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, 1998 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.
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(Exact name of registrant as specified in its charter)
Washington 91-1863696
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(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) I.D. Number)
624 Simpson Avenue, Hoquiam, Washington 98550
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (360) 533-4747
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Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Common Stock, par value $.01 per share
Section 12(g) of the Act: --------------------------------------
(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
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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
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As of December 4, 1998, there were issued and outstanding 5,967,781 shares
of the registrant's Common Stock, which are listed on the Nasdaq National
Market System under the symbol "TSBK." Based on the average of the bid and
asked prices for the Common Stock on December 4, 1998, the aggregate value of
the Common Stock outstanding held by nonaffiliates of the registrant was
$77,208,167 (5,967,781 shares at $12.9375 per share). For purposes of this
calculation, Common Stock held by officers and directors of the registrant and
Timberland Savings Bank, SSB Employee Stock Ownership Plan and Trust are
considered nonaffiliates.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Annual Report to Stockholders for the Fiscal Year Ended
September 30, 1998 ("Annual Report") (Parts I and II).
2. Portions of Definitive Proxy Statement for the 1999 Annual Meeting of
Stockholders (Part III).
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PART I
Item 1. Business
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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 ("Bank") upon the Bank's conversion from a
Washington-chartered mutual to a Washington-chartered stock savings bank
("Conversion"). The Conversion was completed on January 12, 1998 through the
sale and issuance of 6,612,500 shares of common stock by the Company. At
September 30, 1998, the Company had total assets of $265.7 million, total
deposits of $170.8 million and total equity of $81.8 million. The Company's
business activities generally are limited to passive investment activities and
oversight of its investment in the Bank. Accordingly, the information set
forth in this report, including consolidated financial statements and related
data, relates primarily to the Bank and its subsidiary.
The Bank was established in 1915 as "Southwest Washington Savings and Loan
Association." In 1935, the 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 Bank converted to a federally chartered
mutual savings bank under the name "Timberland Savings Bank, FSB." In 1991,
the Bank converted to a Washington-chartered mutual savings bank and adopted
its current name. The Bank's deposits are insured by the FDIC up to
applicable legal limits under the Savings Association Insurance Fund ("SAIF").
The Bank has been a member of the Federal Home Loan Bank ("FHLB") System since
1937. The Bank is regulated by the Washington Department of Financial
Institutions, Division of Banks ("Division") and the FDIC.
The 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 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 Bank considers Grays Harbor, Thurston, Pierce and King Counties and,
to a lesser extent, adjoining Kitsap County as its primary market area. The
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 (Silverdale, opened in 1995 in
Port Orchard and subsequently relocated to Silverdale in 1998) 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 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 Bank. The Bank's recent
expansion into Thurston, King and Kitsap
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Counties and recent opening of a second branch office in Pierce County
represents the Bank's strategy to diversify its primary market area to become
less reliant on the economy of Grays Harbor County.
Lending Activities
General. Historically, the principal lending activity of the 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 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 Bank's
net loans receivable, including loans held for sale, totaled approximately
$199.2 million at September 30, 1998, representing approximately 75.0% 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 $117.3 million, or 50.5%, of total loans.
The Bank's internal loan policy limits the maximum amount of loans to one
borrower to 25% of its capital. At September 30, 1998, the maximum amount
which the Bank could have lent to any one borrower and the borrower's related
entities was approximately $13.5 million under its policy. At September 30,
1998, the Bank had no loans with an aggregate outstanding balance in excess of
this amount. At that date, the Bank had 27 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 $7.7 million.
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Loan Portfolio Analysis. The following table sets forth the composition of the Bank's loan portfolio by
type of loan as of the dates indicated.
At September 30,
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1994 1995 1996 1997 1998
---------------- ---------------- --------------- ---------------- ---------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
----- ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage Loans:
One- to- four
family(1)(2). $ 73,754 52.94% $ 93,582 53.03% $ 95,978 48.51% $100,127 48.76% $100,921 43.48%
Multi-family . 4,806 3.45 10,965 6.21 12,569 6.35 12,178 5.93 12,432 5.36
Commercial . . 11,784 8.46 15,592 8.83 26,529 13.41 29,410 14.32 32,906 14.18
Construction
and land
development . 40,113 28.79 42,752 24.23 47,140 23.83 45,031 21.93 64,172 27.65
Land(2). . . . 4,118 2.96 6,118 3.47 6,115 3.09 6,937 3.38 7,749 3.34
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total mortgage
loans. . . . 134,575 96.60 169,009 95.77 188,331 95.19 193,683 94.32 218,180 94.01
Consumer Loans:
Home equity and
second
mortgage. . . 2,853 2.05 5,201 2.95 6,576 3.32 8,142 3.97 8,740 3.77
Other. . . . . 1,623 1.16 2,019 1.15 2,476 1.25 2,824 1.37 4,066 1.74
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
4,476 3.21 7,220 4.10 9,052 4.57 10,966 5.34 12,806 5.51
Commercial
business
loans. . . . . 268 0.19 232 0.13 476 0.24 964 0.34 1,105 0.48
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans . 139,319 100.00% 176,461 100.00% 197,859 100.00% 205,343 100.00% 232,091 100.00%
-------- ====== -------- ====== -------- ====== -------- ====== -------- ======
Less:
Undisbursed
portion of
loans in
process . . . (15,316) (17,262) (18,434) (14,820) (28,886)
Unearned
income. . . . (1,299) (1,554) (1,708) (1,761) (2,256)
Allowance for
loan losses . (1,120) (1,119) (1,133) (1,716) (1,728)
Market value
adjustment of
loans held-
for-sale. . . (26) (3) (89) (19) --
-------- -------- -------- -------- --------
Total loans
receivable,
net. . . . . $121,558 $156,523 $176,495 $187,027 $199,221
======== ======== ======== ======== ========
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(1) Includes loans held-for-sale.
(2) Includes real estate contracts totaling $1.9 million at September 30, 1998. See " -- Lending
Activities -- Real Estate Contracts."
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Residential One- to- Four Family Lending. At September 30, 1998, $100.9
million, or 43.5%, of the Bank's loan portfolio consisted of loans secured by
one- to- four family residences.
The 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 Bank may be
retained in the Bank's loan portfolio to meet the Bank's asset/liability
management objectives. The 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,
1998, $18.7 million, or 18.5%, of the Bank's one- to- four family loan
portfolio consisted of fixed rate one- to- four family mortgage loans.
The Bank also offers adjustable rate mortgage ("ARM") loans at rates and
terms competitive with market conditions. All of the Bank's ARM loans are
retained in its loan portfolio and not with a view toward sale in the
secondary market.
The 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 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, 1998, $82.2 million, or 81.5%, of
the Bank's one- to- four family loan portfolio consisted of ARM loans.
The material portion of the 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 Bank may require additional collateral
or lower loan-to-value ratios prior to the origination of the loan. The Bank
believes that these loans satisfy a need in its local market area. As a
result, subject to market conditions, the Bank intends to continue to
originate such loans.
The retention of ARM loans in the Bank's loan portfolio helps reduce the
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 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
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 Bank to increase the
sensitivity of its asset base due to changes in the interest rates, the extent
of this interest sensitivity is limited by the periodic and lifetime interest
rate adjustment limits. Because of these considerations, the Bank has no
assurance that yields on ARM loans will be sufficient to offset increases in
the Bank's cost of funds.
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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 Bank's loan portfolio contain due-on-sale clauses providing that the
Bank may declare the unpaid amount due and payable upon the sale of the
property securing the loan. Typically, the 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 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 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 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 Bank sought to
establish a market niche and as a result began originating construction loans.
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 Bank expects that its
margins on construction loans may be reduced in the future.
The Bank currently originates three types of residential construction
loans: (i) speculative construction loans, (ii) custom construction loans and
(iii) owner/builder loans. The Bank initiated its construction lending with
the origination of speculative construction loans. As a result, the 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 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 Bank also originates construction loans
for the development of multi-family and commercial properties. Subject to
market conditions, the Bank intends to continue to emphasize its residential
construction lending activities.
At September 30, 1998, the composition of the Bank's construction and
land development loan portfolio was as follows:
Outstanding Percent of
Balance Total
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(In thousands)
Speculative construction . . . . . . . $20,735 32.31%
Custom and owner/builder construction. 18,275 28.48
Multi-family . . . . . . . . . . . . . 14,758 23.00
Land development . . . . . . . . . . . 7,533 11.74
Commercial real estate . . . . . . . . 2,871 4.47
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Total. . . . . . . . . . . . . . . . $64,172 100.00%
======= ======
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 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
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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 Bank lends to approximately 75
builders located in the Bank's primary market area, each of which generally
have three or four speculative loans outstanding from the Bank during a 12
month period. Rather than originating lines of credit to home builders to
construct several homes at once, the 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, 1998 speculative construction loans totaled $20.7
million, or 32.3%, of the total construction loan portfolio. At September 30,
1998, the Bank had 11 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 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 sales price, 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
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 Bank's
portfolio. At September 30, 1998, custom and owner/builder construction loans
totaled $18.3 million, or 28.5%, of the total construction loan portfolio. At
September 30, 1998, the largest outstanding custom construction loan had an
outstanding balance of $433,000 and was performing according to its terms.
