SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended September 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-23333
TIMBERLAND BANCORP, INC.
- ------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Washington 91-1863696
- --------------------------------------------- ----------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) I.D. Number)
624 Simpson Avenue, Hoquiam, Washington 98550
- --------------------------------------------- ----------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (360) 533-4747
---------------
Securities registered pursuant to Section 12(b) of the Act: None
---------------
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
--------------------------------------
(Title of Class)
Check whether the Registrant (1) filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past
12 months (or for such shorter period that the Registrant was required to file
such reports), and (2) has been subject to such filing requirements for the
past 90 days. YES X NO
----- -----
Check if there is no disclosure of delinquent filers pursuant to Item 405
of Regulation S-K contained herein, and no disclosure will be contained, to
the best of the Registrant's knowledge, in any definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendments to this Form 10-K. X
-----
The Registrant had no shares of capital stock outstanding on December 29,
1997.
DOCUMENTS INCORPORATED BY REFERENCE
None
<PAGE>
<PAGE>
PART I
Item 1. Business
- -----------------
General
Timberland Bancorp, Inc. ("Company"), a Washington corporation, was
organized on September 8, 1997 for the purpose of becoming the holding company
for Timberland Savings Bank, SSB ("Savings Bank") upon the Savings Bank's
conversion from a Washington-chartered mutual to a Washington-chartered stock
savings bank ("Conversion"). As of the filing date of this Annual Report on
Form 10-K, the Conversion has not yet been consummated and the Company has no
shares of capital stock issued and outstanding. Accordingly, the information
set forth in this report, including consolidated financial statements and
related data, relates primarily to the Savings Bank and its subsidiary.
The Savings Bank was established in 1915 as "Southwest Washington Savings
and Loan Association." In 1935, the Savings Bank converted from a
state-chartered mutual savings and loan association to a federally chartered
mutual savings and loan association, and in 1972, changed its name to
"Timberland Federal Savings and Loan Association." In 1990, the Savings Bank
converted to a federally chartered mutual savings bank under the name
"Timberland Savings Bank, FSB." In 1991, the Savings Bank converted to a
Washington-chartered mutual savings bank and adopted its current name. The
Savings Bank's deposits are insured by the FDIC up to applicable legal limits
under the Savings Association Insurance Fund ("SAIF"). The Savings Bank has
been a member of the Federal Home Loan Bank ("FHLB") System since 1937. The
Savings Bank is regulated by the Washington Department of Financial
Institutions, Division of Banks ("Division") and the FDIC.
The Savings Bank is a community oriented savings bank which has
traditionally offered a variety of savings products to its retail customers
while concentrating its lending activities on real estate mortgage loans.
Lending activities have been focused primarily on the origination of loans
secured by one- to- four family residential dwellings, including an emphasis
on construction and land development loans, as well as the origination of
multi-family and commercial real estate loans. The Savings Bank actively
originates adjustable rate residential mortgage loans that do not qualify for
sale in the secondary market under Federal Home Loan Mortgage Corporation
("FHLMC") guidelines.
Market Area
The Savings Bank considers Grays Harbor, Thurston, Pierce and King
Counties and, to a lesser extent, adjoining Kitsap County as its primary
market area. The Savings Bank conducts operations from its main office in
Hoquiam (Grays Harbor County), three branch offices in Grays Harbor County
(Aberdeen, Montesano and Ocean Shores), a branch office in King County
(Auburn, opened in 1994), two branch offices in Pierce County (Edgewood,
opened in 1980, and Puyallup, opened in 1996), a branch office in Thurston
County (Lacey, opened in 1997) and a loan production office in Kitsap County
(Port Orchard, opened in 1995). See "Item 2. Properties."
Hoquiam, population approximately 9,000, is located in Grays Harbor
County which is situated along Washington State's central Pacific coast.
Hoquiam is located approximately 110 miles southwest of Seattle and 145 miles
northwest of Portland, Oregon.
The Savings Bank considers its primary market area to include three
submarkets -- primarily rural Grays Harbor County with its historical
dependence on the timber and fishing industries; Ocean Shores with its
dependence on tourism and vacation home residents; and Pierce, King, Thurston
and Kitsap Counties with their dependence on state government in Olympia, the
state capital, and the aerospace and computer industries in the Seattle-Tacoma
metropolitan area. Each of these markets present operating risks to the
Savings Bank. The Savings Bank's recent expansion into Thurston, King and
Kitsap Counties and recent opening of a second branch office in Pierce County
represents the Savings Bank's strategy to diversify its primary market area to
become less reliant on the economy of Grays Harbor County.
1
<PAGE>
<PAGE>
Selected Financial Data
The following tables set forth certain information concerning the
combined financial position and results of operations of the Company at the
dates and for the periods indicated.
At September 30,
-----------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
(In thousands)
SELECTED FINANCIAL CONDITION
DATA:
Total assets. . . . . . . . $139,233 $151,044 $177,761 $194,357 $211,553
Loans receivable and loans
held-for-sale, net . . . . 106,259 121,558 156,523 176,495 187,027
Investment securities held-
to-maturity. . . . . . . . 1,695 8,597 3,504 -- --
Investment securities
available-for-sale . . . . 1,172 1,330 1,449 1,572 1,586
Mortgage-backed securities
held-to-maturity . . . . . 2,268 7,402 6,352 4,951 3,990
Cash and due from financial
institutions . . . . . . . 24,122 7,360 4,860 5,055 11,446
Deposit accounts. . . . . . 125,404 128,669 143,084 156,549 173,003
FHLB advances . . . . . . . -- 5,753 14,958 14,354 12,241
Total capital . . . . . . . 13,005 15,638 18,653 21,329 24,645
At September 30,
-----------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
(In thousands)
SELECTED OPERATING DATA:
Interest and dividend income $11,220 $11,307 $14,454 $16,500 $17,948
Interest expense. . . . . . 4,938 4,715 6,360 7,629 8,386
------- ------- ------- ------- -------
Net interest income . . . . 6,282 6,592 8,094 8,871 9,562
Provision for loan losses . 175 -- -- 70 597
Net interest income after ------- ------- ------- ------- -------
provision for loan losses. 6,107 6,592 8,094 8,801 8,965
Gains from sale of loans. . 144 145 44 34 339
Noninterest income. . . . . 726 673 554 654 896
Noninterest expense . . . . 3,117 3,613 4,089 5,392 5,041
Income before income taxes. 3,860 3,797 4,603 4,097 5,159
Provision for income taxes. 1,241 1,163 1,603 1,419 1,830
------- ------- ------- ------- -------
Net income. . . . . . . . . $ 2,619 $ 2,634 $ 3,000 $ 2,678 $ 3,329
======= ======= ======= ======= =======
2
<PAGE>
<PAGE>
At September 30,
-----------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
(Dollars in thousands)
KEY FINANCIAL RATIOS:
Performance Ratios:
Return on average assets(1) 1.99% 1.86% 1.82% 1.46% 1.62%
Return on average equity(2) 22.11 18.27 17.44 13.21 14.39
Interest rate spread(3). . 4.47 4.32 4.56 4.34 4.18
Net interest margin(4) . . 4.97 4.78 5.08 4.97 4.84
Average interest-earning
assets to average
interest-bearing
liabilities . . . . . . . 113.09 113.41 113.05 114.76 115.60
Noninterest expense as a
percent of average total
assets. . . . . . . . . . 2.37 2.55 2.49 2.93 2.46
Efficiency ratio(5). . . . 44.68 48.76 47.04 56.82 49.42
Asset Quality Ratios:
Nonaccrual and 90 days or
more past due loans as a
percent of loans receivable,
net . . . . . . . . . . . 0.76 0.45 0.66 0.86 4.10(6)
Nonperforming assets as a
percent of total assets . 0.93 0.63 0.70 0.85 3.83(6)
Allowance for losses as a
percent of loans receivable,
net . . . . . . . . . . . 1.07 0.92 0.71 0.64 0.92
Allowance for losses as a
percent of nonperforming
loans . . . . . . . . . . 140.84 204.95 107.91 74.54 22.39
Net charge-offs to average
outstanding loans . . . . 0.01 0.02 -- -- 0.01
Capital Ratios:
Total equity-to-assets ratio 9.34 10.35 10.49 10.97 11.65
Average equity to average
assets(7) . . . . . . . . 9.01 10.16 10.45 11.02 11.28
- ------------------
(1) Net income divided by average total assets.
(2) Net income divided by average equity.
(3) Difference between weighted average yield on interest-earning assets and
weighted average rate on interest-bearing liabilities.
(4) Net interest income (before provision for loan losses) as a percentage of
average interest-earning assets.
(5) Other expenses (excluding federal income tax expense) divided by the sum
of net interest income and noninterest income.
(6) Includes the four loans discussed under "-- Lending Activities --
Nonperforming Assets and Delinquencies" with aggregate outstanding
balances of $5.8 million at September 30, 1997.
(7) Average total equity divided by average total assets.
3
<PAGE>
<PAGE>
Lending Activities
General. Historically, the principal lending activity of the Savings
Bank has consisted of 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. In recent years, the Savings Bank has
increased its origination of loans secured by multi-family properties,
construction and land development loans, land loans and commercial real estate
loans. The Savings Bank's net loans receivable totalled approximately $187.0
million at September 30, 1997, representing approximately 88.4% of
consolidated total assets and at that date construction and land development
loans, land loans and loans secured by commercial and multi-family properties
were $93.6 million, or 45.6%, of total loans.
The Savings Bank's internal loan policy limits the maximum amount of
loans to one borrower to 25% of its capital. At September 30, 1997, the
maximum amount which the Savings Bank could have lent to any one borrower and
the borrower's related entities was approximately $6.2 million under its
policy. At September 30, 1997, the Savings Bank had no loans with an
aggregate outstanding balance in excess of this amount. At that date, the
Savings Bank had 20 borrowers or related borrowers with total loans
outstanding in excess of $1.0 million. The largest amount outstanding to any
one borrower and the borrower's related entities was approximately $2.9
million to developers for a condominium project, which was not performing
according to its terms at September 30, 1997. See "-- Lending Activities --
Nonperforming Assets and Delinquencies."
4
<PAGE>
<PAGE>
Loan Portfolio Analysis. The following table sets forth the composition
of the Savings Bank's loan portfolio by type of loan as of the dates
indicated.
At September 30,
------------------------------------------------------
1993 1994 1995
---------------- --------------- -----------------
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
(Dollars in thousands)
Mortgage Loans:
One- to- four
family(1)(2). . . $ 73,989 62.87% $ 73,754 52.94% $ 93,582 53.03%
Multi-family . . . 2,374 2.02 4,806 3.45 10,965 6.21
Commercial . . . . 11,242 9.55 11,784 8.46 15,592 8.83
Construction and
land development. 23,202 19.72 40,113 28.79 42,752 24.23
Land(2). . . . . . 2,277 1.94 4,118 2.96 6,118 3.47
Total mortgage ------- ------ ------- ------ ------- ------
loans. . . . . . 113,034 96.10 134,575 96.60 169,009 95.77
Consumer Loans:
Home equity and
second mortgage . 2,596 2.21 2,853 2.05 5,201 2.95
Other. . . . . . . 1,627 1.38 1,623 1.16 2,019 1.15
------- ------ ------- ------ ------- ------
4,223 3.59 4,476 3.21 7,220 4.10
Commercial business
loans. . . . . . . 366 0.31 268 0.19 232 0.13
------- ------ ------- ------ ------- ------
Total loans . . 117,673 100.00% 139,319 100.00% 176,461 100.00%
Less: ------- ====== ------- ====== ------- ======
Undisbursed portion of
loans in process. (9,370) (15,316) (17,262)
Unearned income. . (906) (1,299) (1,554)
Allowance for loan
losses. . . . . . (1,138) (1,120) (1,119)
Market value adjustment
of loans held-
for-sale. . . . . -- (26) (3)
-------- -------- --------
Total loans receivable,
net. . . . . . . $106,259 $121,558 $156,523
======== ======== ========
At September 30,
----------------------------------
1996 1997
---------------- ---------------
Amount Percent Amount Percent
------ ------- ------ -------
(Dollars in thousands)
Mortgage Loans:
One- to- four
family(1)(2). . . $ 95,978 48.51% $100,127 48.76%
Multi-family . . . 12,569 6.35 12,178 5.93
Commercial . . . . 26,529 13.41 29,410 14.32
Construction and
land development. 47,140 23.83 45,031 21.93
Land(2). . . . . . 6,115 3.09 6,937 3.38
Total mortgage ------- ------ ------- ------
loans. . . . . . 188,331 95.19 193,683 94.32
Consumer Loans:
Home equity and
second mortgage . 6,576 3.32 8,142 3.97
Other. . . . . . . 2,476 1.25 2,824 1.37
------- ------ ------- ------
9,052 4.57 10,966 5.34
Commercial business
loans. . . . . . . 476 0.24 964 .34
------- ------ ------- ------
Total loans . . 197,859 100.00% 205,343 100.00%
------- ====== ------- ======
Less:
Undisbursed portion of loans
in process. . . . (18,434) (14,820)
Unearned income. . (1,708) (1,761)
Allowance for loan
losses. . . . . . (1,133) (1,716)
Market value adjustment
of loans held-
for-sale. . . . . (89) (19)
-------- --------
Total loans receivable,
net. . . . . . . $176,495 $187,027
======== ========
- ----------------
(1) Includes loans held-for-sale.
(2) Includes real estate contracts totalling $1.7 million at September 30,
1997. See " -- Lending Activities -- Real Estate Contracts."
5
<PAGE>
<PAGE>
Residential One- to- Four Family Lending. At September 30, 1997, $100.1
million, or 48.8%, of the Savings Bank's loan portfolio consisted of loans
secured by one- to- four family residences.
The Savings Bank originates both fixed-rate loans and adjustable-rate
loans. Generally, 15- and 30-year fixed-rate loans are originated to meet the
requirements for sale in the secondary market to the FHLMC, however, from time
to time, a portion of these fixed-rate loans originated by the Savings Bank
may be retained in the Savings Bank's loan portfolio to meet the Savings
Bank's asset/liability management objectives. The Savings Bank has recently
begun to utilize an automated underwriting program, which preliminarily
qualifies a loan as conforming to FHLMC underwriting standards when the loan
is originated. At September 30, 1997, $13.0 million, or 12.9%, of the Savings
Bank's one- to- four family loan portfolio consisted of fixed rate one- to-
four family mortgage loans.
The Savings Bank also offers adjustable rate mortgage ("ARM") loans at
rates and terms competitive with market conditions. All of the Savings Bank's
ARM loans are retained in its loan portfolio and not with a view toward sale
in the secondary market.
The Savings Bank offers 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 2% and an overall limitation of 6%. These ARM products
have utilized the weekly average yield on one year U.S. Treasury securities
adjusted to a constant maturity of one year plus a margin of 2.875% to 3.500%.
ARM loans held in the Savings Bank's portfolio do not permit negative
amortization of principal and carry no prepayment restrictions. 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. The relative amount of fixed-rate mortgage loans and
ARM loans that can be originated at any time is largely determined by the
demand for each in a competitive environment. At September 30, 1997, $87.2
million, or 87.1%, of the Savings Bank's one- to- four family loan portfolio
consisted of ARM loans.
The material portion of the Savings Bank's ARM loans are "non-conforming"
because they do not satisfy minimum loan amount requirements, acreage limits,
or various other requirements imposed by the FHLMC. Some of these loans are
also originated to meet the needs of borrowers who cannot otherwise satisfy
the FHLMC credit requirements because of personal and financial reasons (i.e.,
divorce, bankruptcy, length of time employed, etc.), and other aspects, which
do not conform to the FHLMC's guidelines. Many of these borrowers have higher
debt to income ratios, or the loans are secured by unique properties in rural
markets for which there are no comparable sales of comparable properties to
support value according to secondary market requirements. These loans are
known as non-conforming loans and the Savings Bank may require additional
collateral or lower loan-to-value ratios prior to the origination of the loan.
The Savings Bank has historically found that its origination of these types of
ARM loans has not resulted in a higher amount of nonperforming loans.
Management of the Savings Bank attributes this low delinquency rate to its
familiarity with its customers and its knowledge of its primary market area.
In addition, the Savings Bank believes that these loans satisfy a need in its
local market area. As a result, subject to market conditions, the Savings
Bank intends to continue to originate such loans.
The retention of ARM loans in the Savings Bank's loan portfolio helps
reduce the Savings Bank's exposure to changes in interest rates. There are,
however, unquantifiable credit risks resulting from the potential of increased
interest to be paid by the customer due to increases in interest rates. It is
possible that, during periods of rising interest rates, the risk of default on
ARM loans may increase as a result of repricing and the increased costs to the
borrower. Furthermore, because the ARM loans originated by the Savings Bank
generally provide, as a marketing incentive, for initial rates of interest
below the rates which would apply were the adjustment index used for pricing
initially, these loans are subject to increased risks of default or
delinquency. The Savings Bank attempts to reduce the potential for
delinquencies and defaults on ARM loans by qualifying the borrower based on
the borrower's ability to repay the ARM loan assuming that the maximum
interest rate that could be charged at the first adjustment period remains
constant during the loan term. Another consideration is that although ARM
loans allow the Savings Bank to increase the sensitivity of its asset base due
to changes in the interest rates, the extent of this interest sensitivity
6
<PAGE>
<PAGE>
is limited by the periodic and lifetime interest rate adjustment limits.
Because of these considerations, the Savings Bank has no assurance that yields
on ARM loans will be sufficient to offset increases in the Savings Bank's cost
of funds.
While fixed-rate, single-family residential mortgage loans are normally
originated with 15 to 30 year terms, such loans typically remain outstanding
for substantially shorter periods. This is because borrowers often prepay
their loans in full upon sale of the property pledged as security or upon
refinancing the original loan. In addition, substantially all mortgage loans
in the Savings Bank's loan portfolio contain due-on-sale clauses providing
that the Savings Bank may declare the unpaid amount due and payable upon the
sale of the property securing the loan. Typically, the Savings Bank enforces
these due-on-sale clauses to the extent permitted by law and as business
judgment dictates. Thus, average loan maturity is a function of, among other
factors, the level of purchase and sale activity in the real estate market,
prevailing interest rates and the interest rates payable on outstanding loans.
The Savings Bank requires fire and extended coverage casualty insurance
(and on loans originated since 1994, if appropriate, generally requires flood
insurance) be maintained on all of its real estate secured loans.
The Savings Bank's lending policies generally limit the maximum
loan-to-value ratio on mortgage loans secured by owner-occupied properties to
95% of the lesser of the appraised value or the purchase price. However, the
Savings Bank usually obtains private mortgage insurance ("PMI") on the portion
of the principal amount that exceeds 80% of the appraised value of the
security property. The maximum loan-to-value ratio on mortgage loans secured
by non-owner-occupied properties is generally 75% (70% for loans originated
for sale in the secondary market to the FHLMC).
Construction and Land Development Lending. Prompted by unfavorable
economic conditions in its primary market area in 1980, the Savings Bank
sought to establish a market niche and as a result initiated the origination
of construction lending. In recent periods, construction lending activities
have been primarily in the Pierce County and King County markets. Competition
from other financial institutions has increased in recent periods and the
Savings Bank expects that its margins on construction loans may be reduced in
the future.
The Savings Bank currently originates three types of residential
construction loans: (i) speculative construction loans, (ii) custom
construction loans and (iii) owner/builder loans. The Savings Bank initiated
its construction lending with the origination of speculative construction
loans. As a result, the Savings Bank began to establish contacts with the
building community and increased the origination of custom construction and
land development loans in rural market areas. The Savings Bank believes that
its in-house computer system has enabled it to establish processing and
disbursement procedures to meet the needs of these borrowers. To a lesser
extent, the Savings Bank also originates construction loans for the
development of multi-family and commercial properties. Subject to market
conditions, the Savings Bank intends to continue to emphasize its residential
construction lending activities.
7
<PAGE>
<PAGE>
At September 30, 1997, the composition of the Savings Bank's construction
and land development loan portfolio was as follows:
Outstanding Percent of
Balance Total
------- -----
(In thousands)
Speculative construction. . . . . . $18,841 41.8%
Custom and owner/builder construction 12,026 26.7
Multi-family. . . . . . . . . . . . 9,477 21.1
Land development. . . . . . . . . . 4,687 10.4
Commercial real estate. . . . . . . -- --
------- ------
Total . . . . . . . . . . . . . . $45,031 100.00%
======= ======
Speculative construction loans are made to home builders and are termed
"speculative" because the home builder does not have, at the time of loan
origination, a signed contract with a home buyer who has a commitment for
permanent financing with either the Savings Bank or another lender for the
finished home. The home buyer may be identified either during or after the
construction period, with the risk that the builder will have to debt service
the speculative construction loan and finance real estate taxes and other
carrying costs of the completed home for a significant time after the
completion of construction until the home buyer is identified. The Savings
Bank lends to approximately 75 builders located in the Savings Bank's primary
market area, each of which generally have three or four speculative loans
outstanding from the Savings Bank during a 12 month period. Rather than
originating lines of credit to home builders to construct several homes at
once, the Savings Bank originates and underwrites a separate loan for each
home. Speculative construction loans are originated for a term of 12 months,
with fixed interest rates ranging from 9.5% to 10.0%, and with a loan-to-value
ratio of no more than 80% of the appraised estimated value of the completed
property. During this 12 month period, the borrower is required to make
monthly payments of accrued interest on the outstanding loan balance. At
September 30, 1997 speculative construction loans totalled $18.8 million, or
41.8%, of the total construction loan portfolio. At September 30, 1997, the
Savings Bank had 9 borrowers each with aggregate outstanding speculative loan
balances of more than $500,000, all of which were performing according to
their respective terms and the largest of which amounted to $535,000.
Unlike speculative construction loans, custom construction loans are made
to home builders who, at the time of construction, have a signed contract with
a home buyer who has a commitment for permanent financing for the finished
home with the Savings Bank or another lender. Custom construction loans are
generally originated for a term of 12 months, with fixed interest rates
ranging from 9.0% to 9.5%, and with loan-to-value ratios of 80% of the
appraised estimated value of the completed property or cost, whichever is
less. During this 12 month period, the borrower is required to make monthly
payments of accrued interest on the outstanding loan balance.
Owner/builder construction loans are originated to the home owner rather
than the home builder as a single loan that automatically converts to a
permanent loan at the completion of construction. The construction phase of a
owner/builder construction loan generally lasts six to nine months with fixed
or adjustable interest rates ranging from 9.0% to 9.5%, and with loan-to-value
ratios of 80% (or up to 95% with PMI) of the appraised estimated value of the
completed property or cost, whichever is less. During this 12 month period,
the borrower is required to make monthly payments of accrued interest on the
outstanding loan balance. At the completion of construction, the loan
converts automatically to either a fixed-rate mortgage loan, which conforms to
secondary market standards, or an ARM loan for retention in the Savings Bank's
portfolio. At September 30, 1997, custom and owner/builder construction
loans totalled $12.0 million, or 26.7%, of the total construction loan
portfolio. At September 30, 1997, the largest outstanding custom construction
loan had an outstanding balance of $330,000 and was performing according to
its terms.
The Savings Bank originates loans to local real estate developers with
whom it has established relationships for the purpose of developing
residential subdivisions (i.e., installing roads, sewers, water and other
utilities)
8
<PAGE>
<PAGE>
(generally with ten to 50 lots). At September 30, 1997, subdivision
development loans totalled $4.7 million, or 10.4% of construction and land
development loans receivable. Land development loans are secured by a lien on
the property and made for a period of two to five years with generally fixed
interest rates, and are made with loan-to-value ratios not exceeding 75%.
Monthly interest payments are required during the term of the loan. Land
development loans are structured so that the Savings Bank is repaid in full
upon the sale by the borrower of approximately 80% of the subdivision lots.
Substantially all of the Savings Bank's land development loans are secured by
property located in its primary market area. In addition, in the case of a
corporate borrower, the Savings Bank also generally obtains personal
guarantees from corporate principals and reviews of their personal financial
statements. At September 30, 1997, the Savings Bank had $______ of no
nonaccruing land development loans.
Land development loans secured by land under development involve greater
risks than one- to- four family residential mortgage loans because such loans
are advanced upon the predicted future value of the developed property. If
the estimate of such future value proves to be inaccurate, in the event of
default and foreclosure the Savings Bank may be confronted with a property the
value of which is insufficient to assure full repayment. The Savings Bank
attempts to minimize this risk by limiting the maximum loan-to-value ratio on
land loans to 75% of the estimated developed value of the secured property.
