendar quarters of 1998, and the subsequent prepayment and refinancing of many higher yielding loans in a lower interest rate environment. Loans yielded 8.85% for the nine months ended December 31, 1999 compared to 9.15% for the nine months ended December 31, 1998. The average balance of mortgage-backed securities, investment securities, daily interest-bearing deposits and FHLB stock increased by $33.0 million for the nine months ended December 31, 1999, causing the interest and dividend income from those investments to increase $2.4 million for the nine months ended December 31, 1999, compared to the nine months ended December 31, 1998. The average yield on mortgage-backed securities increased from 6.00% for the nine months ended December 31, 1998, to 6.38% for the comparable period in 1999. Yields on mortgage-backed securities were particularly low in the 1998 period reflecting the adverse impact of accelerated prepayments on the amortization of purchase premiums on those securities as well as the impact of low market rates on the interest rates paid on the significant portion of those securities that have adjustable interest rates. In the nine-month period ended December 31, 1999, the accelerated prepayments diminished and market rates increased reversing both of those effects on mortgage-backed securities yields. The average yield on investment securities and short term cash investments increased from 6.03% for the nine months ended December 31, 1998, to 6.21% for the comparable nine months in 1999, also reflecting the rise in interest rates during 1999. Earnings on FHLB stock increased by $176,000, reflecting an increase of $4.4 million in the average balance of FHLB stock for the nine months ended December 31, 1999, which was partially offset by a 44 basis point decrease in the dividend yield on that stock.
Interest Expense. Interest expense for the nine months ended December 31, 1999 was $53.2 million compared to $44.3 million for the comparable period in 1998, an increase of $8.9 million, or 20.1%. The increase in interest expense was due to the $330.8 million growth in average interest-bearing liabilities which was offset somewhat by the average cost of all interest-bearing liabilities declining to 4.61% from 4.89%. The $268.5 million increase in average interest-bearing deposits for the nine months ended December 31, 1999 reflects the $125.4 million of deposits acquired in the acquisitions of WSB and SCB as well as solid deposit growth throughout the Company. Deposit interest expense increased $6.8 million for the nine months ended December 31, 1999. Average deposit balances increased from $761.2 million for the nine months ended December 31, 1998, to $1.030 billion for the nine months ended December 31, 1999, while, at the same time, the average rate paid on deposit balances decreased 25 basis points. The decline in the rate paid on deposits reflects the $10.8 million growth in non-interest-bearing deposits, as well as generally lower rates paid on interest-bearing accounts resulting from declining market rates in the second half of 1998. While market rates subsequently rose throughout much of 1999, the lagging impact of changing market rates on deposit costs helped to keep the cost of deposits low when compared to the prior period. Average FHLB advances totaled $425.3 million during the nine months ended December 31, 1999, as compared to $348.8 million during the nine months ended December 31, 1998, resulting in a $2.9 million increase in related interest
expense. The average rate paid on those advances decreased to 5.78% for the nine months ended December 31, 1999 from 5.96% for the nine months ended December 31, 1998. Other borrowings consist of retail repurchase agreements with customers and repurchase agreements with investment banking firms secured by certain investment securities. The average balance for other borrowings decreased $14.2 million from $91.9 million for the nine months ended December 31, 1998, to $77.7 million for the same period in 1999, and the related interest expense decreased $718,000 from $3.9 million to $3.2 million for the respective periods. The average rate paid on other borrowings was 5.50% in the December 1999 nine-month period compared to 5.69% for the same nine-month period in 1998.
Provision for Loan Losses. During the nine months ended December 31, 1999, the provision for loan losses was $1.9 million, compared to $2.2 million for the nine months ended December 31, 1998, a decrease of $325,000. The decrease in the provision for losses reflects the amount required to maintain the allowance for losses at an appropriate level based upon management's evaluation of the adequacy of general and specific loss reserves. The higher provision in the earlier period reflected more significant changes in the portfolio mix and non-performing loans and a higher level of net charge-offs during that period than occurred in the nine months ended December 31, 1999. A comparison of the allowance for loan losses at December 31, 1999 and 1998 shows an increase of $2.8 million to $13.5 million at December 31, 1999 from $10.7 million at December 31, 1998. The allowance for loan losses increased by $1.2 million, to $13.5 million at December 31, 1999, compared to $12.3 million at March 31, 1999. The allowance for loan losses as a percentage of net loans (loans receivable excluding allowance for losses) was 1.02% and 1.09% at December 31, 1999 and December 31, 1998, respectively. The allowance for loan losses equaled 267% of non-performing loans at December 31, 1999 compared to 330% of non-performing loans at December 31, 1998.
Other Operating Income. Other operating income increased $159,000 from $5.4 million for the nine-month period ended December 31, 1998, to $5.5 million for the nine months ended December 31, 1999. The increase included an $824,000 increase in other fees and service charges due in part to the addition of WSB and SCB operations. Fee and service charge income also increased at FSBW and TB (now operating as BB) and IEB (now operating as BBO), reflecting deposit growth and pricing adjustments. There also was an $895,000 decrease in net gains on loans sold in the nine-month period ended December 31, 1999, as compared to the same period in 1998. This decrease primarily reflected decreased sales of loans by FSBW and IEB and the adverse impact of rising interest rates on the profitability of loan sales when compared to the comparable period in the prior year. The volume of loan sales and related net gain on sale of loans decreased from $117.4 million and $2.1 million, respectively, for the nine months ended December 31, 1998, to $99.3 million and $1.0 million, respectively, for the nine months ended December 31, 1999. The $80,000 increase in miscellaneous other income reflects a gain on the sale of IEB real property sold in the second quarter of the nine months ended December 31, 1999.
Other Operating Expenses. Other operating expenses increased $8.1 million, from $22.4 million for the nine-month period ended December 31, 1998, compared to $30.5 million for the nine months ended December 31, 1999. The increase in expenses was largely due to the inclusion of WSB and SCB's operating expenses in the nine months ended December 31, 1999 that were not present in the nine months ended December 31, 1998 and the additional expenses of two new branches opened in the nine months ended December 31, 1999. The increase in other operating expenses was partially offset by a $573,000 increase in capitalized loan origination costs resulting from an increased volume of loan originations. In addition to the acquisitions of WSB and SCB, increases in other operating expenses reflect the overall growth in assets and liabilities, customer relationships and complexity of operations as the Company continued to expand. The higher operating expenses associated with the transition to more of a commercial bank profile caused the Company's efficiency ratio, excluding the amortization of goodwill, to increase 4.55 percentage points, to 52.78% (57.22% including goodwill), for the nine-month period ended December 31, 1999, from 48.23% (52.21% including goodwill) for the comparable period ended December 31, 1998. Other operating expenses as a percentage of average assets were 2.35% (2.17% excluding the amortization of goodwill) for the nine months ended December 31, 1999, compared to 2.15% (1.98% excluding the amortization of goodwill) for the nine months ended December 31, 1998.
Income Taxes. Income tax expense was $8.1 million for the nine months ended December 31, 1999, compared to $6.9 million for the comparable period in 1998. The $1.2 million increase in the provision for income taxes reflects the higher level of income being taxed at higher effective rates due to the phase out of the 34% surtax exemption; the net effect of IEB paying Oregon state income taxes; and the fact that the expenses from the amortization of goodwill acquired in purchasing IEB, TB, WSB and SCB and part of the expense recorded in the release of the ESOP shares are not deductible for tax purposes. The Company's effective tax rates for the nine months ended December 31, 1999 and 1998, were 39% and 38%, respectively.
Comparison of Results of Operations for the Years Ended March 31, 1999 and
General. Net income for the fiscal year ended March 31, 1999 was $15.4 million, or $1.27 per share (diluted), compared to net income of $13.1 million, or $1.13 per share (diluted), recorded in fiscal 1998. Net income for the fiscal year ended March 31, 1999 increased $2.3 million from the comparable period in fiscal 1998. The Company's improved operating results reflect the significant growth of assets and liabilities as well as improvements in net interest margin and non-interest revenues which were offset somewhat by increased operating expenses and amortization of goodwill. Compared to the prior year's levels, total assets increased 41.4% to $1.632 billion at March 31, 1999, total loans rose 45.7% to $1.103 billion, deposits grew 57.8% to $950.8 million and borrowings increased 25.0% to $486.7 million. The net interest margin improved, despite the adverse effects of a flattening yield curve and declining market rates and loan pricing spreads, reflecting the acquisitions of TB and WSB and continuing changes in the asset and liability mix.
Interest Income. Interest income for the year ended March 31, 1999 was $112.3 million compared to $85.1 million for the year ended March 31, 1998, an increase of $27.1 million, or 31.9%. The increase in interest income was a result of a $310.2 million, or 29.7%, growth in average balances of interest-earning assets combined with a 13 basis point increase in the average yield on those assets. The yield on average assets rose to 8..28% in the fiscal year ended March 31, 1999 compared to 8.15% in fiscal 1998. Average loans receivable for the fiscal year ended March 31, 1999 increased by $252.3 million, or 34.5%, when compared to fiscal 1998, reflecting the acquisitions of WSB on January 1, 1999 and TB on April 1, 1998. Interest income on loans increased by $24.9 million, or 38.5%, compared to the prior year, reflecting the impact of the increase in average loan balances and a 26 basis point increase in the average yield, largely resulting from the addition of higher yielding loans held by TB and WSB, but also reflecting higher yields on the expanding balances of commercial and multifamily real estate, construction and land, and non-mortgage loans at FSBW. Loans yielded 9.12% for the fiscal year ended March 31, 1999 compared to 8.86% for fiscal 1998. The average balance of mortgage-backed securities, investment securities, daily interest-bearing deposits and FHLB stock increased by $57.9 million in the fiscal year ended March 31, 1999, causing the interest and dividend income from those investments to increase $2.2 million for the fiscal year ended March 31, 1999 compared to fiscal 1998 despite a 42 basis point decline in the average yield on those investments. The average yield on mortgage-backed securities decreased from 6.61% for the year ended March 31, 1998, to 5.96% in 1999, reflecting both paydowns in certain higher yielding securities and lower yields on most adjustable-rate securities as market rates declined. The average yield on investment securities and short term cash investments decreased from 6.13% for fiscal 1998 to 6.05% in 1999. Earnings on FHLB stock increased by $398,000, reflecting an increase of $5.4 million in the average balance of FHLB stock for the year ended March 31, 1999, offset by a 12 basis point decrease in the dividend yield on that stock.
Interest Expense. Interest expense for the year ended March 31, 1999 was $60.4 million compared to $46.7 million for the comparable period in 1998, an increase of $13.8 million, or 29.6%. The increase in interest expense was due to the $322.6 million growth in average interest-bearing liabilities which was offset somewhat by the average cost of all interest-bearing liabilities declining to 4.83% from 5.02%. The increase in average interest-bearing liabilities in the fiscal year ended March 31, 1999 was largely due to $218.4 million ($158.5 million average balance) of deposits acquired in the acquisitions of TB and WSB along with $9.0 million ($3.7 million average balance) of FHLB borrowings. Deposit interest expense increased $8.7 million for the year ended March 31, 1999. Average deposit balances increased from $573.5 million for the year ended March 31, 1998, to $799.4 million for the year ended March 31, 1999, while, at the same time, the average rate paid on deposit balances decreased 15 basis points. The decline in the rate paid on deposits primarily reflects the acquisition of TB and WSB's $42.1 million of non-interest-bearing deposits as well as generally lower rates paid on interest-bearing accounts resulting from declining market rates. Average FHLB advances totaled $363.3 million during the year ended March 31, 1999, as compared to $276.3 million during the year ended March 31, 1998, resulting in a $4.6 million increase in related interest expense. The average rate paid on those advances decreased to 5.90% for the fiscal year ended March 31, 1999 from 6.07% for fiscal 1998. Other borrowings consist of retail repurchase agreements with customers and repurchase agreements with investment banking firms secured by certain investment securities. The average balance for other borrowings increased $9.8 million from $79.2 million for the year ended March 31, 1998, to $89.0 million for the same period in 1999, and the related interest expense increased $413,000 from $4.6 million to $5.0 million for the respective periods.
Provision for Loan Losses. The provision for loan losses for the year ended March 31, 1999 increased by $1.2 million to $2.8 million compared to $1.6 million for fiscal 1998. This increase is reflective of the growth in loans receivable which, excluding loans acquired through business combination, increased by $165.7 million for the fiscal year ended March 31, 1999 compared to an increase of $111.0 million in the 1998 period. The increase also is reflective of changes in the portfolio mix which resulted in the need for a higher level of loss allowance as well as the impact of a greater amount of non-performing loans and net charge-offs for the year. Specifically, excluding loans acquired through acquisitions, changes in
the loan mix included increases of $119.8 million in commercial and multifamily real estate loans, $59.3 million in construction and land loans, and $27.9 million in commercial and agricultural loans, while one- to four-family loans declined by $40.3 million and consumer loans declined by $1.0 million. Income producing real estate loans, construction and land loans, commercial and agricultural loans are generally riskier than one- to four-family residential loans resulting in a higher provision for losses. Adding to the need for the increased provision for loan losses for the year ended March 31, 1999 was an increase in the amount of non-performing loans which grew to $7.7 million compared to $1.4 million a year earlier. Further adding to the increase in the provision for loan losses was an increase in the level of net charge-offs which increased from $519,000 for the year ended March 31, 1998, to $1.1 million for the year ended March 31, 1999. The allowance for loan losses equaled 1.10% of gross loans and 160% of non-performing loans at March 31, 1999, compared to 1.03% and 553%, respectively, at March 31, 1998.
Other Operating Income. Other operating income increased $2.7 million from $4.7 million for the year ended March 31, 1998, to $7.5 million for the year ended March 31, 1999. The increase included a $1.1 million increase in other fees and service charges due largely to the addition of TB operations. Fee and service charge income also increased at FSBW and IEB, reflecting deposit growth, pricing adjustments, and the fourth quarter acquisition of WSB. There also was a $1.5 million increase in net gains on loans sold in the fiscal year ended March 31, 1999, as compared to the same period in 1998. This increase primarily reflects increased sales of loans by FSBW, with servicing retained, and by IEB which increased the volume of loans sold in the secondary market over the comparable period in the prior year. In addition, gains on loans sold for the fiscal year ended March 31, 1999 include $250,000 of gains on the sale of Small Business Administration (SBA) guaranteed loans originated by TB. The volume of loan sales and related net gain on sale of loans increased from $81.6 million and $933,000, respectively, for the year ended March 31, 1998, to $127.5 million and $1.9 million, respectively, for the year ended March 31, 1999. Increased sales of loans at FSBW were designed to curtail the rate of growth in relatively low yielding fixed-rate residential mortgages during this period of low market rates and to reduce the Banks' exposure to the risk of rising interest rates. The $96,000 increase in miscellaneous other income reflects a gain on the sale of IEB real property in the second quarter of the fiscal year ended March 31, 1999.
Other Operating Expenses. Other operating expenses increased $10.7 million from $21.0 million for the year ended March 31, 1998, to $31.7 million for the year ended March 31, 1999. The increase in expenses was largely due to the inclusion of $7.2 million of TB's operating expenses in the fiscal year ended March 31, 1999, which were not present in fiscal 1998 and the additional expenses of five branches from WSB's acquisition in the last quarter of the fiscal year ended March 31, 1999. The increase in other operating expenses was partially offset by a $620,000 increase in capitalized loan origination costs resulting from an increased volume in loan originations. In addition to the acquisitions of TB and WSB, increases in other operating expenses reflect the overall growth in assets and liabilities, customer relationships and complexity of operations as the Company continued to expand. Despite the higher operating expenses associated with the Company's transition to more of a commercial bank profile, the Company's efficiency ratio, excluding the amortization of goodwill, increased only 2.94 percentage points, to 49.50% (53.53% including goodwill), for the fiscal year ended March 31, 1999, from 46.56% (48.64% including goodwill) in fiscal 1998. Other operating expenses as a percentage of average assets were 2.21% (2.04% excluding the amortization of goodwill) for the year ended March 31, 1999, compared to 1.93% (1.85% excluding the amortization of goodwill) for the year ended March 31, 1998.
Income Taxes. Income tax expense was $9.3 million for the year ended March 31, 1999, compared to $7.4 million for the comparable period in 1998. The $1.8 million increase in the provision for income taxes reflects the higher level of income being taxed at higher effective rates due to the phase out of the 34% surtax exemption; the net effect of IEB paying Oregon state income taxes; and the fact that the expenses from the amortization of goodwill acquired in purchasing IEB, TB and WSB and part of the expense recorded in the release of the ESOP shares are not deductible for tax purposes. The Company's effective tax rates for the years ended March 31, 1999 and 1998, were 38% and 36%, respectively.
Yields Earned and Rates Paid
The earnings of the Company depend largely on the spread between the yield on interest-earning assets (primarily loans and investment securities) and the cost of interest-bearing liabilities (primarily deposit accounts and FHLB advances), as well as the relative size of the Company's interest-earning assets and interest-bearing liability portfolio.
Table I, Analysis of Net Interest Spread, 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, and ratio of average interest-earning assets to average interest-bearing liabilities. Average balances for a period have been calculated using the daily average during such period.