The 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)
(generally with ten to 50 lots). At September 30, 1998, subdivision
development loans totaled $7.5 million, or 11.7% 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 generally not exceeding
75%. Monthly interest payments are required during the term of the loan.
Land development loans are structured so that the Bank is repaid in full upon
the sale by the borrower of approximately 80% of the subdivision lots.
Substantially all of the 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 Bank also generally obtains personal guarantees from corporate
principals and reviews their personal financial statements. At September 30,
1998, the Bank had 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 Bank may be confronted with a property the value
of which is insufficient to assure full repayment. The Bank attempts to
minimize this risk by generally 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 Bank also provides construction financing for
multi-family and commercial properties. At September 30, 1998, such
construction loans amounted to $17.6 million. These loans are secured by
motels,
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apartment buildings, condominiums, office buildings and retail rental space
located in the Bank's primary market area and typically range in amount from
$300,000 to $600,000. At September 30, 1998, the largest outstanding multi-
family construction loan had a balance of $5.7 million and was performing
according to its terms. Periodically, the 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 Bank's primary market area. The Bank underwrites such participation
interests according to its own standards. At September 30, 1998, the largest
participation interest had an outstanding balance of $2.7 million, which
represented a 50% interest in a construction loan secured by a multi-family
property located in Vancouver, Washington. The loan was performing according
to its terms at September 30, 1998.
All construction loans must be approved by the 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 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 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 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. Periodic on-site inspections are made by
qualified Bank employees to document the reasonableness of the draw request.
For most builders, the 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 Bank for payment.
The Bank regularly monitors the construction loan disbursements using an
internal computer program. Property inspections are performed by Bank
personnel for properties located within the Bank's primary market area and by
independent inspectors for properties outside the primary market area. The
Bank believes that its internal monitoring system helps reduce many of the
risks inherent in its construction lending.
The Bank originates construction loan applications through customer
referrals, contacts in the business community and real estate brokers seeking
financing for their clients.
Construction lending affords the 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 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 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 Bank has sought to address these risks by adhering to strict
underwriting policies, disbursement procedures, and monitoring practices. In
addition, because the 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 Bank's construction loan
portfolio.
Real Estate Contracts. The 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
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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 Bank are generally located within its
primary market area. Prior to purchasing the real estate contract, the 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, 1998, the Bank had outstanding $1.9 million of real estate
contracts.
Multi-Family Lending. At September 30, 1998, the Bank had $12.4 million,
or 5.4% of the Bank's total loan portfolio, secured by multi-family dwelling
units (more than four units) located primarily in the Bank's primary market
area. Subject to market conditions, the Bank intends to become a more active
originator of multi-family loans within its primary market area. At September
30, 1998, approximately 39.1% of the Bank's multi-family loans represent
participation interests in loans, secured by properties located in the Bank's
primary market area, purchased from other lenders. Such participation
interests are purchased without recourse to the seller other than for fraud.
The Bank underwrites such participation interests according to its own
standards.
Multi-family loans are generally originated with variable rates of
interest ranging from 3.00% to 3.50% 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 $3.0 million. At September 30, 1998, 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 Bank's primary market area. At September 30, 1998, this loan
was performing according to its terms.
The maximum loan-to-value ratio for multi-family loans is generally 75%.
The Bank requires its multi-family loan borrowers to submit financial
statements and rent rolls on the subject property annually. The Bank also
inspects the subject property annually. The 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 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 Bank seeks 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 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 totaled
$32.9 million, or 14.2% of total loans receivable at September 30, 1998, and
consisted of 138 loans. The 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 a commercial real estate
loan generally ranges between $100,000 and $3.0 million. At September 30,
1998, $2.9 million of commercial real estate loans were not performing
according to terms. See "-- Lending Activities -- Nonperforming Assets and
Delinquencies."
The Bank requires appraisals of all properties securing commercial real
estate loans. Appraisals are performed by an independent appraiser designated
by the Bank, all of which are reviewed by management. The 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 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 Bank generally obtains loan guarantees from financially capable parties
based on a review of personal financial statements.
8
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<PAGE>
Commercial real estate lending affords the 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 Bank seeks to minimize these risks by
generally 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 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, 1998, the Bank's land
loan portfolio totaled $7.7 million and consisted of 181 loans. Land loans
originated by the 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 $100,000. The largest land loan had an outstanding balance of
$294,000 at September 30, 1998 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 Bank may be confronted with a
property the value of which is insufficient to assure full repayment. The
Bank attempts to minimize this risk by generally limiting the maximum loan-to-
value ratio on land loans to 75%.
Consumer Lending. Consumer lending has traditionally been a small part of
the 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, 1998, consumer loans amounted to $12.8 million, or 5.5% of the total loan
portfolio.
At September 30, 1998, the largest component of the consumer loan
portfolio consisted of second mortgage loans and home equity lines of credit,
which totaled $8.7 million, or 3.8%, of the total loan portfolio. Home equity
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 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 Bank began issuing VISA credit cards to its existing
customers. At September 30, 1998, credit card loans amounted to $1.2 million.
The 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 Bank
believes that these risks are not as prevalent in the case of the 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
9
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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 Bank. At
September 30, 1998, there were $17,000 of consumer loans delinquent in excess
of 90 days.
Commercial Business Lending. Commercial business loans totaled $1.1
million, or 0.48% of total loans receivable at September 30, 1998, and
consisted of 17 loans. In July 1998, the Bank established a business banking
division staffed by three experienced commercial bankers to increase the
Bank's origination of commercial business loans.
10
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Loan Maturity
The following table sets forth certain information at September 30, 1998
regarding the dollar amount of loans maturing in the 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 3 After 5
One Year 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. . . . $ 310 $ 1,098 $ 1,488 $ 3,758 $ 94,267 $100,921
Multi-family . -- 195 414 7,369 4,454 12,432
Commercial . . 165 338 1,367 14,769 16,267 32,906
Construction
and land
development
(1) . . . . . 25,087 17,372 -- 1,652 20,061 64,172
Land . . . . . 763 2,337 3,954 458 237 7,749
Consumer loans:
Home equity
and second
mortgage. . . 2,746 523 1,361 1,729 2,381 8,740
Other. . . . . 1,301 1,195 1,013 203 354 4,066
Commercial
business loans 192 180 468 265 -- 1,105
------- ------- ------- ------- -------- --------
Total. . . . 30,564 24,048 10,065 30,203 138,021 232,091
Less:
Undisbursed
portion of
loans in
process . . (28,886)
Unearned
income. . . (2,256)
Allowance for
loan losses (1,728)
Market value
adjustment on
loans held-
for-sale. . --
--------
Loans
receivable,
net . . . $199,221
========
- -------------
(1) Includes construction/permanent that convert to a permanent mortgage loan
once construction is completed.
11
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<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.
Floating or
Fixed Adjustable
Rates Rates Total
----- ----- -----
(In thousands)
Mortgage loans:
One- to- four family . . . . $ 18,682 $ 82,239 $100,921
Multi-family. . . . . . . . 5,313 7,119 12,432
Commercial. . . . . . . . . 4,537 28,369 32,906
Construction and land
development. . . . . . . . 56,426 7,746 64,172
Land. . . . . . . . . . . . 7,617 132 7,749
Consumer loans:
Home equity and second
mortgage . . . . . . . . . 6,150 2,590 8,740
Other . . . . . . . . . . . 3,965 101 4,066
Commercial business loans. . 834 271 1,105
-------- -------- --------
Total . . . . . . . . . . $103,524 $128,567 $232,091
======== ======== ========
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 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 Bank and certified by the State of Washington.
Mortgage loan applications are initiated by loan officers and are required
to be approved by the Bank's Loan Committee, which consists of the 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 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
Bank's Board of Directors.
Loan Originations, Purchases and Sales. During the years ended September
30, 1997 and 1998, the Bank's total gross loan originations were $76.7 million
and $126.9 million, respectively. Periodically, the Bank purchases
participation interests in construction and land development loans and multi-
family loans, secured by properties located in the Bank's primary market area,
from other lenders. Such purchases are underwritten to the 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 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 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, 1998, the Bank's loan servicing portfolio totaled
$60.3 million.
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<PAGE>
The following table shows total loans originated, purchased, sold and
repaid during the periods indicated.