To a lesser extent, the Savings Bank also provides construction financing
for multi-family and commercial properties. At September 30, 1997, such
construction loans amounted to $9.5 million. These loans are secured by
motels, apartment buildings, condominiums, office buildings and retail rental
space located in the Savings Bank's primary market area and typically range in
amount from $300,000 to $600,000. Periodically, the Savings Bank purchases
(without recourse to the seller other than for fraud) from other lenders
participation interests in multi-family and commercial construction loans
secured by properties located in the Savings Bank's primary market area. The
Savings Bank underwrites such participation interests according to its own
standards. At September 30, 1997, the largest participation interest had an
outstanding balance of $2.6 million, which represented a 50% interest in a
construction loan secured by a multi-family property located in Bremerton,
Washington. The loan was performing according to its terms at September 30,
1997.
All construction loans must be approved by the Savings Bank's Loan
Committee. See "-- Lending Activities -- Loan Solicitation and Processing."
Prior to preliminary approval of any construction loan application, an
independent fee appraiser inspects the site and the Savings Bank reviews the
existing or proposed improvements, identifies the market for the proposed
project and analyzes the pro forma data and assumptions on the project. In
the case of a speculative or custom construction loan, the Savings Bank
reviews the experience and expertise of the builder. After preliminary
approval has been given, the application is processed, which includes
obtaining credit reports, financial statements and tax returns on the
borrowers and guarantors, an independent appraisal of the project, and any
other expert reports necessary to evaluate the proposed project. In the event
of cost overruns, the Savings Bank requires that the borrower increase the
funds available for construction by depositing its own funds into a loans in
process account.
Loan disbursements during the construction period are made to the builder
based on a line item budget, which is assessed by periodic on-site inspections
by qualified Savings Bank employees. For most builders, the Savings Bank
disburses loan funds by providing vouchers to suppliers, which when used by
the builder to purchase supplies are submitted by the supplier to the Savings
Bank for payment.
The Savings Bank regularly monitors the construction loan disbursements
using an internal computer program. Property inspections are performed by
Savings Bank personnel for properties located within the Savings Bank's
primary market area and by independent inspectors for properties outside the
primary market area. The Savings Bank believes that its internal monitoring
system helps reduce many of the risks inherent in its construction lending.
The Savings Bank originates construction loan applications through
customer referrals, contacts in the business community and real estate brokers
seeking financing for their clients.
9
<PAGE>
<PAGE>
Construction lending affords the Savings Bank the opportunity to achieve
higher interest rates and fees with shorter terms to maturity than does its
single-family permanent mortgage lending. Construction 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 Savings Bank 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 Savings
Bank may be confronted 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 depends on the
builder's ability to sell the property prior to the time that the construction
loan is due. The Savings Bank has sought to address these risks by adhering
to strict underwriting policies, disbursement procedures, and monitoring
practices. In addition, because the Savings Bank's construction lending is
primarily secured by properties in its primary market area changes in the
local and state economies and real estate markets could adversely affect the
Savings Bank's construction loan portfolio.
Real Estate Contracts. The Savings Bank purchases real estate contracts
and deeds of trust from individuals who have privately sold their homes or
property. These contracts are generally secured by one- to- four family
properties, building lots and undeveloped land and range in principal amount
from $10,000 to $200,000, but typically are in amounts between $20,000 and
$40,000. Real estate contracts purchased by the Savings Bank are generally
located within its primary market area. Prior to purchasing the real estate
contract, the Savings Bank reviews the contract and analyzes and assesses the
collateral for the loan, the down payment made by the borrower and the credit
history on the loan. As of September 30, 1997, the Savings Bank had
outstanding $1.7 million of real estate contracts.
Multi-Family Lending. At September 30, 1997, the Savings Bank had $12.2
million, or 5.9% of the Savings Bank's total loan portfolio, secured by
multi-family dwelling units (more than four units) located primarily in the
Savings Bank's primary market area. Subject to market conditions, the Savings
Bank intends to become a more active originator of multi-family loans within
its primary market area. At September 30, 1997, approximately 41% of the
Savings Bank's multi-family loans represent participation interests in loans,
secured by properties located in the Savings Bank's primary market area,
purchased from other lenders. Such participation interests are purchased
without recourse to the seller other than for fraud. The Savings Bank
underwrites such participation interests according to its own standards.
Multi-family loans are generally originated with variable rates of
interest equal to 3.25% over the one-year constant maturity U.S. Treasury Bill
Index, with principal and interest payments fully amortizing over terms of up
to 30 years. Multi-family loans generally range in principal balance from
$300,000 to $3.6 million. At September 30, 1997, the largest multi-family
loan was a purchased participation interest with an outstanding principal
balance of $1.5 million and was secured by an apartment building located in
the Savings Bank's primary market area. At September 30, 1997, this loan was
performing according to its terms.
The maximum loan-to-value ratio for multi-family loans is generally 75%.
The Savings Bank requires its multi-family loan borrowers to submit financial
statements and rent rolls on the subject property annually. The Savings Bank
also inspects the subject property annually. The Savings Bank generally
imposes a minimum debt coverage ratio of approximately 1.10 for loans secured
by multi-family properties.
Multi-family mortgage lending affords the Savings Bank 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
usually are 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 multi-
family 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. The Savings Bank
seeks
10
<PAGE>
<PAGE>
to minimize these risks by strictly scrutinizing the financial condition of
the borrower, the quality of the collateral and the management of the property
securing the loan. If the borrower is a corporation, the Savings Bank also
generally obtains personal guarantees from corporate principals based on a
review of personal financial statements.
Commercial Real Estate Lending. Commercial real estate loans totalled
$29.4 million, or 14.3% of total loans receivable at September 30, 1997, and
consisted of 125 loans. The Savings Bank originates commercial real estate
loans generally at variable interest rates and secured by properties, such as
restaurants, motels, office buildings and retail/wholesale facilities, located
in its primary market area. The principal balance of an average commercial
real estate loan generally ranges between $100,000 and $2.0 million. At
September 30, 1997, $2.9 million of commercial real estate loans were not
performing according to terms. See "-- Lending Activities -- Nonperforming
Assets and Delinquencies."
The Savings Bank requires appraisals of all properties securing
commercial real estate loans. Appraisals are performed by an independent
appraiser designated by the Savings Bank, all of which are reviewed by
management. The Savings Bank considers the quality and location of the real
estate, the credit of the borrower, the cash flow of the project and the
quality of management involved with the property. The Savings Bank generally
imposes a minimum debt coverage ratio of approximately 1.10 for originated
loans secured by income producing commercial properties. Loan-to-value ratios
on commercial real estate loans are generally limited to 75%. The Savings
Bank generally obtains loan guarantees from financially capable parties based
on a review of personal financial statements.
Commercial real estate lending affords the Savings Bank 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
usually are 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 commercial
properties often depend upon 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. The Savings Bank seeks to minimize
these risks by limiting the maximum loan-to-value ratio to 75% and strictly
scrutinizing the financial condition of the borrower, the quality of the
collateral and the management of the property securing the loan.
Land Lending. The Savings Bank occasionally originates loans for the
acquisition of land upon which the purchaser can then build or make
improvements necessary to build or to sell as improved lots. At September 30,
1997, the Savings Bank's land loan portfolio totalled $6.9 million and
consisted of 163 loans. Land loans originated by the Savings Bank are
generally fixed-rate loans and have maturities of five to ten years. Land
loans generally range in principal amount from $40,000 to $60,000. The
largest land loan had an outstanding balance of $297,000 at September 30, 1997
and was performing according to its terms.
Loans secured by undeveloped land or improved lots involve greater risks
than one- to- four family residential mortgage loans because such loans are
more difficult to evaluate. If the estimate of value proves to be inaccurate,
in the event of default and foreclosure the Savings Bank may be confronted
with a property the value of which is insufficient to assure full repayment.
The Savings Bank attempts to minimize this risk by limiting the maximum
loan-to-value ratio on land loans to 75%.
Consumer Lending. Consumer lending has traditionally been a small part
of the Savings Bank's business. Consumer loans generally have shorter terms
to maturity and higher interest rates than mortgage loans. Consumer loans
include home equity lines of credit, Title I home improvement loans, second
mortgage loans, savings account loans, automobile loans, boat loans,
motorcycle loans, recreational vehicle loans and unsecured loans. Consumer
loans are made with both fixed and variable interest rates and with varying
terms. At September 30, 1997, consumer loans amounted to $11.0 million, or
5.3% of the total loan portfolio.
At September 30, 1997, the largest component of the consumer loan
portfolio consisted of second mortgage loans and home equity lines of credit,
which totalled $8.1 million, or 4.0%, of the total loan portfolio. Home
equity
11
<PAGE>
<PAGE>
lines of credit and second mortgage loans are made for purposes such as the
improvement of residential properties, debt consolidation and education
expenses, among others. The majority of these loans are made to existing
customers and are secured by a first or second mortgage on residential
property. The Savings Bank occasionally solicits these loans. The
loan-to-value ratio is typically 80% or less, when taking into account both
the first and second mortgage loans. Second mortgage loans typically carry
fixed interest rates with a fixed payment over a term between five and 20
years. Home equity lines of credit are generally for a one year term and the
interest rate is tied to the 26 week Treasury Bill plus 4.0%.
In July 1997, the Savings Bank began issuing VISA credit cards to its
existing customers. The Savings Bank does not engage in direct mailings of
pre-approved credit cards.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans that 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 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 that can be recovered on such loans. The Savings
Bank believes that these risks are not as prevalent in the case of the Savings
Bank's consumer loan portfolio because a large percentage of the portfolio
consists of second mortgage loans and home equity lines of credit that are
underwritten in a manner such that they result in credit risk that is
substantially similar to one- to- four family residential mortgage loans.
Nevertheless, second mortgage loans and home equity lines of credit have
greater credit risk than one- to- four family residential mortgage loans
because they are secured by mortgages subordinated to the existing first
mortgage on the property, which may or may not be held by the Savings Bank.
At September 30, 1997, there were $2,000 of consumer loans delinquent in
excess of 90 days.
12
<PAGE>
<PAGE>
Loan Maturity
The following table sets forth certain information at September 30, 1997
regarding the dollar amount of loans maturing in the Savings Bank's portfolio
based on their contractual terms to maturity, but does not include scheduled
payments or potential prepayments. Demand loans, loans having no stated
schedule of repayments and no stated maturity, and overdrafts are reported as
due in one year or less.
After After 5
One Year 3 Years Years
Within Through Through Through After
One Year 3 Years 5 Years 10 Years 10 Years Total
-------- ------- ------- -------- -------- -----
(Dollars in thousands)
Mortgage loans:
One- to- four
family . . . $ 495 $ 637 $ 1,394 $ 3,883 $93,718 $100,127
Multi-family. -- -- 626 6,753 4,799 12,178
Commercial. . 16 245 595 10,418 18,136 29,410
Construction
and land
development(1) 23,171 7,979 17 1,227 12,637 45,031
Land. . . . . 411 1,962 4,115 299 150 6,937
Consumer loans:
Home equity and
second mortgage 2,062 581 1,457 1,754 2,288 8,142
Other . . . . 1,183 747 585 133 176 2,824
Commercial
business loans 81 10 588 15 -- 694
------- ------- ------ ------- -------- --------
Total. . . . 27,419 12,161 9,377 24,482 131,904 205,343
Less:
Undisbursed
portion of
loans in
process . . . (14,820)
Unearned income (1,761)
Allowance for
loan losses . (1,716)
Market value
adjustment on
loans held-
for-sale. . . (19)
Loans -------
receivable,
net. . . . $187,027
=======
- -------------------
(1) Includes construction/permanent that convert to a permanent mortgage loan
once construction is completed.
13
<PAGE>
<PAGE>
The following table sets forth the dollar amount of all loans due after
September 30, 1998, which have fixed interest rates and have floating or
adjustable interest rates.
Fixed Floating or
Rates Adjustable Rates Total
----- ---------------- -----
(In thousands)
Mortgage loans:
One- to- four family. . . $12,951 $87,176 $100,127
Multi-family . . . . . . 5,405 6,773 12,178
Commercial . . . . . . . 6,875 22,535 29,410
Construction and land
development . . . . . . 35,181 9,850 45,031
Land . . . . . . . . . . 6,918 19 6,937
Consumer loans:
Home equity and second
mortgage. . . . . . . . 6,081 2,061 8,142
Other. . . . . . . . . . 2,731 93 2,824
Commercial business loans 685 9 694
------- -------- --------
Total. . . . . . . . . $76,827 $128,516 $205,343
======= ======== ========
Scheduled contractual principal repayments of loans do not reflect the
actual life of such assets. The average life of loans is substantially less
than their contractual terms because of prepayments. In addition, due-on-sale
clauses on loans generally give the Savings Bank the right to declare loans
immediately due and payable in the event, among other things, that the
borrower sells the real property subject to the mortgage and the loan is not
repaid. The average life of mortgage loans tends to increase, however, when
current mortgage loan market rates are substantially higher than rates on
existing mortgage loans and, conversely, decrease when rates on existing
mortgage loans are substantially higher than current mortgage loan market
rates.
Loan Solicitation and Processing. Loan originations are obtained from a
variety of sources, including walk-in customers, and referrals from builders
and realtors. Upon receipt of a loan application from a prospective borrower,
a credit report and other data are obtained to verify specific information
relating to the loan applicant's employment, income and credit standing. An
appraisal of the real estate offered as collateral generally is undertaken by
an appraiser retained by the Savings Bank and certified by the State of
Washington.
Mortgage loan applications are initiated by loan officers and are
required to be approved by the Savings Bank's Loan Committee, which consists
of the Savings Bank's President, Executive Vice President and Vice President.
All loans up to and including $300,000 may be approved by any two of the
Savings Bank's President, Executive Vice President or Vice President, without
Board approval. Loans in excess of $300,000, as well as loans of any size
granted to a single borrower whose aggregate lending relationship exceeds
$300,000, must be approved by the Savings Bank's Board of Directors.
Loan Originations, Purchases and Sales. During the years ended September
30, 1996 and 1997, the Savings Bank's total gross loan originations were $76.5
million and $76.7 million, respectively. Periodically, the Savings Bank
purchases participation interests in construction and land development loans
and multi-family loans, secured by properties located in the Savings Bank's
primary market area, from other lenders. Such purchases are underwritten to
the Savings Bank's underwriting guidelines and are without recourse to the
seller other than for fraud. See "-- Lending Activities -- Construction and
Land Development Lending" and "-- Lending Activities -- Multi-Family Lending."
Consistent with its asset/liability management strategy, the Savings
Bank's policy has been to retain in its portfolio all of the ARM loans and
generally originates fixed rate loans with a view toward sale in the secondary
market to FHLMC; however, from time to time, a portion of fixed-rate loans may
be retained in the Savings Bank's portfolio to meet its asset-liability
objectives. Loans sold in the secondary market are generally sold on a
servicing retained basis. At September 30, 1997, the Savings Bank's loan
servicing portfolio totalled $54.3 million.
14
<PAGE>
<PAGE>
The following table shows total loans originated, purchased, sold and
repaid during the periods indicated.
Year Ended September 30,
---------------------------------
1995 1996 1997
---- ---- ----
(Dollars in thousands)
Loans originated:
Mortgage loans:
One- to- four family . . . . . . $26,883 $24,512 $27,149
Multi-family. . . . . . . . . . . 518 3,946 1,229
Commercial. . . . . . . . . . . . 2,798 10,100 3,635
Construction and land development 33,240 29,662 35,218
Land. . . . . . . . . . . . . . . 2,876 2,590 2,644
Consumer . . . . . . . . . . . . . 6,091 5,358 6,446
Commercial business loans. . . . . 89 348 363
------- ------- -------
Total loans originated. . . . . . 72,495 76,516 76,684
Loans purchased:
Mortgage loans:
One- to- four family. . . . . . . 704 367 163
Multi-family. . . . . . . . . . . 3,318 1,163
Commercial. . . . . . . . . . . . 1,091 -- 546
Construction. . . . . . . . . . . 3,050 4,300
Land. . . . . . . . . . . . . . . 802 83 347
------- ------- -------
Total loans purchased. . . . . . 8,965 5,913 1,056
Total loans originated ------- ------- -------
and purchased . . . . . . . . 81,460 82,429 77,740
Loans sold:
Total whole loans sold. . . . . . (4,200) (9,153) (15,275)
Participation loans . . . . . . . -- (3,229) --
------- ------- -------
Total loans sold. . . . . . . . . (4,200) (12,382) (15,275)
Mortgage loan principal repayments. (40,118) (48,649) (54,981)
Increase (decrease) in other items,
net. . . . . . . . . . . . . . . . (2,177) (1,426) 3,048
Net increase in loans receivable, ------- ------- -------
net. . . . . . . . . . . . . . . . $34,965 $19,972 $10,532
======= ======= =======
Loan Origination and Other Fees. The Savings Bank, in some instances,
receives loan origination fees. Loan fees are a percentage of the principal
amount of the mortgage loan which are charged to the borrower for funding the
loan. The amount of fees charged by the Savings Bank is generally 1.0% to
2.0%. Current accounting standards require fees received (net of certain loan
origination costs) for originating loans to be deferred and amortized into
interest income over the contractual life of the loan. Net deferred fees or
costs associated with loans that are prepaid are recognized as income at the
time of prepayment. The Savings Bank had $1.6 million of net deferred
mortgage loan fees at September 30, 1997.
Nonperforming Assets and Delinquencies. The Savings Bank assesses late
fees or penalty charges on delinquent loans of approximately 5% of the monthly
loan payment amount. Substantially all fixed-rate and ARM loan payments are
due on the first day of the month; however, the borrower is given a 15 day
grace period to make the loan payment. When a mortgage loan borrower fails to
make a required payment when due, the Savings Bank institutes collection
procedures. The first notice is mailed to the borrower eight days after the
date the payment is due and, if necessary, a second written notice is sent on
the sixteenth day giving the borrower 15 days to respond and correct the
delinquency. Attempts to contact the borrower by telephone generally begin
upon the thirtieth day
15
<PAGE>
<PAGE>
of delinquency. If a satisfactory response is not obtained, continuous
follow-up contacts are attempted until the loan has been brought current.
Before the 90th day of delinquency, attempts to interview the borrower,
preferably in person, are made to establish (i) the cause of the delinquency,
(ii) whether the cause is temporary, (iii) the attitude of the borrower toward
the debt, and (iv) a mutually satisfactory arrangement for curing the default.
If the borrower is chronically delinquent and all reasonable means of
obtaining payment on time have been exhausted, foreclosure is initiated
according to the terms of the security instrument and applicable law.
Interest income on loans is reduced by the full amount of accrued and
uncollected interest.
When a consumer loan borrower fails to make a required payment on a
consumer loan by the payment due date, the Savings Bank institutes the same
collection procedures as for its mortgage loan borrowers.
The Savings Bank's Board of Directors is informed monthly as to the
status of all mortgage and consumer loans that are delinquent by more than 30
days, the status on all loans currently in foreclosure, and the status of all
foreclosed and repossessed property owned by the Savings Bank.
The following table sets forth information with respect to the Savings
Bank's non performing assets at the dates indicated.
At September 30,
-----------------------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
(Dollars in thousands)
Loans accounted for
on a nonaccrual basis:
Mortgage loans:
One- to- four family $612 $392 $ 646 $ 735 $ 776
Commercial. . . . . -- -- -- -- 2,886
Construction and land
development. . . . 196 125 391 771 3,891
Consumer loans . . . -- 30 -- 14 2
Commercial business
loans . . . . . . . -- -- -- -- --
------- ------- -------- -------- ------
Total. . . . . . 808 547 1,037 1,520 7,555
Accruing loans which are
contractually past due
90 days or more:
Mortgage loans:
Construction and land
development. . . . -- -- -- -- 109
------- ------- -------- -------- ------
Total . . . . . -- -- -- -- 109
------- ------- -------- -------- ------
Total of nonaccrual
and 90 days past due
loans. . . . . . . . $ 808 $ 547 $ 1,037 $ 1,520 $7,664
Real estate owned and
other repossessed
assets . . . . . . . 484 407 209 125 434
Total nonperforming ------- ------- -------- -------- ------
assets . . . . . . 1,292 954 1,246 1,645 8,098
Restructured loans. . 11 29 207 158 70
(table continued, and footnotes located, on following page)
16
<PAGE>
<PAGE>
At September 30,
-----------------------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
(Dollars in thousands)
Nonaccrual and 90
days or more past
due loans as a
percentage of loans
receivable, net. . . 0.76% 0.45% 0.66% 0.86% 4.10%(3)
Nonaccrual and 90
days or more past
due loans as a
percentage of
total assets . . . . 0.58% 0.36% 0.58% 0.78% 3.62%(3)
Nonperforming
assets as a
percentage of
total assets . . . . 0.93% 0.63% 0.70% 0.85% 3.83%(3)
Loans
receivable,
net(4) . . . . . . .$106,259 $121,558 $156,523 $176,495 $187,027
======== ======== ======== ======== ========
Total assets. . . . .$139,233 $151,044 $177,761 $194,357 $211,553
======== ======== ======== ======== ========
- ---------------------
(1) Includes two loans each with a balance of $1.4 million at September 30,
1997, as discussed below.
(2) Includes two loans with balances of $1.9 million and $1.0 million at
September 30, 1997, as discussed below.
(3) Includes the loans described in footnotes 1 and 2.
(4) Includes loans held-for-sale.
Additional interest income, which would have been recorded for the year
ended September 30, 1997 had nonaccruing loans been current in accordance with
their original terms, amounted to approximately $402,000. No interest income
was included in the results of operations on such loans for the year ended
September 30, 1997.
The following is a discussion of the Savings Bank's major problem assets
included in commercial and construction and land development loans at
September 30, 1997:
Convenience store/retail space and mini-storage, Kitsap County,
Washington. The Savings Bank has two loans that were originated in 1996 on
two separate properties: a convenience store combined with retail space and a
436 unit mini storage facility. The original loan amounts (before additional
advances) were $1.4 million for the convenience store and retail space and
$1.2 million for the mini-storage facility. The convenience store is being
operated by the borrowers with the retail space currently in the lease up
stage, with two of the six spaces occupied. The mini-storage facility is in
the lease up stage with approximately 140 units leased. These loans are
delinquent primarily because of a dispute between the two borrowers. At
September 30, 1997, the loans were classified "special mention" by the Savings
Bank. The borrowers have engaged a commercial real estate broker to market
both properties. The Savings Bank has initiated foreclosure proceedings due
to the delinquent status of the loans. Subsequent to September 30, 1997, the
loans were classified "substandard." The Savings Bank does not expect to
incur any material losses from these loans based on a recent evaluation of the
properties which indicated a value of approximately $4.0 million. See "--
Lending Activities -- Asset Classification."
Condominium loan, Southern King County, Washington. The Savings Bank has
two loans for the construction and sale of a 61-unit condominium complex. The
original loan amounts were $3.9 million and $1.7 million, respectively, and
were originated in 1994 and 1996. At September 30, 1997, 30 units had been
sold, 15 units were available-for-sale, and 16 units were in various stages of
completion. The Savings Bank does not expect to incur any material losses
from these loans based on a recent assessment of the real estate collateral
that indicated a market value of approximately $3.6 million on a finished
basis. At September 30, 1997, the loans were classified "substandard" by the
Savings Bank. See "-- Lending Activities -- Asset Classification." See "--
Real Estate Owned" for events subsequent to September 30, 1997.
17
<PAGE>
<PAGE>
Real Estate Owned. Real estate acquired by the Savings Bank as a result
of foreclosure or by deed-in-lieu of foreclosure is classified as real estate
owned until sold. When property is acquired it is recorded at the lower of
its cost, which is the unpaid principal balance of the related loan plus
foreclosure costs, or fair market value. Subsequent to foreclosure, the
property is carried at the lower of the foreclosed amount or fair value, less
estimated selling costs. At September 30, 1997, the Savings Bank had $434,000
in real estate owned consisting primarily of one- to- four family properties.
On October 29, 1997, the Savings Bank accepted a deed in lieu of
foreclosure for the condominium loans described under "-- Lending Activities
- -- Nonperforming Assets and Delinquencies." The acceptance of the deed in
lieu of foreclosure reduced the balance of nonaccrual loans at September 30,
1997 by $2.9 million. The Savings Bank has ordered an independent appraisal
of the condominium project to substantiate the market value of the condominium
units. The Savings Bank has placed the condominium units for sale with a
broker specializing in the marketing of condominium properties. Sixteen of
the condominium units are in the final finishing stage. Taking into account
the anticipated costs to finish these units, the Savings Bank does not expect
to incur any material losses in connection with the disposition of the
property based on a recent assessment of the property that indicated a market
value of approximately $3.6 million on a finished basis. On December 17,
1997, the Savings Bank accepted earnest money agreements on three of the
unsold condominium units at prices totaling $371,800, and a fourth offer has
been countered by the Savings Bank.