Changes in the economic and interest rate environment, competition in the marketplace and changes in asset and liability mix can cause the Company's average interest rate spread to increase or decrease. Strong competition for both loans and deposits has placed pressure on average interest rate spreads for all of the periods reflected in Table I. In addition, volatile market interest rates over those periods have impacted spreads both positively and negatively. For the most recent periods the interest rate environment, with an inverted yield curve brought about largely by increasing short term interest rates in 1999 and early 2000 and then declining intermediate and long-term interest rates in the second half of 2000, has had a generally adverse impact on the interest rate spread. However, while the spread declined from 3.63% for the year ended December 31, 1999, to 3.49% for the year ended December 31, 2000, on balance the Company's net interest spread increased over the periods reflected in Table I. This general widening reflects significant changes in the Company's asset and liability mix over the longer time frame presented. Contributing to this increased spread has been a decline in the relative portion of the Company's assets invested in securities which was 21.4%, 21.3%, 27.5% and 30.1% of average earning assets respectively for the years ended December 31, 2000 and 1999, and March 31, 1999 and 1998. In addition to the relative decline in investment securities and commensurate increase in loans, the mix of the loan portfolio has changed to include more higher yielding loans. Changes in the portfolio mix are evident in the higher yields on mortgage loans which increased from 8.71% for the year ended December 31, 1999 to 8.96% for the year ended December 31, 2000. Changes in the portfolio mix are also reflected in the increased portion of non-mortgage loans which increased to 18.6% of average earning assets for the year ended December 31, 2000 from 17.2% of average earning assets for the prior year and 14.6% and 8.1% for the years ended March 31, 1999 and 1998. Reflecting these changes, the yield on the total loan portfolio increased 33 basis points for the most recent twelve months from 8.90% for the year ended December 31, 1999, to 9.23% for the year ended December 31, 2000. Also contributing to a generally improved interest rate spread over the periods presented in Table I has been a decline in the cost of deposits primarily brought about by the substantial increase in the amount of non-interest-bearing checking and NOW account balances. However, reflecting the higher interest rate environment, deposit costs increased from 4.08% for the year ended December 31, 1999 to 4.66% for the year ended December 31, 2000, and borrowing costs increased from 5.72% to 6.24% over the same year. As a result, the cost of total interest-bearing liabilities increased from 4.62% for the year ended December 31, 1999, to 5.19% for the year ended December 31, 2000. Improvement in the Company's net interest margin over this same longer time frame, as well as the contraction in the most recent twelve months, mostly reflects the same changes associated with the net interest rate spread. However, counterbalancing to a degree increases in the spread is the somewhat adverse impact on net interest margin resulting from the increased use of leverage which can be seen in the declining ratio of average interest-earning assets to average interest-bearing liabilities. After increasing in prior periods, net interest margin decreased from 3.90% in the year ended December 31, 1999, to 3.77% for the year ended December 31, 2000. Management believes that in the future increased net interest income will come primarily from increased volumes, although continued changes in asset and liability mix and a slightly more favorable interest rate environment may also add to net interest income.
Market Risk and Asset/Liability Management
The financial condition and operations of the Company are influenced significantly by general economic conditions, including the absolute level of interest rates as well as changes in interest rates and the slope of the yield curve. The Company's profitability is dependent to a large extent on its net interest income, which is the difference between the interest received from its interest-earning assets and the interest expense incurred on its interest-bearing liabilities.
The activities of the Company, like all financial institutions, inherently involve the assumption of interest rate risk. Interest rate risk is the risk that changes in market interest rates will have an adverse impact on the institution's earnings and underlying economic value. Interest rate risk is determined by the maturity and repricing characteristics of an institution's assets, liabilities, and off-balance-sheet contracts. Interest rate risk is measured by the variability of financial performance and economic value resulting from changes in interest rates. Interest rate risk is the primary market risk impacting the Company's financial performance.
The greatest source of interest rate risk to the Company results from the mismatch of maturities or repricing intervals for rate sensitive assets, liabilities and off-balance-sheet contracts. This mismatch or gap is generally characterized by a substantially shorter maturity structure for interest-bearing liabilities than interest-earning assets. Additional interest rate risk results from mismatched repricing indices and formulae (basis risk and yield curve risk), and product caps and floors and early repayment or withdrawal provisions (option risk), which may be contractual or market driven, that are generally more favorable to customers than to the Company.
The principal objectives of asset/liability management are to evaluate the interest rate risk exposure of the Company; to determine the level of risk appropriate given the Company's operating environment, business plan strategies, performance objectives, capital and liquidity constraints, and asset and liability allocation alternatives; and to manage the Company's interest rate risk consistent with regulatory guidelines and approved policies of the Board of Directors. Through such management, the Company seeks to reduce the vulnerability of its earnings and capital position to changes in the level of interest rates. The Company's actions in this regard are taken under the guidance of the Asset/Liability Management Committee, which is comprised of members of the Company's senior management. The committee closely monitors the Company's interest sensitivity exposure, asset and liability allocation decisions, liquidity and capital positions, and local and national economic conditions and attempts to structure the loan and investment portfolios and funding sources of the Company to maximize earnings within acceptable risk tolerances.
Sensitivity Analysis
The Company's primary monitoring tool for assessing interest rate risk is asset/liability simulation modeling which is designed to capture the dynamics of balance sheet, interest rate and spread movements and to quantify variations in net interest income resulting from those movements under different rate environments. The sensitivity of net interest income to changes in the modeled interest rate environments provides a measurement of interest rate risk. The Company also utilizes market value analysis, which addresses changes in estimated net market value of equity arising from changes in the level of interest rates. The net market value of equity is estimated by separately valuing the Company's assets and liabilities under varying interest rate environments. The extent to which assets gain or lose value in relation to the gains or losses of liability values under the various interest rate assumptions determines the sensitivity of net equity value to changes in interest rates and provides an additional measure of interest rate risk.
The interest rate sensitivity analysis performed by the Company incorporates beginning-of-the-period rate, balance and maturity data, using various levels of aggregation of that data, as well as certain assumptions concerning the maturity, repricing, amortization and prepayment characteristics of loans and other interest-earning assets and the repricing and withdrawal of deposits and other interest-bearing liabilities into an asset/liability computer simulation model. The Company updates and prepares simulation modeling at least quarterly for review by senior management and the directors. The Company believes the data and assumptions are realistic representations of its portfolio and possible outcomes under the various interest rate scenarios. Nonetheless, the interest rate sensitivity of the Company's net interest income and net market value of equity could vary substantially if different assumptions were used or if actual experience differs from the assumptions used.
Tables III and III(a), Interest Rate Risk Indicators, set forth as of December 31, 2000 and 1999, the estimated changes in the Company's net interest income over a one-year time horizon and the estimated changes in market value of equity based on the indicated interest rate environments.
Table III: Interest Rate Risk Indicators
As of December 31, 2000 (dollars in thousands) Estimated Change in --------------------------------------------- Change (in Basis Points) Net Interest Income in Interest Rates (1) Next 12 Months Net Market Value - ----------------------- ------------------- ----------------------
+400 $ (752) (1.1%) $ (79,954) (41.7%) +300 (431) (0.6%) (61,510) (32.3%) +200 103 0.1% (40,766) (21.4%) +100 168 0.2% (17,654) (9.3%) 0 0 0% 0 0% -100 (1,179) (1.7%) 4,842 2.5% -200 (3,074) (4.3%) (377) (0.2%) -300 (5,796) (8.1%) (14,435) (7.6%) -400 (8,883) (12.4%) (30,652) (16.1%)
Table III(a): Interest Rate Risk Indicators
As of December 31, 1999 (dollars in thousands) Estimated Change in --------------------------------------------- Change (in Basis Points) Net Interest Income in Interest Rates (1) Next 12 Months Net Market Value - ----------------------- ------------------- ----------------------
+400 $ (2,795) (4.4%) $ (82,602) (44.8%) +300 (1,816) (2.8%) (65,753) (35.7%) +200 (922) (1.4%) (45,856) (24.9%) +100 (320) (0.5%) (23,055) (12.5%) 0 0 0% 0 0% -100 (493) (0.8%) 22,190 12.0% -200 (2,203) (3.5%) 20,208 11.0% -300 (4,794) (7.5%) 8,663 4.7% -400 (8,308) (13.0%) (10,992) (6.0%)
- --------- (1) Assumes an instantaneous and sustained uniform change in market interest rates at all maturities.
Another although less reliable monitoring tool for assessing interest rate risk is "gap analysis." The matching of the repricing characteristics of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest sensitive" and by monitoring an institution's interest sensitivity "gap." An asset or liability is said to be interest sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets anticipated, based upon certain assumptions, to mature or reprice within a specific time period and the amount of interest-bearing liabilities anticipated to mature or reprice, based upon certain assumptions, within that same time period. A gap is considered positive when the amount of interest- sensitive assets exceeds the amount of interest-sensitive liabilities. A gap is considered negative when the amount of interest-sensitive liabilities exceeds the amount of interest-sensitive assets. Generally, during a period of rising rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to adversely affect net interest income.
Certain shortcomings are inherent in gap analysis. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as ARM loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Finally, the ability of some borrowers to service their debt may decrease in the event of a severe interest rate increase.
Tables IV and IV(a), Interest Sensitivity Gap, present the Company's interest sensitivity gap between interest-earning assets and interest-bearing liabilities at December 31, 2000 and 1999. The tables set forth the amounts of interest-earning assets and interest-bearing liabilities which are anticipated by the Company, based upon certain assumptions, to reprice or mature in each of the future periods shown. At December 31, 2000, total interest-bearing liabilities maturing or repricing within one year exceeded total interest-earning assets maturing or repricing in the same time period by $121.6 million, representing a one-year gap to total assets ratio of (6.13%).
Management is aware of the sources of interest rate risk and in its opinion actively monitors and manages it to the extent possible. The interest rate risk indicators and interest sensitivity gaps for the Company as of December 31, 2000 and 1999 are within policy guidelines. Management considers that the Company's current level of interest rate risk is reasonable.
Footnotes for Tables IV and IV(a): Interest Sensitivity Gap - ------------------------------------------------------------ (1) Adjustable-rate assets are included in the period in which interest rates are next scheduled to adjust rather than in the period in which they are due to mature, and fixed-rate assets are included in the period in which they are scheduled to be repaid based upon scheduled amortization, in each case adjusted to take into account estimated prepayments. Mortgage loans and other loans are not reduced for allowances for loan losses and non-performing loans. Mortgage loans, mortgage-backed securities, other loans, and investment securities are not adjusted for deferred fees and unamortized acquisition premiums and discounts.
(2) Adjustable-rate liabilities are included in the period in which interest rates are next scheduled to adjust rather than in the period they are due to mature. Although the Banks' regular savings, demand, NOW, and money market deposit accounts are subject to immediate withdrawal, management considers a substantial amount of such accounts to be core deposits having significantly longer maturities. For the purpose of the gap analysis, these accounts have been assigned decay rates to reflect their longer effective maturities. If all of these accounts had been assumed to be short-term, the one-year cumulative gap of interest-sensitive assets would have been $(232..3) million, or (11.72%) of total assets at December 31, 2000 and $(307.7) million, or (16.91%) at December 31, 1999. Interest-bearing liabilities for this table exclude certain non-interest-bearing deposits which are included in the average balance calculations in the earlier Table I, Analysis of Net Interest Spread.
Liquidity and Capital Resources
The Company's primary sources of funds are deposits, borrowings, proceeds from loan principal and interest payments and sales of loans, and the maturity of and interest income on mortgage-backed and investment securities. While maturities and scheduled amortization of loans and mortgage-backed securities are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by market interest rates, economic conditions and competition.
The primary investing activity of the Company, through its subsidiaries, is the origination and purchase of loans. During the year ended December 31, 2000, the nine months ended December 31, 1999 and the fiscal year ended March 31, 1999, the Company closed or purchased loans in the amounts of $892.8 million, $772.8 million and $803.1 million, respectively. This activity was funded primarily by principal repayments on loans and securities, sales of loans, increases in FHLB advances, other borrowings, and deposit growth. For the year ended December 31, 2000, the nine months ended December 31, 1999 and the fiscal year ended March 31, 1999, principal repayments on loans totaled $588.6 million, $486.9 million and $522.0 million, respectively. During the year ended December 31, 2000, the nine-month period ended December 31, 1999 and the fiscal year ended March 31, 1999, the Company sold $135.7 million, $99.3 million and $127.5 million, respectively, of loans. FHLB advances increased $40.6 million, $58.3 million and $101.7 million, respectively, for the year ended December 31, 2000, the nine-month period ended December 31, 1999 and the fiscal year ended March 31, 1999. Other borrowings decreased $7.1 million for the year ended December 31, 2000, increased $3.2 million for the nine months ended December 31, 1999 and decreased $13.3 million for the fiscal year ended March 31, 1999. Net deposit growth was $114.6 million for the year ended December 31, 2000, $86.7 million (excluding $40.6 million of deposits acquired with SCB) for the nine months ended December 31, 1999, and $130.0 million (excluding $218.4 million of deposits acquired with TB and WSB), for the fiscal year ended March 31, 1999.
The Banks must maintain an adequate level of liquidity to ensure the availability of sufficient funds to accommodate deposit withdrawals, to support loan growth, to satisfy financial commitments and to take advantage of investment opportunities. During the year ended December 31, 2000, the nine months ended December 31, 1999 and fiscal year ended March 31, 1999, the Banks used their sources of funds primarily to fund loan commitments, to purchase securities, and to pay maturing savings certificates and deposit withdrawals. At December 31, 2000, the Banks had outstanding loan commitments totaling $148.5 million and undisbursed loans in process totaling $113.9 million. The Banks generally maintain sufficient cash and readily marketable securities to meet short-term liquidity needs. BB maintains a credit facility with the FHLB-Seattle, which provides for advances which in aggregate may equal the lesser of 45% of BB's assets or adjusted qualifying collateral, which as of December 31, 2000 could give a total possible credit line of $521.3 million. Advances under this credit facility totaled $479.5 million, or 27.5% of BB's assets at December 31, 2000. BBO also maintains credit lines with various institutions, including the FHLB-Seattle, that would allow it to borrow up to $20.7 million.
At December 31, 2000, savings certificates amounted to $798.7 million, or 67.0%, of the Banks' total deposits, including $614.9 million which were scheduled to mature by December 31, 2001. Historically, the Banks have been able to retain a significant amount of their deposits as they mature. Management believes it has adequate resources to fund all loan commitments from savings deposits and FHLB-Seattle advances and sale of mortgage loans and that it can adjust the offering rates of savings certificates to retain deposits in changing interest rate environments.
Capital Requirements
The Company is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended (BHCA), and the regulations of the Federal Reserve. Each of the Banks, as state-chartered, federally insured institutions, is subject to the capital requirements established by the FDIC.
The capital adequacy requirements are quantitative measures established by regulation that require the Company and its subsidiary Banks to maintain minimum amounts and ratios of capital. The Federal Reserve requires the Company to maintain capital adequacy that generally parallels the FDIC requirements. The FDIC requires the Banks to maintain minimum ratios of Tier 1 total capital to risk-weighted assets as well as Tier 1 leverage capital to average assets (see further discussion in Note 17 to the Consolidated Financial Statements).
At December 31, 2000 the Company and its banking subsidiaries, BB and BBO, exceeded all current regulatory capital requirements.
The most recent notifications from the FDIC or state banking regulators as of March 31, 2000 for BB and September 31, 2000 for BBO, individually categorized the Banks as "well-capitalized" under the regulatory framework for prompt corrective action.
Table V, Regulatory Capital Ratios, shows the regulatory capital ratios of the Company, BB and BBO and minimum regulatory requirements for the Banks to be categorized as "well-capitalized."
Table V: Regulatory Capital Ratios
The "Well-capitalized" Capital Ratios Company BB BBO Minimum Ratio - ----------------------- ------- -- --- ----------------- Total capital to risk- weighted assets 12.29% 12.20% 10.79% 10.00% Tier 1 capital to risk- weighted assets 11.14 11.01 9.81 6.00
Tier 1 leverage capital to average assets 8.25 7.92 8.54 5.00
Effect of Inflation and Changing Prices
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, which require the measurement of financial position and operating results in terms of historical dollars, without considering the changes in relative purchasing power of money over time due to inflation. The primary impact of inflation on operations of the Company is reflected in increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. 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.
ITEM 7A
ITEM 7A - Quantitative and Qualitative Disclosures about Market Risk
See pages 54-59 of Management's Discussion and Analysis of Financial Condition and Results of Operations.
ITEM 8
ITEM 8 - Financial Statements and Supplementary Data
For financial statements, see index on page 65.
ITEM 9
ITEM 9 - Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Not Applicable
Part III
ITEM 10
ITEM 10 - Directors and Executive Officers of the Registrant
The information contained under the section captioned "Proposal I - Election of Directors" in the Registrant's Proxy Statement is incorporated herein by reference.
Information regarding the executive officers of the Registrant is provided herein in Part I, Item 1 hereof.
Reference is made to the cover page of this Annual Report and the section captioned "Compliance with Section 16(a) of the Exchange Act" of the Proxy Statement for the Annual Meeting of the Stockholders regarding compliance with Section 16(a) of the Securities Exchange Act of 1934.
ITEM 11
ITEM 11 - Executive Compensation
Information regarding management compensation and transactions with management and others is incorporated by reference to the section captioned "Proposal I - Election of Directors" in the Proxy Statement for the Annual Meeting of Stockholders.