Year Ended September 30,
------------------------------
1996 1997 1998
---- ---- ----
(Dollars in thousands)
Loans originated:
Mortgage loans:
One- to- four family . . . . . . . . $24,512 $27,149 $ 45,377
Multi-family . . . . . . . . . . . . 3,946 1,229 5,461
Commercial . . . . . . . . . . . . . 10,100 3,635 6,750
Construction and land development. . 29,662 35,218 58,054
Land . . . . . . . . . . . . . . . . 2,590 2,644 3,265
Consumer. . . . . . . . . . . . . . . 5,358 6,446 7,437
Commercial business loans . . . . . . 348 363 525
------- ------- --------
Total loans originated . . . . . . . 76,516 76,684 126,869
Loans purchased:
Mortgage loans:
One- to- four family . . . . . . . . 367 163 619
Multi-family . . . . . . . . . . . . 1,163 -- --
Commercial . . . . . . . . . . . . . -- 546 --
Construction . . . . . . . . . . . . 4,300 -- --
Land . . . . . . . . . . . . . . . . 83 347 --
------- ------- --------
Total loans purchased . . . . . . . 5,913 1,056 619
------- ------- --------
Total loans originated
and purchased. . . . . . . . . . 82,429 77,740 127,488
Loans sold:
Total whole loans sold . . . . . . . (9,153) (15,275) (25,236)
Participation loans. . . . . . . . . (3,229) -- --
------- ------- --------
Total loans sold . . . . . . . . . . (12,382) (15,275) (25,236)
Mortgage loan principal repayments . . (48,649) (54,981) (75,504)
Decrease (increase) in other items, net (1,426) 3,048 (14,554)
------- ------- --------
Net increase in loans receivable, net. $19,972 $10,532 $ 12,194
======= ======= ========
Loan Origination and Other Fees. The 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 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 Bank had $2.1 million of net deferred mortgage loan fees at
September 30, 1998.
Nonperforming Assets and Delinquencies. The 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 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 of
delinquency. If a satisfactory response is
13
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<PAGE>
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 Bank institutes the same collection
procedures as for its mortgage loan borrowers.
The 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 Bank.
The following table sets forth information with respect to the Bank's non
performing assets at the dates indicated.
At September 30,
----------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(Dollars in thousands)
Loans accounted for
on a nonaccrual basis:
Mortgage loans:
One- to- four family . . $392 $ 646 $ 735 $ 776 $ 996
Commercial . . . . . . . -- -- -- 2,886 2,919
Construction and land
development . . . . . . 125 391 771 3,891 --
Land . . . . . . . . . . -- -- -- -- 397
Consumer loans. . . . . . 30 -- 14 2 17
Commercial business loans -- -- -- -- 81
---- ------ ------ ------ ------
Total . . . . . . . . 547 1,037 1,520 7,555 4,410
Accruing loans which are
contractually past due
90 days or more:
Mortgage loans:
Construction and land
development . . . . . . -- -- -- 109 396
---- ------ ------ ------ ------
Total. . . . . . . . -- -- -- 109 396
---- ------ ------ ------ ------
Total of nonaccrual and
90 days past due loans. . 547 $1,037 $1,520 $7,664 $4,806
Real estate owned and other
repossessed assets. . . . 407 209 125 434 1,724
---- ------ ------ ------ ------
Total nonperforming
assets . . . . . . . 954 1,246 1,645 8,098 6,530
Restructured loans . . . . 29 207 158 70 236
(table continued, and footnotes located, on following page)
14
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At September 30,
--------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(Dollars in thousands)
Nonaccrual and 90 days or more
past due loans as a percentage
of loans receivable, net. . . . 0.45% 0.66% 0.86% 4.06% 2.39%
Nonaccrual and 90 days or more
past due loans as a percentage
of total assets . . . . . . . . 0.36% 0.58% 0.78% 3.62% 1.81%
Nonperforming assets as a
percentage of total assets. . . 0.63% 0.70% 0.85% 3.83% 2.46%
Loans receivable, net(1) . . . . $122,678 $157,642 $177,628 $188,743 $200,949
======== ======== ======== ======== ========
Total assets . . . . . . . . . . $151,044 $177,761 $194,357 $211,553 $265,709
======== ======== ======== ======== ========
- ----------------
(1) Includes loans held-for-sale and is before the allowance for loan losses.
Additional interest income, which would have been recorded for the year
ended September 30, 1998 had nonaccruing loans been current in accordance with
their original terms, amounted to approximately $544,000. No interest income
was included in the results of operations on such loans for the year ended
September 30, 1998.
The following is a discussion of the Bank's major problem assets at
September 30, 1998:
Convenience store/retail space and mini-storage, Kitsap County,
Washington. The 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. These two loans had a combined balance of $2.9
million at September 30, 1998. These loans became delinquent primarily
because of a dispute between the two borrowers. These loans were classified
as "substandard" at September 30, 1998. The Bank initiated foreclosure
proceedings which were stayed due to a bankruptcy filing by the borrowers in
January of 1998. The Bank's attorney's have now secured a dismissal of the
bankruptcy and a receiver has been appointed to manage the properties. The
Bank is currently pursuing foreclosure on the properties. Although no
assurances can be given, the Bank does not expect to incur any material loss
on these two loans. See "-- Lending Activities -- Asset Classification."
Real Estate Owned: Condominiums, Southern King County, Washington. The
Bank accepted a deed in lieu of foreclosure on two delinquent loans for the
construction and sale of a 61-unit condominium complex. These loans were
classified as "substandard" at September 30, 1997 and had a balance of $2.9
million. They were classified by the Bank as "Real Estate Owned" of $752,000
at September 30, 1998. The Bank has been actively marketing the project and,
as of December 1, 1998, had accepted earnest money agreements for 29 of the 30
units. As of December 1, 1998, 26 of these sales had closed and the remaining
real estate owned balance was $484,000. The Bank does not expect to incur a
material loss on the disposition of these assets based on the prices at which
the units are currently selling. See "-- Real Estate Owned."
Real Estate Owned. Real estate acquired by the 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, 1998, the Bank had $1.7 million in
real estate owned consisting primarily of the $752,000 remaining
15
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<PAGE>
balance on the condominium project in Southern King County (See "--
Nonperforming Assets and Delinquencies") and several one- to- four family
properties.
Restructured Loans. Under generally accepted accounting principles
("GAAP"), the 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 Bank for economic or legal reasons related to the
borrower's financial difficulties grants a concession to the borrowers that
the Bank would not otherwise consider. Debt restructuring or loan
modifications for a borrower does not necessarily always constitute troubled
debt restructuring, however, and troubled debt restructuring do not
necessarily result in non-accrual loans. The Bank had $236,000 of
restructured loans as of September 30, 1998, which consisted of a single one-
to- four family mortgage 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
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.
The aggregate amounts of the Bank's classified assets (as determined by
the Bank), and of the Bank's general loss allowances at the dates indicated,
were as follows:
At September 30,
----------------------------------
1996 1997 1998
---- ---- ----
(In thousands)
Loss . . . . . . . . . . . . . $ -- $ -- $ --
Doubtful . . . . . . . . . . . -- -- --
Substandard assets(1). . . . . 2,061 5,470 4,888
Special mention(1) . . . . . . 97 2,886 1,160
General loss allowances. . . . 1,133 1,716 1,728
- ----------------
(1) For further information concerning the increase in classified assets, see
"-- Lending Activities -- Nonperforming Assets and Delinquencies."
Allowance for Loan Losses. The 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 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
16
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<PAGE>
economic conditions and, in the case of a secured loan, the quality of the
security for the loan. The Bank increases its allowance for loan losses by
charging provisions for loan losses against the 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, 1998, the 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 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 Bank's loan portfolio, will not request the 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 Bank's financial condition and results of operations.
17
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<PAGE>
The following table sets forth an analysis of the Bank's gross allowance
for possible loan losses for the periods indicated.
Year Ended September 30,
---------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(Dollars in thousands)
Allowance at beginning of period . $ 1,138 $ 1,120 $ 1,119 $ 1,133 $ 1,716
Provision for loan losses. . . . . -- -- 70 596 200
Recoveries:
Consumer loans:
Automobile . . . . . . . . . . . -- -- -- -- --
Other. . . . . . . . . . . . . . -- -- -- 9 --
------ ------ ------ ------ ------
Total recoveries. . . . . . . . -- -- -- 9 --
Charge-offs:
Mortgage loans:
One- to- four family -- -- -- 19 4
Home equity and second mortgage. 18 -- -- -- --
Other. . . . . . . . . . . . . . -- 1 1 -- 4
------ ------ ------ ------ ------
Total charge-offs . . . . . . . 18 1 1 19 8
------ ------ ------ ------ ------
Net charge-offs . . . . . . . . 18 1 1 10 8
Transfers . . . . . . . . . . . -- -- 55 3 180
------ ------ ------ ------ ------
Balance at end of period. . . $1,120 $1,119 $1,133 $1,716 $1,728
====== ====== ====== ====== ======
Allowance for loan losses as a
percentage of total loans (net)
(1) outstanding at the end
of the period . . . . . . . . . . 0.91% 0.71% 0.64% 0.91% 0.86%
Net charge-offs as a percentage
of average loans outstanding
during the period . . . . . . . . 0.02% --% --% 0.01% --%
Allowance for loan losses as
a percentage of nonperforming
loans at end of period. . . . . . 204.75% 107.91% 74.54% 22.39% 35.96%
- ------------------
(1) Total loans (net) includes loans held for sale and is before the allowance
for loan losses.