Restructured Loans. Under generally accepted accounting principles
("GAAP"), the Savings Bank is required to account for certain loan
modifications or restructuring as a "troubled debt restructuring." In
general, the modification or restructuring of a debt constitutes a troubled
debt restructuring if the Savings Bank for economic or legal reasons related
to the borrower's financial difficulties grants a concession to the borrowers
that the Savings Bank would not otherwise consider. Debt restructurings or
loan modifications for a borrower do not necessarily always constitute
troubled debt restructurings, however, and troubled debt restructurings do not
necessarily result in nonaccrual loans. The Savings Bank had $70,000 of
restructured loans as of September 30, 1997, which consisted of two one- to-
four family mortgage loans and one consumer loan.
Asset Classification. Applicable regulations require that each insured
institution review and classify its assets on a regular basis. In addition,
in connection with examinations of insured institutions, regulatory 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 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 high possibility of loss. An asset classified as loss is
considered uncollectible and of such little value that continuance as an asset
of the institution is not warranted. When an insured institution classifies
problem assets as either substandard or doubtful, it is required to establish
general allowances for loan losses in an amount deemed prudent by management.
These allowances represent loss allowances which have been established to
recognize the inherent risk associated with lending activities and the risks
associated with particular problem assets. When an insured institution
classifies problem assets as loss, it charges off the balances of the asset.
Assets which do not currently expose the insured institution to sufficient
risk to warrant classification in one of the aforementioned categories but
possess weaknesses are required to be designated as special mention. The
Savings Bank's determination as to the classification of its assets and the
amount of its valuation allowances is subject to review by the FDIC and the
Division which can order the establishment of additional loss allowances.
18
<PAGE>
<PAGE>
The aggregate amounts of the Savings Bank's classified assets (as
determined by the Savings Bank), and of the Savings Bank's general loss
allowances at the dates indicated, were as follows:
At September 30,
-------------------------------
1995 1996 1997
---- ---- ----
(In thousands)
Loss. . . . . . . . . . . . . . $ -- $ -- $ --
Doubtful. . . . . . . . . . . . -- -- --
Substandard assets(1) . . . . . 1,371 2,061 5,470
Special mention(1). . . . . . . -- 97 2,886
General loss allowances . . . . 1,119 1,133 1,716
- ------------------
(1) For further information concerning the increase in classified assets, see
"-- Lending Activities -- Nonperforming Assets and Delinquencies."
Allowance for Loan Losses. The Savings Bank has established a systematic
methodology for the determination of provisions for loan losses that takes
into consideration the need for an overall general valuation allowance.
In originating loans, the Savings Bank recognizes that losses will be
experienced and that the risk of loss will vary with, among other things, the
type of loan being made, the creditworthiness 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. The Savings Bank increases its
allowance for loan losses by charging provisions for loan losses against the
Savings Bank's income.
The general valuation allowance is maintained to cover losses inherent in
the loan portfolio. Management reviews the adequacy of the allowance at least
quarterly based on management's assessment of current economic conditions,
past loss and collection experience, and risk characteristics of the loan
portfolio. A provision for losses is charged against income monthly to
maintain the allowances.
At September 30, 1997, the Savings Bank had a general allowance for loan
losses of $1.7 million. Management believes that the amount maintained in the
allowances will be adequate to absorb losses inherent in the portfolio.
Although management believes that it uses the best information available to
make such determinations, future adjustments to the allowance for loan losses
may be necessary and results of operations could be significantly and
adversely affected if circumstances differ substantially from the assumptions
used in making the determinations.
While the Savings Bank believes it has established its existing allowance
for loan losses in accordance with GAAP, there can be no assurance that
regulators, in reviewing the Savings Bank's loan portfolio, will not request
the Savings Bank to increase significantly its 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 Savings Bank's financial condition and results
of operations.
19
<PAGE>
<PAGE>
The following table sets forth an analysis of the Savings Bank's gross
allowance for possible loan losses for the periods indicated.
Year Ended September 30,
----------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
(Dollars in thousands)
Allowance at beginning of
period. . . . . . . . . . $ 972 $ 1,138 $ 1,120 $ 1,119 $ 1,133
Provision for loan
losses. . . . . . . . . . 175 -- -- 70 596
Recoveries:
Consumer loans:
Automobile . . . . . . . 8 -- -- -- --
Other. . . . . . . . . . -- -- -- -- 9
------ ------ ------ ------ ------
Total recoveries. . . . 8 -- -- -- 9
Charge-offs:
Mortgage loans:
One- to- four family . . 10 -- -- -- 19
Home equity and second
mortgage. . . . . . . . 6 18 -- -- --
Other. . . . . . . . . . 1 -- 1 1 --
------ ------ ------ ------ ------
Total charge-offs . . . 17 18 1 1 19
------ ------ ------ ------ ------
Net charge-offs . . . . 9 18 1 1 10
Transfers . . . . . . . -- -- -- 55 3
Balance at end of ------ ------ ------ ------ ------
period . . . . . . . $1,138 $1,120 $1,119 $1,133 $1,716
====== ====== ====== ====== ======
Allowance for loan losses
as a percentage of total
loans (net) outstanding
at the end of the period. 1.07% 0.92% 0.71% 0.64% 0.92%
Net charge-offs as a percentage
of average loans outstanding
during the period . . . . 0.01% 0.02% --% --% 0.01%
Allowance for loan losses as
a percentage of nonperforming
loans at end of period. . 140.84% 204.75% 107.91% 74.54% 22.39%(1)
- -----------------
(1) Includes the four loans discussed under "-- Lending Activities --
Nonperforming Assets and Delinquencies."
20
<PAGE>
<PAGE>
<TABLE>
The following table sets forth the breakdown of the allowance for loan losses by loan category at the
dates indicated.
At September 30,
-----------------------------------------------------------------------------------------
1993 1994 1995 1996 1997
---------------- ------------------ ----------------- ----------------- -----------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in Category in Category in Category in Category in Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage loans:
One- to-
four family. $ -- 62.88% $ 333 52.94% $ 278 53.03% $ 261 48.51% $ 311 48.76%
Multi-family -- 2.02 77 3.45 81 6.21 83 6.35 149 5.93
Commercial . -- 9.55 266 8.46 271 8.84 317 13.41 409 14.32
Construction -- 19.72 240 28.79 337 24.23 316 23.83 646 21.93
Land . . . . -- 1.94 158 2.96 98 3.47 102 3.09 138 3.38
Non-mortgage
loans:
Consumer loans -- 3.58 39 3.21 44 4.09 46 4.57 50 5.34
Commercial
business
loans . . . -- 0.31 7 0.19 10 0.13 8 0.24 13 0.34
Unallocated . 1,138 N/A -- N/A -- N/A -- N/A -- --
Total allowance
for loan ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
losses . . $1,138 100.00% $1,120 100.00% $1,119 100.00% $1,133 100.00% $1,716 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
21
</TABLE>
<PAGE>
<PAGE>
Investment Activities
Under Washington law, savings banks are permitted to invest in various
types of liquid assets, including U.S. Treasury obligations, securities of
various federal agencies, certain certificates of deposit of insured banks and
savings institutions, banker's acceptances, repurchase agreements, federal
funds, commercial paper, investment grade corporate debt securities and
obligations of States and their political sub-divisions.
As of September 30, 1997, the Savings Bank's investment securities
portfolio consisted entirely of mortgage-backed securities and FHLB-Seattle
stock. At September 30, 1997, the Savings Bank's investment in FHLB-Seattle
stock totalled $1.6 million. The market value of the Savings Bank's
investment securities portfolio amounted to $11.2 million, $6.4 million and
$5.6 million at September 30, 1995, 1996 and 1997, respectively.
22
<PAGE>
<PAGE>
<TABLE>
The following table sets forth the investment securities portfolio and carrying values at the dates
indicated.
At September 30,
-------------------------------------------------------------------------
1995 1996 1997
---------------------- ---------------------- ----------------------
Amortized Percent of Amortized Percent of Amortized Percent of
Cost(1) Total Cost(1) Total Cost(1) Total
------- ----- ------- ----- ------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Held-to-Maturity (at
amortized cost):
Debt Securities:
U.S. Treasury obligations $ 2,504 22.15% $ -- --% $ -- --%
U.S. Government agency
obligations. . . . . . . 1,000 8.84 -- -- -- --
Mortgage-backed securities. 6,352 56.19 4,951 75.91 3,991 71.56
Investment certificates of
deposit. . . . . . . . . . -- -- -- -- -- --
Total held-to-maturity -------- ------ ------- ------ ------- ------
securities . . . . . . . . 9,856 87.18 4,951 75.91 3,991 71.56
Available-for-Sale (at
market value):
Mortgage-backed securities. -- -- -- -- --
FHLB stock. . . . . . . . . 1,363 12.06% 1,470 22.54% 1,586 28.44
Other . . . . . . . . . . . 86 0.76 101 1.55 -- --
Total available-for-sale
securities . . . . . . . 1,449 12.82 1,571 24.09 1,586 28.44
-------- ------ ------- ------ ------- ------
Total portfolio . . . . . . $ 11,305 100.00% $ 6,522 100.00% $ 5,577 100.00%
======== ====== ======= ====== ======= ======
- -----------------
(1) The market value of the Savings Bank's investment portfolio amounted to $5.6 million as of September
30, 1997, $6.4 million as of September 30, 1996 and $11.2 million as of September 30, 1995. At
September 30, 1997, the market values of the principal components of the Savings Bank's investment
portfolio were: $4.0 million in mortgage-backed securities and $1.6 million in FHLB stock.
23
</TABLE>
<PAGE>
<PAGE>
The following table sets forth the maturities and weighted average yields
of the debt and mortgage-backed securities in the Savings Bank's investment
securities portfolio at September 30, 1997.
Less Than One to Five to Over Ten
One Year Five Years Ten Years Years
------------- ------------- ------------- ------------
Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
Held-to-Maturity:
Mortgage-backed
securities. . . $ -- --% $ 947 6.01% $ -- --% $3,043 6.66%
Total held-to- ------ ----- ----- ------
maturity
securities. . . $ -- $ 947 6.01 $ -- -- $3,043 6.66
------ ----- ----- ------
Available-for-Sale:
FHLB Stock . . . 1,586 8.00 -- -- -- -- -- --
Other. . . . . . -- -- -- -- -- -- -- --
Total available- ------ ---- ----- ---- ----- ---- ------ ----
for-sale
securities. . . 1,586 8.00 -- -- -- -- -- --
------ ----- ----- ------
Total portfolio. $1,586 8.00% $ 947 6.01% $ -- --% $3,043 6.66%
====== ===== ===== ======
Deposit Activities and Other Sources of Funds
General. Deposits and loan repayments are the major sources of the
Savings Bank's 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 through the
FHLB-Seattle may be used to compensate for reductions in the availability of
funds from other sources. Presently, the Savings Bank has no other borrowing
arrangements.
Deposit Accounts. Substantially all of the Savings Bank's depositors are
residents of Washington. Deposits are attracted from within the Savings
Bank's market area through the offering of a broad selection of deposit
instruments, including money market deposit accounts, regular savings accounts
and certificates of deposit. 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 its
deposit accounts, the Savings Bank considers current market interest rates,
profitability to the Savings Bank, matching deposit and loan products and its
customer preferences and concerns. In recent periods, the Savings Bank has
used deposit interest rate promotions in connection with the opening of new
branch offices.
The Savings Bank has recently adopted a strategy to extend the term of
its liabilities in the form of longer term certificate accounts and maintain
adequate liquidity levels to address its interest rate risk exposure. The
implementation of such strategy, however, is not reflected in the Savings
Bank's recent financial data as most of its liabilities are still in the form
of short term certificate accounts.
At September 30, 1997 the Savings Bank had $20.7 million of jumbo
certificates of deposit, which includes $4.8 million in public unit funds.
The Savings Bank does not solicit brokered deposits and believes that its
jumbo certificates of deposit, which represented 12.0% of total deposits at
September 30, 1997, present similar interest rate risk to its other deposit
products.
24
<PAGE>
<PAGE>
The following table sets forth information concerning the Savings Bank's
time deposits and other interest-bearing deposits at September 30, 1997.
Weighted
Average Percentage
Interest of Total
Rate Category Amount Deposits
- ---- -------- ------ --------
(In thousands)
- --% Non-Interest Bearing $5,164 2.99%
2.50 Negotiable order of withdrawal ("NOW") 19,587 11.32
Checking
2.98 Passbook Savings 26,269 15.18
3.96 Money Market Accounts 14,424 8.34
Certificates of Deposit(1)
--------------------------
5.68 Maturing within 1 year 76,284 44.09
6.10 Maturing after 1 year but within 2 years 22,350 12.92
6.08 Maturing after 2 years but within 5 years 5,737 3.32
6.63 Maturing after 5 years 387 .22
- -- Other Deposits 2,801 1.62
4.58
------- ------
$173,003 100.00%
======= ======
- ----------------
(1) Based on remaining maturity of certificates.
The following table indicates the amount of the Savings Bank's jumbo
certificates of deposit by time remaining until maturity as of September 30,
1997. Jumbo certificates of deposit have principal balances of $100,000 or
more and the rates paid on such accounts are generally negotiable.
Maturity Period Amount
- --------------- ------
(In thousands)
Three months or less. . . . . . . . . . . . . . . . . . $ 7,716
Over three through six months . . . . . . . . . . . . . 4,413
Over six through twelve months. . . . . . . . . . . . . 4,775
Over twelve months. . . . . . . . . . . . . . . . . . . 3,802
-------
Total . . . . . . . . . . . . . . . . . . . . . . . $20,706
=======
25
<PAGE>
<PAGE>
<TABLE>
Deposit Flow
The following table sets forth the balances of savings deposits in the various types of savings
accounts offered by the Savings Bank at the dates indicated.
At September 30,
------------------------------------------------------------------------------
1995 1996 1997
------------------ ----------------------------- ---------------------------
Percent Percent Percent
of of Increase of Increase
Amount Total Amount Total (Decrease) Amount Total (Decrease)
------ ----- ------ ----- ---------- ------ ----- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Non-interest-bearing. . . $ 3,116 2.18% $ 3,571 2.28% $ 455 $ 5,164 2.99% $ 1,593
NOW checking. . . . . . . 17,525 12.25 18,003 11.50 478 19,587 11.32 1,584
Passbook savings accounts 25,553 17.86 25,400 16.22 (153) 26,269 15.18 869
Money market deposit. . . 12,734 8.90 13,364 8.54 630 14,424 8.34 1,060
Certificates of deposit which
mature in the year ending:
Within 1 year . . . . . . 52,658 36.80 64,202 41.01 11,544 76,284 44.09 12,082
After 1 year, but within
2 years. . . . . . . . . 19,434 13.58 18,737 11.97 (697) 22,350 12.92 3,613
After 2 years, but within
5 years. . . . . . . . . 8,911 6.23 9,814 6.27 903 5,737 3.32 (4,077)
Certificates maturing
thereafter . . . . . . . 844 0.59 579 0.37 (265) 387 .22 (192)
Other . . . . . . . . . . 2,309 1.61 2,879 1.84 570 2,801 1.62 (78)
-------- ------ -------- ------ ------- -------- ------ -------
Total. . . . . . . . $143,084 100.00% $156,549 100.00% $13,465 $173,003 100.00% $16,454
======== ====== ======== ====== ======= ======== ====== =======
</TABLE>
26
<PAGE>
<PAGE>
Time Deposits by Rates
The following table sets forth the time deposits in the Savings Bank
classified by rates as of the dates indicated.
At September 30,
-------------------------------
1995 1996 1997
---- ---- ----
(In thousands)
2.00 - 3.99%. . . . . . . . . . . $ 346 $ 171 $ 153
4.00 - 4.99%. . . . . . . . . . . 3,220 6,802 --
5.00 - 5.99%. . . . . . . . . . . 39,921 53,278 79,205
6.00 - 6.99%. . . . . . . . . . . 31,473 26,914 20,351
7.00% and over. . . . . . . . . . 6,887 6,167 5,049
------- ------- --------
Total . . . . . . . . . . . . . . $81,847 $93,332 $104,758
======= ======= ========
Time Deposits by Maturities
The following table sets forth the amount and maturities of time deposits
at September 30, 1997.
Amount Due
-------------------------------------------------------
After
One to Two to
Less Than Two Five After
One Year Years Years Five Years Total
-------- ----- ----- ---------- -----
(In thousands)
2.00 - 3.99%. . . $ 153 $ -- $ -- $ -- $ 153
4.00 - 4.99%. . . -- -- -- -- --
5.00 - 5.99%. . . 64,636 10,992 3,330 247 79,205
6.00 - 6.99%. . . 11,137 7,118 2,055 41 20,351
7.00% and over. . 358 4,240 352 99 5,049
------- ------- ------ ----- --------
Total . . . . . . $76,284 $22,350 $5,737 $ 387 $104,758
======= ======= ====== ===== ========
Deposit Activities
The following table sets forth the savings activities of the Savings Bank
for the periods indicated.
Year Ended September 30,
-------------------------------
1995 1996 1997
---- ---- ----
(In thousands)
Beginning balance . . . . . . . . $128,669 $143,084 $156,549
Net deposits before interest
credited . . . . . . . . . . . . 8,719 6,516 8,938
Interest credited . . . . . . . . 5,696 6,949 7,516
Net increase in deposits. . . . . 14,415 13,465 16,454
-------- -------- --------
Ending balance. . . . . . . . . . $143,084 $156,549 $173,003
======== ======== ========
27
<PAGE>
<PAGE>
Borrowings
Savings deposits are the primary source of funds for the Savings Bank's
lending and investment activities and for general business purposes. The
Savings Bank has the ability to use advances from the FHLB-Seattle to
supplement its supply of lendable funds and to meet deposit withdrawal
requirements. The FHLB-Seattle functions as a central reserve bank providing
credit for savings and loan associations and certain other member financial
institutions. As a member of the FHLB-Seattle, the Savings Bank is required
to own capital stock in the FHLB-Seattle and is 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 creditworthiness standards have
been met. Advances are made pursuant to several different credit programs.
Each credit program has its own interest rate and range of maturities.
Depending on the program, limitations on the amount of advances are based on
the financial condition of the member institution and the adequacy of
collateral pledged to secure the credit. At September 30, 1997, the Savings
Bank maintained an uncommitted credit facility with the FHLB-Seattle that
provided for immediately available advances up to an aggregate amount of $42.3
million, under which $12.2 million was outstanding.
The following table sets forth certain information regarding short-term
borrowings by the Savings Bank at the end of and during the periods indicated
using monthly average balance:
At or For the
Year Ended September 30,
------------------------
1996 1997
---- ----
(Dollars in thousands)
Maximum amount of short-term FHLB
advances at any month end. . . . . . . . . . . $13,000 $16,500
Approximate average short-term FHLB
advances outstanding. . . . . . . . . . . . . . 9,500 4,583
Approximate weighted average rate
paid on short-term FHLB advances . . . . . . . . 5.57% 5.53%
Total short-term FHLB advances at
end of period. . . . . . . . . . . . . . . . . . 12,000 500
REGULATION OF THE SAVINGS BANK
General. As a state-chartered, federally insured savings bank, the
Savings Bank is subject to extensive regulation. Lending activities and other
investments must comply with various statutory and regulatory requirements,
including prescribed minimum capital standards. The Savings Bank is regularly
examined by the FDIC and the Division and files periodic reports concerning
the Savings Bank's activities and financial condition with its regulators.
The Savings Bank's relationship with depositors and borrowers also is
regulated to a great extent by both federal law and the laws of Washington,
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 Savings Bank, including reserves, loans, mortgages, capital,
issuance of securities, payment of dividends and establishment of branches.
Federal and state bank regulatory agencies also have the general authority to
limit the dividends paid by insured banks and bank holding companies if such
payments should be deemed to constitute an unsafe and unsound practice. The
respective primary federal regulators of the Company and the Savings Bank have
authority to impose
28
<PAGE>
<PAGE>
penalties, initiate civil and administrative actions and take other steps
intended to prevent banks from engaging in unsafe or unsound practices.
State Regulation and Supervision. As a state-chartered savings bank, the
Savings Bank is subject to applicable provisions of Washington law and the
regulations of the Division adopted thereunder. Washington law and
regulations govern the Savings Bank's 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. Under
state law, savings banks in Washington also generally have all of the powers
that federal mutual savings banks have under federal laws and regulations.
The Savings Bank is subject to periodic examination and reporting requirements
by and of the Division.
Deposit Insurance. The FDIC insures deposits at the Savings Bank to the
maximum extent permitted by law. The Savings Bank currently pays deposit
insurance premiums to the FDIC based on a risk-based assessment system
established by the FDIC for all SAIF-member institutions. Under applicable
regulations, institutions are assigned to one of three capital groups which
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 under the Federal Deposit Insurance Act ("FDIA"), as
discussed below. The FDIC is authorized to raise assessment rates in certain
circumstances. The Savings Bank's assessments expensed for the year ended
September 30, 1997, equaled $76,000.
Pursuant to the Deposit Insurance Fund ("DIF") Act, which was enacted on
September 30, 1996, the FDIC imposed a special assessment on each depository
institution with SAIF-assessable deposits which resulted in the SAIF achieving
its designated reserve ratio. In connection therewith, the FDIC reduced the
assessment schedule for SAIF members, effective January 1, 1997, to a range of
0% to 0.27%, with most institutions, including the Savings Bank, paying 0%.
This assessment schedule is the same as that for the Bank Insurance Fund
("BIF"), which reached its designated reserve ratio in 1995. In addition,
since January 1, 1997, SAIF members are charged an assessment of 0.065% of
SAIF-assessable deposits for the purpose of paying interest on the obligations
issued by the Financing Corporation ("FICO") in the 1980's to help fund the
thrift industry cleanup. BIF-assessable deposits will be charged an
assessment to help pay interest on the FICO bonds at a rate of approximately
.013% until the earlier of December 31, 1999 or the date upon which the last
savings association ceases to exist, after which time the assessment will be
the same for all insured deposits.
The DIF Act provides for the merger of the BIF and the SAIF into the
Deposit Insurance Fund on January 1, 1999, but only if no insured depository
institution is a savings association on that date. The DIF Act contemplates
the development of a common charter for all federally chartered depository
institutions and the abolition of separate charters for national banks and
federal savings associations. It is not known what form the common charter
may take and what effect, if any, the adoption of a new charter would have on
the operation of the Savings Bank.
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 which could
result in termination of the deposit insurance of the Savings Bank.
Prompt Corrective Action. The FDIA requires each federal banking agency
to implement a system of prompt corrective action for institutions which it
regulates. The federal banking agencies have promulgated substantially
similar regulations to implement this system of prompt corrective action.
Under the regulations, an institution shall be deemed to be: (i) "well
capitalized" if it has a total risk-based capital ratio of 10.0% or more, has
a Tier I risk-based capital ratio of 6.0% or more, has a Tier I leverage
capital ratio of 5.0% or more and is not
29
<PAGE>
<PAGE>
subject to specified requirements to meet and maintain a specific capital
level for any capital measure; (ii) "adequately capitalized" if it has a total
risk-based capital ratio of 8.0% or more, a Tier I risk-based capital ratio of
4.0% or more and a Tier I leverage capital ratio of 4.0% or more (3.0% under
certain circumstances) and does not meet the definition of "well capitalized;"
(iii) "undercapitalized" if it has a total risk-based capital ratio that is
less than 8.0%, a Tier I risk-based capital ratio that is less than 4.0% or a
Tier I leverage capital ratio that is less than 4.0% (3.0% under certain
circumstances); (iv) "significantly undercapitalized" if it has a total
risk-based capital ratio that is less than 6.0%, a Tier I risk-based capital
ratio that is less than 3.0% or a Tier I leverage capital ratio that is less
than 3.0%; and (v) "critically undercapitalized" if it has a ratio of tangible
equity to total assets that is equal to or less than 2.0%.
The FDIA also provides that a federal banking agency may, after notice
and an opportunity for a hearing, reclassify a well capitalized institution as
adequately capitalized and may require an adequately capitalized institution
or an undercapitalized institution to comply with supervisory actions as if it
were in the next lower category if the institution is in an unsafe or unsound
condition or engaging in an unsafe or unsound practice. (The FDIC may not,
however, reclassify a significantly undercapitalized institution as critically
undercapitalized.)