ITEM 12
ITEM 12 - Security Ownership of Certain Beneficial Owners and Management
{a} Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by reference to the section captioned "Securities Ownership of Certain Beneficial Owners and Management" in the Proxy Statement for the Annual Meeting of Stockholders.
{b} Security Ownership of Management
Information required by this item is incorporated herein by reference to the section captioned "Securities Ownership of Certain Beneficial Owners and Management" in the Proxy Statement for the Annual Meeting of Stockholders.
{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.
ITEM 13
ITEM 13 - Certain Relationships and Related Transactions
The information contained under the sections captioned "Transactions with Management" in the Proxy Statement for the Annual Meeting of Stockholders is incorporated herein by reference.
Part IV
ITEM 14
ITEM 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K
{a} {1} Financial Statements
See Index to Consolidated Financial Statements on page 65.
{2} Financial Statement Schedules
All financial statement schedules are omitted because they are not applicable or not required, or because the required information is included in the Consolidated Financial Statements or the Notes thereto or in Part 1, Item 1.
{b} Reports on 8-K:
Reports on Form 8-K filed during the quarter ended December 31, 2000 are as follows:
Date Filed Purpose ---------- -------
October 30, 2000 The Registrant changed its corporate name from First Washington Bancorp, Inc. to Banner Corporation effective October 30, 2000. The Registrant will continue to trade on the Nasdaq Stock Market under the new "BANR" symbol. In connection with the Registrant's name change, two of its three banking subsidiaries, First Savings Bank of Washington (including its divisions Whatcom State Bank and Seaport Citizens Bank) and Towne Bank, were merged, and the resulting bank, First Savings Bank, converted to a commercial bank under Title 30 of the Revised Code of Washington. As amended, and changed its name to Banner Bank. These transactions were completed in connection with the Registrant's name change and also were effective on October 30, 2000. Additionally, Inland Empire Bank, the Registrant's Oregon chartered commercial bank, is operating under the new name, Banner Bank of Oregon, effective October 30, 2000.
November 22, 2000 On November 22, 2000, Banner Corporation ("Company") issued a press release which announced that its Board of Directors has authorized the repurchase up to 5% of the Company's outstanding shares, or approximately 600,000 shares, during the next 12 months. For further information, reference is made to the Registrant's press release dated November 22, 2000, which is attached as Exhibit 99 to the original Form 8-K filing dated November 22, 2000 and incorporated herein by reference.
{c} Exhibits
See Index of Exhibits on page 112.
Signatures of Registrant
Pursuant to the requirements of the Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on March 29, 2001.
Banner Corporation
/s/ Gary Sirmon ------------------------------------- Gary Sirmon President and Chief Executive Officer
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 Company and in the capacities indicated on March 29, 2001.
/s/ Gary Sirmon /s/ Lloyd W. Baker - -------------------------------------- ------------------------------------- Gary Sirmon Lloyd W. Baker President and Chief Executive Officer; Executive Vice President and Chief Director Financial Officer (Principal Executive Officer) (Principal Financial and Accounting Officer)
/s/ David Casper /s/ Robert D. Adams - -------------------------------------- ------------------------------------- David Casper Robert D. Adams Chairman of the Board Director
/s/ Marvin Sundquist /s/Jesse G. Foster - -------------------------------------- ------------------------------------- Marvin Sundquist Jesse G. Foster Director Director
/s/ S. Rick Meikle /s/ Dean W. Mitchell - -------------------------------------- ------------------------------------- S. Rick Meikle Dean W. Mitchell Director Director
/s/ Brent A. Orrico /s/Wilber Pribilsky - -------------------------------------- ------------------------------------- Brent A. Orrico Wilber Pribilsky Director Director
/s/ Margaret C. Langlie - -------------------------------------- Margaret C. Langlie Director
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS BANNER CORPORATION AND SUBSIDIARIES (Item 8 and Item 14 (a) (1))
Report of Management . . . . . . . . . . . . . . . . . . . . . . . . 66 Report of Audit Committee. . . . . . . . . . . . . . . . . . . . . . 66 Independent Auditors' Report. . . . . . . . . . . . . . . . . . . . .67 Consolidated Statements of Financial Condition as of December 31, 2000 and 1999 . . . . . . . . . . . . . . . . . 68 Consolidated Statements of Income for the Years Ended December 31, 2000 and 1999, the Nine Months Ended December 31, 1999 and the Year Ended March 31, 1999. . . . . 69 Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2000 and 1999, the Nine Months Ended December 31, 1999 and the Year ended March 31, 1999. . . . . . . . . . . . . . . . . . . . . 70 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 2000 and 1999, the Nine Months Ended December 31, 1999 and the Year Ended March 31, 1999 . . . . . . . . . . . . . . . . . . . . . . . 71 Consolidated Statements of Cash Flows for the Years Ended December 31, 2000 and 1999, the Nine Months Ended December 31, 1999 and the Year Ended March 31, 1999. . . . . 73 Notes to the Consolidated Financial Statements . . . . . . . . . . . 76
February 26, 2001
Report of Management:
To the Stockholders:
The management of Banner Corporation (the Company) is responsible for the preparation, integrity, and fair presentation of its published financial statements and all other information presented in this annual report. The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and, as such, include amounts based on informed judgments and estimates made by management. In the opinion of management, the financial statements and other information herein present fairly the financial condition and operations of the Company at the dates indicated in conformity with accounting principles generally accepted in the United States of America.
Management is responsible for establishing and maintaining an effective system of internal control over financial reporting. The internal control system is augmented by written policies and procedures and by audits performed by an internal audit staff which reports to the Audit Committee of the Board of Directors. Internal auditors monitor the operation of the internal control system and report findings to management and the Audit Committee. When appropriate, corrective actions are taken to address identified control deficiencies and other opportunities for improving the system. The Audit Committee provides oversight to the financial reporting process. There are inherent limitations in the effectiveness of any system of internal control, including the possibility of human error and circumvention or overriding of controls. Accordingly, even an effective internal control system can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of an internal control system may vary over time.
The Audit Committee of the Board of Directors is comprised entirely of outside directors who are independent of the Company's management. The Audit Committee is responsible for recommending to the Board of Directors the selection of independent auditors. It meets periodically with management, the independent auditors and the internal auditors to ensure that they are carrying out their responsibilities. The Committee is also responsible for performing an oversight role by reviewing and monitoring the financial, accounting, and auditing procedures of the Company in addition to reviewing the Company's financial reports. The independent auditors and the internal auditors have full and free access to the Audit Committee, with or without the presence of management, to discuss the adequacy of the internal control structure for financial reporting and any other matters which they believe should be brought to the attention of the Committee.
/s/Gary Sirmon /s/Lloyd W. Baker Gary Sirmon, Chief Executive Officer Lloyd W. Baker, Chief Financial Officer
February 26, 2001
Report of the Audit Committee of the Board of Directors
The Audit Committee of the Board of Directors is comprised of all directors who are not employees of the Company. The Audit Committee has reviewed the audited financial statements of Banner Corporation with management of the Company, including a discussion of the quality of the accounting principles applied and significant judgments and estimates affecting the financial statements. The Audit Committee has also discussed with the outside auditors the auditors' opinion of the quality of those principles and significant judgments as applied by management in preparation of the financial statements. In addition, the members of the Audit Committee have discussed among themselves, without management or the outside auditors present, the information disclosed to the committee by management and the outside auditors and have met regularly with the internal audit staff, without management present, to review compliance with approved policies and procedures. In reliance on these reviews and discussions, the Audit Committee believes that the financial statements of Banner Corporation and subsidiaries are fairly presented.
/s/Robert D. Adams Robert D. Adams Audit Committee Chairman
INDEPENDENT AUDITORS' REPORT
Board of Directors Banner Corporation and Subsidiaries Walla Walla, Washington
We have audited the accompanying consolidated statements of financial condition of Banner Corporation and subsidiaries (the Company) as of December 31, 2000 and 1999, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity, and cash flows for the year ended December 31, 2000, the nine-month period ended December 31, 1999 and the year ended March 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial condition of Banner Corporation and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for the year ended December 31, 2000, the nine-month period ended December 31, 1999 and for the year ended March 31, 1999 in conformity with accounting principles generally accepted in the United States of America.
/s/Deloitte and Touche LLP
DELOITTE & TOUCHE LLP Seattle, Washington February 26, 2001
BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (in thousands, except shares) December 31, 2000 and 1999
December 31, 2000 December 31, 1999 ----------------- ----------------- ASSETS Cash and due from banks $ 67,356 $ 44,769 Securities available for sale, cost $310,538 and $356,617 308,798 348,347 Securities held to maturity, fair value $18,269 and $13,716 17,717 13,770 Federal Home Loan Bank stock 28,807 24,543 Loans receivable: Held for sale, fair value $8,011 and $9,519 7,934 9,519 Held for portfolio 1,479,149 1,312,186 Allowance for loan losses (15,314) (13,541) ---------- ---------- 1,471,769 1,308,164
Accrued interest receivable 12,963 10,732 Real estate held for sale, net 3,287 3,293 Property and equipment, net 17,746 16,637 Costs in excess of net assets acquired (goodwill), net 34,617 37,733 Deferred income tax asset, net 2,337 5,338 Bank owned life insurance 14,190 3,842 Other assets 3,244 2,942 ---------- ---------- $1,982,831 $1,820,110 ========== ========== LIABILITIES Deposits: Non-interest-bearing $ 140,779 $ 114,252 Interest-bearing 1,051,936 963,900 ---------- ---------- 1,192,715 1,078,152
Advances from Federal Home Loan Bank 507,098 466,524 Other borrowings 74,538 81,655 Accrued expenses and other liabilities 10,857 10,524 Deferred compensation 2,293 1,944 Income taxes payable 1,535 2,138 ---------- ---------- 1,789,036 1,640,937 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Preferred stock - $0.01 par value, 500,000 shares authorized, no shares issued -- -- Common stock - $0.01 par value, 27,500,000 shares authorized, 13,201,718 shares issued: 12,005,298 shares and 12,337,027 shares outstanding at December 31, 2000 and 1999, respectively 133,839 123,204 Retained earnings 66,893 69,170 Accumulated other comprehensive income: Unrealized gain (loss) on securities available for sale (1,125) (5,331) Unearned shares of common stock issued to Employee Stock Ownership Plan(ESOP) trust: 633,278 and 745,631 restricted shares outstanding at December 31, 2000 and 1999, respectively, at cost (5,234) (6,162)
Carrying value of shares held in trust for stock related compensation plans (3,130) (4,041) Liability for common stock issued to deferred, stock related, compensation plan 2,552 2,333 ---------- ---------- (578) (1,708) ---------- ---------- 193,795 179,173 ---------- ---------- $1,982,831 $1,820,110 ========== ==========
See notes to consolidated financial statements
BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands except for per share data) For the Years Ended December 31, 2000 and 1999 and the Nine Months Ended December 31, 1999 and the Year Ended March 31, 1999
Nine Months Year Years Ended Ended Dec- Ended December 31 ember 31 March 31 ----------------- ---------- -------- 2000 1999 1999 1999 ---- ---- ---- ---- (Unaudited) INTEREST INCOME: Loans receivable $131,394 $106,468 $ 82,107 $ 89,615 Mortgage-backed securities 15,358 14,953 11,630 13,025 Securities and cash equivalents 11,546 10,081 7,295 9,652 -------- -------- -------- -------- 158,298 131,502 101,032 112,292 -------- -------- -------- -------- INTEREST EXPENSE: Deposits 53,120 40,801 31,475 34,019 Federal Home Loan Bank advances 31,568 24,284 18,505 21,430 Other borrowings 4,906 4,275 3,221 4,993 -------- -------- -------- -------- 89,594 69,360 53,201 60,442 -------- -------- -------- -------- Net interest income before provision for loan losses 68,704 62,142 47,831 51,850
PROVISION FOR LOAN LOSSES 2,867 2,516 1,885 2,841 -------- -------- -------- -------- Net interest income 65,837 59,626 45,946 49,009
OTHER OPERATING INCOME: Loan servicing fees 1,069 953 741 798 Other fees and service charges 5,251 4,398 3,367 3,574 Gain on sale of loans 2,517 1,989 1,157 2,884 Gain on sale of securities 63 6 2 11 Miscellaneous 351 266 248 186 -------- -------- -------- -------- Total other operating income 9,251 7,612 5,515 7,453
OTHER OPERATING EXPENSES: Salary and employee benefits 26,392 23,121 17,503 18,644 Less capitalized loan origination costs (3,519) (3,262) (2,572) (2,689) Occupancy and equipment 7,084 6,051 4,660 4,816 Information/computer data service 2,526 2,224 1,751 1,603 Advertising 788 688 514 590 Deposit insurance 223 337 257 338 Amortization of goodwill 3,170 3,047 2,364 2,389 Miscellaneous 9,838 7,667 6,045 6,054 -------- -------- -------- -------- Total other operating expenses 46,502 39,873 30,522 31,745 -------- -------- -------- -------- Income before provision for income taxes 28,586 27,365 20,939 24,717
PROVISION FOR INCOME TAXES 10,238 10,467 8,070 9,277 -------- -------- -------- -------- NET INCOME $ 18,348 $ 16,898 $12,869 $15,440 ======== ======== ======== ======== Earnings per common share: see Notes 2 and 24 Basic $ 1.62 $ 1.46 $ 1.12 $ 1.33 Diluted $ 1.60 $ 1.41 $ 1.09 $ 1.27
Cumulative dividends declared per common share $ 0.52 $ 0.44 $ 0.33 $ 0.35
See notes to consolidated financial statements
BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (in thousands) For the Years Ended December 31, 2000 and 1999 and the Nine Months Ended December 31, 1999 and the Year Ended March 31, 1999
Nine Months Year Years Ended Ended Dec- Ended December 31 ember 31 March 31 ----------------- ---------- -------- 2000 1999 1999 1999 ---- ---- ---- ---- (Unaudited)
NET INCOME $18,348 $16,898 $12,869 $15,440
OTHER COMPREHENSIVE INCOME (LOSS), NET OF INCOME TAXES: Unrealized holding gain (loss) during the period, net of deferred income tax (benefit) of $2,344, $(4,201), $(4,123) and $(194) 4,248 (7,767) (7,626) (377)
Less adjustment for gains included in net income, net of income tax of $21, $2, $1 and $4 (42) (4) (1) (7) ------- ------- ------- ------- Other comprehensive income/ (loss) 4,206 (7,771) (7,627) (384) ------- ------- ------- ------- COMPREHENSIVE INCOME $22,554 $ 9,127 $ 5,242 $15,056 ======= ======= ======= =======
See notes to consolidated financial statements
BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (in thousands) For the Years Ended December 31, 2000 and 1999 and the Nine Months Ended December 31, 1999 and the Year Ended March 31, 1999
Nine Months Year Years Ended Ended Dec- Ended December 31 ember 31 March 31 ----------------- ---------- -------- 2000 1999 1999 1999 ---- ---- ---- ---- (Unaudited) COMMON STOCK: Balance, beginning of period $123,204 $122,049 $130,770 $108,994 Issuance of stock in connection with acquisitions 53 11,516 -- 12,776 Assumption of options in connection with acquisitions -- 527 -- 2,546 Excess(deficiency) of proceeds over basis of stock reissued for exercised stock options 578 100 80 (265) Issuance of shares-10% stock dividend: see Note 2 14,731 -- -- 24,371 Purchase and retirement of treasury stock (5,373) (12,515) (8,572) (7,955) Retirement of treasury stock resulting from reincorporation in State of Washington -- -- -- (11,116)
Net issuance of stock through employees' stock plans, including tax benefit 646 1,527 926 1,419 ------- ------- ------- ------- Balance, end of period 133,839 123,204 123,204 130,770
RETAINED EARNINGS: Balance, beginning of period 69,170 57,273 59,958 72,962 Net income 18,348 16,898 12,869 15,440 Issuance of shares-10% stock dividend (14,731) -- -- (24,371) Cash dividends (5,887) (5,001) (3,657) (4,073) Other (7) -- -- -- ------- ------- ------- ------- Balance, end of period 66,893 69,170 69,170 59,958
ACCUMULATED OTHER COMPREHENSIVE INCOME: Balance, beginning of period (5,331) 2,440 2,296 2,680 Other comprehensive income/(loss), net of related income taxes 4,206 (7,771) (7,627) (384) ------- ------- ------- ------- Balance, end of period (1,125) (5,331) (5,331) 2,296
TREASURY STOCK: Balance, beginning of period -- -- -- (20,979) Issuance of stock in connection with acquisitions -- -- -- 17,206 Purchases of treasury stock, prior to reincorporation -- -- -- (7,340) Purchases of treasury stock for exercised stock options -- -- -- (409) Issuance of treasury stock for MRP and/or exercised stock options -- -- -- 409 Repurchase of forfeited shares from MRP -- -- -- (3) Retirement of treasury shares resulting from reincorporation in State of Washington -- -- -- 11,116 ------- ------- ------- ------- Balance, end of period -- -- -- --
UNEARNED, RESTRICTED ESOP SHARES AT COST: Balance, beginning of period (6,162) (6,781) (6,781) (7,163) Release of earned ESOP shares 928 619 619 382 ------- ------- ------- ------- Balance, end of period (5,234) (6,162) (6,162) (6,781)
continued on next page
BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (in thousands) For the Years Ended December 31, 2000 and 1999 and the Nine Months Ended December 31, 1999 and the Year Ended March 31, 1999
Nine Months Year Years Ended Ended Dec- Ended December 31 ember 31 March 31 ----------------- ---------- -------- 2000 1999 1999 1999 ---- ---- ---- ---- (Unaudited)
CARRYING VALUE OF SHARES HELD N TRUST FOR STOCK RELATED COMPENSATION PLANS: Balance, beginning of period $(1,708) $(4,098) $(2,635) $(6,310) Cumulative effect of change in accounting for Rabbi Trust: see Note 1 -- 673 -- 1,095 Stock issued to fund Rabbi Trust plans -- (601) -- (601) Net change in number and/or valuation of shares held in trust 140 1,095 5 1,987 Issuance of stock for MRP (62) (52) (52) -- Amortization of compensation related to MRP 1,052 1,275 974 1,194 ------- ------- ------- ------- Balance, end of period (578) (1,708) (1,708) (2,635) ------- ------- ------- ------- TOTAL STOCKHOLDERS' EQUITY $193,795 $179,173 $179,173 $183,608 ======= ======= ======= ======= COMMON STOCK, SHARES ISSUED:* Number of shares, beginning of period 13,202 13,202 13,202 13,202 ------- ------- ------- ------- Number of shares, end of period 13,202 13,202 13,202 13,202 ------- ------- ------- ------- LESS TREASURY STOCK RETIRED/ REPURCHASED:* Number of shares, beginning of period (865) (770) (389) (1,159) Repurchase of stock (394) (693) (487) (742) Repurchase of stock for exercised stock options -- -- -- (20) Issuance of stock to deferred compensation plan and/or exercised stock options 70 44 13 37 Stock issued in acquisitions 2 558 -- 1,497 Repurchase of stock forfeited from MRP (10) (4) (2) (2) ------- ------- ------- ------- Shares of stock retired/ repurchased, end of period (1,197) (865) (865) (389) ------- ------- ------- ------- SHARES OUTSTANDING, END OF PERIOD* 12,005 12,337 12,337 12,813 ======= ======= ======== =======
UNEARNED, RESTRICTED ESOP SHARES:* Number of shares, beginning of period (746) (821) (821) (867) Release of earned shares 113 75 75 46 ------- ------- ------- ------- Number of shares, end of period (633) (746) (746) (821) ======= ======= ======== =======
* Adjusted for stock dividends: see Note 2.