18
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<TABLE>
The following table sets forth the breakdown of the allowance for loan losses by loan category at the
dates indicated.
At September 30,
---------------------------------------------------------------------------------
1994 1995 1996 1997 1998
---------------- --------------- ---------------- -------------- ---------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in in in in in
Category Category Category Category 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 . . $ 333 52.94% $ 278 53.03% $ 261 48.51% $ 311 48.76% $ 311 43.48%
Multi-family. . . . . . 77 3.45 81 6.21 83 6.35 149 5.93 70 5.36
Commercial. . . . . . . 266 8.46 271 8.84 317 13.41 409 14.32 706 14.18
Construction. . . . . . 240 28.79 337 24.23 316 23.83 646 21.93 368 27.65
Land. . . . . . . . . . 158 2.96 98 3.47 102 3.09 138 3.38 180 3.34
Non-mortgage loans:
Consumer loans. . . . . 39 3.21 44 4.09 46 4.57 50 5.34 65 5.51
Commercial business
loans . . . . . . . . 7 0.19 10 0.13 8 0.24 13 0.34 28 0.48
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total allowance
for loan losses. . $1,120 100.00% $1,119 100.00% $1,133 100.00% $1,716 100.00% $1,728 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
19
</TABLE>
<PAGE>
<PAGE>
Investment Activities
At September 30, 1998, the Company's investment securities portfolio
totaled $35.4 million, consisting of $17.8 million of securities available for
sale and $17.6 million of mortgage-backed securities available for sale. This
compares with a total portfolio of $5.6 million at September 30, 1997,
comprised of $1.6 million of securities available for sale and $4.0 million of
mortgage-backed securities held to maturity. The composition of the
portfolios by type of security, at each respective date is presented in the
table, which follows.
The investment policies of the Company are established and monitored by
the Board of Directors. The policies are designed primarily to provide and
maintain liquidity, to generate a favorable return on investments without
incurring undue interest rate and credit risk, and to compliment the Bank's
lending activities. These policies dictate the criteria for classifying
securities as either available for sale or held for investment. The policies
permit investment in various types of liquid assets permissible under
applicable regulations, which includes U.S. Treasury obligations, securities
of various federal agencies, certain certificates of deposit of insured banks,
banker's acceptances, federal funds, FHLB stock, and mortgage-backed
securities. The Company's investment policy also permits investment in equity
securities in certain financial service companies.
20
<PAGE>
<PAGE>
The following table sets forth the investment securities portfolio and
carrying values at the dates indicated.
At September 30,
-----------------------------------------------------------
1996 1997 1998
------------------ ----------------- ------------------
Percent Percent Percent
Amortized of Amortized of Amortized of
Cost(1) Total Cost(1) Total Cost(1) Total
------- ----- ------ ----- ------- -----
(Dollars in thousands)
Held-to-Maturity
(at amortized cost):
Mortgage-backed
securities . . . $ 4,951 75.91% $ 3,991 71.56% $ -- --%
Investment
certificates of
deposit. . . . . -- -- -- -- -- --
Total held-to- ------- ------ ------- ------ ------- -----
maturity
securities . . . 4,951 75.91 3,991 71.56 -- --
Available-for-Sale
(at market value):
U.S. Agency
Securities . . . -- -- -- -- 8,937 25.23%
Mortgage-backed
securities . . . -- -- -- -- 17,555 49.57
Mutual funds. . . -- -- -- -- 7,121 20.11
FHLB stock. . . . 1,470 22.54% 1,586 28.44 1,713 4.84
Equity securities 101 1.55 -- -- 89 0.25
------- ------ ------- ------ ------- -----
Total available-
for-sale
securities . . 1,571 24.09 1,586 28.44 35,415 100.00
------- ------ ------- ------ ------- -----
Total portfolio . $ 6,522 100.00% $ 5,577 100.00% $35,415 100.00%
======= ====== ======= ====== ======= ======
- ------------------
(1) The market value of the Company's investment portfolio amounted to $35.4
million as of September 30, 1998, $5.6 million as of September 30, 1997
and $6.4 million as of September 30, 1996.
21
<PAGE>
<PAGE>
The following table sets forth the maturities and weighted average yields
of the debt and mortgage-backed securities in the Company's investment
securities portfolio at September 30, 1998.
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)
Available-for-Sale:
U.S. Agency
securities . . . $ -- --% $8,937 5.98% $ -- --% $ -- --%
Mortgage-backed
securities . . . 326 4.67 82 6.87 2,008 6.36 15,139 6.22
Mutual funds. . . 7,121 5.67 -- -- -- -- -- --
FHLB Stock. . . . 1,713 7.66 -- -- -- -- -- --
Equity securities 89 1.06 -- -- -- -- -- --
------ ---- ------ ---- ------ ---- ------- ----
Total available-
for-sale
securities . . . 9,249 5.94 9,019 5.99 2,008 6.36 15,139 6.22
------ ------ ------ -------
Total portfolio . $9,249 5.94% $9,019 5.99% $2,008 6.36% $15,139 6.22%
====== ====== ====== =======
Deposit Activities and Other Sources of Funds
General. Deposits and loan repayments are the major sources of the 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 Bank has no other borrowing arrangements.
Deposit Accounts. Substantially all of the Bank's depositors are
residents of Washington. Deposits are attracted from within the 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 Bank considers current market interest rates, profitability to
the Bank, matching deposit and loan products and its customer preferences and
concerns. In recent periods, the Bank has used deposit interest rate
promotions in connection with the opening of new branch offices.
At September 30, 1998 the Bank had $14.6 million of jumbo certificates of
deposit, which includes $834,000 in public unit funds. The Bank does not
solicit brokered deposits and believes that its jumbo certificates of deposit,
which represented 8.5% of total deposits at September 30, 1998, present
similar interest rate risk to its other deposit products.
22
<PAGE>
<PAGE>
The following table sets forth information concerning the Bank's time
deposits and other interest-bearing deposits at September 30, 1998.
Weighted
Average Percentage
Interest of Total
Rate Category Amount Deposits
---- -------- ------ --------
(In thousands)
--% Non-Interest Bearing $ 5,839 3.42%
1.75 Negotiable order of withdrawal ("NOW")
Checking 21,595 12.64
2.61 Passbook Savings 27,315 15.99
3.79 Money Market Accounts 15,013 8.79
-- Other Deposits 3,511 2.05
Certificates of Deposit(1)
--------------------------
5.68 Maturing within 1 year 72,330 42.34
5.68 Maturing after 1 year but within 2 years 19,393 11.35
5.96 Maturing after 2 years but within 5 years 5,174 3.03
6.19 Maturing after 5 years 664 0.39
-------- ------
4.23 $170,834 100.00%
======== ======
- -----------------
(1) Based on remaining maturity of certificates.
The following table indicates the amount of the Bank's jumbo certificates
of deposit by time remaining until maturity as of September 30, 1998. 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 . . . . . . . $ 4,443
Over three through six months. . . 2,590
Over six through twelve months . . 4,432
Over twelve months . . . . . . . . 3,092
-------
Total. . . . . . . . . . . . . $14,557
=======
23
<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 Bank at the dates indicated.
At September 30,
-----------------------------------------------------------------------------
1996 1997 1998
----------------- ----------------------------- ---------------------------
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 . . . . $ 3,571 2.28% $ 5,164 2.99% $ 1,593 $ 5,839 3.42% $ 675
NOW checking . . . . . . . . 18,003 11.50 19,587 11.32 1,584 21,595 12.64 2,008
Passbook savings accounts. . 25,400 16.22 26,269 15.18 869 27,315 15.99 1,046
Money market deposit . . . . 13,364 8.54 14,424 8.34 1,060 15,013 8.79 589
Certificates of deposit which
mature in the year ending:
Within 1 year. . . . . . . . 64,202 41.01 76,284 44.09 12,082 72,330 42.34 (3,954)
After 1 year, but within
2 years. . . . . . . . . . 18,737 11.97 22,350 12.92 3,613 19,393 11.35 (2,957)
After 2 years, but within
5 years. . . . . . . . . . 9,814 6.27 5,737 3.32 (4,077) 5,174 3.03 (563)
Certificates maturing
thereafter . . . . . . . . 579 0.37 387 .22 (192) 664 0.39 277
Other. . . . . . . . . . . . 2,879 1.84 2,801 1.62 (78) 3,511 2.05 710
-------- ------ -------- ------ ------- -------- ------ -------
Total. . . . . . . . . $156,549 100.00% $173,003 100.00% $16,454 $170,834 100.00% ($2,169)
======== ====== ======== ====== ======= ======== ====== ======
24
</TABLE>
<PAGE>
<PAGE>
Time Deposits by Rates
The following table sets forth the time deposits in the Bank classified by
rates as of the dates indicated.