An institution generally must file a written capital restoration plan
which meets specified requirements, as well as a performance guaranty by each
company that controls the institution, with the appropriate federal banking
agency within 45 days of the date that the institution receives notice or is
deemed to have notice that it is undercapitalized, significantly
undercapitalized or critically undercapitalized. Immediately upon becoming
undercapitalized, an institution shall become subject to the provisions of
Section 38 of the FDIA, which sets forth various mandatory and discretionary
restrictions on its operations.
At September 30, 1997, the Savings Bank was categorized as "well
capitalized" under the prompt corrective action regulations of the FDIC.
Standards for Safety and Soundness. The FDIA requires the federal
banking regulatory agencies to prescribe, 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; and
(vi) compensation, fees and benefits. The federal banking agencies recently
adopted final regulations and Interagency Guidelines Prescribing Standards for
Safety and Soundness ("Guidelines") to implement safety and soundness
standards required by the FDIA. 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. The agencies also proposed asset quality and earnings standards
which, if adopted in final, would be added to the Guidelines. Under the final
regulations, if the FDIC determines that the Savings Bank fails to meet any
standard prescribed by the Guidelines, the agency may require the Savings Bank
to submit to the agency an acceptable plan to achieve compliance with the
standard, as required by the FDIA. The final regulations establish deadlines
for the submission and review of such safety and soundness compliance plans.
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 the most highly
rated or are anticipating or experiencing significant growth.
The FDIC's capital regulations require higher capital levels for banks
which exhibit more than a moderate degree of risk or exhibit other
characteristics which necessitate that higher than minimum levels of capital
be maintained. 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
pursuant to Section 8(a) of the FDIA unless the insured bank enters into a
written
30
PAGE
<PAGE>
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. The FDIC includes
in its evaluation of a bank's capital adequacy an assessment of the exposure
to declines in the economic value of the bank's capital due to changes in
interest rates. However, no measurement framework for assessing the level of
a bank's interest rate risk exposure has been codified. In the future, the
FDIC will issue a proposed rule that would establish an explicit minimum
capital charge for interest rate risk, based on the level of a bank's measured
interest rate risk exposure.
An undercapitalized, significantly undercapitalized, or critically
undercapitalized institution is required to submit an acceptable capital
restoration plan to its appropriate federal banking agency. The plan must
specify (i) the steps the institution will take to become adequately
capitalized, (ii) the capital levels to be attained each year, (iii) how the
institution will comply with any regulatory sanctions then in effect against
the institution and (iv) the types and levels of activities in which the
institution will engage. The banking agency may not accept a capital
restoration plan unless the agency determines, among other things, that the
plan "is based on realistic assumptions, and is likely to succeed in restoring
the institution's capital" and "would not appreciably increase the risk...to
which the institution is exposed." Under the FDIA, a bank holding company
must guarantee that a subsidiary depository institution meet its capital
restoration plan, subject to certain limitations. The obligation of a
controlling bank holding company under the FDIA to fund a capital restoration
plan is limited to the lesser of 5.0% of an undercapitalized subsidiary's
assets and the amount required to meet regulatory capital requirements.
The FDIA provides that the appropriate federal regulatory agency must
require an insured depository institution that is significantly
undercapitalized or is undercapitalized and either fails to submit an
acceptable capital restoration plan within the time period allowed or fails in
any material respect to implement a capital restoration plan accepted by the
appropriate federal banking agency to take one or more of the following
actions: (i) sell enough shares, including voting shares, to become
adequately capitalized; (ii) merge with (or be sold to) another institution
(or holding company), but only if grounds exist for appointing a conservator
or receiver; (iii) restrict certain transactions with banking affiliates as if
the "sister bank" requirements of Section 23A of the Federal Reserve Act
("FRA") did not exist; (iv) otherwise restrict transactions with bank or
non-bank affiliates; (v) restrict interest rates that the institution pays on
deposits to "prevailing rates" in the institution's region; (vi) restrict
asset growth or reduce total assets; (vii) alter, reduce or terminate
activities; (viii) hold a new election of directors; (ix) dismiss any director
or senior executive officer who held office for more than 180 days immediately
before the institution became undercapitalized; (x) employ "qualified" senior
executive officers; (xi) cease accepting deposits from correspondent
depository institutions; (xii) divest certain non-depository affiliates which
pose a danger to the institution; (xiii) be divested by a parent holding
company; and (xiv) take any other action which the agency determines would
better carry out the purposes of the Prompt Corrective Action provisions. See
"-- Prompt Corrective Action."
31
<PAGE>
<PAGE>
The Division requires that net worth equal at least 5% of total assets.
Intangible assets must be deducted from net worth and assets when computing
compliance with this requirement. At September 30, 1997, the Savings Bank had
a Tier 1 leverage capital ratio of 12.0% and net worth of 11.7% of total
assets.
The FDIC has adopted the Federal Financial Institutions Examination
Council's recommendation regarding the adoption of Statement of Financial
Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." Specifically, the agencies determined that net
unrealized holding gains or losses on available for sale debt and equity
securities should not be included when calculating core and risk-based capital
ratios.
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 or that bank is greater
than the minimum standards established in the regulation.
The Savings Bank's management believes that, under the current
regulations, the Savings Bank will continue to meet its minimum capital
requirements in the foreseeable future. However, events beyond the control of
the Savings Bank, such as a downturn in the economy in areas where the Savings
Bank has most of its loans, could adversely affect future earnings and,
consequently, the ability of the Savings Bank to meet its capital
requirements.
The table below sets forth the Savings Bank's capital position relative
to its FDIC capital requirements at September 30, 1997. The definitions of
the terms used in the table are those provided in the capital regulations
issued by the FDIC.
At September 30, 1997
----------------------------------
Percent of Adjusted
Amount Total Assets(1)
------ -------------------
(Dollars in thousands)
Tier 1 (leverage) capital................. $24,645 12.01%
Tier 1 (leverage) capital requirement..... 8,205 4.00
------- -----
Excess.................................... $16,440 8.01%
======= ====
Tier 1 risk adjusted capital.............. $26,361 17.43%
Tier 1 risk adjusted capital requirement.. 6,049 4.00
------- -----
Excess.................................... $20,312 13.43%
======= ====
Total risk-based capital.................. $26,361 17.43%
Total risk-based capital requirement...... 12,099 8.00
------- -----
Excess.................................... $14,262 9.43%
======= ====
- --------------------
(1) For the Tier 1 (leverage) capital and Washington regulatory capital
calculations, percent of total average assets of $205.1 million. For
the Tier 1 risk-based capital and total risk-based capital
calculations, percent of total risk-weighted assets of $151.2 million.
(2) As a Washington-chartered savings bank, the Savings Bank is subject to
the capital requirements of the FDIC and the Division. The FDIC
requires state-chartered savings banks, including the Savings Bank, to
have a minimum leverage ratio of Tier 1 capital to total assets of at
least 3%, provided, however, that all institutions, other than those
(i) receiving the highest rating during the examination process and
(ii) not anticipating any significant growth, are required to maintain
a ratio of 1% to 2% above the stated minimum,
32
<PAGE>
<PAGE>
with an absolute total capital to risk-weighted assets of at least 8%.
The Savings Bank has not been notified by the FDIC of any leverage
capital requirement specifically applicable to it.
Activities and Investments of Insured State-Chartered Banks. The FDIA
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.
Subject to certain regulatory exceptions, FDIC regulations provide 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 or for which the FDIC has granted and
exception must cease the impermissible activity.
Environmental Issues Associated With Real Estate Lending. The
Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA"), a federal statute, generally imposes strict liability on, among
other things, all prior and present "owners and operators" of hazardous waste
sites. However, the U.S. Congress created a safe harbor provision for secured
creditors by providing that the term "owner and operator" excludes a person
who, without participating in the management of the site, holds indicia of
ownership primarily to protect its security interest in the site. Since the
enactment of the CERCLA, this "secured creditor exemption" has been the
subject of judicial interpretations which have left open the possibility that
lenders could be liable for cleanup costs on contaminated property that they
hold as collateral for a loan.
In response to the uncertainty created by judicial interpretations, in
April 1992, the United States Environmental Protection Agency ("EPA"), an
agency within the Executive Branch of the government, promulgated a regulation
clarifying when and how secured creditors could be liable for cleanup costs
under the CERCLA. Generally, the regulation protected a secured creditor that
acquired full title to collateral property through foreclosure as long as the
creditor did not participate in the property's management before foreclosure
and undertook certain due diligence efforts to divest itself of the property.
However, in February 1994, the U.S. Court of Appeals for the District of
Columbia Circuit held that the EPA lacked authority to promulgate such
regulation on the grounds that Congress meant for decisions on liability under
the CERCLA to be made by the courts and not the Executive Branch. In January
1995, the U.S. Supreme Court denied to review the U.S. Court of Appeal's
decision. In light of this adverse court ruling, in October 1995 the EPA
issued a statement entitled "Policy on CERCLA Enforcement Against Lenders and
Government Entities that Acquire Property Involuntarily" explaining that as an
enforcement policy, the EPA intended to apply as guidance the provisions of
the EPA lender liability rule promulgated in 1992.
To the extent that legal uncertainty exists in this area, all creditors,
including the Savings Bank, that have made loans secured by properties with
potential hazardous waste contamination (such as petroleum contamination)
could be subject to liability for cleanup costs, which costs often
substantially exceed the value of the collateral property.
Federal Reserve System. In 1980, Congress enacted legislation which
imposed Federal Reserve requirements (under "Regulation D") 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
33
<PAGE>
<PAGE>
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 $49.3 million of transaction
accounts and for amounts greater than $49.3 million, the reserve requirement
is 10% of that portion of total transaction accounts in excess of $49.3
million. The first $4.4 million of otherwise reservable balances are exempt
from reserve requirements. The reserve requirement on nonpersonal time
deposits with original maturities of less than 1-1/2 years is 0%. As of
September 30, 1997, the Savings Bank met its reserve requirements.
Affiliate Transactions. The Company and the Savings Bank will be legal
entities separate and distinct. Various legal limitations restrict the
Savings Bank 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 bank 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 ("CRA"), 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. The Savings Bank received a "satisfactory"
rating during its most recent CRA examination.
Dividends. Dividends from the Savings Bank will constitute the major
source of funds for dividends which may be paid by the Company. The amount of
dividends payable by the Savings Bank to the Company will depend upon the
Savings Bank's earnings and capital position, and is limited by federal and
state laws, regulations and policies. According to Washington law, the
Savings Bank may not declare or pay a cash dividend on its capital stock if it
would cause its net worth to be reduced below (i) the amount required for
liquidation accounts or (ii) the net worth requirements, if any, imposed by
the Director of the Division. Dividends on the Savings Bank's capital stock
may not be paid in an aggregate amount greater than the aggregate retained
earnings of the Savings Bank, without the approval of the Director of the
Division.
The amount of dividends actually paid during any one period will be
strongly affected by the Savings Bank's management policy of maintaining a
strong capital position. 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.
REGULATION OF THE COMPANY
General. The Company, as the sole shareholder of the Savings Bank upon
consummation of the Conversion, will become a bank holding company and will
register as such with the Federal Reserve. Bank holding companies are subject
to comprehensive regulation by the Federal Reserve under the Bank Holding
Company Act
34
<PAGE>
<PAGE>
of 1956, as amended ("BHCA"), and the regulations of the Federal Reserve. As
a bank holding company, the Company will be required to file with the Federal
Reserve annual reports and such additional information as the Federal Reserve
may require and will be 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.
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.
Any direct or indirect acquisition by a bank holding company or its
subsidiaries of more than 5% of the voting shares of, or substantially all of
the assets of, any bank located outside of the state in which the operations
of the bank holding company's banking subsidiaries are principally conducted,
may not be approved by the Federal Reserve unless the laws of the state in
which the bank to be acquired is located specifically authorize such an
acquisition. Most states have authorized interstate bank acquisitions by
out-of-state bank holding companies on either a regional or a national basis,
and most such statutes require the home state of the acquiring bank holding
company to have enacted a reciprocal statute. Washington law permits
out-of-state bank holding companies to acquire banks or bank holding companies
located in Washington so long as the laws of the state in which the acquiring
bank holding company is located permit bank holding companies located in
Washington to acquire banks or bank holding companies in the acquiror's state
and the Washington bank sought to be acquired has been in existence for at
least three years. Beginning September 30, 1995, federal law permits well
capitalized and well managed bank holding companies to acquire control of an
existing bank in any state.
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. Under the BHCA, the Federal Reserve is authorized to approve
the ownership of shares by a bank holding company in any company, the
activities of which the Federal Reserve has determined to be so closely
related to the business of banking or managing or controlling banks as to be a
proper incident thereto. The list of activities determined by regulation to
be closely related to banking within the meaning of the BHCA 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. In September 1994, Congress passed the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994 ("Interstate Banking
Act"). The Interstate Banking Act permits adequately capitalized bank and
savings bank holding companies to acquire control of banks and savings banks
in any state beginning on September 29, 1995, one year after the effectiveness
of the Interstate Banking Act. Washington adopted nationwide reciprocal
interstate acquisition legislation in 1994.
Such interstate acquisitions are subject to certain restrictions. States
may require the bank or savings bank being acquired to have been in existence
for a certain length of time, but not for more than five years. In addition,
no bank or savings bank may acquire more than 10% of the insured deposits in
the United States or more than 30% of the insured deposits in any one state,
unless the state specifically legislated a higher deposit cap. States are
free to legislate stricter deposit caps and, at present, 18 states have
deposit caps lower than 30%.
35
<PAGE>
<PAGE>
The Interstate Banking Act also provides for interstate branching. The
McFadden Act of 1927 established state lines as the ultimate barrier to
geographic expansion of a banking network by branching. The Interstate
Banking Act withdraws these barriers, effective June 1, 1997, allowing
interstate branching in all states, provided that a particular state has not
specifically prohibited interstate branching by legislation prior to such
time. Unlike interstate acquisitions, a state may prohibit interstate
branching if it specifically elects to do so by June 1, 1997. States may
choose to allow interstate branching prior to June 1, 1997 by opting-in to a
group of states that permits these transactions. These states generally allow
interstate branching via a merger of an out-of-state bank with an in-state
bank, or on a de novo basis. Washington has enacted legislation permitting
interstate branching transactions.
It is anticipated that the Interstate Banking Act will increase
competition within the market in which the Company and the Savings Bank
operate, although the extent to which such competition will increase in such
market or the timing of such increase cannot be predicted. In addition, there
can be no assurance as to whether, or in what form, legislation may be enacted
in Washington in reaction to the Interstate Banking Act or what impact such
legislation or the Interstate Banking Act might have upon the Company and the
Savings Bank.
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 earnings 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. Furthermore, under the prompt corrective action
regulations adopted by the Federal Reserve, the Federal Reserve may prohibit a
bank holding company from paying any dividends if the holding company's bank
subsidiary is classified as "undercapitalized" under the prompt corrective
action regulations.
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.
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 Savings Bank. 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. For bank holding companies with less than $150 million
in consolidated assets the guidelines are applied on a bank-only basis unless
the parent bank holding company (i) is engaged in nonbank activity involving
significant leverage or (ii) has a significant amount of outstanding debt
that is held by the general public.
Bank holding companies subject to the Federal Reserve's capital adequacy
guidelines are required to comply with the Federal Reserve's risk-based
capital regulations. Under these regulations, the minimum ratio of total
capital to risk-weighted assets (including certain off-balance sheet
activities, such as standby letters of credit) is 8%. At least half of the
total capital is required to be Tier 1 capital, principally consisting of
common stockholders' equity, noncumulative perpetual preferred stock, and a
limited amount of cumulative perpetual preferred stock, less certain goodwill
items. The remainder, Tier II capital, may consist of a limited amount of
subordinated debt, certain hybrid capital instruments and other debt
securities, perpetual preferred stock, and a limited amount of the general
loan loss allowance. In addition to the risk-based capital guidelines, the
Federal Reserve has adopted a minimum Tier I (leverage) capital ratio, under
which a bank holding company must maintain a minimum level of Tier 1 capital
to average total consolidated assets of at least 3% in the case of a bank
holding company which has the highest
36
<PAGE>
<PAGE>
regulatory examination rating and is not contemplating significant growth or
expansion. All other bank holding companies are expected to maintain a Tier 1
(leverage) capital ratio of at least 1% to 2% above the state minimum.
Federal Securities Laws
The Company has filed a registration statement on Form S-1 ("Registration
Statement") with the Securities and Exchange Commission ("SEC") under the
Securities Act of 1934, as amended ("Securities Act") for the registration of
the Common Stock to be issued in the Conversion. Upon completion of the
Conversion, the Common Stock will be registered with the SEC under the
Securities Exchange Act of 1934, as amended ("Exchange Act") and generally may
not be deregistered for at least three years thereafter. The Company will
then be subject to the information, proxy solicitation, insider trading
restrictions and other requirements of the Exchange Act.
The registration under the Securities Act of the Common Stock to be
issued in the Conversion does not cover the resale of such shares. Shares of
the Common Stock purchased by persons who are not affiliates of the Company
may be resold without registration. Shares purchased by an affiliate of the
Company may comply with the resale restrictions of Rule 144 under the
Securities Act. If the Company meets the current public information
requirements of Rule 144 under the Securities Act, each affiliate of the
Company who complies with the other conditions of Rule 144 (including those
that require the affiliate's sale to be aggregated with those of certain other
persons) would be able to sell in the public market, without registration, a
number of shares not to exceed, in any three-month period, the greater of (i)
1% of the outstanding shares of the Company or (ii) the average weekly volume
of trading in such shares during the preceding four calendar weeks. Provision
may be made in the future by the Company to permit affiliates to have their
shares registered for sale under the Securities Act under certain
circumstances. There are currently no demand registration rights outstanding.
However, in the event the Company, at some future time, determines to issue
additional shares from its authorized but unissued shares, the Company might
offer registration rights to certain of its affiliates who want to sell their
shares.
TAXATION
Federal Taxation
General. The Company and the Savings Bank will report their income on a
fiscal year basis using the accrual method of accounting and will be subject
to federal income taxation in the same manner as other corporations with some
exceptions, including particularly the Savings Bank's 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 Savings Bank or the Company.
Bad Debt Reserve. Historically, savings institutions such as the Savings
Bank which met certain definitional tests primarily related to their assets
and the nature of their business ("qualifying thrift") were permitted to
establish a reserve for bad debts and to make annual additions thereto, which
may have been deducted in arriving at their taxable income. The Savings
Bank's deductions with respect to "qualifying real property loans," which are
generally loans secured by certain interest in real property, were computed
using an amount based on the Savings Bank's actual loss experience, or a
percentage equal to 8% of the Savings Bank's taxable income, computed with
certain modifications and reduced by the amount of any permitted additions to
the non-qualifying reserve. Due to the Savings Bank's loss experience, the
Savings Bank generally recognized a bad debt deduction equal to 8% of taxable
income.
The provisions repealing the current thrift bad debt rules were passed by
Congress as part of "The Small Business Job Protection Act of 1996." The new
rules eliminate the 8% of taxable income method for deducting additions to the
tax bad debt reserves for all thrifts for tax years beginning after December
31, 1995. These rules also require that all institutions recapture all or a
portion of their bad debt reserves added since the base year (last taxable
year beginning before January 1, 1988). The Savings Bank has previously
recorded a deferred tax liability equal to the bad debt recapture and as such
the new rules will have no effect on the net income or federal income
37
<PAGE>
<PAGE>
tax expense. For taxable years beginning after December 31, 1995, the Savings
Bank's bad debt deduction will be determined under the experience method using
a formula based on actual bad debt experience over a period of years or, if
the Savings Bank is a "large" association (assets in excess of $500 million)
on the basis of net charge-offs during the taxable year. The new rules allow
an institution to suspend bad debt reserve recapture for the 1996 and 1997 tax
years if the institution's lending activity for those years is equal to or
greater than the institutions average mortgage lending activity for the six
taxable years preceding 1996 adjusted for inflation. For this purpose, only
home purchase or home improvement loans are included and the institution can
elect to have the tax years with the highest and lowest lending activity
removed from the average calculation. If an institution is permitted to
postpone the reserve recapture, it must begin its six year recapture no later
than the 1998 tax year. The unrecaptured base year reserves will not be
subject to recapture as long as the institution continues to carry on the
business of banking. In addition, the balance of the pre-1988 bad debt
reserves continue to be subject to provisions of present law referred to below
that require recapture in the case of certain excess distributions to
shareholders.
Distributions. To the extent that the Savings Bank makes "nondividend
distributions" to the Company, such distributions will be considered to result
in distributions from the balance of its bad debt reserve as of December 31,
1987 (or a lesser amount if the Savings Bank's loan portfolio decreased since
December 31, 1987) and then from the supplemental reserve for losses on loans
("Excess Distributions"), and an amount based on the Excess Distributions will
be included in the Savings Bank's taxable income. Nondividend distributions
include distributions in excess of the Savings Bank's current and accumulated
earnings and profits, distributions in redemption of stock and distributions
in partial or complete liquidation. However, dividends paid out of the
Savings Bank's current or accumulated earnings and profits, as calculated for
federal income tax purposes, will not be considered to result in a
distribution from the Savings Bank's bad debt reserve. The amount of
additional taxable income created from an Excess Distribution is an amount
that, when reduced by the tax attributable to the income, is equal to the
amount of the distribution. Thus, if, after the Conversion, the Savings Bank
makes a "nondividend distribution," then approximately one and one-half times
the Excess Distribution would be includable in gross income for federal income
tax purposes, assuming a 34% corporate income tax rate (exclusive of state and
local taxes). See "REGULATION OF THE SAVINGS BANK" for limits on the payment
of dividends by the Savings Bank. The Savings Bank does not intend to pay
dividends that would result in a recapture of any portion of its tax bad debt
reserve.
Corporate Alternative Minimum Tax. The Code imposes a tax on alternative
minimum taxable income ("AMTI") at a rate of 20%. In addition, only 90% of
AMTI can be offset by net operating loss carryovers. AMTI is increased by an
amount equal to 75% of the amount by which the Savings Bank'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
0.12% of the excess of AMTI (with certain modification) over $2.0 million is
imposed on corporations, including the Savings Bank, whether or not an
Alternative Minimum Tax is paid.
Dividends-Received Deduction. The Company may exclude from its income
100% of dividends received from the Savings Bank 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 Savings Bank will not file a
consolidated tax return, except that if the Company or the Savings Bank owns
more than 20% of the stock of a corporation distributing a dividend, then 80%
of any dividends received may be deducted.
Audits. The Savings Bank's federal income tax returns have been audited
through September 30, 1997. The Savings Bank did not incur any net increase
in tax liability as a result of the audit.
Washington Taxation
The Savings Bank is subject to a business and occupation tax imposed
under Washington law at the rate of 1.60% of gross receipts. Interest received
on loans secured by mortgages or deeds of trust on residential properties is
exempt from such tax.
38
<PAGE>
<PAGE>
Competition
The Savings Bank operates in an intensely competitive market for the
attraction of savings deposits (its primary source of lendable funds) and in
the origination of loans. Historically, its most direct competition for
savings deposits has come from large commercial banks, thrift institutions and
credit unions in its primary market area. Particularly in times of high
interest rates, the Savings Bank has faced additional significant competition
for investors' funds from short-term money market securities and other
corporate and government securities. The Savings Bank's competition for loans
comes principally from mortgage bankers, commercial banks and other thrift
institutions. Such competition for deposits and the origination of loans may
limit the Savings Bank's future growth and earnings prospects.
Subsidiary Activities
The Savings Bank has one wholly-owned subsidiary, Timberland Service
Corporation ("Timberland Service"), whose primary function is to act as the
Savings Bank's escrow department. Additionally, Timberland Service's
employees sell annuities through the Savings Bank.
Personnel
As of September 30, 1997, the Savings Bank had 77 full-time employees and
21 part-time employees. The employees are not represented by a collective
bargaining unit and the Savings Bank believes its relationship with its
employees is good.
Item 2. Properties
- -------------------
The Savings Bank operates eight full-service facilities. The Savings
Bank owns its all of its offices except for the Port Orchard Loan Center,
which is leased. The lease expires in July 1998.
The following table sets forth certain information regarding the Savings
Bank's offices at September 30, 1997, all of which are owned except for the
loan center, which is leased.