See notes to consolidated financial statements
BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) For the Years Ended December 31, 2000 and 1999 and the Nine Months Ended December 31, 1999 and the Year Ended March 31, 1999
Nine Months Year Years Ended Ended Dec- Ended December 31 ember 31 March 31 ----------------- ---------- -------- 2000 1999 1999 1999 ---- ---- ---- ---- (Unaudited) OPERATING ACTIVITIES: Net income $ 18,348 $ 16,898 $ 12,869 $ 15,440 Adjustments to reconcile net income to net cash provided by operating activities: Deferred taxes 678 (303) (302) (144) Depreciation 2,718 2,369 1,764 1,901 Loss(gain) on sale of securities (63) (6) (2) (11) Increase in cash surrender value of bank owned life insurance (348) (331) (242) (221) Net amortization of premiums and discounts on investments 86 655 325 1,017 Amortization of costs in excess of net assets acquired 3,170 3,047 2,364 2,389 Amortization of MRP compensation liability 1,052 1,275 974 1,194 Loss(gain)on disposal of equipment 41 (7) (7) (95) Loss (gain) on sale of loans (2,121) (1,619) (1,029) (1,903) Net change in deferred loan fees, premiums and discounts 765 1,931 1,934 46 Loss(gain) on disposal of real estate held for sale 43 (50) (61) 35 Amortization of mortgage servicing rights 251 296 215 277 Capitalization of mortgage servic- ing rights from sale of mortgages with servicing retained (395) (370) (128) (981) Provision for losses on loans and REO 3,058 2,516 1,885 2,841 FHLB stock dividend (1,727) (1,722) (1,287) (1,545) Net change in: Loans held for sale 1,585 5,187 1,737 3,306 Accrued interest receivable (2,231) (1,345) (454) (1,111) Other assets (136) 1,233 238 1,086 Deferred compensation 463 520 382 380 Accrued expenses and other liabilities (3) 1,599 2,512 170 Income taxes payable (601) 1,261 1,092 (1,709) -------- ------- ------- ------- Net cash provided by operating activities 24,633 33,034 24,779 22,362 -------- ------- ------- -------
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BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) For the Years Ended December 31, 2000 and 1999 and the Nine Months Ended December 31, 1999 and the Year Ended March 31, 1999 (continued from prior page)
Nine Months Year Years Ended Ended Dec- Ended December 31 ember 31 March 31 ----------------- ---------- -------- 2000 1999 1999 1999 ---- ---- ---- ---- (Unaudited) INVESTING ACTIVITIES: Purchases of securities available for sale $(17,969)$(116,025)$(45,021)$(353,354) Principal repayments and maturities of securities available for sale 42,303 106,384 53,120 301,393 Sales of securities available for sale 21,703 6,260 5,829 2,637 Purchases of securities held to maturity (4,759) (12,058) (12,058) -- Principal repayments and maturities of securities held to maturity 830 586 449 647 Loans originated and closed, net (880,824)(964,454)(759,640) (716,952) Purchases of loans and parti- cipating interest in loans (11,986) (40,236) (13,171) (86,165) Sales of loans and partici- pating interest in loans 135,670 143,799 99,316 127,452 Principal repayments on loans 588,587 623,550 486,948 521,958 Net sales(purchases) of FHLB stock (2,537) 269 (119) (3,437) Proceeds from sale of property and equipment 19 10 10 373 Purchases of property and equipment (3,887) (2,539) (1,866) (3,067) Additional investment in real estate held for sale, net of insurance proceeds (88) (426) (346) (165) Proceeds from sale of real estate held for sale 1,608 3,395 2,407 2,661 Funds transferred to deferred compensation plans (136) (489) (99) (494) (Investment in)proceeds from bank owned life insurance (10,000) 280 280 -- Acquisitions,net of cash acquired (6) (874) (5,423) 13,877 -------- -------- -------- -------- Net cash used by investing activities (141,472)(252,568)(189,384) (192,636) -------- -------- -------- -------- FINANCING ACTIVITIES: Increase(decrease) in deposits 114,563 142,885 86,302 129,998 Proceeds from FHLB advances 873,179 477,153 420,900 300,807 Repayment of FHLB advances (832,605)(411,480)(362,628) (199,099) Proceeds from repurchase agreement borrowings 993 4,500 4,500 268 Repayment of repurchase agreement borrowings (4,301) (12,246) (10,492) (13,008) Increase(decrease) in other borrowings (3,705) 5,029 9,180 (516) Compensation expense recognized for shares released for allocation to participants of the ESOP: Original basis of shares 928 619 619 382 Excess of fair value of released shares over basis 582 685 686 542 Cash dividends paid (5,553) (4,694) (3,709) (3,595) Net (cost)proceeds from exercised stock options 578 100 80 (265) Repurchases of stock, net of forfeitures (5,233) (12,481) (8,567) (15,266) -------- -------- -------- -------- Net cash provided by financing activities 139,426 190,070 136,871 200,248 -------- -------- -------- --------
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BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) For the Years Ended December 31, 2000 and 1999 and the Nine Months Ended December 31, 1999 and the Year Ended March 31, 1999 (Continued from prior page)
Nine Months Year Years Ended Ended Dec- Ended December 31 ember 31 March 31 ----------------- ---------- -------- 2000 1999 1999 1999 ---- ---- ---- ---- (Unaudited) NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS 22,587 (29,464) (27,734) 29,974
CASH AND DUE FROM BANKS, BEGINNING OF PERIOD 44,769 74,233 72,503 42,529 ------- ------- ------- ------- CASH AND DUE FROM BANKS, END OF PERIOD $67,356 $44,769 $44,769 $72,503 ======= ======= ======= =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest paid $88,444 $70,719 $54,792 $59,407 Taxes paid $10,161 $ 9,037 $ 7,298 $10,619 Non-cash transactions: Loans, net of discounts, specific loss allowances and unearned income transferred to real estate held for sale $ 1,922 $ 3,890 $ 3,854 $ 3,007 Net change in accrued dividends payable $ 336 $ 333 $ 52 $ 477 Net change in unrealized gain/ (loss) in deferred compensation trust and related liability $ 113 $ 2,177 $ 66 $ 3,498 Stock issued to Rabbi Trust/ MRP $ 86 $ 653 $ 52 $ 601 Stock forfeited by MRP $ 5 $ 34 $ 5 $ 32 Recognize tax benefit of vested MRP shares $ 2 $ 188 $ 188 $ 276 Non-cash portion of 10% stock dividend $14,731 $ -- $ -- $24,371
The following summarizes the non-cash activities relating to acquisitions:
Fair value of assets acquired (48)(157,278) (51,374) (270,436) Fair value of liabilities assumed -- 134,917 41,201 230,012 Fair value of stock issued and options assumed to acquisitions' shareholders 48 12,043 -- 32,527 ------- ------- ------- ------- Cash paid out in acquisition -- (10,318) (10,173) (7,897) Less cash acquired -- 9,444 4,750 21,774 ------- ------- ------- ------- Net cash acquired (used) $ -- $ (874) $(5,423) $13,877 ======= ======= ======= =======
See notes to consolidated financial statements
BANNER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: BASIS OF PRESENTATION AND SUMMARY OF ACCOUNTING POLICIES
Name Change/Consolidation of Banking Operations: On October 30, 2000 First Washington Bancorp, Inc. (FWWB) changed its name to Banner Corporation (BANR or the Company) in conjunction with a consolidation of banking operations affecting its banking subsidiaries. Towne Bank (TB) merged with First Savings Bank of Washington (FSBW), FSBW converted from a Washington state-chartered savings bank to a Washington state-chartered commercial bank and changed its name, along with the names of its divisions, Whatcom State Bank and Seaport Citizens Bank, to Banner Bank (BB). At the same time, Inland Empire Bank (IEB) changed its name to Banner Bank of Oregon (BBO). Because the changes occurred during the effective date of the current financial presentation, the names of First Savings Bank of Washington, Inland Empire Bank and Towne Bank continue to be used in this document when discussing business segment information in Note 27.
Basis for Presentation: The Company is a bank holding company incorporated in the State of Washington. The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly owned subsidiaries, BB and BBO (together, the Banks). BB is a Washington-chartered commercial bank the deposits of which are insured by the Federal Deposit Insurance Corporation (FDIC) under the Savings Association Insurance Fund (SAIF). BB conducts business from its main office in Walla Walla, Washington and its thirty-two branch offices and four loan production offices located in Washington, Oregon and Idaho. BBO is an Oregon- chartered commercial bank whose deposits are insured by the FDIC under the Bank Insurance Fund (BIF). BBO conducts business from its main office in Hermiston, Oregon, and its six branch offices and one loan production office located in northeast Oregon.
The Company and its Bank subsidiaries are subject to regulation by the Federal Reserve Board (FRB) and the FDIC. In addition BB and BBO are subject to the state banking regulations applicable to their state charters.
Change in Fiscal Year End: During May of 1999, the Company announced its decision to change its fiscal year from April 1 through March 31 to January 1 through December 31. The prior fiscal period is for the transition period April 1, 1999 through December 31, 1999.
Nature of Business: The operating results of the Company depend primarily on its net interest income, which is the difference between interest income on interest-earning assets, consisting of loans and securities, and interest expense on interest-bearing liabilities, composed primarily of savings deposits, Federal Home Loan Bank (FHLB) advances and repurchase agreements. Net interest income is a function of the Company's interest rate spread, which is the difference between the yield earned on interest-earning assets and the rate paid on interest-bearing liabilities, as well as a function of the average balance of interest-earning assets as compared to the average balance of interest-bearing liabilities.
In addition to interest income on loans and securities, the Banks receive other income from deposit service charges, loan origination and servicing fees and from the sale of loans and investments.
Principles of Consolidation: The consolidated financial statements include the accounts of BANR and its wholly owned subsidiaries, BB and BBO. All material intercompany transactions, profits and balances have been eliminated.
Use of Estimates: The preparation of the financial statements in conformity with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect amounts reported in the financial statements. Changes in these estimates and assumptions are considered reasonably possible and may have a material impact on the financial statements. The Company has used significant estimates in determining reported reserves and allowances for loan losses, mortgage servicing rights, goodwill, tax liabilities and other contingencies.
Securities: Securities are classified as held to maturity when the Company has the ability and positive intent to hold them to maturity. Securities classified as available for sale are available for future liquidity requirements and may be sold prior to maturity.
Securities held to maturity are carried at cost, adjusted for amortization of premiums and accretion of discounts to maturity. Unrealized losses on securities held to maturity due to decreases in fair value are recognized when it is determined that an other than temporary decline in value has occurred. Securities available for sale are carried at fair value. Unrealized gains and losses on securities available for sale are excluded from earnings and are reported net of tax as accumulated other comprehensive income, a component of stockholders' equity, until realized. Realized gains and losses on sale are computed on the specific identification method and are included in operations on the trade date sold.
Loans Receivable: The Banks originate mortgage loans for both portfolio investment and sale in the secondary market. At the time of origination, mortgage loans are designated as held for sale or held for investment. Loans held for sale are stated at lower of cost or estimated fair value determined on an aggregate basis. The Banks also originate commercial, financial, agribusiness and installment credit loans for portfolio investment. Loans receivable not designated as held for sale are recorded at the principal amount outstanding, net of allowance for loan losses, deferred fees, discounts, and premiums. Premiums, discounts and deferred loan fees are amortized to maturity using the level-yield methodology.
Interest is accrued as earned unless management doubts the collectibility of the loan or the unpaid interest. Interest accruals are generally discontinued when loans become 90 days past due for interest. All previously accrued but uncollected interest is deducted from interest income upon transfer to nonaccrual status. Future collection of interest is included in interest income based upon an assessment of the likelihood that the loans will be repaid or recovered. A loan may be put in nonaccrual status sooner than this policy would dictate if, in management's judgment, the loan may be uncollectible. Such interest is then recognized as income only if it is ultimately collected.
Allowances for Loan Losses: The adequacy of general and specific reserves is based on management's continuing evaluation of the pertinent factors underlying the quality of the loan portfolio, including changes in the size and composition of the loan portfolio, delinquency rates, actual loan loss experience and current economic conditions. Large groups of smaller-balance homogeneous loans are collectively evaluated for impairment. Loans that are collectively evaluated for impairment by the Banks include residential real estate and consumer loans. Smaller balance non-homogeneous loans also may be evaluated collectively for impairment. Larger balance non-homogeneous residential construction and land, commercial real estate, commercial business loans and unsecured loans are individually evaluated for impairment. Loans are considered impaired when, based on current information and events, management determines that it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. Factors involved in determining impairment include, but are not limited to, the financial condition of the borrower, value of the underlying collateral and current status of the economy. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of collateral if the loan is collateral dependent. Subsequent changes in the value of impaired loans are included within the provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the provision that would otherwise be reported.
The Company's methodology for assessing the appropriateness of the allowance consists of several key elements, which include specific allowances, an allocated formula allowance, and an unallocated allowance. Losses on specific loans are provided for when the losses are probable and estimable. General loan loss reserves are established to provide for inherent loan portfolio risks not specifically provided for. The level of general reserves is based on analysis of potential exposures existing in the Banks' loan portfolios including evaluation of historical trends, current market conditions and other relevant factors identified by management at the time the financial statements are prepared. The formula allowance is calculated by applying loss factors to outstanding loans, excluding loans with specific allowances. Loss factors are based on the Company's historical loss experience adjusted for significant factors including the experience of other banking organizations that, in management's judgment, affect the collectibility of the portfolio as of the evaluation date. The unallocated allowance is based upon management's evaluation of various factors that are not directly measured in the determination of the formula and specific allowances. This methodology may result in losses or recoveries differing significantly from those provided in the financial statements.
When available information confirms that specific loans or portions thereof are uncollectible, these amounts are charged off against the allowance for loan losses. The existence of some or all of the following criteria will generally confirm that a loss has been incurred: the loan is significantly delinquent and the borrower has not evidenced the ability or intent to bring the loan current; the Company has no recourse to the borrower, or if it does, the borrower has insufficient assets to pay the debt; or the fair value of the loan collateral is significantly below the current loan balance and there is little or no near-term prospect for improvement.
Loan Origination and Commitment Fees: Loan origination fees, net of certain specifically defined direct loan origination costs, are deferred and recognized as an adjustment of the loans' interest yield using the level-yield method over the contractual term of each loan adjusted for actual loan prepayment experience. Net deferred fees or costs related to loans held for sale are recognized in income at the time the loans are sold. Loan commitment fees are deferred until the expiration of the commitment period unless management believes there is a remote likelihood that the underlying commitment will be exercised, in which case the fees are amortized to fee income using the straight-line method over the commitment period. If a loan commitment is exercised, the deferred commitment fee is accounted for in the same manner as a loan origination fee. Deferred commitment fees associated with expired commitments are recognized as fee income.