At September 30,
---------------------------------
1996 1997 1998
---- ---- ----
(In thousands)
2.00 - 3.99% . . . . . . $ 171 $ 153 $ 227
4.00 - 4.99% . . . . . . 6,802 -- 381
5.00 - 5.99% . . . . . . 53,278 79,205 80,539
6.00 - 6.99% . . . . . . 26,914 20,351 11,548
7.00% and over . . . . . 6,167 5,049 4,866
------- -------- -------
Total. . . . . . . . . . $93,332 $104,758 $97,561
======= ======== =======
Time Deposits by Maturities
The following table sets forth the amount and maturities of time deposits
at September 30, 1998.
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% . . . . . $ 227 $ -- $ -- $ -- $ 227
4.00 - 4.99% . . . . . 381 -- -- -- 381
5.00 - 5.99% . . . . . 58,853 17,264 3,861 561 80,539
6.00 - 6.99% . . . . . 8,477 2,016 1,055 -- 11,548
7.00% and over . . . . 4,392 113 258 103 4,866
------- ------- ------ ---- -------
Total. . . . . . . . . $72,330 $19,393 $5,174 $664 $97,561
======= ======= ====== ==== =======
Deposit Activities
The following table sets forth the savings activities of the Bank for the
periods indicated.
Year Ended September 30,
------------------------------------
1996 1997 1998
---- ---- ----
(In thousands)
Beginning balance. . . . . . . . $143,084 $156,549 $173,003
Net deposits (withdrawals) before
interest credited . . . . . . 6,516 8,938 (9,639)
Interest credited. . . . . . . . 6,949 7,516 7,470
Net increase (decrease in -------- -------- --------
deposits. . . . . . . . . . . 13,465 16,454 (2,169)
-------- -------- --------
Ending balance . . . . . . . . . $156,549 $173,003 $170,834
======== ======== ========
25
<PAGE>
<PAGE>
Borrowings
Savings deposits are the primary source of funds for the Bank's lending
and investment activities and for general business purposes. The 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 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, 1998, the Bank maintained an uncommitted credit facility with
the FHLB-Seattle that provided for immediately available advances up to an
aggregate amount of $49.0 million, under which $11.6 million was outstanding.
The following table sets forth certain information regarding short-term
borrowings by the Bank at the end of and during the periods indicated using
monthly average balance:
At or For the
Year Ended September 30,
------------------------
1997 1998
---- ----
(Dollars in thousands)
Maximum amount of short-term FHLB
advances at any month end . . . . . $16,500 $500
Approximate average short-term FHLB
advances outstanding. . . . . . . . 4,583 250
Approximate weighted average rate
paid on short-term FHLB advances. . 5.53% 6.70%
Total short-term FHLB advances at
end of period . . . . . . . . . . . 500 --
REGULATION OF THE BANK
General. As a state-chartered, federally insured savings bank, the 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 Bank is regularly examined by the
FDIC and the Division and files periodic reports concerning the Bank's
activities and financial condition with its regulators. The 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 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 Bank have
authority to impose penalties, initiate civil and administrative actions and
take other steps intended to prevent banks from engaging in unsafe or unsound
practices.
26
<PAGE>
<PAGE>
State Regulation and Supervision. As a state-chartered savings bank, the
Bank is subject to applicable provisions of Washington law and the regulations
of the Division adopted thereunder. Washington law and regulations govern the
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 Bank is subject to periodic examination and
reporting requirements by and of the Division.
Deposit Insurance. The FDIC is an independent federal agency that
insures the deposits, up to prescribed statutory limits, of depository
institutions. The FDIC maintains two separate insurance funds: the Bank
Insurance Fund ("BIF") and the SAIF. As insurer of the Bank's deposits, the
FDIC has examination, supervisory and enforcement authority over the Bank.
Under applicable regulations, the FDIC assigns an institution to one of
three capital categories based on the institution's financial information, as
of the reporting period ending seven months before the assessment period.
The capital categories are: (i) well-capitalized, (ii) adequately capitalized,
or (iii) undercapitalized. An institution is also placed in one of three
supervisory subcategories within each capital group. The supervisory subgroup
to which an institution is assigned is based on a supervisory evaluation
provided to the FDIC by the institution's primary federal regulator and
information that the FDIC determines to be relevant to the institution's
financial condition and the risk posed to the deposit insurance funds. An
institution's assessment rate depends on the capital category and supervisory
category to which it is assigned with the most well-capitalized, healthy
institutions receiving the lowest rates.
On September 30, 1996, the Deposit Insurance Funds Act ("DIF Act") was
enacted, which, among other things, imposed a special one-time assessment on
SAIF member institutions, including the Bank, to recapitalize the SAIF. The
SAIF special assessment was recognized by the Bank as an expense in the
quarter ended September 30, 1996 and amounted to $875,000 on a pre-tax basis
and $571,000 on an after-tax basis.
As a result of the DIF Act, 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 Bank, paying 0%. This assessment schedule is the
same as that for the 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 1980s to help
fund the thrift industry cleanup. BIF-assessable deposits are charged an
assessment to help pay interest on the FICO bonds at a rate of approximately
.013%. Full pro rata sharing of the FICO payments between BIF and SAIF
members will occur until the earlier of December 31, 1999,or the date the BIF
and SAIF are merged.
The FDIC is authorized to raise the assessment rates in certain
circumstances. The FDIC has exercised this authority several times in the
past and may raise insurance premiums in the future. If such action is taken
by the FDIC, it could have an adverse effect on the earnings of the Bank.
Under the Federal Deposit Insurance Act ("FDIA"), insurance of deposits
may be terminated by the FDIC upon a finding that the institution has engaged
in unsafe or unsound practices, is in an unsafe or unsound condition to
continue operations or has violated any applicable law, regulation, rule,
order or condition imposed by the FDIC or the OTS. Management of the Bank
does not know of any practice, condition or violation that might lead to
termination of deposit insurance.
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 subject to specified requirements to
meet
27
<PAGE>
<PAGE>
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, 1998, the Bank was categorized as "well capitalized"
under the prompt corrective action regulations of the FDIC.
Standards for Safety and Soundness. The federal banking regulatory
agencies have prescribed, by regulation, standards for all insured depository
institutions relating to: (i) internal controls, information systems and
internal audit systems; (ii) loan documentation; (iii) credit underwriting;
(iv) interest rate risk exposure; (v) asset growth; (vi) asset quality; (vii)
earnings; and (viii) compensation, fees and benefits ("Guidelines"). The
Guidelines set forth the safety and soundness standards that the federal
banking agencies use to identify and address problems at insured depository
institutions before capital becomes impaired. If the FDIC determines that the
Bank fails to meet any standard prescribed by the Guidelines, the agency may
require the Bank to submit to the agency an acceptable plan to achieve
compliance with the standard. Management is aware of no conditions relating
to these safety and soundness standards which would require submission of a
plan of compliance.
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 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
28
<PAGE>
<PAGE>
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."
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, 1998, the Bank had a Tier
1 leverage capital ratio of 22.4% and net worth of 21.9% of total assets.
29
<PAGE>
<PAGE>
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 for that bank is greater
than the minimum standards established in the regulation.
The Bank's management believes that, under the current regulations, the
Bank will continue to meet its minimum capital requirements in the foreseeable
future. However, events beyond the control of the Bank, such as a downturn in
the economy in areas where the Bank has most of its loans, could adversely
affect future earnings and, consequently, the ability of the Bank to meet its
capital requirements.
The table below sets forth the Bank's capital position relative to its
FDIC capital requirements at September 30, 1998. The definitions of the terms
used in the table are those provided in the capital regulations issued by the
FDIC.
At September 30, 1998
-------------------------
Percent of
Adjusted
Amount Total Assets(1)
------ ---------------
(Dollars in thousands)
Tier 1 (leverage) capital. . . . . . . . $53,865 22.36%
Tier 1 (leverage) capital requirement. . 9,636 4.00
------- -----
Excess . . . . . . . . . . . . . . . . . $44,229 18.36%
======= =====
Tier 1 risk adjusted capital . . . . . . $53,865 32.26%
Tier 1 risk adjusted capital requirement 6,680 4.00
------- -----
Excess . . . . . . . . . . . . . . . . . $47,185 28.26%
======= =====
Total risk-based capital . . . . . . . . $55,593 33.29%
Total risk-based capital requirement . . 13,359 8.00
------- -----
Excess . . . . . . . . . . . . . . . . . $42,234 25.29%
======= =====
- ---------------
(1) For the Tier 1 (leverage) capital and Washington regulatory capital
calculations, percent of total average assets of $240.9 million. For the
Tier 1 risk-based capital and total risk-based capital calculations,
percent of total risk-weighted assets of $167.0 million.
(2) As a Washington-chartered savings bank, the Bank is subject to the capital
requirements of the FDIC and the Division. The FDIC requires state-
chartered savings banks, including the 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, with an absolute total capital to risk-weighted assets of at
least 8%. The 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
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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 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 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
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requirements. The reserve requirement on nonpersonal time deposits with
original maturities of less than 1-1/2 years is 0%. As of September 30, 1998,
the Bank met its reserve requirements.
Affiliate Transactions. The Company and the Bank will be legal entities
separate and distinct. Various legal limitations restrict the 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 Bank received a "satisfactory" rating
during its most recent CRA examination.