Approximate
Location Year Opened Square Footage Deposits
- -------- ---------- -------------- --------
(In thousands)
Main Office:
624 Simpson Avenue 1966 7,700 $60,272
Hoquiam, Washington 98550
Branch Offices:
300 N. Boone Street 1974 3,400 23,675
Aberdeen, Washington 98520
39
<PAGE>
<PAGE>
Approximate
Location Year Opened Square Footage Deposits
- -------- ----------- -------------- ---------
(In thousands)
314 Main South 1975 2,800 $19,580
Montesano, Washington 98563
361 Damon Road 1977 2,100 20,577
Ocean Shores, Washington 98569
2418 Meridian East 1980 2,400 33,153
Edgewood, Washington 98371
12814 Meridian East (South Hill) 1996 4,200 5,215
Puyallup, Washington 98373
202 Auburn Way South 1994 4,200 9,461
Auburn, Washington 98002
1201 Marvin Road, N.E. 1997 4,400 1,070
Lacey, Washington 98516
Loan Center:
Port Orchard Loan Center 1995 444 N/A
700 Prospect Street, Suite #102
Port Orchard, Washington 98366
Data Center:
422 6th Street 1990 2,700 N/A
Hoquiam, Washington 98550
The Savings Bank also operates ten proprietary ATMs that are part of a
nationwide cash exchange network.
Item 3. Legal Proceedings
- --------------------------
Periodically, there have been various claims and lawsuits involving the
Savings Bank, such as claims to enforce liens, condemnation proceedings on
properties in which the Savings Bank holds security interests, claims
involving the making and servicing of real property loans and other issues
incident to the Savings Bank's business. The Savings Bank is 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 Savings Bank.
Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended September 30, 1997.
40
<PAGE>
<PAGE>
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
- -------------------------------------------------------------------------
The Company had no shares of Common Stock outstanding at September 30,
1997.
The Board of Directors of the Company has not formulated a dividend
policy, but intends to consider a policy of paying cash dividends in the
future. The payment of dividends on the Common Stock will be subject to the
requirements of applicable law and the determination by the Board of Directors
of the Company that the net income, capital and financial condition of the
Company, industry trends and general economic conditions justify the payment
of dividends. The rate of such dividends and the initial or continued payment
thereof will depend upon various factors at the intended time of declaration
and payment, including the Savings Bank's profitability and liquidity,
alternative investment opportunities, and regulatory restrictions on dividend
payments and on capital levels applicable to the Savings Bank. Accordingly,
there can be no present assurance that any dividends will be paid.
Periodically, the Board of Directors, if market, economic and regulatory
conditions permit, may combine or substitute periodic special dividends with
or for regular dividends. In addition, since the Company initially will have
no significant source of income other than dividends from the Savings Bank and
earnings from investment of the net proceeds of the Conversion retained by the
Company, the payment of dividends by the Company will depend in part upon the
amount of the net proceeds from the Conversion retained by the Company and the
Company's earnings thereon and the receipt of dividends from the Savings Bank,
which are subject to various tax and regulatory restrictions on the payment of
dividends. Dividend payments by the Company will be subject to regulatory
restriction under Federal Reserve policy as well as to limitation under
applicable provisions of Washington corporate law. Under Washington law, the
Company is prohibited from paying a dividend is, as a result of its payment,
the Company would be unable to pay its debts as they become due in the normal
course of business, or if the Company's total liabilities would exceed its
total assets.
Item 6. Selected Financial Data
- --------------------------------
The information under Item 1 of this Report under the caption "Selected
Consolidated Financial Information" is incorporated herein by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- -----------------------------------------------------------------------
General
Management's discussion and analysis of financial condition and results
of operations is intended to assist in understanding the financial condition
and results of operations of the Savings Bank. The information contained in
this section should be read in conjunction with the Consolidated Financial
Statements and accompanying Notes thereto.
Comparison of Financial Condition at September 30, 1996 and September 30, 1997
Total assets increased 8.8% from $194.4 million at September 30, 1996 to
$211.6 million at September 30, 1997, primarily as a result of an increase in
loans receivable, net, which was funded by increased deposits and retained net
income.
Cash and due from financial institutions increased 126.4% from $5.1
million at September 30, 1996 to $11.4 million at September 30, 1997,
primarily as a result of an increase in public unit funds on deposit.
Investments and mortgage-backed securities held-to-maturity decreased
14.5% from $6.5 million at September 30, 1996 to $5.6 million at September 30,
1997. This decrease was attributable primarily to prepayments.
41
<PAGE>
<PAGE>
Loans receivable, including loans held-for-sale, net, increased 6.0% from
$176.5 million at September 30, 1996 to $187.0 million at September 30, 1997,
primarily as a result of an increase in one- to- four family mortgage loans
from $96.0 million at September 30, 1996 to $100.1 million at September 30,
1997. Increases in commercial real estate loans (from $26.5 million to $29.4
million) and home equity and second mortgage loans (from $6.6 million to $8.1
million) also contributed to the increase in loans receivable, net. The
increase in loans receivable, net, was attributable primarily to the opening
of the South Hill branch office in October 1996 and the Lacey branch office in
May 1997, as well as increased local loan demand. Construction and land
development loans, however, decreased from $47.1 million at September 30, 1996
to $45.0 million at September 30, 1997 primarily as a result of construction
loans being converted to permanent mortgage loans.
Loans held-for-sale decreased from $6.1 million at September 30, 1996 to
$3.9 million at September 30, 1997. This 37.1% decrease resulted primarily
from increased loans sales.
Premises and fixed assets, net, increased 11.8% from $4.9 million at
September 30, 1996 to $5.4 million at September 30, 1997, primarily as a
result of construction of the Lacey branch office, which opened in May 1997.
See "Item 2. Properties."
Deposits increased 10.5% from $156.5 million at September 30, 1996 to
$173.0 million at September 30, 1997, primarily as a result of normal growth
and promotions associated with the opening of the South Hill and Lacey branch
offices. The Savings Bank offered certificates of deposit with premium
interest rates during a one month period after the opening of each branch
office as an incentive to attract depositors in light of increased competition
in these markets.
Total capital increased 15.5% from $21.3 million at September 30, 1996 to
$24.6 million at September 30, 1997, primarily as a result of retained net
income for the year ended September 30, 1997.
Comparison of Operating Results for the Years Ended September 30, 1996 and
1997
Net Income. Net income increased 24.3% from $2.7 million for the year
ended September 30, 1996 to $3.3 million for the year ended September 30, 1997
primarily as a result of the legislatively-mandated, one-time assessment
levied by the FDIC on all SAIF-insured institutions to recapitalize the SAIF.
Without this assessment, which amounted to $875,000 ($571,000 after tax) and
was accrued during the year ended September 30, 1996, net income would have
been $3.2 million for the year ended September 30, 1996.
Net Interest Income. Net interest income increased from $8.9 million for
the year ended September 30, 1996 to $9.6 million for the year ended September
30, 1997 as a result of total interest income increasing more than interest
expense.
Total interest income increased 8.8% from $16.5 million for the year
ended September 30, 1996 to $17.9 million for the year ended September 30,
1997 primarily as a result of an increase in the average balance of loans
receivable, net, from $168.0 million to $188.7 million as a result of
increased loan demand. The average yield earned on loans receivable, net,
decreased from 9.45% for year ended September 30, 1996 to 9.23% for the year
ended September 30, 1997 primarily because of a decline in market interest
rates and an increase in the balance of nonaccrual loans. See "Item 1.
Business -- Lending Activities -- Nonperforming Assets and Delinquencies."
Total interest expense increased 9.9% from $7.6 million for the year
ended September 30, 1996 to $8.4 million for the year ended September 30, 1997
primarily as a result of an increase in the average balance of deposit
accounts from $144.4 million to $154.9 million.
The interest rate spread decreased from 4.34% for the year ended
September 30, 1996 to 4.18% for the year ended September 30, 1997 primarily as
a result of declining market interest rates and the effect of deposit account
promotions associated with the opening of the South Hill and Lacey branch
offices. The Savings Bank also increased
42
<PAGE>
<PAGE>
rates on deposit accounts in response to increased competition, which also
contributed to the reduction in the interest rate spread.
Provision for Loan Losses. The provision for loan losses increased from
$70,000 for the year ended September 30, 1996 to $597,000 for the year ended
September 30, 1997. Based on the previously discussed risk weighted analysis
performed quarterly by management, management increased the provision as a
result of a change in the loan mix to include a larger percentage of
non-residential mortgage loans, which are inherently riskier than one- to-
four family mortgage loans, as well as its evaluation of nonperforming loans
at September 30, 1997. Management deemed the allowance for loan losses
adequate at September 30, 1997. See "Item 1. Business -- Lending Activities
- -- Allowance for Loan Losses."
Noninterest Income. Total noninterest income increased 37.0% from
$654,000 for the year ended September 30, 1996 to $896,000 for the year ended
September 30, 1997. The increase resulted primarily from the recognition of
mortgage loan servicing income in accordance with SFAS No. 125 beginning in
January 1997 and normal increases in other income categories.
Noninterest Expense. Total noninterest expense decreased 6.5% from $5.4
million for the year ended September 30, 1996 to $5.0 million for the year
ended September 30, 1997 primarily as a result of the one-time SAIF assessment
fee accrued during fiscal 1996. Salaries and employee benefits increased from
$2.5 million to $2.9 million and premises and fixed assets expense increased
from $554,000 to $723,000, both as a result of the opening of the South Hill
and Lacey branch offices.
Provision for Income Taxes. The provision for income taxes increased
from $1.4 million for the year ended September 30, 1996 to $1.8 million for
the year ended September 30, 1997 as a result of higher income before income
taxes. The effective tax rate was 34.6% in fiscal 1996 and 35.5% in fiscal
1997.
Comparison of Operating Results for the Years Ended September 30, 1995 and
1996
Net Income. Net income decreased 10.7% from $3.0 million in fiscal 1995
to $2.7 million in fiscal 1996 primarily as a result of the
legislatively-mandated, one-time assessment levied by the FDIC on all
SAIF-insured institutions to recapitalize the SAIF. Without this assessment,
which amounted to $875,000 ($571,000 after tax), fiscal 1996 net income would
have been $3.2 million.
Net Interest Income. Net interest income increased 9.6% from $8.1
million in fiscal 1995 to $8.9 million in fiscal 1996 as total interest income
increased more than total interest expense.
Total interest income increased 14.2% from $14.5 million in fiscal 1995
to $16.5 million in fiscal 1996 primarily as a result of an increase in the
average balance of loans receivable, net, from $143.1 million in fiscal 1995
to $168.1 million in fiscal 1996 as a result of increased loan demand. The
average yield earned on loans receivable, net, decreased from 9.51% in fiscal
1995 to 9.45% in fiscal 1996 primarily because of a decline in market interest
rates. Interest earned on investment and mortgage-backed securities decreased
from $667,000 in fiscal 1995 to $397,000 in fiscal 1996 as average balances
decreased from $12.7 million in fiscal 1995 to $6.7 million in fiscal 1996 as
a result of prepayments of mortgage-backed securities and the maturity of U.S.
Treasury securities. Dividend income from FHLB-Seattle and Financial
Institution Insurance Group ("FIIG") stock increased from $98,000 in fiscal
1995 to $126,000 in fiscal 1996 primarily because of higher dividend rates.
Interest earned from financial institutions on interest-earning deposits
increased from $85,000 in fiscal 1995 to $97,000 in fiscal 1996 as a result of
an increase in the average rate paid from 4.11% in fiscal 1995 to 4.68% in
fiscal 1996.
Total interest expense increased 20.0% from $6.4 million in fiscal 1995
to $7.6 million in fiscal 1996 primarily as a result of an increase in the
average balance of certificates of deposit from $73.6 million in fiscal 1995
to $89.0 million in fiscal 1996, coupled with an increase in the average rate
paid from 5.41% in fiscal 1995 to 5.92% in fiscal 1996, as a result of
promotions associated with the opening of the South Hill branch office.
43
<PAGE>
<PAGE>
Interest rate spread decreased from 4.56% in fiscal 1995 to 4.34% in
fiscal 1996. This decrease is primarily attributable to higher interest
expense on certificates of deposit associated with new branch office
promotions.
Provision for Loan Losses. There was no provision for loan losses in
fiscal 1995 compared to $70,000 in fiscal 1996. Management increased the
provision in fiscal 1996 as a result of a larger loan portfolio and a change
in the loan mix (as quantified by the quarterly reserve analysis described
previously) to include a larger percentage of non-residential mortgage loans,
which are inherently riskier than one- to- four family mortgage loans.
As a result of management's quarterly reserve analysis discussed
previously, the calculated reserve range was between $589,000 and $2.2 million
at September 30, 1996. The four nonperforming loans described under "Item 1.
Business -- Lending Activities -- Nonperforming Assets and Delinquencies"
added $33,000 and $141,000 to the high and low ends, respectively, of the
calculated reserve range at September 30, 1996. General loan loss reserves
were $1.1 million at September 30, 1996 and, in management's opinion, were
adequate to provide for estimated losses based on an evaluation of known and
inherent risks in the loan portfolio at that date. Management considered the
likelihood of losses in excess of $1.1 million to be remote at September 30,
1996. See "Item 1. Business -- Lending Activities -- Allowance for Loan
Losses."
Noninterest Income. Total noninterest income increased 15.1% from
$598,000 in fiscal 1995 to $688,000 in fiscal 1996. The increase resulted
primarily from an increase in other fees from $113,000 in fiscal 1995 to
$163,000 in fiscal 1996 as a result of an increased number of ATMs, together
with increased escrow and annuity fees from $111,000 in fiscal 1995 to
$132,000 in fiscal 1996 as a result of establishing a second escrow company
division within the Savings Bank's service corporation subsidiary to service
the Puget Sound area. This increase was partially offset by a decrease in
gains on sales of loan from $45,000 in fiscal 1995 to $34,000 in fiscal 1996
because of lower sales volume resulting from higher market interest rates.
Noninterest Expense. Total noninterest expense increased 31.9% from $4.1
million in fiscal 1995 to $5.4 million in fiscal 1996 primarily as a result of
an increase in deposit insurance premiums from $295,000 in fiscal 1995 to $1.2
million in fiscal 1996 attributable to the SAIF assessment. Prior to the SAIF
recapitalization, the Savings Bank's total annual deposit insurance premiums
amounted to 0.23% of assessable deposits. Effective January 1, 1997, the rate
decreased to 0.065% of assessable deposits. See "REGULATION OF THE SAVINGS
BANK -- Deposit Insurance." Salaries and employee benefits increased from
$2.3 million in fiscal 1995 to $2.5 million in fiscal 1996 as a result of
adding and training of staff to operate the newly opened South Hill branch
office. Premises and fixed assets expense increased from $506,000 in fiscal
1995 to $554,000 in fiscal 1996, also because of the opening of the South Hill
branch office.
Provision for Income Taxes. The provision for income taxes decreased
from $1.6 million in fiscal 1995 to $1.4 million in fiscal 1996 as a result of
lower income before income taxes. The effective tax rate was 34.8% in fiscal
1995 and 34.6% in fiscal 1996.
Average Balances, Interest and Average Yields/Cost
The following table sets forth certain information for the periods
indicated 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 and average
yields and costs. Such yields and costs for the periods indicated are derived
by dividing income or expense by the average weekly balance of assets or
liabilities, respectively, for the periods presented. Average balances are
derived from weekly balances. Management does not believe that the use of
weekly balances instead of daily balances has caused any material difference
in the information presented.
44
<PAGE>
<PAGE>
<TABLE>
Year Ended September 30,
-------------------------------------------------------------------------------
1995 1996 1997
Interest Interest Interest
Average and Yield/ Average and Yield/ Average and Yield/
Balance Dividends Cost Balance Dividends Cost Balance Dividends Cost
------- --------- ---- ------- --------- ---- ------- --------- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable(1)(2). $143,103 $13,603 9.51% $168,060 $15,880 9.45% $188,729 $17,418 9.23%
Mortgage-backed and
investment securities. 12,676 667 5.26 6,689 397 5.94 4,484 279 6.22
FHLB stock and equity
securities . . . . . . 1,370 99 7.15 1,499 126 8.41 1,550 116 7.48
Interest-bearing
deposits . . . . . . . 2,069 85 4.11 2,072 97 4.68 2,758 134 4.86
Total interest-earning -------- ------- -------- ------- -------- -------
assets . . . . . . . 159,218 14,454 9.08 178,320 16,500 9.25 197,521 17,947 9.09
Non-interest-earning
assets. . . . . . . . . 5,294 5,674 7,598
-------- -------- --------
Total assets. . . . . $164,512 $183,994 $205,119
Interest-bearing ======== ======== ========
liabilities:
Passbook accounts . . . $ 27,512 821 2.98 $ 24,800 738 2.98 25,068 750 2.99
Money market accounts . 10,115 469 4.64 13,182 520 3.94 12,985 514 3.96
NOW accounts. . . . . . 19,078 425 2.23 17,377 421 2.42 17,997 445 2.47
Certificates of deposit 73,596 3,981 5.41 89,024 5,271 5.92 98,842 5,807 5.88
FHLB advances-other
borrowed money . . . . 10,539 664 6.30 11,005 679 6.17 15,980 870 5.44
Total interest bearing -------- ------- -------- ------- -------- -------
liabilities. . . . . $140,840 $ 6,360 4.52 $155,388 $ 7,629 4.91 $170,872 $ 8,386 4.91
Non-interest bearing
liabilities. . . . . . 6,474 8,330 11,107
-------- -------- --------
Total liabilities . . 147,314 163,718 181,979
Retained earnings. . . . 17,198 20,276 23,140
-------- -------- --------
Total liabilities and
retained earnings. . $164,512 $183,994 $205,119
======== ======== ========
Net interest income. . . $ 8,094 $ 8,871 $ 9,561
Interest rate spread . . 4.56% 4.34% 4.18%
Net interest margin(3) . 5.08% 4.97% 4.84%
Ratio of interest-earning
assets to average
interest-bearing
liabilities . . . . . . 113.05% 114.76% 115.60%
- --------------------
(1) Does not include interest on loans 90 days or more past due. Includes loans originated for sale.
(2) Average balance includes nonaccrual loans.
(3) Net interest income divided by total interest earning assets.
45
</TABLE>
<PAGE>
<PAGE>
Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes
on net interest income of the Savings Bank. Information is provided with
respect to (i) effects on interest income attributable to changes in volume
(changes in volume multiplied by prior rate); and (ii) effects on interest
income attributable to changes in rate (changes in rate multiplied by prior
volume); (iii) changes in rate/volume (change in rate multiplied by change in
volume); and (iv) the net change (sum of the prior columns).
Year Ended September 30, Year Ended September 30,
1996 Compared to Year 1997 Compared to Year
Ended September 30, 1995 Ended September 30, 1996
Increase (Decrease) Increase (Decrease)
Due to Due to
---------------------------- ----------------------------
Rate/ Net Rate/ Net
Rate Volume Volume Change Rate Volume Volume Change
---- ------ ------ ------ ---- ------ ------ ------
(Dollars in thousands)
Interest-earning
assets:
Loans
receivable
(1)(2). . . . $(86) $2,377 $(15) $2,276 $(370) $1,954 $(45) $1,539
Mortgage-backed
securities and
investment
securities. . . 86 (315) (41) (270) 19 (131) (6) (118)
FHLB stock and
equity
securities. . . 17 9 2 28 (14) 4 -- (10)
Interest-bearing
deposits. . . . 12 -- -- 12 4 32 1 37
----- ------ ----- ------ ----- ------ ---- ------
Total net change
in income on
interest-earning
assets. . . . . . 29 2,071 (54) 2,046 (361) 1,859 (50) 1,448
Interest-bearing
liabilities:
Passbook accounts -- (83) -- (83) 3 9 -- 12
NOW accounts. . . 36 (37) (3) (4) 9 15 -- 24
Money market
accounts . . . . (71) 144 (22) 51 3 (9) -- (6)
Certificate
accounts . . . . 375 836 79 1,290 (36) 576 (4) 536
FHLB advances and
other borrowed
money. . . . . . (14) 30 (1) 15 (80) 307 (36) 191
----- ------ ----- ------ ----- ------ ---- ------
Total net change
in expense on
interest-bearing
liabilities . . . 326 890 53 1,269 (101) 898 (40) 757
----- ------ ----- ------ ----- ------ ---- ------
Net change in net
interest income $(297) $1,181 $(107) $ 777 $(260) $ 961 $(10) $ 691
===== ====== ===== ====== ===== ====== ==== ======
- ---------------------
(1) Excludes interest on loans 90 days or more past due. Includes loans
originated for sale.
(2) Net change in interest income on loans includes loan fees of $164,000,
$164,000 and $157,000 for the years ended September 30, 1995, 1996 and
1997, respectively.
46
<PAGE>
<PAGE>
Asset and Liability Management and Interest Rate Risk
The Savings Bank's principal financial objective is to achieve long-term
profitability while reducing its exposure to fluctuating market interest
rates. The Savings Bank has sought to reduce the exposure of its earnings to
changes in market interest rates by attempting to manage the mismatch between
asset and liability maturities and interest rates. The principal element in
achieving this objective is to increase the interest-rate sensitivity of the
Savings Bank's interest-earning assets by retaining for its portfolio loans
with interest rates subject to periodic adjustment to market conditions and
selling fixed-rate one- to- four family mortgage loans. The Savings Bank
relies on retail deposits as its primary source of funds. Management believes
retail deposits, compared to brokered deposits, reduce the effects of interest
rate fluctuations because they generally represent a more stable source of
funds. As part of its interest rate risk management strategy, the Savings Bank
promotes transaction accounts and certificates of deposit with terms up to six
years.
The Savings Bank has adopted a strategy that is designed to maintain or
improve the interest rate sensitivity of assets relative to its liabilities.
The primary elements of this strategy involve the origination of ARM loans for
its portfolio; maintaining residential construction loans as a portion of
total net loans receivable because of their generally shorter terms and higher
yields than other one- to- four family residential mortgage loans; matching
asset and liability maturities; investing in short-term securities; and the
origination of fixed-rate loans for sale in the secondary market and the
retention of the related loan servicing rights.
Sharp decreases in interest rates may adversely affect the Savings Bank's
earnings while increases in interest rates may beneficially affect the Savings
Bank's earnings because a larger portion of the Savings Bank's interest rate
sensitive assets than interest rate sensitive liabilities would reprice within
a one year period. Management has sought to sustain the match between asset
and liability maturities and rates, while maintaining an acceptable interest
rate spread. Pursuant to this strategy, the Savings Bank actively originates
adjustable rate loans for retention in its loan portfolio. Fixed-rate
mortgage loans generally are originated for the intended purpose of resale in
the secondary mortgage market. At September 30, 1997, adjustable rate loans
and adjustable rate mortgage-backed securities constituted $131.5 million, or
62.8%, of the Savings Bank's total combined mortgage loan and mortgage-backed
securities portfolio. Although the Savings Bank has sought to originate ARM
loans, the ability to originate such loans depends to a great extent on market
interest rates and borrowers' preferences. Particularly in lower interest
rate environments, borrowers often prefer to obtain fixed rate loans.
Consumer loans and construction and land development loans typically have
shorter terms and higher yields than permanent residential mortgage loans, and
accordingly reduce the Savings Bank's exposure to fluctuations in interest
rates. At September 30, 1997, the construction and land development and
consumer loan portfolios amounted to $45.0 million and $11.0 million, or 21.9%
and 5.3% of total loans receivable, respectively. See "Item 1. Business --
Lending Activities -- Construction and Land Development Lending" and "--
Lending Activities -- Consumer Lending."
The Savings Bank also invests in short-term to medium-term U.S.
Government securities as well as mortgage-backed securities issued or
guaranteed by U.S. Government agencies. See "Item 1. Business -- Investment
Activities."
The following table is provided by the Office of Thrift Supervision
("OTS") and illustrates the change in net portfolio value ("NPV") at September
30, 1997, based on OTS assumptions, that would occur in the event of an
immediate change in interest rates, with no effect given to any steps that
management might take to counter the effect of that interest rate movement.
47
<PAGE>
<PAGE>
<TABLE>
The following table presents the Savings Bank's interest sensitivity gap between interest-earning
assets and interest-bearing liabilities at September 30, 1997.