Real Estate Held for Sale: Property acquired by foreclosure or deed in lieu of foreclosure is recorded at the lower of estimated fair value, less cost to sell, or the principal balance of the defaulted loan. Development, improvement, and direct holding costs relating to the property are capitalized. The carrying value of such property is periodically evaluated by management and, if necessary, allowances are established to reduce the carrying value to net realizable value. Gains or losses at the time the property is sold are charged or credited to operations in the period in which they are realized. The amounts the Banks will ultimately recover from real estate held for sale may differ substantially from the carrying value of the assets because of future market factors beyond the Banks' control or because of changes in the Banks' strategy for recovering the investment.
Property and Equipment: The provision for depreciation is based upon the straight-line method applied to individual assets and groups of assets acquired in the same year at rates adequate to charge off the related costs over their estimated useful lives:
Buildings and improvements. . . . . . . . . . . . . . . . .10-30 years Furniture and equipment . . . . . . . . . . . . . . . . . . 3-10 years
Routine maintenance, repairs, and replacement costs are expensed as incurred. Expenditures which materially increase values or extend useful lives are capitalized. The Company reviews buildings, leasehold improvements, and equipment for impairment whenever events or changes in circumstances indicate that the undiscounted cash flows for the property are less than its carrying value. If identified, an impairment loss is recognized through a charge to earnings based on the fair value of the property.
Costs in Excess of Net Assets Acquired: Costs in excess of net assets acquired (goodwill) is an intangible asset arising from the purchase of IEB, TB, WSB and SCB. It is being amortized on a straight-line basis over the 14-year period of expected benefit. The Company periodically evaluates goodwill for impairment.
Mortgage Servicing Rights: Purchased servicing rights represent the cost of acquiring the right to service mortgage loans. Originated servicing rights are recorded when mortgage loans are originated and subsequently sold or securitized with the servicing rights retained. The total cost of mortgage loans sold is allocated to the servicing rights and the loans (without the servicing rights) based on relative fair values. The cost relating to purchased and originated servicing is capitalized and amortized in proportion to, and over the period of, estimated future net servicing income.
The Banks assess the fair value of unamortized servicing rights for impairment on a stratum by stratum basis every quarter by using secondary market quotes for comparable packages of serviced loans and a valuation model that calculates the present value of future cash flows using market discount rates and market based assumptions for prepayment speeds, servicing costs and ancillary income for those pools of serviced mortgages for which secondary market quotes are not readily available. For purposes of measuring impairment, the servicing rights are stratified based on their interest rate, original and remaining terms to maturity and balances outstanding.
Income Taxes: The Company files a consolidated income tax return including all of its wholly owned subsidiaries on a calendar year basis. Income taxes are accounted for using the asset and liability method. Under this method, a deferred tax asset or liability is determined based on the enacted tax rates which will be in effect when the differences between the financial statement carrying amounts and tax bases of existing assets and liabilities are expected to be reported in the Company's income tax returns. The effect on deferred taxes of a change in tax rates is recognized in income in the period of change. Where state income tax laws do not permit consolidated income tax returns, applicable state income tax returns are filed.
Stock Compensation Plans: The Company loaned the ESOP the funds necessary to fund the purchase of 8% of the Company's initial public offering of common stock. The loan to the ESOP will be repaid principally from the Company's contribution to the ESOP, and the collateral for the loan is the Company's common stock purchased by the ESOP. As the debt is repaid, shares are released from collateral based on the proportion of debt service paid in the year and allocated to participants' accounts. As shares are released from collateral, compensation expense is recorded equal to the average current market price of the shares, and the shares become outstanding for earnings-per-share calculations. Stock and cash dividends on allocated shares are recorded as a reduction of retained earnings and paid or distributed directly to participants' accounts. Stock and cash dividends on unallocated shares are recorded as a reduction of debt and accrued interest (see additional discussion in Note 15).
In July 1998, the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB) reached a consensus on the accounting treatment for deferred compensation arrangements where amounts earned are held in a Rabbi Trust and invested. The consensus position (EITF 97-14) was applied as of September 30, 1998 for all awards granted, and existing plans were required to be amended prior to September 30, 1998. Application of the consensus is reflected as a change in accounting principle under which the Company stock purchased for a Rabbi Trust obligation and the related liability for deferred compensation are recorded at acquisition cost. Prior to this change the stock was recorded at fair market value. The effect of this change in accounting increased equity by $1.1 million and reduced the related liability for deferred compensation by the same amount.
Average Balances: Average balances are obtained from the best available daily, weekly or monthly data, which BANR's management believes approximate the average balances calculated on a daily basis.
Accounting for Derivative Instruments and Hedging Activities: Statement of Financial Accounting Standards (SFAS) No. 133, as amended by SFAS Nos. 137 and 138, was issued in June 1998 and establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. BANR implemented this statement on January 1, 2001. The impact of the adoption of the provisions of this statement on the results of operations and financial condition of BANR was considered to be immaterial.
Reclassification: Certain amounts in the prior periods' financial statements have been reclassified to conform to the current period's presentation.
Note 2: RECENT DEVELOPMENTS AND ACQUISITIONS
Consolidation of Banking Operations: On October 30, 2000 the Company changed its name from First Washington Bancorp, Inc. (FWWB) to Banner Corporation (BANR or the Company) in conjunction with a consolidation of banking operations affecting its banking subsidiaries. Towne Bank (TB) merged with First Savings Bank of Washington (FSBW), FSBW converted from a Washington state-chartered savings bank to a Washington state-chartered commercial bank and changed its name, along with the names of its divisions, Whatcom State Bank (WSB) and Seaport Citizens Bank (SCB), to Banner Bank (BB). At the same time, Inland Empire Bank (IEB) changed its name to Banner Bank of Oregon (BBO). The combination was designed to strengthen the Company's commitment to community banking by more effectively sharing the resources of the existing subsidiaries, improving operating efficiency and developing a broader regional and brand identity. Final integration of all data processing into a common system is scheduled for completion by December 31, 2001. In light of the new Gramm-Leach-Bliley financial modernization legislation, the Company chose to retain a separate charter for BBO and to operate two banking subsidiaries. The recent legislation enacts Federal Home Loan Bank System reforms that impact community financial institutions. A community financial institution is defined as a "member of the Federal Home Loan Bank (FHLB) System, the deposits of which are insured by the Federal Deposit Insurance Corporation (FDIC) and that has average total assets (over the preceding three years) of less than $500 million." One provision of the reform provides community financial institutions with the ability to obtain long-term FHLB advances to fund small business, small farm and small agribusiness loans. In addition, community financial institutions will be able to offer these loans as collateral for such borrowings. This provision, which represents a change in policy from the previous requirements that these funds be securitized primarily by residential mortgage loans, will be available only to community financial institutions. As an independent subsidiary, BBO currently qualifies as a community financial institution. Merging BBO and BB would disqualify it and remove this favorable status. On the other hand, consolidation of support operations continues and the Company expects to receive long-term benefits from the proposed efficiencies. BB and BBO operate under the direction of the same Board of Directors and Executive Management.
Note 2: RECENT DEVELOPMENTS AND ACQUISITIONS (continued)
Declaration of 10% Stock Dividend: On October 19, 2000 BANR's Board of Directors declared a 10% stock dividend payable November 10, 2000 to shareholders of record on October 31, 2000. All earnings per share and share data have been adjusted to reflect the 10% stock dividend.
Mortgage Lending Subsidiary: On April 1, 2000 BB opened a new mortgage lending subsidiary, Community Financial Corporation (CFC), located in the Lake Oswego area of Portland, Oregon, with John Satterberg as President. Primary lending activities for CFC are in the area of construction and permanent financing for one- to four-family residential dwellings. CFC, an Oregon corporation, functions as a wholly owned subsidiary of Banner Bank. BB has capitalized CFC with $2 million of equity capital and provides funding support for CFC's lending operations.
Recent Accounting Standard Not Yet Adopted: In September 2000, the FASB issued Statement of Financial Accounting Standards(SFAS) No. 140 Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, which revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but carries over most of the provisions of SFAS No. 125 without reconsideration. SFAS No. 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. The provisions of this statement are not expected to have a material effect on the Company's financial position or results of operations.
Acquisition of Seaport Citizens Bank: On April 1, 1999, the Company and FSBW (now operating as BB) completed the acquisition of Seaport Citizens Bank (SCB). FSBW paid $10.1 million in cash for all the outstanding common shares of SCB, which was headquartered in Lewiston, Idaho. As a result of the merger of SCB into FSBW, SCB became a division of FSBW. The acquisition was accounted for as a purchase and resulted in the recording of $6.1 million of costs in excess of the fair value of SCB's net assets acquired (goodwill). Goodwill assets are being amortized over a 14-year period and resulted in a current charge to earnings of $108,100 per quarter, beginning in the quarter ended June 30,1999, or $433,000 per year. Founded in 1979, SCB was a commercial bank which had, before recording of purchase accounting adjustments, approximately $45 million in total assets, $41 million in deposits, $27 million in loans, and $4.1 million in shareholders' equity at March 31, 1999. SCB operated two full service branches in Lewiston, Idaho. SCB's results of operations are included in the Company's consolidated results of operations and financial statements for all periods subsequent to April 1,1999.
Acquisition of Whatcom State Bancorp, Inc.: On January 1, 1999 the Company completed the acquisition of Whatcom State Bancorp, Inc. The Company paid $12.1 million in common stock for all the outstanding common shares and stock options of Whatcom State Bancorp, Inc., which was the holding company for Whatcom State Bank (WSB), headquartered in Bellingham, Washington. As a result of the merger of Whatcom State Bancorp, Inc. into the Company, WSB became a division of FSBW ( now operating as BB ). The acquisition was accounted for as a purchase and resulted in the recording of approximately $6.0 million of costs in excess of the fair value of Whatcom State Bancorp, Inc. net assets acquired (goodwill). Goodwill assets are being amortized over a 14-year period resulting in a current charge to earnings of approximately $105,200 per quarter or $421,000 per year. Founded in 1980, WSB was a community commercial bank which had, before recording of purchase accounting adjustments, approximately $99 million in total assets, $85 million in deposits, $79 million in loans, and $5.4 million in shareholders' equity at December 31, 1998. WSB operated five branches in the Bellingham, Washington, area Bellingham, Ferndale, Lynden, Blaine and Point Roberts. WSB's results of operations are included in the Company's consolidated results of operations and financial statements for all periods subsequent to January 1,1999.
Note 3: CASH AND DUE FROM BANKS
Cash and due from banks consisted of the following (in thousands):
December 31 December 31 2000 1999 ------ ------ Cash on hand and demand deposits $52,053 $41,810 Cash equivalents: Short-term cash investments 4,073 559 Federal funds sold 11,230 2,400 ------ ------ $67,356 $44,769 ====== ======
For the purpose of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, overnight investments and short-term deposits with original maturities less than 90 days.
FRB regulations require depository institutions to maintain certain minimum reserve balances. Included in cash and demand deposits were reserves required by the FRB of $12.5 million and $9.1 million at December 31, 2000 and 1999, respectively.
Note 4: SECURITIES AVAILABLE FOR SALE
The amortized cost and estimated fair value of securities available for sale are summarized as follows (in thousands):
December 31, 2000 ------------------------------------------- Gross Gross Estimated Amortized unrealized unrealized fair cost gains losses value --------- ---------- -------- ------ U.S.Government and agency obligations $61,468 $ 181 $ (224) $ 61,425 Municipal bonds: Taxable 5,354 20 (259) 5,115 Tax exempt 25,383 583 (193) 25,773 Corporate bonds 21,350 -- (915) 20,435 Mortgage-backed securities: FHLMC certificates 3,025 40 (21) 3,044 FHLMC collateralized mortgage obligations 38,643 29 (1,284) 37,388 -------- -------- -------- -------- Total FHLMC mortgage- backed securities 41,668 69 (1,305) 40,432
GNMA certificates 16,808 76 (242) 16,642 GNMA collateralized mortgage obligations 7,220 19 (39) 7,200 -------- -------- -------- -------- Total GNMA mortgage- backed securities 24,028 95 (281) 23,842
FNMA certificates 5,311 81 (27) 5,365 FNMA collateralized mortgage obligations 67,641 482 (1,700) 66,423 -------- -------- -------- -------- Total FNMA mortgage- backed securities 72,952 563 (1,727) 71,788
Other collateralized mortgage obligations 56,987 129 (1,097) 56,019
FHLMC stock 1,035 2,479 -- 3,514 FNMA stock 303 101 -- 404 FARMERMAC stock 10 34 -- 44 Miscellaneous equities -- 7 -- 7 -------- -------- -------- -------- $310,538 $ 4,261 $(6,001) $308,798 ======== ======== ======== ========
Proceeds from sales of securities during the year ended December 31, 2000 were $21,703,000. Gross gains of $957,000 and gross losses of $894,000 were realized on those sales.
Note 4: SECURITIES AVAILABLE FOR SALE (continued)
December 31, 1999 ------------------------------------------- Gross Gross Estimated Amortized unrealized unrealized fair cost gains losses value --------- ---------- ---------- --------
U.S. Government and agency obligations $ 60,197 $ 62 $(1,391) $ 58,868 Municipal bonds: Taxable 4,947 33 (229) 4,751 Tax exempt 30,505 635 (555) 30,585 Corporate bonds 22,689 -- (1,125) 21,564 Mortgage-backed securities: FHLMC certificates 3,372 20 (68) 3,324 FHLMC collateralized mortgage obligations 56,935 48 (2,773) 54,210 -------- -------- -------- -------- Total FHLMC mortgage- backed securities 60,307 68 (2,841) 57,534
GNMA certificates 18,982 34 (710) 18,306 GNMA collateralized mortgage obligations 8,697 8 (201) 8,504 -------- -------- -------- -------- Total GNMA mortgage- backed securities 27,679 42 (911) 26,810
FNMA certificates 5,518 17 (83) 5,452 FNMA collateralized mortgage obligations 80,916 254 (2,551) 78,619 -------- -------- -------- -------- Total FNMA mortgage- backed securities 86,434 271 (2,634) 84,071
Other collateralized mortgage obligations 62,497 24 (2,126) 60,395
FHLMC stock 1,049 2,327 (20) 3,356 FNMA stock 303 72 (3) 372 FARMERMAC stock 10 27 -- 37 Miscellaneous equities -- 4 -- 4 --------- --------- -------- -------- $356,617 $ 3,565 $(11,835) $348,347 ========= ========= ======== ========
Proceeds from sales of securities during the nine months ended December 31, 1999 were $5,829,000. Gross gains of $2,000 and gross losses of $0 were realized on those sales.
At December 31, 2000 and 1999, the Company's investment portfolio did not contain any securities of an issuer (other than the U.S. Government, its agencies and U.S. Government sponsored enterprises) which had an aggregate book value in excess of 10% of the Company's stockholders' equity at that date.
The amortized cost and estimated fair value of securities available for sale at December 31, 2000, by contractual maturity, are shown below (in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
December 31, 2000 ----------------------- Amortized Estimated cost fair value --------- ----------
Due in one year or less $ 12,034 $ 12,016 Due after one year through five years 61,413 61,449 Due after five years through ten years 24,991 24,785 Due after ten years 210,752 206,579 --------- ---------- 309,190 304,829 Equity securities 1,348 3,969 --------- ---------- $ 310,538 $ 308,798 ========= ==========
Note 5: SECURITIES HELD TO MATURITY
The amortized cost and estimated fair value of securities held to maturity are summarized as follows (in thousands):
December 31, 2000 ------------------------------------------- Gross Gross Estimated Amortized unrealized unrealized fair cost gains losses value --------- ---------- ---------- --------- Mortgage-backed securities: FHLMC/FNMA certificates $ 1,992 $ 44 $ -- $ 2,036 Municipal bonds: Tax exempt 2,438 34 (27) 2,445 Taxable 997 8 -- 1,005 Corporate bonds 7,000 493 -- 7,493 Asset-backed securities 5,290 -- -- 5,290 --------- ---------- ---------- -------- $ 17,717 $ 579 $ (27) $18,269 ========= ========== ========== ========
December 31, 1999 ------------------------------------------- Gross Gross Estimated Amortized unrealized unrealized fair cost gains losses value --------- ---------- ---------- --------- Mortgage-backed securities: FHLMC certificates $ 1,196 $ -- $ (25) $ 1,171 Municipal bonds: Tax exempt 1,613 11 (2) 1,622 Taxable 1,096 11 (10) 1,097 Corporate bonds 4,000 -- (10) 3,990 Asset-backed securities 5,865 -- (29) 5,836 --------- ---------- ---------- -------- $ 13,770 $ 22 $ (76) $13,716 ========= ========== ========== =======
The amortized cost and estimated fair value of securities held to maturity at December 31, 2000, by contractual maturity, are shown below (in thousands):
December 31, 2000 ----------------------- Amortized Estimated cost fair value --------- ----------
Due in one year or less $ 227 $ 226 Due after one year through five years 7,557 7,562 Due after five years through ten years 102 113 Due after ten years 9,831 10,368 --------- ---------- $ 17,717 $ 18,269 ========= ==========
Note 6: ADDITIONAL INFORMATION REGARDING INTEREST INCOME FROM SECURITIES AND CASH EQUIVALENTS.