Dividends. Dividends from the Bank constitute the major source of funds
for dividends which may be paid by the Company. The amount of dividends
payable by the Bank to the Company depends upon the Bank's earnings and
capital position, and is limited by federal and state laws, regulations and
policies. According to Washington law, the 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 Bank's capital stock may not be paid in an aggregate amount greater than
the aggregate retained earnings of the 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 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 Bank is a bank
holding company and is registered as such with the Federal Reserve. Bank
holding companies are subject to comprehensive regulation by the Federal
Reserve under the Bank Holding Company Act of 1956, as amended ("BHCA"), and
the regulations of the Federal Reserve. As a bank holding company, the
Company is 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.
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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%.
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
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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 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
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 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 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.
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TAXATION
Federal Taxation
General. The Company and the Bank report their income on a fiscal year
basis using the accrual method of accounting and are subject to federal income
taxation in the same manner as other corporations with some exceptions,
including particularly the 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
Bank or the Company.
Bad Debt Reserve. Historically, savings institutions such as the 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 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 Bank's actual loss experience, or a percentage equal to 8% of the 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 Bank's
loss experience, the 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 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 tax expense.
For taxable years beginning after December 31, 1995, the 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 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 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 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 Bank's taxable income. Nondividend distributions include
distributions in excess of the 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 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 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 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 BANK --
Dividends" for limits on the payment of dividends by
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the Bank. The 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 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 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 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 Bank will not file a consolidated tax return,
except that if the Company or the 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 Bank's federal income tax returns have been audited through
September 30, 1997. The Bank did not incur any net increase in tax liability
as a result of the audit.
Washington Taxation
The Bank is subject to a business and occupation tax imposed under
Washington law at the rate of 1.50% of gross receipts. Interest received on
loans secured by mortgages or deeds of trust on residential properties is
exempt from such tax.
Competition
The 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 Bank
has faced additional significant competition for investors' funds from short-
term money market securities and other corporate and government securities.
The 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 Bank's future growth and earnings
prospects.
Subsidiary Activities
The Bank has one wholly-owned subsidiary, Timberland Service Corporation
("Timberland Service"), whose primary function is to act as the Bank's escrow
department. Additionally, Timberland Service's employees sell annuities
through the Bank.
Personnel
As of September 30, 1998, the Bank had 87 full-time employees and 17 part-
time employees. The employees are not represented by a collective bargaining
unit and the Bank believes its relationship with its employees is good.
Item 2. Properties
- -------------------
The Bank operates eight full-service facilities. The Bank owns all of its
offices except for the Silverdale Loan Center, which is leased. The lease
expires in November 2000.
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The following table sets forth certain information regarding the Bank's
offices at September 30, 1998, 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 $53,379
Hoquiam, Washington 98550
Branch Offices:
300 N. Boone Street 1974 3,400 23,750
Aberdeen, Washington 98520
314 Main South 1975 2,800 19,082
Montesano, Washington 98563
361 Damon Road 1977 2,100 20,088
Ocean Shores, Washington 98569
2418 Meridian East 1980 2,400 31,403
Edgewood, Washington 98371
12814 Meridian East (South Hill) 1996 4,200 7,974
Puyallup, Washington 98373
202 Auburn Way South 1994 4,200 12,106
Auburn, Washington 98002
1201 Marvin Road, N.E. 1997 4,400 3,052
Lacey, Washington 98516
Loan Center:
Silverdale Loan Center 1995 1,225 N/A
10030 Silverdale Way, Suite 106
Silverdale, Washington 98383
Data Center:
422 6th Street 1990 2,700 N/A
Hoquiam, Washington 98550
The Bank also operates nine 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
Bank, such as claims to enforce liens, condemnation proceedings on properties
in which the Bank holds security interests, claims involving the making and
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servicing of real property loans and other issues incident to the Bank's
business. The 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 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, 1998.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
- --------------------------------------------------------------------------
Matters
- -------
The information contained under the section captioned "Common Stock
Information" is included in the Company's Annual Report and is incorporated
herein by reference.
Item 6. Selected Financial Data
- --------------------------------
The information contained under the section captioned "Selected
Consolidated Financial Information" is included in the Company's Annual Report
and is incorporated herein by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and
- ------------------------------------------------------------------------
Results of Operations
- ---------------------
The information contained under the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations" is
included in the Company's Annual Report and is incorporated herein by
reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
- --------------------------------------------------------------------
The information contained under the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations
Market Risk and Asset and Liability Management" is included in the Company's
Annual Report and is incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data
- ----------------------------------------------------
The information contained under the section captioned "Consolidated
Financial Statements" is included in the Company's Annual Report and is
incorporated herein by reference.
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 information contained under the section captioned "Proposal I --
Election of Directors" is included in the Company's Definitive Proxy Statement
for the 1999 Annual Meeting of Stockholders ("Proxy Statement") and is
incorporated herein by reference.
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The following table sets forth certain information with respect to the
executive officers of the Company and the Bank. Each of the executive
officers holds the same position with the Company and the Bank.
Executive Officers of the Company and Bank
Age at Position
September ---------------------------------------------------
Name 30, 1998 Company Bank
- ---- -------- ------- ----
Clarence E. Hamre 64 Chairman of the Board, Chairman of the Board,
President and Chief President and Chief
Executive Officer Executive Officer
Michael R. Sand 44 Executive Vice President Chief Financial Officer
and Secretary and Executive Vice
President, Secretary
and Director
Paul G. MacLeod 54 Treasurer Treasurer
Biographical Information
Clarence E. Hamre has served as the Bank's President and Chief Executive
Officer since 1969.
Michael R. Sand has been affiliated with the Bank since 1977 and has
served as the Bank's Executive Vice President since 1986.
Paul G. MacLeod is the Bank's Treasurer and has been with the Bank since
1987.
Item 11. Executive Compensation
- --------------------------------
The information contained under the section captioned "Proposal I --
Election of Directors" is included in the Company's Proxy Statement and is
incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
- ------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners.
The information contained under the section captioned "Security Ownership
of Certain Beneficial Owners and Management" is included in the Company's
Proxy Statement and is incorporated herein by reference.
(b) Security Ownership of Management.
The information contained under the sections captioned "Security Ownership
of Certain Beneficial Owners and Management" and "Proposal I -- Election of
Directors" is included in the Company's Proxy Statement and are incorporated
herein by reference.
(c) Changes In Control
The Company is not aware of any arrangements, including any pledge by any
person of securities of the Company, the operation of which may at a
subsequent date result in a change in control of the Company.
Item 13. Certain Relationships and Related Transactions
- --------------------------------------------------------
The information contained under the section captioned "Proposal I --
Election of Directors Transactions with Management" is included in the
Company's Proxy Statement and is incorporated herein by reference.
39
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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*
10.1 Employee Severance Compensation Plan**
10.2 Employee Stock Ownership Plan**
(13) 1998 Annual Report to Stockholders
(21) Subsidiaries of the Registrant**
(27) Financial Data Schedule
- --------------------
* Filed as an exhibit to the Registrant's Registration Statement on Form S-1
333-35817).
** Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the quarter ended December 31, 1997.
(b) Reports on Form 8-K
No Reports on Form 8-K were filed during the quarter ended September
30, 1998.
40
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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, 1998 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, 1998
- ------------------------ President, Chief Executive
Clarence E. Hamre Officer and Director
(Principal Executive Officer)
/s/Michael R. Sand Executive Vice President, December 24, 1998
- ------------------------ Secretary and Director
Michael R. Sand (Principal Financial and
Accounting Officer)
/s/Andrea M. Clinton Director December __, 1998
- ------------------------
Andrea M. Clinton
/s/Robert Backstrom Director December __, 1998
- ------------------------
Robert Backstrom
/s/Richard R. Morris Director December __, 1998
- ------------------------
Richard R. Morris
/s/Alan E. Smith Director December __, 1998
- ------------------------
Alan E. Smith
/s/Peter J. Majar Director December 24, 1998
- ------------------------
Peter J. Majar
/s/Jon C. Parker Director December 24, 1998
- ------------------------
Jon C. Parker
/s/James C. Mason Director December 24, 1998
- ------------------------
James C. Mason
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Exhibit 13
Timberland Bancorp, Inc.
=========================
1998
ANNUAL REPORT
=========================
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<PAGE>
TIMBERLAND BANCORP, INC
1998 ANNUAL REPORT
TABLE OF CONTENTS
Letter to Shareholders................................................ 1
Business of the Corporation........................................... 2
Common Stock Information.............................................. 2
Selected Consolidated Financial Information........................... 3
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................ 5
Independent Auditors' Report.......................................... 16
Consolidated Financial Statements..................................... 17
Notes to Consolidated Financial Statements............................ 22
Directors and Officers................................................ 44
Corporate Information................................................. 45
<PAGE>
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Timberland Bancorp, Inc.
To the Shareholders of Timberland Bancorp, Inc.