First Year Repricing Later Repricing
-------------------------- -----------------------------------------------
0-3 4-6 7-12 1-3 3-5 5-10 10-20 Over 20
TOTAL Months Months Months Years Years Years Years Years
----- ------ ------ ------ ----- ----- ----- ----- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
LOANS(1)
ARMs . . . . . $93,727 $25,437 $29,277 $16,097 $21,411 $1,505 $ -- $ -- $ --
Fixed rate
mortgages . . 20,758 2,684 2,298 3,440 6,248 2,693 2,273 973 148
Home equity/
security
mortgage. . . 8,117 2,711 784 970 2,186 868 527 72 --
Consumer . . . 1,797 1,031 223 212 253 48 24 6 --
Automobile . . 1,028 138 117 204 439 98 26 6 --
Construction . 28,147 12,753 3,762 6,381 4,014 -- 1,237 -- --
Nonresidential
mortgage
(adjustable
rate) . . . . 22,548 2,893 2,852 5,590 11,213 --
Nonresidential
mortgage
(fixed rate). 13,710 1,593 1,352 2,283 5,432 1,935 998 117 --
Commercial
variable rate 8 8 -- -- -- -- -- -- --
Commercial fixed
rate. . . . . 685 132 49 92 296 114 3 -- --
INVESTMENTS
Investment
securities. . 8,037 8,037 -- -- -- -- -- -- --
Mortgage
securities. . 3,990 1,295 1,648 560 452 28 5 3 --
Total rate -------- ------- ------- ------- ------- ------- ------ ------ ----
sensitive
assets . . . . $202,552 $58,711 $42,362 $35,828 $51,944 $7,289 $5,092 $1,177 $148
======== ======= ======= ======= ======= ======= ====== ====== ====
LIABILITIES
Money market
deposits. . . $14,424 $4,778 $3,195 $3,566 $2,769 $111 $ 5 $ -- $ --
Certificates of
deposit . . . 104,758 21,791 25,647 28,845 26,028 2,066 329 52 --
Passbook
accounts. . . 26,269 2,241 2,050 3,590 9,378 4,595 3,673 721 21
NOW accounts . 19,587 1,671 1,528 2,677 6,993 3,426 2,739 538 16
BORROWINGS
FHLB advances. 12,241 -- -- 500 -- 10,442 1,299 -- --
Total rate -------- ------- ------- ------- ------- ------- ------- ------- ----
sensitive
liabilities. . $177,279 $30,481 $32,420 $39,178 $45,168 $20,640 $ 8,044 $ 1,311 $ 37
======== ======= ======= ======= ======= ======= ======= ======= ====
PERIODIC GAP. . $28,230 $ 9,942 $(3,349) $ 6,776 $(13,351) $(2,952) $ (134) $ 112
Gap ratio. . . 1.93% 1.31% 0.91% 1.15% 0.35% 0.63% 0.90% 4.06%
Gap percentage
total . . . . 13.34 4.70 (1.58) 3.20 (6.31) (1.40) (0.06) 0.05
CUMULATIVE GAP $28,230 $38,172 $34,822 $41,598 $28,247 $25,295 $25,161 $25,273
Gap ratio. . . 1.93 1.61 1.34 1.28 1.17 1.14 1.14 1.14
Gap percentage
total . . . . 13.34 18.04 16.46 19.66 13.35 11.96 11.89 11.95
- ----------------
(1) Net of loans in process.
48
</TABLE>
<PAGE>
<PAGE>
The Savings Bank's analysis of its interest-rate sensitivity, as
illustrated in the preceding table, incorporates certain assumptions regarding
the amortization of loans and other interest-earning assets and the withdrawal
of deposits. The Savings Bank's interest-rate sensitivity analysis, as
illustrated in the foregoing table, could vary substantially if different
assumptions were used or if actual experience differs from the assumptions
used. The assumptions used in preparing the table are based on market loan
prepayment rates and market deposit decay rates observed by the FHLB-Seattle
on or about September 30, 1997. The Savings Bank believes that the
FHLB-Seattle assumptions are a realistic representation of its own portfolio.
Net Portfolio Value and Net Interest Income Analysis. In addition to the
interest rate gap analysis as discussed above, management monitors the Savings
Bank's interest rate sensitivity through the use of a model which estimates
the change in NPV and net interest income in response to a range of assumed
changes in market interest rates. The model first estimates the level of the
Savings Bank's NPV (market value of assets, less market value of liabilities,
plus or minus the market value of any off-balance sheet items) under the
current rate environment. In general, market values are estimated by
discounting the estimated cash flows of each instrument by appropriate
discount rates. The model then recalculates the Savings Bank's NPV under
different interest rate scenarios. The change in NPV under the different
interest rate scenarios provides a measure of the Savings Bank's exposure to
interest rate risk. The following information is presented as of September
30, 1997.
Projected Net Interest Income Current Market Value
Interest ------------------------------- -------------------------------
Rate Estimated $ Change % Change Estimated $ Change % Change
Scenario Value from Base from Base Value from Base from Base
- -------- ----- --------- --------- ----- --------- ---------
(Dollars in thousands)
400 $9,226 $531 6.11% $24,455 $(931) (3.67)%
300 9,299 604 6.95 25,528 142 0.56
200 9,360 665 7.65 26,485 1,099 4.33
100 9,095 400 4.60 26,348 962 3.79
BASE 8,695 -- -- 25,386 -- --
(100) 8,228 (467) (5.37) 23,948 (1,438) (5.67)
(200) 7,714 (981) (11.28) 22,261 (3,125) (12.31)
(300) 7,362 (1,333) (15.33) 21,252 (4,135) (16.29)
(400) 6,971 (1,723) (19.82) 20,823 (4,563) (17.97)
Computations of prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market
interest rates, loan repayments and deposit decay, and should not be relied
upon as indicative of actual results. Further, the computations do not
reflect any actions management may undertake in response to changes in
interest rates.
In the event of a 200 basis point decrease in interest rates, the Savings
Bank would be expected to experience an 12.3% decrease in NPV and a 11.3%
decrease in net interest income. In the event of a 200 basis point increase
in interest rates, a 4.3% increase in NPV and a 7.7% increase in net interest
income would be expected. Based upon the modelling described above, the
Savings Bank's asset and liability structure results in decreases in NPV and
decreases in net interest income in a declining interest rate scenario and
increases in NPV and increases in net interest income in a rising interest
rate scenario. However, the amount of change in value of specific assets and
liabilities due to changes in rates is not the same in a rising rate
environment as in a falling rate environment.
As with any method of measuring interest rate risk, certain shortcomings
are inherent in the method of analysis presented in the foregoing table. For
example, although certain assets and liabilities may have similar maturities
or periods to repricing, they may react in different degrees to changes in
market interest rates. Also, the interest rates on certain types of assets
and liabilities may fluctuate in advance of changes in market interest rates,
while interest rates on other types may lag behind changes in market rates.
Additionally, certain assets have
49
<PAGE>
<PAGE>
features which 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, expected rates of prepayments on loans and early withdrawals from
certificates could likely deviate significantly from those assumed in
calculating the table.
Liquidity and Capital Resources
The Savings Bank's primary sources of funds are customer deposits,
proceeds from principal and interest payments on and the sale of loans,
maturing securities and FHLB advances. While maturities and scheduled
amortization of loans are a predictable source of funds, deposit flows and
mortgage prepayments are greatly influenced by general interest rates,
economic conditions and competition.
The Savings Bank must maintain an adequate level of liquidity to ensure
the availability of sufficient funds to fund loan originations and deposit
withdrawals, to satisfy other financial commitments and to take advantage of
investment opportunities. The Savings Bank generally maintains sufficient
cash and short-term investments to meet short-term liquidity needs. At
September 30, 1997, the Savings Bank's regulatory liquidity ratio (net cash,
and short-term and marketable assets, as a percentage of net deposits and
short-term liabilities) was 11.11%. At September 30, 1997, the Savings Bank
also maintained an uncommitted credit facility with the FHLB-Seattle that
provided for immediately available advances up to an aggregate amount of $42.3
million, under which $12.2 million was outstanding.
Liquidity management is both a short- and long-term responsibility of the
Savings Bank's management. The Savings Bank adjusts its investments in liquid
assets based upon management's assessment of (i) expected loan demand, (ii)
projected loan sales, (iii) expected deposit flows, and (iv) yields available
on interest-bearing deposits. Excess liquidity is invested generally in
interest-bearing overnight deposits and other short-term government and agency
obligations. If the Savings Bank requires funds beyond its ability to
generate them internally, it has additional borrowing capacity with the FHLB
and collateral for repurchase agreements.
The Savings Bank's primary investing activity is the origination of one-
to- four family mortgage loans and construction and land development loans.
During the years ended September 30, 1995, 1996 and 1997, the Savings Bank
originated $26.9 million, $24.5 million and $27.1 million of one- to- four
family mortgage loans and $33.2 million, $29.7 million and $35.2 million of
construction and land development loans, respectively. At September 30, 1997,
the Savings Bank had mortgage loan commitments totalling $6.0 million and
undisbursed loans in process totalling $14.8 million. The Savings Bank
anticipates that it will have sufficient funds available to meet current loan
commitments. Certificates of deposit that are scheduled to mature in less
than one year from September 30, 1997 totalled $76.3 million. Historically,
the Savings Bank has been able to retain a significant amount of its deposits
as they mature.
Federally-insured state-chartered banks are required to maintain minimum
levels of regulatory capital. At September 30, 1997, the Savings Bank was in
compliance with all applicable FDIC capital requirements. For a detailed
discussion of regulatory capital requirements, see "REGULATION OF THE SAVINGS
BANK -- Capital Requirements."
Impact of New Accounting Pronouncements
Accounting for Employee Stock Ownership Plans. In November 1993 the
American Institute of Certified Public Accountants issued Statement of
Position ("SOP") 93-6, which requires an employer to record compensation
expense in an amount equal to the fair value of shares committed to be
released to employees from an employee stock ownership plan and to exclude
unallocated shares from earnings per share computations. The effect of SOP
93-6 on net income and book value per share in future periods cannot be
predicted due to the uncertainty of the fair value of the shares at the time
they will be committed to be released.
50
<PAGE>
<PAGE>
Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities. See Note 1 of Notes to the Consolidated
Financial Statements for a discussion of SFAS No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of
Liabilities," and of SFAS No. 127, "Deferral of the Effective Date of Certain
Provisions of SFAS No. 125. SFAS No. 127 defers the effective date of the
application of certain portions of SFAS No. 125 until January 1, 1998.
Following the adoption of SFAS No. 125 on January 1, 1997, the Savings Bank
recorded servicing income on loans sold of $160,000.
Earnings Per Share. SFAS No. 128, "Earnings Per Share," issued in
February 1997, establishes standards for computing and presenting earnings per
share ("EPS") and applies to entities with publicly-held common stock or
potential common stock. It replaces the presentation of primary EPS with a
presentation of basic EPS and requires the dual presentation of basic and
diluted EPS on the face of the income statement. SFAS No. 128 is effective
for the financial statements for the periods ending after December 15, 1997.
SFAS No. 128 requires restatement of all prior period EPS data presented. The
impact of its adoption is not expected to be material to the Savings Bank.
Disclosure of Information About Capital Structure. SFAS No. 129,
"Disclosure of Information About Capital Structure," establishes standards for
disclosing information about an entity's capital structure and applies to all
entities. SFAS No. 129 continues the previous requirements to disclose
certain information about an entity's capital structure found in Accounting
Principles Board ("APB") Opinions No. 10, "Omnibus Opinion - 1966," and No.
15, "Earnings Per Share," and SFAS No. 47, "Disclosure of Long-Term
Obligations," for entities that were subject to those standards. SFAS No. 129
is effective for financial statements for periods ending after December 15,
1997. SFAS No. 129 contains no change in disclosure requirements for entities
that were previously subject to the requirements of APB Opinions Nos. 10 and
15 and SFAS No. 47. The adoption of the provisions of SFAS No. 129 is not
expected to have a material impact on the Savings Bank.
Comprehensive Income. SFAS No. 130, "Reporting Comprehensive Income,"
issued in July 1997, establishes standards for reporting and presenting of
comprehensive income and its components (revenues, expenses, gains, and
losses) in a full set of general-purpose financial statements. It requires
that all items that are required to be recognized under accounting standards
as components of comprehensive income be reported in a financial statement
that is presented with the same prominence as other financial statements.
SFAS No. 130 requires that companies (i) classify items of other comprehensive
income by their nature in a financial statement and (ii) display the
accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of the statement
of financial condition. SFAS No. 130 is effective for fiscal years beginning
after December 15, 1997. Reclassification of financial statements for earlier
periods provided for comprehensive purposes is required.
Disclosure About Segments. SFAS No. 131, "Disclosure About Segments of
an Enterprise and Related Information," issued in June 1997, establishes
standards for disclosure about operating segments in annual financial
statements and selected information in interim financial reports. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. SFAS No. 131 supersedes SFAS No. 14,
"Financial Reporting for Segments of a Business Enterprise." SFAS No. 131
becomes effective for the Savings Bank's fiscal year ending September 30,
1999, and requires that comparative information from earlier years be restated
to conform to its requirements. The adoption of the provisions of SFAS No.
131 is not expected to have a material impact on the Savings Bank.
Disclosures About Fair Value of Financial Instruments. See Notes 1 and
14 of Notes to the Consolidated Financial Statements for a discussion of SFAS
No. 107, "Disclosures About Fair Value of Financial Instruments." The Savings
Bank adopted SFAS No. 107 for the year ended September 30, 1996.
Accounting for Stock-Based Compensation. SFAS No. 123, "Accounting for
Stock-Based Compensation," establishes financial accounting and reporting
standards for stock-based employee compensation
51
<PAGE>
<PAGE>
plans. This statement encourages all entities to adopt a new method of
accounting to measure compensation cost of all employee stock compensation
plans based on the estimated fair value of the award at the date it is
granted. Companies are, however, allowed to continue to measure compensation
cost for those plans using the intrinsic value based method of accounting,
which generally does not result in compensation expense recognition for most
plans. Companies that elect to remain with the existing accounting method are
required to disclose in a footnote to the financial statements pro forma net
income and, if presented, earnings per share, as if this statement had been
adopted. The accounting requirements of this statement are effective for
transactions entered into in fiscal years that begin after December 15, 1995;
however, companies are required to disclose information for awards granted in
their first fiscal year beginning after December 15, 1994. Management expects
to use the intrinsic value method upon consummation of the Conversion and the
adoption of stock based benefit plans.
Effect of Inflation and Changing Prices
The consolidated financial statements and related financial data
presented herein have been prepared in accordance with GAAP, which require the
measurement of financial position and operating results in terms of historical
dollars, without considering the change in the relative purchasing power of
money over time due to inflation. The primary impact of inflation is
reflected in the increased cost of the Savings Bank's operations. 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. Quantitative and Qualitative Disclosures About Market Risk
- --------------------------------------------------------------------
Quantitative Aspects of Market Risk. Neither the Company nor the Savings
Bank maintains a trading account for any class of financial instrument nor do
they engage in hedging activities or purchase high-risk derivative
instruments. Furthermore, neither the Company nor the Savings Bank is subject
to foreign currency exchange rate risk or commodity price risk. For
information regarding the sensitivity to interest rate risk of the Savings
Bank's interest-earning assets and interest-bearing liabilities, see the
tables under Item 1, "Lending Activities -- Loan Maturity," "-- Investment
Activities" and "-- Deposit Activities and Other Sources of Funds -- Time
Deposits by Maturities."
Qualitative Aspects of Market Risks. See the discussion under Item 7,
"Asset and Liability Management and Interest Rate Risk."
Item 8. Financial Statements and Supplementary Data
- -------------------------------------------------------
All schedules have been omitted as the required information is either
inapplicable or included in the Consolidated Financial Statements or related
Notes.
52
<PAGE>
<PAGE>
[Letterhead of Dwyer Pemberton and Coulson, P.C.]
November 13, 1997
Board of Trustees
Timberland Savings Bank, S.S.B.
We have audited the accompanying consolidated balance sheets of Timberland
Savings Bank, S.S.B. and subsidiary as of September 30, 1996 and 1997, and the
related consolidated statements of income, capital, and cash flows for each of
the three years in the period ended September 30, 1997. These consolidated
financial statements are the responsibility of the Savings Bank's management.
Our responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Timberland
Savings Bank, S.S.B. and subsidiary as of September 30, 1996 and 1997, and the
results of their operations and their cash flows for each of the three years
in the period ended September 30, 1997, in conformity with generally accepted
accounting principles.
As discussed in Note 1 to the consolidated financial statements, the Savings
Bank adopted Statement of Financial Accounting Standards No. 115, Accounting
For Certain Investments in Debt and Equity Securities, as of October 1, 1994,
adopted Statement of Financial Accounting Standards No. 107, Disclosures About
Fair Value of Financial Instruments, as of September 30, 1996 and adopted
Statement of Financial Accounting Standards No. 125, Accounting for Transfers
and Servicing of Financial Assets and Extinguishment of Liabilities, as of
January 1, 1997.
/s/Dwyer Pemberton and Coulson, P.C.
53
<PAGE>
<PAGE>
TIMBERLAND SAVINGS BANK, S.S.B.
CONSOLIDATED BALANCE SHEETS
September 30, 1996 and 1997
- ------------------------------------------------------------------------------
ASSETS
1996 1997
----------------------------
Cash and due from financial institutions:
Noninterest bearing deposits $ 3,930,641 $ 4,996,116
Interest bearing deposits 1,124,684 6,450,339
----------------------------
5,055,325 11,446,455
----------------------------
Investments and mortgage-backed securities:
Held to maturity, market value:
1996 - $4,865,614; 1997 - $3,981,865 4,950,794 3,990,229
Available for sale, cost:
1996 - $1,551,540; 1997 - $1,586,400 1,571,676 1,586,400
----------------------------
6,522,470 5,576,629
----------------------------
Loans receivable - net 170,368,073 183,171,027
Loans held for sale - at market value 6,126,870 3,856,293
----------------------------
176,494,943 187,027,320
----------------------------
Accrued interest receivable 1,056,885 1,137,052
Premises and fixed assets - net 4,856,347 5,431,187
Other real estate owned - net 124,533 433,715
Other assets 246,301 500,740
----------------------------
TOTAL ASSETS $194,356,804 $211,553,098
============================
LIABILITIES AND CAPITAL
LIABILITIES
Deposits $156,549,417 $173,003,403
Federal Home Loan Bank advances 14,354,380 12,241,304
Other liabilities and accrued expenses 2,123,705 1,663,506
----------------------------
TOTAL LIABILITIES 173,027,502 186,908,213
----------------------------
CAPITAL
Undivided profits 21,315,990 24,644,885
Net unrealized appreciation in equity
investments, net of deferred federal
income taxes of $6,824 in 1996 13,312 -0-
----------------------------
TOTAL CAPITAL 21,329,302 24,644,885
----------------------------
TOTAL LIABILITIES AND CAPITAL $ 194,356,804 $ 211,553,098
============================
See accompanying notes.
54
<PAGE>
<PAGE>
TIMBERLAND SAVINGS BANK, S.S.B.
CONSOLIDATED STATEMENTS OF INCOME
For the years ended September 30, 1995, 1996 and 1997
- ------------------------------------------------------------------------------
1995 1996 1997
---------------------------------------------
INTEREST AND DIVIDEND INCOME
Loans receivable $ 13,602,716 $ 15,879,506 $ 17,418,130
Investments and mortgage-
backed securities 666,671 396,571 279,212
Dividends 98,471 126,189 116,281
Financial institutions 85,461 97,283 133,776
---------------------------------------------
TOTAL INTEREST INCOME 14,453,319 16,499,549 17,947,399
---------------------------------------------
INTEREST EXPENSE
Deposits 5,695,604 6,949,485 7,515,843
Federal Home Loan Bank
advances and mortgage
indebtness 663,918 679,075 869,822
---------------------------------------------
TOTAL INTEREST EXPENSE 6,359,522 7,628,560 8,385,665
---------------------------------------------
NET INTEREST INCOME 8,093,797 8,870,989 9,561,734
PROVISION FOR LOAN LOSSES -0- 70,000 596,782
---------------------------------------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 8,093,797 8,800,989 8,964,952
---------------------------------------------
NONINTEREST INCOME
Service charges on deposits 277,275 278,046 313,667
Gain on sale of loans - net 44,512 33,908 339,199
Other fees 113,129 163,419 200,119
Income (loss) on operations
of real estate - net (17,216) (999) 6,020
Escrow and annuity fees 111,092 132,088 108,548
Servicing income on loans sold -0- -0- 160,068
Other 64,490 81,927 107,356
---------------------------------------------
TOTAL NONINTEREST INCOME 598,282 688,389 1,234,977
---------------------------------------------
NONINTEREST EXPENSE
Salaries and employee benefits 2,328,768 2,505,717 2,894,058
Premises and fixed assets 505,924 554,084 723,364
Deposit insurance premiums 295,252 1,202,535 76,316
Advertising 132,638 136,496 234,061
Other 826,828 993,435 1,112,902
---------------------------------------------
TOTAL NONINTEREST EXPENSE 4,089,410 5,392,267 5,040,701
---------------------------------------------
INCOME BEFORE INCOME TAXES 4,602,669 4,097,111 5,159,228
PROVISION FOR INCOME TAXES 1,602,976 1,419,307 1,830,333
---------------------------------------------
NET INCOME $ 2,999,693 $ 2,677,804 $ 3,328,895
=============================================
See accompanying notes.
55
<PAGE>
<PAGE>
TIMBERLAND SAVINGS BANK, S.S.B.
CONSOLIDATED STATEMENTS OF CAPITAL
For the years ended September 30, 1995, 1996 and 1997
- ------------------------------------------------------------------------------
NET
UNREALIZED
APPRECIATION
UNDIVIDED IN EQUITY TOTAL
PROFITS INVESTMENTS CAPITAL
-------------------------------------------
BALANCE, October 1, 1994 $ 15,638,493 $ -0- $ 15,638,493
Net income 2,999,693 2,999,693
Unrealized appreciation in
available-for-sale
investments, net of
deferred income taxes
of $7,363 14,357 14,357
-------------------------------------------
BALANCE, September 30, 1995 18,638,186 14,357 18,652,543
Net income 2,677,804 2,677,804
Unrealized depreciation in
available-for-sale
investments, net of
deferred income taxes
of $539 (1,045) (1,045)
-------------------------------------------
BALANCE, September 30, 1996 21,315,990 13,312 21,329,302
Net income 3,328,895 3,328,895
Realized gain on sale of
investments, net
of deferred income taxes
of $6,824 (13,312) (13,312)
-------------------------------------------
BALANCE, September 30, 1997 $ 24,644,885 $ -0- $ 24,644,885
===========================================
See accompanying notes.
56
<PAGE>
<PAGE>
TIMBERLAND SAVINGS BANK, S.S.B.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended September 30, 1995, 1996 and 1997
- ------------------------------------------------------------------------------
1995 1996 1997
-------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,999,693 $ 2,677,804 $ 3,328,895
--------------------------------------
Noncash revenues, expenses, gains
and losses included in income:
Depreciation 223,346 243,291 303,901
Deferred federal income taxes 180,000 (188,000) 42,000
Federal Home Loan Bank stock
dividends (82,900) (107,000) (116,100)
Market value adjustment -
loans held for sale (23,502) 86,793 (70,305)
Loss (gain) on sale of other
real estate owned, net 20,591 (28) (12,358)
FIIG stock dividends (14,080) (17,160) -0-
Provision for loan and other
real estate owned losses -0- 72,000 597,532
Net (increase) decrease in loans
originated for sale (2,294,988) (689,927) 2,340,882
Increase in other assets, net (288,707) (47,296) (334,606)
Increase (decrease) in other
liabilities and accrued
expenses, net (104,412) 1,245,675 (502,198)
--------------------------------------
(2,384,652) 598,348 2,248,748
--------------------------------------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 615,041 3,276,152 5,577,643
--------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of held-to-maturity
investments and mortgage-
backed securities (2,552,775) -0- -0-
Sales of held-to-maturity
investments and principal
repayments on mortgage-
backed securities 8,695,567 4,905,387 947,253
Sale of available-for-sale
investments -0- -0- 101,376
Increase in loans receivable, net (32,646,646) (19,438,869) (13,399,736)
Additions to premises and fixed
assets, net (370,912) (1,491,635) (878,741)
Additions to other real estate
owned (14,830) (98,759) (568,172)
Dispositions of other real estate
owned 191,726 181,283 270,598
Investment in limited partnership (36,898) -0- -0-
--------------------------------------
NET CASH USED BY INVESTING
ACTIVITIES (26,734,768) (15,942,593) (13,527,422)
--------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase in certificates of
deposit, net 17,888,549 11,485,062 11,425,914
Increase (decrease) in other
deposits, net (3,473,501) 1,980,132 5,027,871
Increase (decrease) in Federal
Home Loan Bank advances, net 9,204,810 (603,748) (2,113,076)
---------------------------------------
NET CASH PROVIDED BY
FINANCING ACTIVITIES 23,619,858 12,861,446 14,340,709
---------------------------------------
NET INCREASE (DECREASE)
IN CASH (2,499,869) 195,005 6,390,930
CASH AND DUE FROM FINANCIAL
INSTITUTIONS, Beginning 7,360,189 4,860,320 5,055,325
---------------------------------------
CASH AND DUE FROM FINANCIAL
INSTITUTIONS, Ending $ 4,860,320 $ 5,055,325 $11,446,255
=======================================
57
<PAGE>
<PAGE>
1995 1996 1997
---------------------------------------
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION
Income taxes paid $ 1,450,000 $ 1,545,000 $ 1,578,367
Interest paid $ 6,255,112 $ 7,628,336 $ 8,377,026
SUPPLEMENTAL DISCLOSURE OF
NONCASH INVESTING ACTIVITIES
Market value adjustment of
investments held for sale $ 21,720 $ (1,584) $ (20,136)
Deferred federal income taxes
on market value adjustment
of investments held for sale $ (7,363) $ 539 $ 6,824
Loans transferred to other
real estate owned $ -0- $ 85,253 $ 506,575
See accompanying notes.