The following table sets forth the composition of income from securities and cash equivalents for the periods indicated (in thousands):
Year Ended Nine Months Year December 31 Ended Dec- Ended ------------- ember 31 March 31 2000 1999 1999 1999 ---- ---- ---- ---- (Unaudited)
Taxable interest income $7,853 $6,239 $4,409 $6,069 Tax-exempt interest income 1,859 2,036 1,517 1,967 Other stock dividend income 106 85 83 71 Federal Home Loan Bank stock dividend income 1,728 1,721 1,286 1,545 Total income from securities and cash equivalents ------ ------- ------- ------- $11,546 $10,081 $ 7,295 $ 9,652 ====== ======= ======= =======
Note 7: LOANS RECEIVABLE
Loans receivable at December 31, 2000 and 1999 are summarized as follows (in thousands) (includes loans held for sale):
December 31 December 31 2000 1999 ---------- ----------- Loans: Secured by real estate One- to four-family real estate loans $ 408,613 $ 419,132 Commercial 366,071 330,258 Multifamily 84,282 66,287 Construction and land 271,273 194,625 Commercial 228,676 194,817 Agribusiness 67,809 55,052 Consumer, including credit cards 60,359 61,534 ---------- ---------- Total loans 1,487,083 1,321,705 Less allowance for loan losses 15,314 13,541 ---------- ---------- Total net loans at end of period $1,471,769 $1,308,164 ========== ==========
Loans serviced for others totaled $284,551,000 and $273,926,000 at December 31, 2000 and 1999, respectively. Custodial accounts maintained in connection with this servicing totaled $2,469,000 and $2,531,000 at December 31, 2000 and 1999, respectively.
The Banks' outstanding loan commitments totaled $262,418,000 and $166,921,000 at December 31, 2000 and 1999, respectively. In addition, the Banks had outstanding commitments to sell loans of $7,940,000 at December 31, 2000.
The amount of impaired loans and the related allocated reserve for loan losses were as follows (in thousands):
December 31 December 31 2000 1999 ----------------- ----------------- Loan Allocated Loan Allocated amount reserves amount reserves ------ --------- ------ --------- Impaired loans: Non-accrual $3,865 $ 133 $2,563 $ 117 Accrual -- -- 400 -- ------ ------- ------ ------- $3,865 $ 133 $2,963 $ 117 ====== ======= ====== =======
The average balance of impaired loans and the related interest income recognized were as follows:
Nine Year Ended Months Ended Year Ended December 31 December 31 March 31 -------------- ------------ ---------- 2000 1999 1999 1999 ---- ---- ---- ---- (Unaudited)
Average balance of impaired loans $3,899 $3,455 $3,447 $ 622 Interest income recognized -- -- -- --
The Banks originate both adjustable- and fixed-rate loans. At December 31, 2000, the maturity and repricing composition of those loans, less undisbursed amounts and deferred fees, were as follows (in thousands):
Fixed-rate (term to maturity): Due in one year or less $ 49,844 Due after one year through three years 80,466 Due after three years through five years 95,240 Due after five years through ten years 142,888 Due after ten years 342,179 --------- $ 710,617 ========= Adjustable-rate (term to rate adjustment): Due in one year or less $ 601,110 Due after one year through three years 65,676 Due after three years through five years 70,911 Due after five years through ten years 32,173 Due after ten years 6,596 --------- $ 776,466 =========
The adjustable-rate loans have interest rate adjustment limitations and are generally indexed to the Banks' internal cost of funds, the FHLB's National Cost of Funds Index and 11th District Cost of Funds, One Year Constant Maturity Treasury Index, or Prime Rate (The Wall Street Journal). Future market factors may affect the correlation of the interest rate adjustment with the rates the Banks pay on the short-term deposits that primarily have been utilized to fund these loans.
Note 8: ALLOWANCE FOR LOAN LOSSES AND NON-PERFORMING LOANS An analysis of the changes in the allowances for loan losses is as follows (in thousands): Nine Years Ended Months Ended Year Ended December 31 December 31 March 31 -------------- ------------ ---------- 2000 1999 1999 1999 ---- ---- ---- ---- (Unaudited)
Balance, beginning of period $13,541 $10,718 $12,261 $ 7,857 Allowances added through business combinations -- 1,554 477 2,693 Sale of credit card portfolio (174) -- -- -- Provision 2,867 2,516 1,885 2,841 Recoveries of loans previously charged off: One-to four-family real estate loans 2 2 -- -- Commercial/multifamily real estate 2 -- 1 60 Commercial business 40 458 450 143 Agricultural business 1 6 6 1 Consumer finance 3 16 8 15 Credit cards 63 5 3 6 ------- ------- ------- ------- 111 487 468 225 Loans charged off: One-to four-family real estate loans (90) (532) (532) (25) Commercial/multifamily real estate (31) (29) -- (35) Construction/land (12) (33) (24) (69) Commercial business (403) (856) (841) (911) Agricultural business (16) (19) (19) (5) Consumer finance (85) (85) (8) (126) Credit cards (394) (180) (126) (184) ------- ------- ------- ------- (1,031) (1,734) (1,550) (1,355) Net charge-offs (920) (1,247) (1,082) (1,130) ------- ------- ------- ------- Balance, end of period $15,314 $13,541 $13,541 $12,261 ======= ======= ======= =======
The following is a schedule of the Company's allocation of the allowance for loan losses (in thousands):
December 31 December 31 March 31 2000 1999 1999 ---- ---- ---- Specific or allocated loss allowances: Secured by real estate: One- to four-family real estate loans $ 2,256 $ 2,334 $ 2,757 Commercial/multifamily 5,287 4,273 3,567 Construction/land 2,738 1,638 1,597 Commercial/agricultural business 3,710 2,830 2,522 Consumer, credit card and other 879 1,023 841 ------- ------- ------- Total allocated 14,870 12,098 11,284
Unallocated 444 1,443 977 ------- ------- ------- Total allowance for loan losses $15,314 $13,541 $12,261 ======= ======= ======= Ratio of allowance for loan losses to non-performing loans 1.83 2.67 1.60 Allowance for loan losses as a percent of net loans(loans receivable excluding allowance for losses) 1.03% 1.02% 1.10%
The following is a schedule of the Company's non-performing loans (in thousands):
December 31 December 31 March 31 2000 1999 1999 ---- ---- ---- Nonaccrual Loans: One-to four-family real estate loans $ 873 $ 623 $3,564 Commercial/multifamily real estate 1,741 129 351 Construction/land 2,937 2,514 767 Commercial business 1,734 1,203 1,392 Agricultural business 529 -- 47 Consumer, credit card and other 18 9 17 ------ ------ ------ 7,832 4,478 6,138 Loans more than 90 days delinquent, still on accrual: One-to four-family real estate loans 20 155 20 Commercial/multifamily real estate -- -- 384 Construction/land -- -- -- Commercial business 1 25 -- Agricultural business 467 334 1,052 Consumer, credit card and other 54 79 82 ------ ------ ------ 542 593 1,538 ------ ------ ------ Total non-performing loans $8,374 $5,071 $7,676 ====== ====== ====== Non-performing loans to net loans 0.56% 0.38% 0.69%
Loans are normally placed on nonaccrual status when interest is 90 days past due; however, certain loans with third party guarantees from government- sponsored enterprises or readily accessible cash collateral may remain on an accrual basis beyond 90 days past due.
Note 9: PROPERTY AND EQUIPMENT
Land, buildings and equipment owned by the Company and its subsidiaries at December 31, 2000 and 1999 are summarized as follows (in thousands):
December 31 December 31 2000 1999 ---- ---- Buildings and leasehold improvements $17,789 $16,524 Furniture and equipment 15,320 13,709 ------- ------- 33,109 30,233 Less accumulated depreciation 17,694 15,927 ------- ------- 15,415 14,306 Land 2,331 2,331 ------- ------- $17,746 $16,637 ======= =======
Note 10: DEPOSITS
Deposits consist of the following at December 31, 2000 and 1999 (in thousands):
December 31 December 31 2000 1999 ---- ---- Demand, NOW and Money Market accounts, including non-interest-bearing deposits at December 31, 2000 and 1999 of $140,779 and $114,252, respectively, 0% to 6% $ 349,636 $ 342,592
Regular savings, 2% to 6% 44,427 53,305
Certificate accounts: 0.00% to 2% 257 -- 2.01% to 4% 2,015 2,339 4.01% to 6% 217,799 576,597 6.01% to 8% 425,456 102,625 8.01% to 10% 153,075 688 10.01% to 12% 50 6 ---------- ---------- 798,652 682,255 ---------- ---------- $1,192,715 $1,078,152 ========== ==========
Deposits at December 31, 2000 and 1999 include public funds of $82,205,000 and $72,943,000, respectively. CD's and securities with a carrying value of $14,092,000 and $13,711,000 were pledged as collateral on these deposits at December 31, 2000 and 1999, respectively, which exceeds the minimum collateral requirements established by state regulations.
Scheduled maturities of certificate accounts at December 31, 2000 and 1999 are as follows (in thousands):
December 31 December 31 2000 1999 ---- ----
Due in one year or less $614,873 $477,112 Due after one year through two years 121,329 99,422 Due after two years through three years 36,202 69,956 Due after three years through four years 8,050 14,533 Due after four years through five years 9,581 12,349 Due after five years 8,617 8,883 -------- -------- $798,652 $682,255 ======== ========
Included in deposits are deposit accounts in excess of $100,000 of $314,889,000 and $248,129,000 at December 31, 2000 and 1999, respectively. Interest on deposit accounts in excess of $100,000 totaled $13,103,000 for the year ended December 31, 2000, $8,786,000 for the nine months ended December 31, 1999 and $7,568,000 for the year ended March 31, 1999.
Deposit interest expense by type for the years ended December 31, 2000 and 1999, the nine months ended December 31, 1999 and the year ended March 31, 1999 was as follows (in thousands):
Nine Months Year Year Ended Ended Dec- Ended December 31 ember 31 March 31 --------------- ----------- --------- 2000 1999 1999 1999 ---- ---- ---- ----- (Unaudited)
Certificates $44,892 $32,553 $25,105 $27,407 Demand, NOW and Money Market accounts 6,782 6,497 5,034 5,256 Regular savings 1,446 1,751 1,336 1,356 ------- ------- ------- ------- $53,120 $40,801 $31,475 $34,019 ======= ======= ======= =======
Note 11: ADVANCES FROM FEDERAL HOME LOAN BANK OF SEATTLE
The Banks have entered into borrowing arrangements with the FHLB to borrow funds under a short-term cash management advance program and long-term loan agreements. All borrowings are secured by stock of, and cash held by, the FHLB. Additionally, mortgage loans receivable and securities issued, insured, or guaranteed by the U.S. Government or agencies thereof are pledged as security for the loans. At December 31, 2000, FHLB advances were scheduled to mature as follows (in thousands):
Adjustable-rate Fixed-rate Total advances advances advances ------------- -------------- -------------- Rate* Amount Rate* Amount Rate* Amount ----- ------ ----- ------ --------------
Due in one year or less 6.61% $8,000 6.20% $192,280 6.22% $200,280 Due after one year through two years -- -- 6.26 153,470 6.26 153,470 Due after two years through three years -- -- 6.21 82,920 6.21 82,920 Due after three years through four years -- -- 6.58 10,000 6.58 10,000 Due after four years through five years -- -- 6.98 29,500 6.98 29,500 Due after five years -- -- 6.06 30,928 6.06 30,928 ------ -------- -------- 6.61% $8,000 6.27% $499,098 6.27% $507,098 ====== ======== ======== * Weighted average interest rate
The maximum and average outstanding balances and average interest rates on advances from the FHLB were as follows for the years ended December 31, 2000 and 1999, the nine months ended December 31, 1999 and the year ended March 31, 1999 (in thousands): Nine Months Year Years Ended Ended Dec- Ended December 31 ember 31 March 31 ------------------ --------- -------- 2000 1999 1999 1999 ---- ---- ---- ---- (Unaudited) Maximum outstanding at any month end $545,198 $466,524 $466,524 $410,304 Average outstanding 509,665 420,647 425,293 363,279 Weighted average interest rates: Annual 6.19% 5.77% 5.78% 5.90% End of period 6.27 5.86 5.86 5.74 Interest expense during the period $ 31,568 $ 24,284 $ 18,505 $ 21,430
Note 12: OTHER BORROWINGS
Retail Repurchase Agreements and Other Short-Term Borrowings are included in other borrowings. At December 31, 2000, retail repurchase agreements carry interest rates ranging from 3.54% to 7.20%, payable at maturity, and are secured by the pledge of certain FNMA, GNMA and FHLMC mortgage-backed securities with a carrying value of $12,229,000 as of December 31, 2000.
A summary of retail repurchase agreements and other short-term borrowings at December 31, 2000 and 1999 by the period remaining to maturity is as follows (in thousands):
December 31, 2000 December 31, 1999 ----------------- ----------------- Weighted Weighted average average rate Balance rate Balance ---- ------- ---- ------- Retail repurchase agreements: Due in one year or less 6.24% $ 6,449 5.29% $ 7,356 Due after one year through two years 6.82 251 -- -- Due after two years through three years 7.19 973 -- -- Due after three years through four years 6.45 2,046 7.18 1,101 Due after five years 5.75 1,429 -- -- ------- ------- 6.31% 11,148 5.53% 8,457 ------- ------- Other short-term borrowings: Due in one year or less -- -- 4.67% 6,500 ------- ------- Total retail repurchase agreements and other short- term borrowings $11,148 $14,957 ======= =======
The maximum and average outstanding balances and average interest rates on retail repurchase agreements and other short-term borrowings were as follows for the years ended December 31, 2000 and 1999, nine months ended December 31, 1999 and the year ended March 31, 1999, respectively (in thousands):
Nine Months Year Years Ended Ended Dec- Ended December 31 ember 31 March 31 ------------------ --------- -------- 2000 1999 1999 1999 ---- ---- ---- ---- (Unaudited)
Maximum outstanding at any month end $ 12,806 $ 14,957 $ 9,917 $ 17,300 Average outstanding 10,217 7,928 8,698 10,404 Weighted average interest rates: Annual 6.67% 5.60% 5.49% 5.61% End of period 6.31 5.53 5.53 5.59 Interest expense during the period $ 681 $ 444 $ 360 $ 584
Wholesale Repurchase Agreements: The table below outlines the wholesale repurchase agreements as of December 31, 2000 and 1999. The agreements to repurchase are secured by mortgage-backed securities with a carrying value of $66,405,000 at December 31, 2000. The broker holds the security while BB continues to receive the principal and interest payments from the security. Upon maturity of the agreement the pledged securities will be returned to BB.
A summary of wholesale repurchase agreements at December 31, 2000 and 1999 by the period remaining to maturity is as follows (in thousands):
December 31, 2000 December 31, 1999 --------------------- ---------------------- Weighted Weighted average average rate Balance rate Balance ---- ------- ---- --------
Due in one year or less 6.64% $ 63,390 6.02% $ 66,698
The maximum and average outstanding balances and average interest rates on wholesale repurchase agreements were as follows for the year ended December 31, 2000 and 1999, nine months ended December 31, 1999 and the year ended March 31, 1999 (in thousands):
Nine Months Year Years Ended Ended Dec- Ended December 31 ember 31 March 31 ------------------ --------- -------- 2000 1999 1999 1999 ---- ---- ---- ---- (Unaudited)
Maximum outstanding at any month end $ 65,810 $ 74,444 $ 71,099 $ 85,430 Average outstanding 65,043 70,364 68,982 72,276 Weighted average interest rates: Annual 6.50% 5.44% 5.50% 5.78% End of period 6.64 6.02 6.02 5.65 Interest expense during the period $ 4,225 $ 3,831 $ 4,409 $ 4,180
Note 13: INCOME TAXES
Provisions of the Small Business Job Protection Act of 1996 (the "Job Protection Act") significantly altered the Company's tax bad debt deduction method and the circumstances that would require a tax bad debt reserve recapture. Prior to enactment of the Job Protection Act, savings institutions were permitted to compute their tax bad debt deduction through use of either the reserve method or the percentage of taxable income method. The Job Protection Act repealed both of these methods for large savings institutions and allows bad debt deductions based only on actual current losses. While repealing the reserve method for computing tax bad debt deductions, the Job Protection Act allows thrifts to retain their existing base year bad debt reserves but requires that reserves in excess of the balance at December 31, 1987, be recaptured into taxable income. The tax liability for this recapture is included in the accompanying Consolidated Financial Statements.
The base year reserve is recaptured into taxable income only in limited situations, such as in the event of certain excess distributions, complete liquidation or disqualification as a bank. None of the limited circumstances requiring recapture are contemplated by the Company. The amount of the Company's tax bad debt reserves subject to recapture in these circumstances approximates $5,318,000 at December 31, 2000. Due to the remote nature of events that may trigger the recapture provisions, no tax liability has been established in the accompanying Consolidated Financial Statements.
In addition, as a result of certain acquisitions, the company is required to recapture certain tax bad debt reserves of the acquiree. The Company has elected to recapture these reserves into income over a four-year period using the deferral method. The recapture does not result in a charge to earnings as the Company provided for this liability on the acquisition date.