It is my pleasure to report to you the progress of Timberland Bancorp, Inc.
for the 12 months ended September 30, 1998. Timberland Savings Bank converted
to a Stock Company on January 12, 1998. The conversion raised $65.0 million
in new capital for the Company and its subsidiary Timberland Savings Bank. A
total of 6,612,500 shares of common stock were sold at a price of $10.00 per
share, and trading on the Nasdaq Stock Market began January 13, 1998.
With the additional capital, Timberland is embarking on an aggressive campaign
to expand its boundaries of service. Three new branch offices are expected to
be added during 1999, all within the southwest part of the State.
Incidentally, when our bank was chartered in 1915 it was named "Southwest
Washington Savings & Loan." Today, our business plan calls for continuing
service in this area, while also expanding into other Clarence E. Hamre
regions.
Picture of Clarence E. Hamre
Timberland is truly committed to serving small communities from Auburn to
Ocean Shores. We specialize in construction lending and home loans of all
sizes and types.
Recently, we added a Business Banking Division staffed by three experienced
commercial bankers. This division will service Timberland's many existing
commercial accounts while acquainting other businesses in our area with the
services we provide.
With our infusion of capital, Timberland experienced a record year of lending.
Loans originated totaled $126.9 million, which is a 65.4% increase over the
previous year. Total assets increased to $265.7 million as of September 30,
1998, while net income increased by 53.1% to $5.1 million.
Timberland has upgraded its technology to comply with regulatory requirements
for the Year 2000. We have a Y2K Steering Committee that meets to address
compliance and customer concerns. We expect to be fully Y2K compliant by
February 1, 1999.
We are pleased with our first nine months as a public company. At the close
of our fiscal year, September 30th, our return on assets was 1.99% and our net
interest margin was 5.13%.
What makes Timberland stand out over other institutions is our commitment to
all members of the communities we serve. We truly value long term
relationships, and our success has been the result of understanding and caring
about each customer's unique situation. We feel that this is our
responsibility as a community bank. Customer service is our trademark. This
is confirmed by local surveys and our own customer satisfaction surveys.
We welcome your comments and suggestions as we move forward with the growth of
our Company. I would like to thank our Directors, officers and staff for a
healthy first year as a public company. Please feel free to join us at our
first annual meeting January 25, 1999 at 1:00 p.m. at the Hoquiam Elks Lodge.
/s/ Clarence E. Hamre
Clarence E. Hamre
President, Chief Executive Officer and Chairman of the Board
624 Simpson Ave., Hoquiam, WA 98550 * (360) 533-4747 * FAX (360) 533-4743
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BUSINESS OF THE CORPORATION
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 ("Bank"), upon its conversion from a state-chartered
mutual savings bank to a state-chartered capital stock savings bank. The
conversion was completed on January 12, 1998, through the issuance of
6,612,500 shares of common stock at a price of $10.00 per share to certain
former depositors of Timberland Savings Bank and other members of the general
public. At September 30, 1998, the Company had total consolidated assets of
$265.7 million and consolidated shareholders' equity of $81.8 million.
The Company is not engaged in any significant business activity other than
holding the stock of the Bank. Accordingly, the information set forth in this
report, including financial statements and related data, applies primarily to
the Bank.
The Bank is a state-chartered stock savings bank, originally organized in
1915. The Bank is regulated by the Federal Deposit Insurance Corporation
("FDIC") and the Washington Department of Financial Institutions, Division of
Banks ("Division"). Its deposits are insured up to the applicable legal
limits by the Savings Association Insurance Fund ("SAIF") of the FDIC. The
Bank is also a member of the Federal Home Loan Bank ("FHLB") System.
The Bank operates as a community-oriented savings bank, which offers a variety
of savings products to its retail customers while concentrating its lending
activities on real estate mortgage loans. Lending activities are 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. A business banking division was established in July 1998
to increase the Bank's portfolio of commercial business loans. The Bank
actively originates adjustable rate mortgages ("ARMs") that do not qualify for
sale in the secondary market under Federal Home Loan Mortgage Corporation
("FHLMC") guidelines.
COMMON STOCK INFORMATION
The Company's common stock is traded on the Nasdaq National Market under the
symbol "TSBK". As of September 30, 1998, there were 6,281,875 shares of
common stock outstanding and approximately 1,124 shareholders of record,
excluding persons or entities who hold stock in nominee or "street name"
accounts with brokers. Dividend payments by the Company are dependent
primarily on dividends received by the Company from the Bank. Under federal
regulations, the dollar amount of dividends the Bank may pay is dependent upon
its capital position and recent net income. Generally, if the Bank satisfies
its regulatory capital requirements, it may make dividend payments up to the
limits prescribed in the FDIC regulations. However, institutions that have
converted to a stock form of ownership may not declare or pay a dividend on,
or repurchase any of, its common stock if the effect thereof would cause the
regulatory capital of the institution to be reduced below the amount required
for the liquidation account which was established in connection with the
mutual to stock conversion.
The following table sets forth the market price range of the Company's common
stock for the year ended September 30, 1998. This information was provided by
the Nasdaq Stock Market.
High Low Dividends
Fiscal 1998 ---- --- ---------
- -----------
First Quarter N/A N/A N/A
Second Quarter $18.75 $14.50 N/A
Third Quarter $18.50 $15.50 $0.06
Fourth Quarter $16.75 $10.75 $0.06
Fiscal 1997
- -----------
There were no shares issued or outstanding during the fiscal year ended
September 30, 1997 since the conversion to stock form was not completed until
January 12, 1998.
2
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SELECTED CONSOLIDATED FINANCIAL INFORMATION
The following table sets forth certain information concerning the consolidated
financial position and results of operations of the Company at and for the
dates indicated. Since the Company had not commenced operations prior to the
Bank's mutual-to-stock conversion in January 1998, the financial information
presented for the periods prior to 1998 is that of the Bank only. The
consolidated data is derived in part from, and should be read in conjunction
with, the Consolidated Financial Statements of the Company and its subsidiary
presented herein.
At September 30,
--------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(In thousands)
SELECTED FINANCIAL CONDITION DATA:
Total assets............... $ 265,709 $ 211,553 $ 194,357 $ 177,761 $ 151,044
Loans receivable and loans
held for sale, net........ 199,221 187,027 "76,495 156,523 121,558
Investment securities held-
to-maturity............... -- -- -- 3,504 8,597
Investment securities
available-for-sale........ 17,860 1,587 1,572 1,449 1,330
Mortgage-backed securities
held-to-maturity.......... -- 3,990 4,951 6,352 7,402
Mortgage-backed securities
available-for-sale........ 17,555 -- -- -- --
Cash and due from financial
institutions.............. 21,784 11,446 5,055 4,860 7,360
Deposits................... 170,834 173,003 156,549 143,084 128,669
FHLB advances.............. 11,618 12,241 14,354 14,958 5,753
Shareholders' equity....... 81,780 24,645 21,329 18,653 15,638
At September 30,
--------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(In thousands, except per share data)
SELECTED OPERATING DATA:
Interest and dividend
income.................... $ 20,650 $ 17,947 $ 16,500 $ 14,454 $ 11,307
Interest expense........... 8,144 8,386 7,629 6,360 4,715
--------- --------- --------- --------- ---------
Net interest income........ 12,506 9,561 8,871 8,094 6,592
Provision for loan losses.. 200 597 70 -- --
Net interest income after --------- --------- --------- --------- ---------
provision for loan losses. 12,306 8,964 8,801 8,094 6,592
Noninterest income......... 1,540 1,235 688 598 818
Noninterest expense........ 6,340 5,040 5,392 4,089 3,613
Income before income taxes. 7,506 5,159 4,097 4,603 3,797
Provision for income taxes. 2,410 1,830 1,419 1,603 1,163
--------- --------- --------- --------- ---------
Net income................. $ 5,096 $ 3,329 $ 2,678 $ 3,000 $ 2,634
--------- --------- --------- --------- ---------
Basic earnings per common
share..................... $ 0.84 N/A N/A N/A N/A
At September 30,
--------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
OTHER DATA:
Number of
Real estate loans
outstanding............. 2,708 2,679 2,512 2,535 2,344
Deposit accounts......... 22,014 21,668 19,994 18,681 17,552
Full-service offices..... 8 8 7 6 6
3
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At September 30,
--------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(In thousands, except per share data)
KEY FINANCIAL RATIOS:
Performance Ratios:
Return on average
assets (1).............. 1.99 % 1.62 % 1.46 % 1.82 % 1.86 %
Return on average equity
(2)..................... 7.56 14.39 13.21 17.44 18.27
Interest rate spread (3). 3.87 4.18 4.34 4.56 4.32
Net interest margin (4).. 5.13 4.84 4.97 5.08 4.78
Average interest-earning
assets to average
interest-bearing
liabilities............. 137.84 115.60 114.76 113.05 113.41
Noninterest expense as a
percent of average total
assets.................. 2.47 2.46 2.93 2.49 2.55
Efficiency ratio (5)..... 45.13 46.68 56.82 47.04 48.76
Book value per share..... N/A N/A N/A N/A N/A
Asset Quality Ratios:
Nonaccrual and 90 days or
more past due loans as a
percent of loans receivable,
net (6)................. 2.39 4.06 0.86 0.66 0.45
Nonperforming assets as a
percent of total assets. 2.46 3.83 0.85 0.70 0.63
Allowance for loan losses
as a percent of total
loans receivable, net... 0.86 0.91 0.64 0.71 0.92
Allowance for losses as a
percent of nonperforming
loans................... 36.00 22.39 74.54 107.91 204.95
Net charge-offs to average
outstanding loans....... -- 0.01 -- -- 0.02
Capital Ratios:
Total equity-to-assets
ratio................... 30.78 11.65 10.97 10.49 10.35
Average equity to average
assets (7).............. 26.27 11.28 11.02 10.45 10.16
- ----------------------
(1) Net income divided by average total assets.