58
<PAGE>
<PAGE>
TIMBERLAND SAVINGS BANK, S.S.B.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the years ended September 30, 1996 and 1997
NOTE 1. Organization and Summary of Significant Accounting Policies
Timberland Savings Bank, S.S.B. (the Savings Bank) was established in 1915 and
provides financial services to borrowers and depositors located primarily in
Western Washington.
The accounting principles followed by the Savings Bank and its wholly-owned
subsidiary, Timberland Service Corp., and the methods of applying them conform
with generally accepted accounting principles and with general industry
practice. The more significant accounting policies are summarized below.
Principles of Consolidation:
All significant intercompany balances and transactions between the Savings
Bank and its subsidiary have been eliminated in consolidation.
Estimates:
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect certain reported amounts and disclosures. Accordingly, actual
results could differ from those estimates.
Financial Instruments:
For the year ended September 30, 1996, the Savings Bank has adopted Statement
of Financial Accounting Standards (SFAS) No. 107, Disclosures About Fair Value
of Financial Instruments. Under SFAS No. 107, the fair value of a financial
instrument is the amount at which the instrument could be exchanged in a
current transaction between willing parties (Note 14).
Investments and Mortgage-Backed Securities:
In accordance with Statement of Financial Accounting Standards No. 115,
Accounting for Certain Investments in Debt and Equity Securities, which was
adopted as of October 1, 1994, the Savings Bank has classified its investments
and mortgage-backed securities as follows:
Held-to-Maturity: Debt securities that management has the positive intent and
ability to hold until maturity are classified as held-to-maturity and are
stated at their remaining unpaid principal balance, net of unamortized
premiums or unaccreted discounts. Premiums are amortized and discounts are
accreted using the interest method.
Available-for-Sale: Debt and equity securities that will be held for
indefinite periods of time, including securities that may be sold in response
to changes in market interest rates, prepayment rates, need for liquidity, and
changes in the availability of and the yield of alternative investments are
classified as available-for-sale. These assets are stated at market value.
Market value is determined using published quotes as of the close of business.
Unrealized gains and losses are excluded from earnings and reported as a
separate component of capital until realized.
Trading Securities: Debt and equity securities that are bought and held
principally for the purpose of selling them in the near term are classified as
trading securities and stated at market value with unrealized gains and losses
included in earnings. The Savings Bank has no investments or mortgage-backed
securities classified for trading purposes.
Gains or losses upon disposition of securities, regardless of classification,
are based on the net proceeds and the adjusted stated amount of the securities
sold, using the specific-identification method.
59
<PAGE>
<PAGE>
NOTE 1. (Continued)
Loans Receivable:
- ----------------
Loans receivable are reported at the principal amount outstanding, net of
loans in process of completion, unearned income, an allowance for loan losses
and participating interests sold.
Allowance for Losses:
Allowances for losses on specific problem loans and other real estate owned
are charged to earnings when it is determined that the value of these loans
and properties, in the judgment of management, is impaired. In addition to
specific reserves, the Savings Bank also maintains general provisions for loan
losses based on evaluating known and inherent risks in the loan portfolio,
including management's continuing analysis of the factors and trends
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 and anticipated 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. The ultimate recovery of loans is susceptible
to future market factors beyond the Savings Bank's control, which may result
in losses or recoveries differing significantly from those provided in the
consolidated financial statements.
The Savings Bank accounts for impaired loans in accordance with SFAS No. 114,
Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118,
Accounting by Creditors for Impairment of a Loan-Income Recognition and
Disclosures. These statements address the disclosure requirements and
allocations of the allowance for loan losses for certain impaired loans. A
loan within the scope of these statements is considered impaired when, based
on current information and events, it is probable that a creditor will be
unable to collect all amounts due according to the contractual terms of the
loan agreement, including scheduled interest payments. The Savings Bank
excludes smaller balance homogeneous loans, including single family
residential and consumer loans from the scope of this statement.
When a loan has been identified as being impaired, the amount of the
impairment is measured by using discounted cash flows, except when it is
determined that the sole source of repayment for the loan is the operation or
liquidation of the underlying collateral. In such case, impairment is
measured at current fair value of the collateral, reduced by estimated selling
costs. When the measurement of the impaired loan is less than the recorded
investment in the loan (including accrued interest and net deferred loan fees
or costs), loan impairment is recognized by establishing or adjusting an
allocation of the allowance for loan losses. SFAS No. 114, as amended, does
not change the timing of charge-offs of loans to reflect the amount ultimately
expected to be collected. At September 30, 1995, 1996 and 1997, respectively,
the Savings Bank had no loans deemed to be impaired as defined by SFAS No.
114.
Loans Held for Sale:
Mortgage loans originated and intended for sale in the secondary market are
stated at the lower of cost or estimated market value in the aggregate. Gains
or losses on sales of loans are recognized at the time of sale and include
adjustments to record such loans at the lower of cost or market. The gain or
loss is determined by the difference between the net sales proceeds and the
recorded value of the loans, including any remaining deferred loan fees.
Premises and Fixed Assets:
Premises and fixed assets are recorded at cost. Depreciation is computed on
the straight-line method over the following estimated useful lives: buildings
- - thirty to forty years; furniture and equipment - three to five years;
automobile - five years. The cost of maintenance and repairs is charged to
expense as incurred.
60
<PAGE>
<PAGE>
NOTE 1. (Continued)
Other Real Estate Owned:
Other real estate owned consists of properties acquired through loan
foreclosure and are initially recorded at fair value at the date of
foreclosure. Costs relating to development and improvement of property are
capitalized, whereas costs relating to holding property are expensed.
Valuations are periodically performed by management, and an allowance for
losses is established by a charge to operations if the recorded value of a
property exceeds its estimated net realizable value.
Interest on Loans and Loan Fees:
Interest on loans is recorded as income as borrowers' monthly payments become
due. Allowances are established for uncollected interest on loans for which
the interest is determined to be uncollectible. All loans past due three or
more payments are placed on nonaccrual status and internally classified as
substandard. Any interest income recorded in the current reporting period is
fully reserved. Subsequent collections are applied proportionately to past
due principal and interest. Loans are removed from nonaccrual status only
when the loan is deemed current, and collectibility of principal and interest
is no longer doubtful.
The Savings Bank charges fees for originating and servicing loans. These fees
are for inspection of property and other miscellaneous services. That portion
of loan fees exceeding the estimated cost of initiating and closing loans is
deferred and amortized to income, on the level-yield basis, over the loan
term. If the loan is repaid prior to maturity, the remaining balance is
credited to income at the time of repayment.
Loan Servicing Fees:
Fees earned for servicing loans for the Federal Home Loan Mortgage Corporation
("FHLMC") are reported as income when the related mortgage loan payments are
collected. Loan servicing costs are charged to expense as incurred.
Income Taxes:
The Savings Bank files a consolidated federal income tax return with its
subsidiary. The Savings Bank qualifies under provisions of the Internal
Revenue Code which permit, as a deduction from taxable income, an allowance
for bad debts based on a percentage of taxable income. The percentage method
bad debt deduction available was 8 percent for the years ended September 30,
1995 and 1996.
Due to the passage of the Small Business Job Protection Act, effective October
1, 1996, the percentage-of-income bad debt deduction for federal tax purposes
was eliminated. In addition, federal tax bad debt reserves which have been
accumulated since October 1, 1988, that exceed the reserves which would have
been accumulated based on actual experience, are subject to recapture over a
six-year recapture period effective for tax years beginning October 1, 1996.
However, the six-year recapture period may be postponed for up to two years
provided the Savings Bank satisfies a mortgage origination test. As of
September 30, 1997, the Savings Bank's federal tax bad debt reserves subject
to recapture approximated $1,700,000.
Deferred federal income taxes result from temporary differences between the
tax basis of assets and liabilities and their reported amounts on the
financial statements. These will result in differences between income for tax
purposes and income for financial statement purposes in future years (Note
11).
Advertising:
The Savings Bank expenses all advertising costs as incurred. Direct-response
advertising costs incurred will be capitalized and amortized over the
estimated period to be benefited.
61
<PAGE>
<PAGE>
NOTE 1. (Continued)
Statement of Cash Flows:
Cash and due from financial institutions include cash, funds due from
financial institutions, and certificates of deposit with maturities of ninety
days or less.
Recently Adopted Accounting Standards:
In June 1996, the FASB issued SFAS No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities. This
Statement amends SFAS Nos. 65 and 115 and supersedes SFAS Nos. 76, 77 and 122
and provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities. It requires that
liabilities and derivatives incurred or obtained by transferors as part of
financial assets be initially measured at fair value, if practicable. It also
requires that servicing assets and other retained interests in the transferred
assets be measured by allocating the previous carrying amount between the
assets sold, if any, and retained interests, if any, based on their relative
fair values at the date of the transfer. Servicing assets and liabilities
must be subsequently measured by amortization in proportion to and over the
period of estimated net servicing income or loss and assessment for asset
impairment or increased obligation based on their fair values. This Statement
is effective for transfers and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996.
The Savings Bank adopted SFAS No. 125 effective January 1, 1997, as required.
SFAS No. 125 also requires that mortgage servicing rights be evaluated for
impairment based on the assets fair value. The Savings Bank estimates fair
value by discounting servicing asset cash flows using discount and prepayment
rates that it believes market participants would use. For purposes of
measuring impairment, mortgage servicing rights are stratified predominantly
by loan term.
Reclassifications:
Certain September 30, 1995 and 1996 amounts have been reclassified to conform
to the September 30, 1997 presentation. The reclassifications had no effect
on previously reported net income or capital.
NOTE 2. Investments and Mortgage-Backed Securities
The following tables summarize the amortized cost, gross unrealized gains and
losses, and the estimated market value of the Bank's investments and
mortgage-backed securities at September 30, 1996 and 1997:
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
1996 COST GAINS LOSSES VALUE
---- ---------------------------------------------
Held-to-Maturity
Mortgage-backed
securities:
FHLMC $1,848,550 $ 2,356 $ (28,472) $1,822,434
FNMA 1,536,235 5,095 (58,637) 1,482,693
GNMA 1,566,009 -0- (5,522) 1,560,487
----------------------------------------------
TOTAL HELD-TO-
MATURITY $4,950,794 $ 7,451 $ (92,631) $4,865,614
==============================================
Available-for-Sale
FHLB stock $1,470,300 $ -0- $ -0- $1,470,300
FIIG stock 81,240 20,136 101,376
----------------------------------------------
TOTAL AVAILABLE-
FOR-SALE $1,551,540 $ 20,136 $ -0- $1,571,676
==============================================
62
<PAGE>
<PAGE>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
1997 COST GAINS LOSSES VALUE
---- ---------------------------------------------
Held-to-Maturity
Mortgage-backed
securities:
FHLMC $1,398,454 $ 7,699 $ (12,600) $1,393,553
FNMA 1,255,534 9,614 (39,596) 1,225,552
GNMA 1,336,241 26,519 -0- 1,362,760
----------------------------------------------
TOTAL HELD-TO-
MATURITY $3,990,229 $ 43,832 $ (52,196) $3,981,865
==============================================
Available-for-Sale
FHLB stock $1,586,400 $ -0- $ -0- $1,586,400
==============================================
The FHLB stock has a par value of $100 per share and is recorded at cost.
Stock owned in excess of required amounts can only be redeemed by the Federal
Home Loan Bank of Seattle.
Mortgage-backed securities pledged as collateral for public fund deposits
totaled $1,161,000 and $1,663,000 at September 30, 1996 and 1997,
respectively.
The contractual maturity of investments and mortgage-backed securities at
September 30, 1997, follows. Expected maturities may differ from contractual
maturities due to the prepayment of principal or call provision.
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
---------------------------------------------
Held-To-Maturity:
Due after 1 year
through 5 years $ 946,661 $ 1,798 $ (12,600) $ 935,859
Due after 10 years 3,043,568 42,034 (39,596) 3,046,006
----------------------------------------------
$3,990,229 $ 43,832 $ (52,196) $3,981,865
==============================================
Available-For-Sale:
FHLB stock $1,586,400 $ -0- $ -0- $1,586,400
==============================================
63
<PAGE>
<PAGE>
NOTE 3. Loans Receivable - Net and Loans Held for Sale
Loans receivable including loans held for sale consisted of the following at
September 30:
1996 1997
-----------------------------
Mortgage loans:
One-to-four family $ 89,761,659 $ 96,252,021
Multi-family 12,569,371 12,177,603
Commercial 26,529,011 29,409,840
Construction and land development 47,140,084 45,031,339
Land 6,115,264 6,937,002
-----------------------------
TOTAL MORTGAGE LOANS 182,115,389 189,807,805
-----------------------------
Consumer loans:
Home equity and second mortgage 6,576,284 8,142,495
Other 2,474,958 2,824,365
-----------------------------
TOTAL CONSUMER LOANS 9,051,242 10,966,860
-----------------------------
Commercial business loans 475,731 693,787
-----------------------------
TOTAL LOANS RECEIVABLE 191,642,362 201,468,452
-----------------------------
Less:
Undisbursed portion of loans in process 18,433,608 14,820,370
Unearned income 1,707,718 1,760,945
Allowance for loan losses 1,132,963 1,716,110
-----------------------------
21,274,289 18,297,425
-----------------------------
LOANS RECEIVABLE - NET 170,368,073 183,171,027
-----------------------------
Loans held for sale (one-to-four family) 6,216,243 3,875,361
Market-value adjustment (89,373) (19,068)
-----------------------------
LOANS HELD FOR SALE - NET 6,126,870 3,856,293
-----------------------------
LOANS RECEIVABLE AND LOANS HELD
FOR SALE - NET $ 176,494,943 $187,027,320
=============================
The composition of loans receivable including loans held for sale by interest
rate type at September 30, 1997, is as follows:
FIXED ADJUSTABLE
RATE RATE TOTAL
-------------------------------------------
Mortgage loans:
One-to-four family $ 12,951,771 $ 87,175,611 $ 100,127,382
Multi-family 5,404,429 6,773,174 12,177,603
Commercial 6,875,212 22,534,628 29,409,840
Construction and land
development 35,180,824 9,850,515 45,031,339
Land 6,917,544 19,458 6,937,002
-------------------------------------------
TOTAL MORTGAGE LOANS 67,329,780 126,353,386 193,683,166
-------------------------------------------
Consumer loans:
Home equity and second mortgage 6,081,523 2,060,972 8,142,495
Other 2,730,873 93,492 2,824,365
-------------------------------------------
TOTAL CONSUMER LOANS 8,812,396 2,154,464 10,966,860
-------------------------------------------
Commercial business loans 685,331 8,456 693,787
-------------------------------------------
TOTAL LOANS $ 76,827,507 $128,516,306 205,343,813
=========================== -------------
Less:
Undisbursed portion of
loans in process 14,820,370
Unearned income 1,760,945
Allowance for loan losses 1,716,110
Market-value adjustment -
loans held for sale 19,068
-------------
18,316,493
-------------
LOANS RECEIVABLE AND LOANS HELD FOR SALE - NET $ 187,027,320
=============
64
<PAGE>
<PAGE>
<TABLE>
NOTE 3. (Continued)
The contractual maturity of loans receivable including loans held for sale at September 30, 1997, is as
follows:
ONE YEAR THREE YEARS FIVE YEARS
WITHIN TO TO TO AFTER
ONE YEAR THREE YEARS FIVE YEARS TEN YEARS TEN YEARS TOTAL
------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Mortgage loans:
One-to-four family $ 494,834 $ 637,626 $1,394,205 $ 3,883,095 $ 93,717,622 $100,127,382
Multi-family -0- 322 626,126 6,752,589 4,798,566 12,177,603
Commercial 15,947 244,713 595,210 10,418,019 18,135,951 29,409,840
Construction
and land
development 23,171,038 7,978,457 17,384 1,227,335 12,637,125 45,031,339
Land 411,272 1,961,820 4,114,805 298,700 150,405 6,937,002
------------------------------------------------------------------------------
TOTAL MORT-
GAGE LOANS 24,093,091 10,822,938 6,747,730 22,579,738 129,439,669 193,683,166
------------------------------------------------------------------------------
Consumer loans:
Home equity and
second mortgage 2,062,239 580,532 1,456,866 1,754,855 2,288,003 8,142,495
Other 1,183,220 747,042 584,158 133,199 176,746 2,824,365
------------------------------------------------------------------------------
TOTAL CON-
SUMER LOANS 3,245,459 1,327,574 2,041,024 1,888,054 2,464,749 10,966,860
------------------------------------------------------------------------------
Commercial business
loans 80,634 10,158 588,461 14,534 -0- 693,787
------------------------------------------------------------------------------
TOTAL LOANS $27,419,184 $ 12,160,670 $ 9,377,215 $24,482,326 $131,904,418 205,343,813
================================================================ ------------
Less:
Undisbursed portion of loans in process 14,820,370
Unearned income 1,760,945
Allowance for loan losses 1,716,110
Market-value adjustment - loans held for sale 19,068
------------
18,316,493
------------
LOANS RECEIVABLE AND LOANS HELD FOR SALE - NET $187,027,320
============
</TABLE>
<PAGE>
The weighted average interest rate on all loans at September 30, 1996 and
1997, was 8.77 percent and 8.79 percent respectively.
Loans serviced for the Federal Home Loan Mortgage Corporation and others at
September 30, 1996 and 1997, $45,859,000 and $54,353,000 respectively.
At September 30, 1996 and 1997, the Savings Bank had commitments outstanding
to originate mortgage loans at current market rates totaling $2,642,000 and
$6,011,000 respectively.
At September 30, 1996 and 1997, the Savings Bank had commitments outstanding
for nonmortgage loans totaling $1,621,000 and $2,922,000 respectively.
Officers, employees and trustees of the Savings Bank have outstanding loans
which were made in the ordinary course of business. At September 30, 1996 and
1997, such loans approximated $1,862,000 and $1,820,000 respectively.
An analysis of loans outstanding to executive officers and trustees, net of
percentage sold, as of September is as follows:
1996 1997
-----------------------
Balance, Beginning of period $ 702,392 $ 845,444
New loans 377,150 17,500
Repayments/sales (234,098) (59,731)
-----------------------
Balance, End of period $ 845,444 $ 803,213
=======================
65
<PAGE>
<PAGE>
NOTE 3. (Continued)
At September 30, 1996 and 1997, the Savings Bank had non-accruing loans
totaling approximately $1,520,000 and $7,555,000 respectively. At September
30, 1997, approximately $109,000 of loans were past due ninety days or more
and still accruing. Unrecorded interest on the non-accrual loans totaled
approximately $402,000 at September 30, 1997. No interest income was recorded
on non-accrual loans for the year ended September 30, 1997.
An analysis of the allowance for loan losses at September 30 follows:
1995 1996 1997
---------------------------------------
Balance, Beginning of period $ 1,120,108 $ 1,119,159 $ 1,132,963
Provision for loan losses 70,000 596,782
Transfers (54,718) (3,000)
Loans charged off (949) (1,478) (19,160)
Recoveries 8,525
---------------------------------------
Balance, End of period $ 1,119,159 $ 1,132,963 $ 1,716,110
=======================================
Mortgage servicing rights totaling $166,785 were capitalized subsequent to the
adoption of SFAS Nos. 125 and 127 on January 1, 1997. Amortization of these
rights was $8,446 for the period ended September 30, 1997. The balance of
$158,339 is included in "Other Assets" in the consolidated balance sheet at
September 30, 1997.
NOTE 4. Premises and Fixed Assets
Premises and fixed assets consisted of the following at September 30:
1996 1997
-------------------------
Land $ 1,130,286 $ 1,804,067
Office buildings and improvements 3,073,018 4,261,597
Furniture and equipment 1,680,731 1,898,136
Automobiles 21,883 21,883
Property held for future expansion 20,584 20,584
Construction and purchases in progress 1,230,679 6,199
-------------------------
7,157,181 8,012,466
Less accumulated depreciation 2,300,834 2,581,279
-------------------------
TOTAL $ 4,856,347 $ 5,431,187
=========================
NOTE 5. Other Real Estate Owned
Other real estate owned consisted of the following at September 30:
1996 1997
-------------------------
Real estate acquired through foreclosure $ 194,765 $ 466,161
Allowance for possible losses (70,232 (32,446)
-------------------------
TOTAL $ 124,533 $ 433,715
=========================
On October 29, 1997, the Savings Bank accepted a deed in lieu of foreclosure
on a condominium project which had an unpaid balance of $2,886,755 and was
included in non-accruing loans at September 30, 1997. Management does not
expect to incur any material loss upon disposition of the property.
66
<PAGE>
<PAGE>
NOTE 5. (Continued)
An analysis of the allowance for possible losses follows:
1995 1996 1997
---------------------------------
Balance, Beginning of period $ 13,514 $ 13,514 $ 70,232
Provision for additional losses 17,550 2,000 750
Transfers 54,718 3,000
Charged off (17,550) (41,536)
---------------------------------
Balance, End of period $ 13,514 $ 70,232 $ 32,446
=================================
NOTE 6. Accrued Interest Receivable
Accrued interest receivable consisted of the following at September 30:
1996 1997
---------------------------
Loans receivable $ 1,102,107 $ 1,573,627
Less reserve for uncollected interest 84,204 479,992
1,017,903 1,093,635
Interest bearing deposits and securities 38,982 43,417
---------------------------
TOTAL $ 1,056,885 $ 1,137,052
===========================
NOTE 7. Deposits
Deposits consisted of the following at September 30:
1996 1997
---------------------------
Noninterest bearing $ 3,571,060 $ 5,163,986
N.O.W. checking 18,002,534 19,587,043
Passbook savings 25,400,165 26,268,977
Money market accounts 13,364,304 14,423,860
Certificates of deposit 93,332,220 104,758,135
Other 2,879,134 2,801,402
---------------------------
TOTAL $156,549,417 $173,003,403
===========================
The weighted-average interest rate on all deposits at September 30, 1996 and
1997, was 4.55 percent and 4.64 percent respectively.
Officers, employees and trustees of the Savings Bank have deposits totaling
$1,089,823 and $1,072,880 at September 30, 1996 and 1997, respectively.
Deposits of $100,000 or greater totaled $17,721,000 and $22,897,000 at
September 30, 1996 and 1997, respectively.
Scheduled maturities of certificates of deposit accounts at September 30 are
as follows:
1996 1997
---------------------------
Within one year $ 64,201,806 $ 76,283,894
One to two years 18,737,200 22,350,343
Two to five years 9,814,221 5,736,988
After five years 578,993 386,910
---------------------------
TOTAL $ 93,332,220 $104,758,135
===========================
67
<PAGE>
<PAGE>
NOTE 7. (Continued)
Certificates of deposit by scheduled maturity and interest rate at September
30, 1997, are as follows:
INTEREST RATE WITHIN ONE TO TWO TO OVER FIVE
RANGE ONE YEAR TWO YEARS FIVE YEARS YEARS TOTAL
- ------------- -----------------------------------------------------------
2.00 - 3.99% $ 153,078 $ -0- $ -0- $ -0- $ 153,078
5.00 - 5.99% 64,636,550 10,991,633 3,330,073 246,306 79,204,562
6.00 - 6.99% 11,136,631 7,118,283 2,054,566 41,468 20,350,948
7.00 and over 357,634 4,240,428 352,349 99,136 5,049,547
-----------------------------------------------------------
TOTAL $76,283,893 $22,350,344 $5,736,988 $386,910 $104,758,135
===========================================================
Interest expense, by account type, is as follows at September 30:
1995 1996 1997
---------------------------------------
Certificates of deposit $ 3,980,879 $ 5,270,398 $ 5,806,717
Money market accounts 468,575 520,235 514,495
Passbook savings 820,657 737,665 749,593
N.O.W. checking 425,493 421,187 445,038
---------------------------------------
TOTAL $ 5,695,604 $ 6,949,485 $ 7,515,843
=======================================
NOTE 8. Federal Home Loan Bank Advances
The Savings Bank has been approved for participation in the Federal Home Loan
Bank of Seattle Cash Management Advance Program, maturing July 1998, with a
maximum facility of $10,210,000. Advances requested under this program are
payable on demand or, if no demand is made, in one year from the date of
advance and bear interest at the rate in effect at that time. Advances are
subject to the existing Advances, Security and Deposit Agreement and are
granted at the sole discretion of the Federal Home Loan Bank of Seattle.