The provision for income taxes for the year ended December 31, 2000, the nine-month period ended December 31, 1999 and the fiscal year ended March 31, 1999 differs from that computed at the statutory corporate tax rate as follows (in thousands): Nine Year Ended Months Ended Year Ended December 31 December 31 March 31 2000 1999 1999 ---- ---- ----
Taxes at statutory rate $ 10,005 $ 7,329 $ 8,651 Increase (decrease) in taxes: Tax-exempt interest (571) (463) (597) Amortization of costs in excess of net assets acquired 1,096 817 822 Investment in life insurance (115) (48) (73) Difference in fair market value versus basis of released ESOP shares (10) 32 34 State income taxes net of federal tax benefit 281 229 279 Other (448) 174 161 -------- -------- -------- $ 10,238 $ 8,070 $ 9,277 ======== ======== ========
The provision for income tax expense for the year ended December 31, 2000, the nine months ended December 31, 1999 and the fiscal year ended March 31, 1999 is composed of the following (in thousands):
Nine Year Ended Months Ended Year Ended December 31 December 31 March 31 2000 1999 1999 ---- ---- ----
Current $ 9,560 $ 8,346 $ 9,696 Deferred 678 (276) (296) Change in valuation allowance -- -- (123) -------- -------- -------- $ 10,238 $ 8,070 $ 9,277 ======== ======== ========
Income taxes are provided for the temporary differences between the tax basis and financial statement carrying amounts of assets and liabilities. Components of the Company's net deferred tax assets (liabilities) at December 31, 2000 and 1999 consisted of the following (in thousands):
December 31 December 31 2000 1999 ---- ----
Deferred tax assets: Loan loss reserves per books $ 5,461 $ 4,835 Deferred compensation and vacation 1,869 1,740 Other 121 119 -------- -------- 7,451 6,694 -------- -------- Deferred tax liabilities: Change in method of accounting for amortization of premium and discount on investments 59 84 Tax basis bad debt reserves to be recovered 439 659 FHLB stock dividends 3,256 2,418 Depreciation 984 762 Deferred loan fees and servicing rights 827 336 Other 152 23 -------- -------- 5,717 4,282 -------- -------- 1,734 2,412
Valuation allowance (13) (13) -------- -------- Income benefit related to unrealized gain/loss on securities available for sale 1,721 2,399 616 2,939 -------- -------- Deferred tax asset (liability), net $ 2,337 $ 5,338 ======== ========
Note 14: EMPLOYEE BENEFIT PLANS
The Banks have their own profit sharing plans for all eligible employees. The plans are funded annually at the discretion of the individual Banks' Boards of Directors. There were no contributions charged to operations for the year ended December 31, 2000 and the nine months ended December 31, 1999. For the year ended March 31, 1999, $5,500 was expensed.
BB has entered into a salary continuation agreement with certain of its senior management. This program was funded by purchasing single premium life insurance contracts. The program provides for aggregate continued annual compensation for all participants totaling $240,000 for life with a 15-year guarantee. Participants vest ratably each plan year until retirement, termination, death or disability. BB is recording the salary obligation over the estimated remaining service lives of the participants. Expenses related to this program for the year and nine months ended December 31, 2000 and 1999 were $241,300 and $162,300, respectively, and $139,000 for the year ended March 31, 1999. The plan's projected benefit obligation is $2,117,000, of which $1,039,500 was vested at December 31, 2000. The assumed discount rate was 7.00% for the year and nine months ended December 31, 2000 and 1999, respectively, and 8.00% for the year ended March 31, 1999. At December 31, 2000, an obligation of $1,039,500 and cash value of life insurance of $2,441,800 were recorded. At December 31, 1999, an obligation of $805,800 and cash value of life insurance of $2,331,800 were recorded. Increases in cash surrender value and related net earnings from the life insurance contracts partially offset the expenses of this program resulting in a net cost of $131,200 and $82,700 for the year and nine months ended December 31, 2000 and 1999, respectively, and $31,000 for the year ended March 31, 1999.
BBO also has a non-qualified, non-contributory retirement compensation plan for certain bank employees whose benefits are based upon a percentage of defined participant compensation. Expenses related to this plan included in the year and nine months ended December 31, 2000 and 1999, and fiscal year ended March 31, 1999 operations were $84,000, $79,000 and $54,000, respectively.
The Company and its subsidiaries also offer non-qualified deferred compensation plans to members of their Boards of Directors and certain bank employees. The plans permit each participant to defer a portion of director fees, non-qualified retirement contributions, salary or bonuses until the future. Compensation is charged to expense in the period earned. In order to fund the plans' future obligations the Company has purchased life insurance polices, contributed to money market investments and purchased common stock of the Company which are held in a "Rabbi Trust." The obligation relating to the purchased shares was reclassified from liabilities to stockholders' equity. As the Company is the owner of the investments and beneficiary of life insurance contracts, and in order to reflect the Company's policy to pay benefits equal to accumulations, the assets and liabilities under the plans are reflected in the consolidated balance sheets of the Company. Common stock of the Company held for such plans is reported as a contra-equity account and was recorded at original cost of $2,552,000 at December 31, 2000 and $2,333,000 at December 31, 1999. The money market investments and cash surrender value of the life insurance policies are included in other assets.
Note 15: EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST
The Company established for eligible employees an ESOP and related trust that became effective upon the former mutual holding company's conversion to a stock-based holding company. Eligible employees of BB as of January 1, 1995 and eligible employees of the Company employed after such date who have been credited with at least 1,000 hours during a 12-month period will become participants.
The ESOP borrowed $8,728,500 from the Company in order to purchase the common stock. The loan will be repaid principally from the Company's contributions to the ESOP over a period not to exceed 25 years, and the collateral for the loan will be the unreleased, restricted common stock purchased by the ESOP. Contributions to the ESOP will be discretionary; however, the Company intends to make annual contributions to the ESOP in an aggregate amount at least equal to the principal and interest requirements of the debt. The interest rate for the loan is 8.75%.
Participants generally become 100% vested in their ESOP account after seven years of credited service or if their service was terminated due to death, early retirement, permanent disability or a change in control. Prior to the completion of one year of credited service, a participant who terminates employment for reasons other than death, retirement, disability, or change in control of the Company will not receive any benefit. Forfeitures will be reallocated among remaining participating employees in the same proportion as contributions. Benefits are payable upon death, retirement, early retirement, disability or separation from service. The contributions to the ESOP are not fixed, so benefits payable under the ESOP cannot be estimated. ESOP compensation expense for the year ended December 31, 2000, nine months ended December 31, 1999 and the year ended March 31, 1999 was $1,510,000, $974,000 and $924,000, respectively.
As of December 31, 2000, the Company has 633,278 unearned, restricted shares remaining to be released to the ESOP. The fair value of unearned, restricted shares held by the ESOP trust was $9,657,000 at December 31, 2000.
Note 16: STOCK BASED COMPENSATION PLANS AND STOCK OPTIONS
The Company operates the following stock based compensation plans as approved by the shareholders: the 1996 Management Recognition and Development Plan (MRP), the 1996 Stock Option Plan and the 1998 Stock Option Plan (together, SOPs).
Under the MRP, the Company is authorized to grant up to 528,075 shares of restricted stock to directors, officers and employees of BANR (formerly FWWB). The initial grant of 489,181 shares with a total cost of $6.0 million vests over a five-year period starting from the July 26, 1996, MRP approval date. The consolidated statements of income for the year ended December 31, 2000, nine months ended December 31, 1999 and the year ended March 31, 1999 reflect an accrual of $1,137,000, $1,045,000 and $1,307,000, respectively, in compensation expense for the MRP including $84,500, $71,000 and $113,900, respectively, of expense for dividends on the allocated, restricted stock. A summary of the changes in the granted, but not vested, MRP shares for the year ended December 31, 2000, nine months ended December 31, 1999 and the year ended March 31, 1999 follows:
Nine Year Ended Months Ended Year Ended December 31 December 31 March 31 2000* 1999* 1999* ----- ----- -----
Shares granted-not vested, beginning of period 183,527 287,753 387,451 Shares granted 4,476 3,025 -- Shares vested (90,330) (106,779) (97,084) Shares forfeited (11,349) (472) (2,614) -------- -------- -------
Shares granted not vested, end of period 86,324 183,527 287,753 ======== ======== =======
* Adjusted for stock dividend: see Note 2
Under the 1996 and 1998 SOPs, the Company has reserved 1,804,186 shares (adjusted for 10% stock dividend) for issuance pursuant to the exercise of stock options which may be granted to directors and employees. The exercise price of the stock options is set at 100% of the fair market value of the stock price at date of grant. Such options will vest ratably over a five-year period and any unexercised options will expire ten years after vesting or 90 days after employment or service ends.
SFAS No. 123, Accounting for Stock-based Compensation, requires expanded disclosures of stock-based compensation arrangements with employees and encourages (but does not require) application of the fair value recognition provisions in the statement. Companies may continue following those rules to recognize and measure compensation as outlined in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, but they are now required to disclose the pro forma amounts of net income and earnings per share that would have been reported had the company elected to follow the fair value recognition provisions of SFAS No. 123. The Company continues to measure its employee stock-based compensation arrangements under the provisions of APB Opinion No. 25. Accordingly, no compensation cost has been recognized for its stock option plans. If the compensation cost for the Company's compensation plans had been determined consistent with SFAS No. 123, the Company's net income available to diluted common stock and diluted earnings per share would have been reduced to the pro forma amounts indicated below:
Nine Year Ended Months Ended Year Ended December 31 December 31 March 31 2000 1999 1999 ----------- ----------- ---------- (dollars in thousands, except per share amounts) Net income attributable to common stock: Basic: As reported $ 18,348 $ 12,869 $ 15,440 Pro forma 17,168 11,891 14,113 Diluted: As reported $ 18,348 $ 12,869 $ 15,440 Pro forma 17,168 11,891 14,113 Net income per common share: * Basic: As reported $ 1.62 $ 1.12 $ 1.33 Pro forma 1.52 1.04 1.22 Diluted: As reported $ 1.60 $ 1.09 $ 1.27 Pro forma 1.49 1.00 1.16
The compensation expense included in the pro forma net income attributable to diluted common stock and diluted earnings per share is not likely to be representative of the effect on reported net income for future years because options vest over several years and additional awards generally are made each year.
* Adjusted for stock dividends: see Note 2
The fair value of options granted under the Company's stock option plans is estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted average assumptions used for grants:
Nine Year Ended Months Ended Year Ended December 31 December 31 March 31 2000 1999 1999 ---------- ------------ -----------
Annual dividend yield 4.25% 2.75% 1.20 to 1.75% Expected volatility 28.2 to 41.1% 30.8 to 38.5% 23.9 to 35.7% Risk free interest rate 6.18 to 6.95% 5.51 to 6.57% 4.96 to 6.79% Expected lives 5 to 9 yrs 8.5 to 12.5 yrs 8.5 to 12.5 yrs
Note 17: REGULATORY CAPITAL REQUIREMENTS
The Company is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended (BHCA), and the regulations of the Federal Reserve. Each of the Banks as state-chartered federally insured institutions is subject to the capital requirements established by the FDIC.
The capital adequacy requirements are quantitative measures established by regulation that require the Company, BB, and BBO to maintain minimum amounts and ratios of capital. The Federal Reserve requires the Company to maintain capital adequacy that generally parallels the FDIC requirements. The FDIC requires the Banks to maintain minimum ratios of total capital and Tier 1 capital to risk-weighted assets as well as Tier 1 leverage capital to average assets.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) created a statutory framework that increased the importance of meeting applicable capital requirements. For BB and BBO, FDICIA established five capital categories: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. An institution's category depends upon where its capital levels are in relation to relevant capital measures, which include a risk- based capital measure, a leverage ratio capital measure, and certain other factors. The federal banking agencies (including the FDIC) have adopted regulations that implement this statutory framework. Under these regulations, an institution is treated as well-capitalized if its ratio of total capital to risk-weighted assets is 10.00% or more, its ratio of core capital to risk-weighted assets is 6.00% or more, its ratio of core capital to adjusted total assets is 5.00% or more and it is not subject to any federal supervisory order or directive to meet a specific capital level. In order to be adequately capitalized, an institution must have a total risk-based capital ratio of not less than 8.00%, a Tier 1 risk-based capital ratio of not less than 4.00%, and leverage ratio of not less than 4.00%. Any institution which is neither well-capitalized nor adequately capitalized will be considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls and restrictions which become more extensive as an institution becomes more severely undercapitalized. Failure by the Banks, individually, to comply with applicable capital requirements would, if unremedied, result in restrictions on their activities and lead to enforcement actions against BB and BBO by the FDIC, including, but not limited to, the issuance of a capital directive to ensure the maintenance of required capital levels. FDICIA requires the federal banking regulators to take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. Additionally, FDIC approval of any regulatory application filed for its review may be dependent on compliance with capital requirements.
Federal law requires that the federal banking agencies' risk-based capital guidelines take into account various factors including interest rate risk, concentration of credit risk, risks associated with nontraditional activities, and the actual performance and expected risk of loss of multifamily mortgages. In 1994, the federal banking agencies jointly revised their capital standards to specify that concentration of credit and nontraditional activities are among the factors that the agencies will consider in evaluating capital adequacy. In that year, the FDIC amended its risk-based capital standards with respect to the risk weighting of loans made to finance the purchase or construction of multifamily residences. Management believes that the effect of including such an interest rate risk component in the calculation of risk-adjusted capital will not cause the Company and the Banks to cease to be well-capitalized. In June 1996, the FDIC and certain other federal banking agencies issued a joint policy statement providing guidance on prudent interest rate risk management principles. The agencies stated that they would determine banks' interest rate risk on a case-by-case basis, and would not adopt a standardized measure or establish an explicit minimum capital charge for interest rate risk.
Note 17: REGULATORY CAPITAL REQUIREMENTS (continued)
The Company may not declare or pay cash dividends on, or repurchase, any of its shares of common stock if the effect thereof would cause equity to be reduced below applicable regulatory capital maintenance requirements or if such declaration and payment would otherwise violate regulatory requirements.
Minimum to be categorized as "well- capitalized" Minimum under prompt for capital corrective Actual adequacy action purposes provisions --------------- --------------- -------------- Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- (dollars in thousands) December 31, 2000: The Company - consolidated Total capital to risk-weighted assets $ 176,623 12.29% $ 114,963 8.00% N/A N/A Tier 1 capital to risk-weighted assets 160,130 11.14 57,481 4.00 N/A N/A Tier 1 leverage capital to average assets 160,130 8.25 77,599 4.00 N/A N/A
BB Total capital to risk-weighted assets 150,882 12.20 98,975 8.00 $ 123,718 10.00% Tier 1 capital to risk-weighted assets 136,273 11.01 49,487 4.00 74,231 6.00 Tier 1 leverage capital to average assets 136,273 7.92 68,787 4.00 85,983 5.00
BBO Total capital to risk-weighted assets 20,702 10.79 15,354 8.00 19,193 10.00 Tier 1 capital to risk-weighted assets 18,833 9.81 7,677 4.00 11,516 6.00 Tier 1 leverage capital to average assets 18,833 8.54 8,818 4.00 11,023 5.00
Note 17: REGULATORY CAPITAL REQUIREMENTS (continued)
Minimum to be categorized as "well- capitalized" Minimum under prompt for capital corrective Actual adequacy action purposes provisions --------------- --------------- -------------- Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- (dollars in thousands) December 31, 1999: The Company - consolidated Total capital to risk-weighted assets $ 160,152 12.79% $ 100,163 8.00% N/A N/A Tier 1 capital to risk-weighted assets 146,612 11.71 50,082 4.00 N/A N/A Tier 1 leverage capital to average assets 146,612 8.39 69,886 4.00 N/A N/A
FSBW (now BB) Total capital to risk-weighted assets 107,294 13.27 64,704 8.00 $ 80,879 10.00% Tier 1 capital to risk-weighted assets 98,465 12.17 32,352 4.00 48,528 6.00 Tier 1 leverage capital to average assets 98,465 7.74 50,907 4.00 63,633 5.00
IEB (now BBO) Total capital to risk-weighted assets 22,237 13.16 13,516 8.00 16,895 10.00 Tier 1 capital to risk-weighted assets 20,485 12.13 6,758 4.00 10,137 6.00 Tier 1 leverage capital to average assets 20,485 9.96 8,228 4.00 10,285 5.00
TB (now merged into BB) Total capital to risk-weighted assets 27,034 9.86 21,941 8.00 27,426 10.00 Tier 1 capital to risk-weighted assets 24,075 8.78 10,970 4.00 16,456 6.00 Tier 1 leverage capital to average assets 24,075 8.91 10,812 4.00 13,515 5.00
Company management believes that as of December 31, 2000, the Company, BB and BBO individually met all capital adequacy requirements to which they were subject. There have been no conditions or events since the end of the period that management believes have changed any Bank's individual category. The most recent exam notifications from the FDIC or state banking regulators as of December 31, 2000, individually categorized the Banks as "well-capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well-capitalized," a bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table above.
Note 18: CONTINGENCIES
In the normal course of business, the Company and/or its subsidiaries have various legal claims and other contingent matters outstanding. The Company believes that any liability ultimately arising from these actions would not have a material adverse effect on the results of operations or consolidated financial position at December 31, 2000.
Note 19: INTEREST RATE RISK
The financial condition and operation of the Company are influenced significantly by general economic conditions, including the absolute level of interest rates as well as changes in interest rates and the slope of the yield curve. The Company's profitability is dependent to a large extent on its net interest income, which is the difference between the interest received from its interest-earning assets and the interest expense incurred on its interest-bearing liabilities.
The activities of the Company, like all financial institutions, inherently involve the assumption of interest rate risk. Interest rate risk is the risk that changes in market interest rates will have an adverse impact on the institution's earnings and underlying economic value. Interest rate risk is determined by the maturity and repricing characteristics of an institution's assets, liabilities, and off-balance-sheet contracts. Interest rate risk is measured by the variability of financial performance and economic value resulting from changes in interest rates. Interest rate risk is the primary market risk impacting the Company's financial performance.
The greatest source of interest rate risk to the Company results from the mismatch of maturities or repricing intervals for rate-sensitive assets, liabilities and off-balance-sheet contracts. This mismatch or gap is generally characterized by a substantially shorter maturity structure for interest-bearing liabilities than interest-earning assets. Additional interest rate risk results from mismatched repricing indices and formulae (basis risk and yield curve risk), product caps and floors, and early repayment or withdrawal provisions (option risk), which may be contractual or market driven, that are generally more favorable to customers than to the Company.
The Company's primary monitoring tool for assessing interest rate risk is "asset/liability simulation modeling," which is designed to capture the dynamics of balance sheet, interest rate and spread movements, and to quantify variations in net interest income and net market value resulting from those movements under different rate environments. Another monitoring tool used by the Company to assess interest rate risk is "gap analysis." The matching of repricing characteristics of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest sensitive" and by monitoring the Company's interest sensitivity "gap." Management is aware of the sources of interest rate risk and in its opinion actively monitors and manages it to the extent possible, and considers that the Company's current level of interest rate risk is reasonable.
Note 20: GOODWILL
Costs in excess of net assets acquired (goodwill) consisted of the following (in thousands):
December 31 December 31 2000 1999 ----------- -----------
Acquisitions net of accumulated amortization of $9,414,000 and $6,244,000, respectively $ 34,617 $ 37,733 ========== ==========
Note 21: FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, Disclosures About Fair Value of Financial Instruments.. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessary to interpret market data in the development of the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The estimated fair value of financial instruments is as follows (in thousands):
Fair value estimates, methods, and assumptions are set forth below for the Company's financial and off-balance-sheet instruments:
Cash: The carrying amount of these items is a reasonable estimate of their fair value.
Securities: The estimated fair values of investment securities and mortgaged-backed securities available for sale and held to maturity are based on quoted market prices or dealer quotes.
Loans Receivable: Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as multifamily real estate, residential mortgage, nonresidential, commercial/agricultural, consumer and other. Each loan category is further segmented into fixed- and adjustable-rate interest terms and by performing and non-performing categories.
The fair value of performing residential mortgages held for sale is estimated based upon secondary market sources by type of loan and terms such as fixed or variable interest rates. For performing loans held in portfolio, the fair value is based on discounted cash flows using as a discount rate the current rate offered on similar products.
Fair value for significant non-performing loans is based on recent appraisals or estimated cash flows discounted using rates commensurate with risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discount rates are judgmentally determined using available market information and specific borrower information.
FHLB Stock: The fair value is based upon the redemption value of the stock which equates to its carrying value.
Deposit Liabilities: The fair value of deposits with no stated maturity, such as savings, checking and NOW accounts, is equal to the amount payable on demand. The market value of certificates of deposit is based upon the discounted value of contractual cash flows. The discount rate is determined using the rates currently offered on comparable instruments.
FHLB Advances and Other Borrowings: The fair value of FHLB advances and other borrowings is estimated based on discounting the estimated future cash flows using rates currently available to the Company for debt with similar remaining maturities.
Commitments: Commitments to sell loans with a notional balance of $7,940,000 and $2,647,000 at December 31, 2000 and 1999, respectively, have a carrying value of zero, representing the cost of such commitments. Commitments to originate loans, $262,418,000 and $166,921,000 at December 31, 2000 and 1999, respectively, also have a carrying value of zero. There were no commitments to purchase or sell securities at December 31, 2000. The fair value of such commitments is also estimated to be zero based upon current market rates for similar loans and any fees received to enter into similar agreements.
Limitations: The fair value estimates presented herein are based on pertinent information available to management as of December 31, 2000. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.
Fair value estimates are based on existing on- and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business. The fair value has not been estimated for assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not financial instruments include the deferred tax assets/liabilities; land, buildings and equipment; costs in excess of net assets acquired; and real estate held for sale.
Note 22: BANNER CORPORATION (BANR) (PARENT COMPANY ONLY)
Summary financial information is as follows (in thousands):
BANR Balance Sheets December 31, 2000 and 1999 December 31 December 31 2000 1999 ---- ----
ASSETS Cash $ 2,544 $ 2,446 Investment in subsidiaries 188,771 175,586 Deferred tax asset 405 405 Other assets 3,034 2,556 ----------- ----------- $ 194,754 $ 180,993 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities $ 959 $ 1,820 Stockholders' equity 193,795 179,173 ----------- ----------- $ 194,754 $ 180,993 =========== ===========
BANR Statements of Income For the year ended December 31, 2000 and 1999, the nine months ended December 31, 1999 and the year ended March 31, 1999
Nine Years Ended Months Ended Year Ended December 31 December 31 March 31 --------------- ----------- ---------- 2000 1999 1999 1999 ---- ---- ----- ---- (Unaudited)
INTEREST INCOME: Certificates and time deposits $ 48 $ 93 $ 81 $ 56 Investments -- 40 -- 401 ESOP loan -- -- -- 325 ------- ------- --------- --------- 48 133 81 782
OTHER INCOME: Dividend income from subsidiaries 8,351 8,032 6,041 6,914 Equity in undistributed income of subsidiaries 11,288 9,915 7,638 9,096
OTHER EXPENSE 2,027 1,751 1,331 1,653 -------- ------- --------- --------- 17,660 16,329 12,429 15,139 PROVISION FOR (BENEFIT FROM) INCOME TAXES (688) (569) (440) (301) -------- ------- --------- --------- NET INCOME $ 18,348 $16,898 $ 12,869 $ 15,440 ======== ======= ========= =========
BANR Statements of Cash Flows For the year ended December 31, 2000, the nine months ended December 31, 1999 and the year ended March 31, 1999
Nine Year Ended Months Ended Year Ended December 31 December 31 March 31 2000 1999 1999 ----------- ------------ ------------
OPERATING ACTIVITIES: Net income $ 18,348 $ 12,869 $ 15,440 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed earnings of subsidiaries (11,288) (7,638) (9,096) Net amortization of investment discounts -- -- (394) Amortization of MRP liability 302 339 339 (Increase) decrease in deferred taxes -- (67) -- (Increase) decrease in other assets (447) 52 44 Increase (decrease) in other liabilities (1,167) 147 (123) ----------- ------------ ------------ Net cash provided (used) by operating activities (5,748) (5,702) (6,210) ----------- ------------ ------------ INVESTING ACTIVITIES: Purchase of securities available for sale -- -- (136,831) Principal repayments and maturities of securities available for sale -- -- 149,200 Funds transferred to deferred compensation trust (60) (66) (80) Acquisitions of subsidiaries (7) -- (7,824) Dividends received from subsidiaries 4,000 12,000 -- Payments received on loan to ESOP for release of shares 1,510 1,305 633 Additional investment in subsidiaries (1,100) (4,494) (5,730) ----------- ------------ ------------ Net cash provided (used) by investing activities 4,343 8,745 (632) ----------- ------------ ------------
FINANCING ACTIVITIES: Repurchases of stock (5,233) (8,568) (15,266) Repurchase of forfeited MRP shares (120) -- (32) Net proceeds from exercise of stock options 914 166 250 Cash dividends paid (5,554) (3,709) (3,597) ----------- ------------ ------------ Net cash provided (used) by financing activities (9,993) (12,111) (18,645) ----------- ------------ ------------
NET INCREASE (DECREASE) IN CASH 98 2,336 (13,067) CASH, BEGINNING OF PERIOD 2,446 110 13,177 ----------- ------------ ------------ CASH, END OF PERIOD $ 2,544 $ 2,446 $ 110 =========== ============ ============
BANR Statements of Cash Flows (continued) For the year ended December 31, 2000, the nine months ended December 31, 1999 and the year ended March 31, 1999
Nine Year Ended Months Ended Year Ended December 31 December 31 March 31 2000 1999 1999 -------- ------- --------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Interest paid $ -- $ -- $ -- Taxes paid $ -- $ -- $ -- Non-cash transactions: Net change in accrued dividends payable $ 336 $ 52 $ 477 Increase of investment in subsidiary for shares released to ESOP participants as compensation $ -- $ -- $ 291 Net change in unrealized gain (loss) in deferred compensation trust and related liability, including subsidiaries $ 173 $ 56 $ 5,516 Recognize tax benefit of vested MRP shares, including subsidiaries $ 2 $ 188 $ 276 Non-cash portion of 10% stock dividend $ 14,731 $ -- $ 24,360
The following summarizes the non-cash activities relating to acquisitions: Fair value of assets acquired $ (48) $ - $(270,436) Fair value of liabilities assumed $ -- $ -- $ 230,012 Fair value of stock issued to acquisitions' shareholders $ 48 $ -- $ 32,527 -------- -------- --------- Cash paid out in acquisition $ -- $ -- $ (7,897) Less cash acquired $ -- $ -- $ 21,774 -------- -------- --------- Net cash acquired (used) $ -- $ -- $ 13,877 ======== ======== =========
Note 23: STOCK REPURCHASE
On November 19, 1996, the Company completed its stock repurchase program initiated in April 1996 which authorized the repurchase of 660,085 shares of its outstanding common stock. On November 20, 1996, the Company's Board of Directors approved continuance of the stock repurchase program authorizing the purchase of up to 10% of total shares outstanding over the next 12 months. Similar authorizations were approved by the Board of Directors in November 1997, October 1998, November 1999 and November 2000 (for 5% of outstanding shares). As of December 31, 2000, the Company has repurchased a total of 3,287,923 shares at an average price of $17.02 per share. The Company has reserved 528,074 shares for its MRP of which 479,149 shares were awarded as of December 31, 2000 (see Note 16 to financial statements). The remaining 48,925 unallocated shares are held as authorized but unissued shares reserved for the MRP. Management reissued 941,246 shares in connection with the acquisition of TB, and 557,758 shares in connection with the acquisition of WSB.
Note 24: CALCULATION OF WEIGHTED AVERAGE SHARES OUTSTANDING USED TO CALCULATE EARNINGS PER SHARE (in thousands) Nine Years Ended Months Ended Year Ended December 31 December 31 March 31 ------------------ ------------ ---------- 2000 1999* 1999* 1999* ------ ------ ------------ ---------- (Unaudited)
Total shares issued 13,202 13,202 13,202 13,202 Less stock repurchased/ retired including shares allocated to MRP (1,151) (819) (909) (749) Less unallocated shares held by the ESOP (746) (820) (820) (849) ------ ------ ------ ------ Basic weighted average shares outstanding 11,305 11,563 11,473 11,604 Plus MRP and stock option incremental shares considered outstanding for diluted EPS calculations 182 411 378 543 ------ ------ ------ ------ Diluted weighted average shares outstanding 11,487 11,974 11,851 12,147 ====== ====== ====== ======
* Weighted average shares, restated for stock dividend: see Note 2
Note 27: BUSINESS SEGMENTS
The Company is managed by legal entity or Bank, not by lines of business. Each Bank is managed by its executive management team that is responsible for its own lending, deposit operations, information systems and administration. Marketing, sales training assistance, credit card administration and human resources administration is provided from a central source at BB, and costs are allocated to the individual Banks using appropriate methods based on usage. In addition, corporate overhead and centralized administrative costs are allocated to each Bank. The accounting policies followed by each Bank are the same as those described in Note 1 to the Consolidated Financial Statements.
FSBW (now BB) was a community oriented savings bank which traditionally offered a wide variety of deposit products to its retail customers while concentrating its lending activities on real estate loans. FSBW has increased its involvement in non-mortgage commercial and agricultural lending while continuing to be actively engaged in residential mortgage lending for the purchase of homes and home construction. FSBW's primary business is originating loans for portfolio in its primary market area, which consists of the states of Washington and Idaho. FSBW has two wholly owned subsidiaries, Northwest Financial Corporation, which provides trustee services for FSBW, is engaged in real estate sales and receives commissions from the sale of annuities. Community Financial Corporation (CFC) is a new mortgage lending subsidiary located in the Lake Oswego area of Portland, OR. CFC's primary lending activities are in the area of construction and permanent financing for one- to four-family residential dwellings. FSBW includes WSB and SCB effective January 1, 1999 and April 1, 1999, respectively.
IEB (now known as BBO) is a community oriented commercial bank chartered in the State of Oregon. IEB's lending activities consist of granting agribusiness, commercial and consumer loans to customers throughout the northeastern Oregon region. IEB has two wholly owned subsidiaries: Pioneer American Property Company, which owns a building that is leased to IEB, and Inland Securities Corporation, which previously made a market for IEB's stock but is currently inactive.
TB (merged into BB) was a community oriented commercial bank chartered in the State of Washington. TB's lending activities consist of granting commercial and consumer loans to customers throughout the Seattle, Washington, metropolitan area.
The performance of each Bank is reviewed by the Company's executive management team and the Board of Directors on a monthly basis.
Financial highlights by legal entity were as follows:
Banner Corporation Index of Exhibits Exhibit - -------
3{a} Certificate of Incorporation of Registrant [incorporated by reference to Registration Statement on Form S-1, as amended (File No. 33-93386)].
3{b} Bylaws of Registrant [incorporated by reference to exhibits filed with the Quarterly Report on Form 10-Q for the quarter ended December 31, 1997 (File No. 0-26584)].
10{a} Employment Agreement with Gary L. Sirmon [incorporated by reference to exhibits filed with the Annual Report on Form 10-k dated March 31, 1996 (File No. 0-26584)].
10{b} Executive Salary Continuation Agreement with Gary L. Sirmon [incorporated by reference to exhibits filed with the Annual Report on Form 10-k dated March 31, 1996 (File No. 0-26584)].
10{c} Employment Agreement with D. Allan Roth [incorporated by reference to exhibits filed with the Annual Report on Form 10-k dated March 31, 1996 (File No. 0-26584)].
10{d} Executive Salary Continuation Agreement with D. Allan Roth [incorporated by reference to exhibits filed with the Annual Report on Form 10-k dated March 31, 1996 (File No. 0-26584)].
10{e} Employment Agreement with Michael K. Larsen [incorporated by reference to exhibits filed with the Annual Report on Form 10-k dated March 31, 1996 (File No. 0-26584)].
10{f} Executive Salary Continuation Agreement with Michael K. Larsen [incorporated by reference to exhibits filed with the Annual Report on Form 10-k dated March 31, 1996 (File No. 0-26584)].
10{g} 1996 Stock Option Plan (incorporated by reference to Exhibit A to the Proxy Statement for the Annual Meeting of Stockholders held on July 26, 1996).
10{h} 1996 Management Recognition and Development Plan (incorporated by reference to Exhibit B to the Proxy Statement for the Annual Meeting of Stockholders held on July 26, 1996).
10{i} Employment and Non-competition Agreement with Jesse G. Foster [incorporated by reference to exhibits filed with the Annual Report on Form 10-K dated March 31, 1997 (file No. 0-26584)].
10{j} Supplemental Retirement Plan as Amended with Jesse G. Foster [incorporated by reference to exhibits filed with the Annual Report on Form 10-K dated March 31, 1997 (file No. 0-26584)].
10{k} Towne Bank of Woodinville 1992 Stock Option Plan [incorporated by reference to exhibits filed with the Registration Statement on Form S-8 dated April 2, 1999 (file No. 333-49193)].
10{l} 1998 Stock Option Plan (incorporated by reference to Exhibit A to the Proxy Statement for the Annual Meeting of Stockholders held on July 24, 1998).
21 Subsidiaries of the Registrant.
23 Independent Auditors Consent.
Exhibit 21 Subsidiaries of the Registrant
Parent - ------
Banner Corporation
Percentage of Jurisdiction of Subsidiaries ownership State of Incorporation - ------------ --------- ----------------------
Banner Bank (1) 100% Washington
Banner Bank of Oregon (1) 100% Oregon
Community Financial Corporation (2) 100% Oregon
Northwest Financial Corporation (2) 100% Washington
Pioneer American Property Company (3) 100% Oregon
Inland securities Corporation (3) 100% Oregon
- ------------------ (1) Wholly-owned by Banner Corporation (2) Wholly-owned by Banner Bank (3) Wholly-owned by Banner Bank of Oregon
Exhibit 23 Independent Auditors Consent
INDEPENDENT AUDITORS' CONSENT =============================================================================
We consent to the incorporation by reference in Registration Statement Nos. 333-10819, 333-49193, and 333-71625 of Banner Corporation on Form S-8 of our report dated February 26, 2001, appearing in the Annual Report on Form 10-K of Banner Corporation for the year ended December 31, 2000.
/s/Deloitte & Touche LLP DELOITTE & TOUCHE LLP
Seattle, Washington March 28, 2001