There were no advances outstanding under the Cash Management Advance Program
at September 30, 1996 and 1997.
The Advances, Security and Deposit Agreement which includes the Cash
Management Advance Program, is maintained at 20 percent of total assets. The
Savings Bank had advances at September 30, 1997, as follows:
Borrowing Interest Rate Maturity Date Balance
- ------------ ------------- ------------- --------
Fixed rate 6.70% 04/28/98 $ 500,000
Fixed rate (monthly
amortization) 6.11% 02/22/02 442,491
Fixed rate callable 5.39% 06/03/02 10,000,000
Fixed rate (monthly
amortization) 6.55% 02/22/06 1,298,813
------------
$ 12,241,304
============
The weighted average rate for all advances at September 30, 1997 was 5.60
percent.
Under the Advances, Security and Deposit Agreement, virtually all of the
Savings Bank's assets, not otherwise encumbered, are pledged as collateral for
advances.
At September 30, 1997, annual repayments of FHLB advances, through September
30, 2002, and thereafter, totaled $500,000 for the year ending September 30,
1998, $10,442,491 for the year ending September 30, 2002 and $1,298,813 for
the year ending September 30, 2006.
68
<PAGE>
<PAGE>
NOTE 9. Other Liabilities and Accrued Expenses
Other liabilities and accrued expenses consisted of the following at September
30:
1996 1997
-----------------------
S.A.I.F. special assessment $ 874,917 $ -0-
Federal income taxes 237,735 482,877
Accrued pension and profit sharing 417,137 492,680
Accrued interest on deposits and
FHLB advances 138,246 146,885
Accounts payable and accrued expenses -
other 455,670 541,064
-----------------------
TOTAL $2,123,705 $1,663,506
=======================
NOTE 10. Regulatory Capital
As a Washington-chartered savings bank, the Savings Bank is subject to the
capital requirements of the FDIC and the Division. The FDIC requires
state-chartered savings banks, including the Savings Bank, to have a minimum
leverage ratio of Tier 1 capital to total assets of at least 3 percent,
provided that all institutions other than those (i) receiving the highest
rating during the examination process and (ii) not anticipating any
significant growth are required to maintain a ratio of 1 percent to 2 percent
above the stated minimum with an absolute total capital to risk-weighted
assets of at least 8 percent. The Savings Bank has not been notified by the
FDIC of any leverage capital requirements specifically applicable to it.
The Savings Bank's capital position relative to its FDIC capital requirements
at September 30, 1997, is as follows:
AMOUNT PERCENT
----------------------------
Tier 1 (leverage) capital $ 24,644,885 12.01
Tier 1 (leverage) capital requirement 8,204,760 4.00
--------------------------
EXCESS $ 16,440,125 8.01
==========================
Tier 1 risk adjusted capital $ 26,360,885 17.43
Tier 1 risk adjusted capital
requirement 6,049,400 4.00
--------------------------
EXCESS $ 20,311,485 13.43
==========================
Total risk-based capital $ 26,360,885 17.43
Total risk-based capital requirement 12,098,800 8.00
--------------------------
EXCESS $ 14,262,085 9.43
==========================
The Savings Bank's total capital to total assets at September 30, 1996 and
1997, was 11.0 percent and 11.7 percent respectively.
NOTE 11. Federal Income Taxes
The Savings Bank has qualified under provisions of the Internal Revenue Code
that permit federal income taxes to be computed after deduction of additions
to bad debt reserves. Accordingly, capital includes approximately $2,100,000
for which no provision for federal income taxes has been made. If in the
future capital is used for any purpose other than to absorb bad debt losses,
federal income taxes at the current applicable rates would be imposed.
The components of the provision for income taxes at September 30 are as
follows:
1995 1996 1997
---------------------------------------
Current $ 1,422,976 $ 1,607,307 $ 1,872,333
Deferred (credit) 180,000 (188,000) (42,000)
---------------------------------------
TOTAL $ 1,602,976 $ 1,419,307 $ 1,830,333
=======================================
69
<PAGE>
<PAGE>
NOTE 11. (Continued)
The components of federal income taxes at September 30 are as follows:
1996 1997
-----------------------
Current $ 48,911 $ 342,877
Deferred 182,000 140,000
Deferred, available-for-sale securities 6,824 -0-
----------------------
TOTAL $ 237,735 $ 482,877
======================
The components of the Bank's deferred tax assets and liabilities at September
30 are as follows:
1996 1997
-----------------------
Deferred tax assets:
Accrued interest on loans $ -0- $ 87,424
S.A.I.F. special assessment 297,472 -0-
Depreciation 22,620 26,488
Accrued vacation 18,112 23,602
Deferred compensation 30,021 60,041
Loans held for sale market value
adjustment 30,387 6,483
----------------------
TOTAL DEFERRED TAX ASSETS 398,612 204,038
----------------------
Deferred tax liabilities:
FHLB and FIIG stock dividends 277,692 306,544
Federal income tax bad debt deduction 269,274 -0-
Real estate sale, installment basis 33,212 32,858
Unrealized securities gains 6,824 -0-
Other 434 4,636
----------------------
TOTAL DEFERRED TAX LIABILITIES 587,436 344,038
----------------------
DEFERRED TAX LIABILITY - NET $ 188,824 $ 140,000
======================
The provision for federal income taxes differs from that computed at the
statutory corporate tax rate at September 30 as follows:
1995 1996 1997
---------------------------------------
Tax provision at statutory
rate $1,564,907 $1,393,018 $1,754,138
Bad debt deduction
Gain on sale of other
real estate owned
Nondeductible losses/
expenses - net 10,021 27,659 8,024
Other - net 28,048 (1,370) 68,171
---------------------------------------
TOTAL TAX EXPENSE $1,602,976 $1,419,307 $1,830,333
=======================================
NOTE 12. Profit Sharing Plans
The Savings Bank maintains a tax-qualified profit sharing plan for the benefit
of all eligible employees who are at least twenty-one years of age and work a
minimum of 501 hours. The Savings Bank contributed $177,581 and $171,616 to
the plan in 1996 and 1997 respectively. Contributions are made on a
discretionary basis.
In addition, the Savings Bank has an employee bonus plan based on net income.
Bonuses accrued for the years ended September 30, 1996 and 1997, totaled
$107,112 and $144,472 respectively.
70
<PAGE>
<PAGE>
NOTE 13. Deferred Compensation/Noncompetition Agreement
The Savings Bank has a deferred compensation/noncompetition arrangement with
its chief executive officer which will provide monthly payments of $1,600 per
month if retirement occurs at age sixty-two or $2,000 per month if retirement
occurs at age sixty-five. Once payments have commenced they will continue
until his death, at which time payments will continue to his surviving spouse
until her death or for sixty months. The present value of the payments based
upon the life expectancy of the chief executive officer are being accrued
based on a retirement age of sixty-five and are included in other liabilities
in the consolidated financial statements. As of September 30, 1996 and 1997,
$132,444 and $176,592 respectively, has been accrued under the agreement.
NOTE 14. Fair Value of Financial Instruments
The Savings Bank has adopted Statement of Financial Accounting Standards No.
107, Disclosure About Fair Value of Financial Instruments, which requires
disclosure of estimated fair values for financial instruments. Such estimates
are subjective in nature and significant judgment is required regarding the
risk characteristics of various financial instruments at a discrete point in
time. Therefore, such estimates could vary significantly if assumptions
regarding uncertain factors were to change. Major assumptions, methods, and
fair value estimates for the Savings Bank's significant financial instruments
are set forth below.
Cash and Due from Financial Institutions: The recorded amount is a reasonable
estimate of fair value.
Investments and Mortgage-backed Securities and Loans Held for Sale: The fair
value of investments and mortgage-backed securities and loans held for sale
have been based upon quoted market prices or dealer quotes.
Loans Receivable - Net: Fair values for loans are estimated for portfolios of
loans with similar financial characteristics. Fair value is estimated by
discounting the future cash flows using the current rates at which similar
loans would be made to borrowers for the same remaining maturities.
Prepayments are based upon the historical experience of the Savings Bank.
Mortgage Servicing Rights: The fair value of mortgage servicing rights is
estimated using projected cash flows, adjusted for the effects of anticipated
prepayments, using a market discount rate.
Other Assets, Other Liabilities and Accrued Expenses: The recorded amount is
a reasonable estimate of fair value because of the short-term nature of these
items.
Deposits: The fair value of deposits with no stated maturity date are
included at the amount payable on demand. The fair value of fixed-maturity
certificates of deposit is estimated by discounting future cash flows using
the rates currently offered by the Savings Bank for deposits of similar
remaining maturities.
Federal Home Loan Bank Advances: The fair value of borrowed funds is
estimated by discounting the future cash flows of the borrowings at a rate
which approximates the current offering rate of the borrowings with a
comparable remaining life.
The estimated fair values of financial instruments at September 30, 1997, are
as follows:
RECORDED FAIR
AMOUNT VALUE
---------------------------
Financial assets:
Cash and due from financial institutions $ 11,446,455 $ 11,446,000
Investments and mortgage-backed securities 5,576,629 5,568,000
Loans receivable - net and loans held
for sale 187,027,320 191,655,000
Mortgage servicing rights 158,339 166,000
Other assets 1,913,168 1,913,000
Financial liabilities:
Deposits 173,003,403 173,468,000
Federal Home Loan Bank advances 12,241,304 12,176,000
Other liabilities and accrued expenses 1,663,506 1,664,000
71
<PAGE>
<PAGE>
NOTE 15. Conversion to Capital Stock Form of Ownership:
The Board of Trustees of the Savings Bank adopted a Plan of Conversion on July
10, 1997, to convert from a Washington-chartered mutual savings bank to a
Washington-chartered capital stock savings bank with the concurrent formation
of a holding company, subject to approval by the regulatory authorities and
members of the Savings Bank. The conversion is expected to be accomplished
through amendment of the Savings Bank's Washington charter and the sale of the
holding company's common stock in an amount equal to the consolidated proforma
market value of the holding company and the Savings Bank after giving effect
to the conversion. The shares of common stock will be offered initially to
the Savings Bank's depositors, employee benefit plans and to certain other
eligible subscribers in a subscription offering. It is anticipated that any
shares not purchased in the subscription offering will be offered in a direct
community offering, and then any remaining shares offered to the general
public in a syndicated community offering.
At the time of the conversion, the Savings Bank will establish a liquidation
account in an amount equal to its capital as of the last date of the
consolidated statement of financial condition appearing in the final
prospectus. The liquidation account will be maintained for the benefit of
eligible account holders who continue to maintain their accounts at the
Savings Bank after conversion. The liquidation account will be reduced
annually to the extent that eligible account holders have reduced their
qualifying deposits as of each anniversary date. Subsequent increases will
not restore an eligible account holder's interest in the liquidation account.
In the event of a complete liquidation of the Savings Bank, each eligible
account holder will be entitled to receive a distribution from the liquidation
account in an amount proportionate to the current adjusted qualifying balances
for accounts then held.
Under Washington law, the holding company is prohibited from paying a dividend
if, as a result of its payment, the holding company would be unable to pay its
debts as they become due in the normal course of business, or if the Holding
Company's total liabilities would exceed its total assets. As a converted
institution, the Savings Bank also will be subject to the regulatory
restriction that it will not be permitted to declare or pay a dividend on or
repurchase any of its capital stock if the effect thereof would be to cause
its regulatory capital to be reduced below the amount required for the
liquidation account established in connection with the conversion.
Conversion costs will be deferred and reduce the proceeds from the shares
sold in the conversion. If the conversion is not completed, all costs will be
charged as an expense. Conversion costs incurred for the year ended September
30, 1997, were approximately $145,000.
72
<PAGE>
<PAGE>
Item 9. Changes in and Disagreements with Accountants on Accounting and
- ------------------------------------------------------------------------
Financial Disclosure
--------------------
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant
- ------------------------------------------------------------
The Board of Directors of the Savings Bank is presently composed of nine
members, who are elected for terms of three years, one-third of whom are
elected annually in accordance with the Bylaws of the Savings Bank. The
executive officers of the Savings Bank are elected annually by the Board of
Directors and serve at the Board's discretion. The following table sets forth
information with respect to the Directors and executive officers of the
Savings Bank.
Directors of the Company
Age at Current
September Director Term
Name 30, 1997 Since Expires
- ---- -------- ----- -------
Richard R. Morris, Jr. 60 1997 1998
Jon C. Parker 48 1997 1998
James C. Mason 42 1997 1998
Clarence E. Hamre 63 1997 1999
Robert Backstrom 68 1997 1999
Andrea M. Clinton 40 1997 1999
Michael R. Sand 43 1997 2000
Alan E. Smith 66 1997 2000
Peter J. Majar 70 1997 2000
Directors of the Savings Bank
Age at Current
September Director Term
Name 30, 1997 Since Expires
- ---- -------- ----- -------
Clarence E. Hamre 63 1969 1999
Michael R. Sand 43 1993 2000
Andrea M. Clinton 40 1996 1999
Robert Backstrom 68 1992 1999
Richard R. Morris, Jr. 60 1992 1998
Alan E. Smith 66 1992 2000
Peter J. Majar 70 1987 2000
Jon C. Parker 48 1992 1998
James C. Mason 42 1993 1998
73
<PAGE>
<PAGE>
Executive Officers of the Company and Savings Bank
Age at Position
September ------------------------------------------
Name 30, 1997 Company Savings Bank
- ---- -------- ------- ------------
Clarence E. Hamre 63 Chairman of the Board, Chairman of the Board,
President and Chief President and Chief
Executive Officer Executive Officer
Michael R. Sand 43 Executive Vice Chief Financial Officer
President and and Executive Vice
Secretary President, Secretary and
Director
Paul G. MacLeod 53 Treasurer Treasurer
Biographical Information
Clarence E. Hamre has served as the Savings Bank's President and Chief
Executive Officer since 1969.
Michael R. Sand has served as the Savings Bank's Executive Vice President
since 1986. Mr. Sand is the President of the Aberdeen Neighborhood Housing
Services, the former President of the Grays Harbor Chamber of Commerce and a
member of the Hoquiam Lion's Club.
Paul G. MacLeod is the Savings Bank's Treasurer and has been with the
Savings Bank since 1987.
Item 11. Executive Compensation
- ---------------------------------
Summary Compensation Table. The following information is furnished for
Messrs. Hamre and Sand. No other executive officer of Savings Bank received
salary and bonus in excess of $100,000 during the year ended September 30,
1997.
Annual Compensation
--------------------------------------------
Other Annual All Other
Name and Compensation Compensation
Position Year(1) Salary($) Bonus($) ($)(2) ($)(3)
- -------- ------- --------- -------- ------ ------
Clarence E. Hamre 1997 $152,289 $26,778 -- $59,148
Chairman of the 1996 146,588 29,997 -- 59,148
Board, President
and Chief
Executive Officer
Michael R. Sand 1997 $95,673 4,742 -- 10,042
Executive Vice 1996 91,004 5,246 -- 9,625
President and Secretary
- -------------
(1) Information prior to 1996 is not disclosed because the Company was not a
SEC-registrant during the time.
(2) Includes perquisites and other personal benefits, unless the aggregate
amount of such compensation is the lesser of either $50,000 or 10% of
total annual salary and bonus.
(3) Includes amounts paid in connection with (i) any contract or arrangement
with the Savings Bank, (ii) dollar value of amounts earned on long-term
incentive plans; (iii) contributions made by the Savings Bank on behalf
of the officer to vested and unvested defined contribution plans.
Deferred Compensation Agreement. The Savings Bank has entered into a
deferred compensation agreement with Mr. Hamre which provides that, commencing
upon his retirement at or after age 65, Mr. Hamre will
74
<PAGE>
<PAGE>
receive $2,000 per month for life. The monthly benefit is reduced to $1,600
per month in the event of Mr. Hamre's retirement prior to age 65. At Mr.
Hamre's death, the monthly benefit would be payable to his surviving spouse
until the earlier to occur of her death or 60 months. At September 30, 1997,
the Savings Bank had accrued $177,000 in compensation expense with respect to
its obligation to Mr. Hamre under the agreement.
Directors' Compensation
Board Fees. Except for the Messrs. Hamre and Sand, Directors are paid
$500 per month and $250 for each regular Board meeting that they attend.
Directors also receive $200 for each special Board meeting or committee
meeting that they attend. Director fees totalled $88,000 for the year ended
September 30, 1997. It is currently anticipated that, after completion of the
Conversion, directors' fees will be paid by the Company and no separate fees
will be paid for service on the Board of Directors of the Savings Bank.
Deferred Compensation Plan. The Savings Bank maintains a deferred
compensation plan for the benefit of directors who may elect to defer receipt
of all or a portion of their fees until retirement or termination of service.
At the director's election, benefits are distributed in a lump sum or
installment payments. At September 30, 1997, none of the Savings Bank's
directors had elected to participate in the plan.
Item 12. Security Ownership of Certain Beneficial Owners and Management
- ------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners.
The Company had no shares of common stock outstanding at September
30, 1997.
(b) Security Ownership of Management.
The Company had no shares of common stock outstanding at September
30, 1997.
(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. Certain Relationships and Related Transactions
- --------------------------------------------------------
Current law requires that all loans or extensions of credit to executive
officers and directors must be made on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
transactions with other persons and does not involve more than the normal risk
of repayment or present other unfavorable features. The Savings Bank is
therefore prohibited from making any new loans or extensions of credit to the
Savings Bank's executive officers and directors and at different rates or
terms than those offered to the general public and has adopted a policy to
this effect. The aggregate amount of loans by the Savings Bank to its
executive officers and directors was approximately $803,000 at September 30,
1997. Such loans (i) were made in the ordinary course of business, (ii) were
made on substantially the same terms and conditions, including interest rates
and collateral, as those prevailing at the time for comparable transactions
with the Savings Bank's other customers, and (iii) did not involve more than
the normal risk of collectibility or present other unfavorable features when
made.
75
<PAGE>
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
- --------------------------------------------------------------------------
(a) Exhibits
3.1 Articles of Incorporation of the Registrant*
3.2 Bylaws of the Registrant*
27 Financial Data Schedule
- -----------------
* Filed as an exhibit to the Registrant's Registration Statement on Form S-1
(333-35817).
(b) Reports on Form 8-K
No Reports on Form 8-K were filed during the quarter ended September
30, 1997.
76
<PAGE>
<PAGE>
SIGNATURES
Pursuant to the requirements of section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
TIMBERLAND BANCORP, INC.
Date: December 24, 1997 By: /s/ Clarence E. Hamre
-----------------------------------------
Clarence E. Hamre
Chairman of the Board, President and Chief
Executive Officer
Pursuant to the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
SIGNATURES TITLE DATE
- ---------- ----- ----
/s/ Clarence E. Hamre
- ------------------------ Chairman of the Board, December 24, 1997
Clarence E. Hamre President, Chief Executive
Officer and Director
(Principal Executive Officer)
/s/ Michael R. Sand
- ------------------------ Executive Vice President, December 24, 1997
Michael R. Sand Secretary and Director
(Principal Financial and
Accounting Officer)
/s/ Andrea M. Clinton
- ------------------------ Director December 24, 1997
Andrea M. Clinton
/s/ Robert Backstrom
- ------------------------ Director December 24, 1997
Robert Backstrom
/s/ Richard R. Morris
- ------------------------ Director December 24, 1997
Richard R. Morris
/s/ Alan E. Smith
- ------------------------ Director December 24, 1997
Alan E. Smith
/s/ Peter J. Majar
- ------------------------ Director December 24, 1997
Peter J. Majar
/s/ Jon C. Parker
- ------------------------ Director December 24, 1997
Jon C. Parker
/s/ James C. Mason
- ------------------------ Director December 24, 1997
James C. Mason
<PAGE>
<PAGE>
Exhibit 27
Financial Data Schedule (in thousands)
This schedule contains financial information extracted from the consolidated
financial statements of Timberland Bancorp, Inc. for the year ended September
30, 1997 and is qualified in its entirety by reference to such financial
statements.
Financial Data
as of or for the year
Item Number ended September 30, 1997 Item Description
- ----------- ------------------------ ----------------
9-03 (1) 4,996 Cash and Due from Banks
9-03 (2) 6,450 Interest - bearing deposits
9-03 (3) NA Federal funds sold - purchased
securities for resale
9-03 (4) NA Trading account assets
9-03 (6) 1,586 Investment and mortgage backed
securities held for sale
9-03 (6) 3,990 Investment and mortgage backed
securities held to maturity -
carrying value
9-03 (6) 3,982 Investment and mortgage backed
securities held to maturity -
market value
9-03 (7) 188,743 Loans
9-03 (7)(2) 1,716 Allowance for loan losses
9-03 (11) 211,553 Total assets
9-03 (12) 173,003 Deposits
9-03 (13) 500 Short - term borrowings
9-03 (15) 1,664 Other liabilities
9-03 (16) 11,741 Long - term debt
9-03 (19) NA Preferred stock - mandatory
redemption
9-03 (20) NA Preferred stock - no mandatory
redemption
9-03 (21) NA Common stocks
9-03 (22) 24,645 Other stockholders' equity
9-03 (23) 211,553 Total liabilities and
stockholders' equity
9-04 (1) 17,418 Interest and fees on loans
9-04 (2) 395 Interest and dividends on
investments
9-04 (4) 134 Other interest income
9-04 (5) 17,947 Total interest income
9-04 (6) 7,516 Interest on deposits
9-04 (9) 8,386 Total interest expense
9-04 (10) 9,562 Net interest income
9-04 (11) 596 Provision for loan losses
9-04 (13)(h) -0- Investment securities gains/
(losses)
9-04 (14) 5,041 Other expenses
9-04 (15) 5,159 Income/loss before income tax
9-04 (17) 5,159 Income/loss before extraordinary
items
9-04 (18) NA Extraordinary items, less tax
9-04 (19) NA Cumulative change in accounting
principles
9-04 (20) 3,329 Net income or loss
9-04 (21) NA Earnings per share - primary
9-04 (21) NA Earnings per share - fully
diluted
I.B. 5 9.09% Net yield - interest earnings -
actual
III.C.1. (a) 7,555 Loans on non - accrual
III.C.1. (b) 109 Accruing loans past due 90 days
or more
III.C.2. (c) 70 Troubled debt restructuring
III.C.2 -- Potential problem loans
IV.A.1 1,133 Allowance for loan loss -
beginning of period
IV.A.2 22 Total chargeoffs
IV.A.3 9 Total recoveries
IV.A.4 1,716 Allowance for loan loss - end of
period
IV.B.1 1,716 Loan loss allowance allocated to
domestic loans
IV.B.2 -- Loan loss allowance allocated to
foreign loans
IV.B.3 -- Loan loss allowance -
unallocated
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1997
<PERIOD-END> SEP-30-1997
<CASH> 4996
<INT-BEARING-DEPOSITS> 6450
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 1586
<INVESTMENTS-CARRYING> 3990
<INVESTMENTS-MARKET> 3982
<LOANS> 188743
<ALLOWANCE> 1716
<TOTAL-ASSETS> 211553
<DEPOSITS> 173003
<SHORT-TERM> 500
<LIABILITIES-OTHER> 1664
<LONG-TERM> 11741
0
0
<COMMON> 0
<OTHER-SE> 24645
<TOTAL-LIABILITIES-AND-EQUITY> 211553
<INTEREST-LOAN> 17418
<INTEREST-INVEST> 395
<INTEREST-OTHER> 134
<INTEREST-TOTAL> 17947
<INTEREST-DEPOSIT> 7516
<INTEREST-EXPENSE> 8386
<INTEREST-INCOME-NET> 9562
<LOAN-LOSSES> 596
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 5041
<INCOME-PRETAX> 5159
<INCOME-PRE-EXTRAORDINARY> 5159
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3329
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<YIELD-ACTUAL> 9.09
<LOANS-NON> 7555
<LOANS-PAST> 109
<LOANS-TROUBLED> 70
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1133
<CHARGE-OFFS> 22
<RECOVERIES> 9
<ALLOWANCE-CLOSE> 1716
<ALLOWANCE-DOMESTIC> 1716
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