(2) Net income divided by average total equity.
(3) Difference between weighted average yield on interest-earning assets and
weighted average 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) Loans receivable includes loans held for sale and is not net of allowance
for loan losses.
(7) Average total equity divided by average total assets.
4
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
General
- -------
Management's discussion and analysis of the financial condition and results of
operations is intended to assist in understanding the consolidated financial
condition and results of operations of the Company. The information contained
in this section should be read in conjunction with the Consolidated Financial
Statements and accompanying notes thereto.
Operating Strategy
- ------------------
The Bank is a community-oriented bank which has traditionally offered a wide
variety of savings products to its retail customers while concentrating its
lending activities on real estate loans. The primary elements of the Bank's
operating strategy include:
- - Emphasize Residential Mortgage Lending and Residential Construction
Lending. The Bank has attempted to establish itself as a niche lender in
its primary market areas by focusing its lending activities primarily on
the origination of loans secured by one- to- four family residential
dwellings, including an emphasis on loans for the construction of
residential dwellings. In an effort to meet the credit needs of borrowers
in its primary area, the Bank actively originates one- to- four family
mortgage loans that do not qualify for sale in the secondary market under
FHLMC guidelines. The Bank also originates loans secured by multi-family
and commercial real estate properties and, to a lesser extent, originates
consumer loans. The Bank has also been an active participant in the
secondary market, originating residential loans for sale to the FHLMC on a
servicing retained basis. The Bank also established a business banking
division in July 1998 to increase the Bank's origination of commercial
business loans.
- - Diversify Primary Market Area by Expanding Branch Office Network. In an
effort to lessen its dependence on the Grays Harbor County market whose
economy has historically been tied to the timber and fishing industries,
the Bank has opened branch offices in Pierce, King and Thurston Counties
and a loan production office in Kitsap County. Thurston, Pierce, King and
Kitsap Counties contain the Olympia and Seattle-Tacoma metropolitan areas
and their economies are more diversified with the presence of state
government, aerospace and computer industries.
- - Limit Exposure to Interest Rate Risk. In recent years, the loans that the
Bank has retained in its portfolio generally have periodic interest rate
adjustment features or have been relatively short-term in nature. Loans
originated for portfolio primarily have included ARM loans and short-term
construction loans. Longer fixed-rate mortgage loans have generally been
originated for sale in the secondary market. Management believes that the
interest rate sensitivity of these adjustable rate and short- term loans
more closely match the interest rate sensitivity of the Bank's funding
sources than do other longer duration assets with fixed interest rates.
Due to the current interest rate environment, the Bank has increased its
retention of fifteen and thirty year fixed-rate mortgage loans. Such
loans are retained and designated as loans held for sale.
Market Risk and Asset and Liability Management
- ----------------------------------------------
General
Market risk is the risk of loss from adverse changes in market prices and
rates. The Company's market risk arises primarily from interest rate risk
inherent in its lending, investment, deposit and borrowing activities. The
Bank, like other financial institutions, is subject to interest rate risk to
the extent that its interest-earning assets reprice differently than its
interest-bearing liabilities. Management actively monitors and manages its
interest rate risk exposure. Although the Bank manages other risks, such as
credit quality and liquidity risk, in the normal course of business management
considers interest rate risk to be its most significant market risk that could
potentially have the largest material effect on the Bank's financial condition
and results of operations. The Bank does not maintain a trading account for
any class of financial instruments nor does it engage in hedging activities or
derivative instruments. Furthermore, the Bank is not subject to foreign
currency exchange rate risk or commodity price risk.
5
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Qualitative Aspects of Market Risk
The Bank's principal financial objective is to achieve long-term profitability
while reducing its exposure to fluctuating market interest rates. The 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 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 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 Bank promotes transaction accounts
and certificates of deposit with terms of up to six years.
The 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 retention or sale in the secondary market
and the retention of the related loan servicing rights.
Sharp decreases in interest rates may adversely affect the Bank's earnings
while increases in interest rates may beneficially affect the Bank's earnings
because a larger portion of the 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 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, 1998, adjustable rate loans and adjustable rate
mortgage-backed securities constituted $132.7 million or 54.3%, of the Bank's
total combined mortgage loan and mortgage-backed securities portfolio.
Although the 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 Bank's exposure to fluctuations in interest rates. At
September 30, 1998, the construction and land development, and consumer loan
portfolios amounted to $64.2 million and $12.8 million, or 27.7% and 5.5% of
total loans receivable (including loans held for sale), respectively.
Quantitative Aspects of Market Risk
Management of the Bank monitors the Bank's interest rate sensitivity through
the use of a model provided for the Bank by the FHLB of Seattle. The model
estimates the changes in NPV (net portfolio value) and net interest income in
response to a range of assumed changes in market interest rates. The model
first estimates the level of the 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 Bank's NPV under
different interest rate scenarios. The change in NPV under the different
interest rate scenarios provides a measure of the Bank's exposure to interest
rate risk. The following table is provided by the FHLB of Seattle based on
data at September 30, 1998.
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 $11,165 $2,107 23.26% $55,113 ($122) (0.22)%
+300 11,127 2,069 22.84 56,305 1,070 1.94
+200 10,696 1,638 18.08 56,676 1,441 2.61
+100 9,968 910 10.04 56,271 1,036 1.88
BASE 9,058 -- -- 55,235 -- --
- -100 8,100 (958) (10.58) 52,894 (2,341) (4.24)
- -200 7,274 (1,785) (19.70) 50,771 (4,464) (8.08)
- -300 6,502 (2,556) (28.21) 49,065 (6,170) (11.17)
- -400 5,822 (3,236) (35.72) 47,938 (7,296) (13.21)
6
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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. Furthermore, 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 Bank would
be expected to experience an 8.1% decrease in NPV and a 19.7% decrease in net
interest income. In the event of a 200 basis point increase in interest
rates, a 2.6% increase in NPV and an 18.1% increase in net interest income
would be expected. Based upon the modeling described above, the 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 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 possibly deviate significantly
from those assumed in calculating the table.
Comparison of Financial Condition at September 30, 1997 and 1998
- ----------------------------------------------------------------
Total Assets: Total assets increased 25.6% from $211.6 million at September
30, 1997 to $265.7 million at September 30, 1998, primarily as a result of the
January 1998 stock offering which resulted in net proceeds of $65.0 million.
A portion of this increase was offset by the use of $7.9 million of net stock
proceeds to purchase 529,000 shares of the Company's stock for the employee
stock ownership plan ("ESOP") trust, $4.7 million used to repurchase 5.0% of
the Company's shares, and approximately $8.0 million in funds withdrawn from
deposit accounts to purchase stock.
Cash and Due from Financial Institutions: Cash and due from financial
institutions increased by 90.3% from $11.4 million at September 30, 1997 to
$21.8 million at September 30, 1998, primarily as a result of a portion of the
stock offering proceeds being invested with financial institutions.
Investments and Mortgage-backed Securities: Investments and mortgage-backed
securities increased by 535.0% from $5.6 million at September 30, 1997 to
$35.4 million at September 30, 1998. This increase is attributable primarily
to a portion of the stock offering proceeds being invested into these assets.
For additional details on investments and mortgage- backed securities see Note
3 to the Notes to Consolidated Financial Statements.
Loans Receivable, and Loans Held-for-sale, net of allowance for loan losses:
Loans receivable, including loans held-for-sale, net, increased by 6.5% from
$187.0 million at September 30, 1997 to $199.2 million at September 30, 1998,
primarily as a result of increased construction and land development loans and
commercial real estate loans in the Bank's portfolio. Construction and land
development loans increased $19.1 million or 42.5% between September 30, 1997
and September 30, 1998.
Real Estate Owned, net: Real estate owned, net, increased from $434,000 at
September 30, 1997 to $1.7 million at September 30, 1998. This increase is
primarily attributable to the Bank accepting a deed in lieu of foreclosure on
two related condominium loans (with balances totaling $752,000 at September
30, 1998, a decrease from $3.0 million at March 31, 1998) in Southern King
County, Washington. These two loans were classified as "substandard assets"
at September 30, 1997. The remaining portion of the increased real estate
owned balance is a result of the Bank foreclosing on seven one-to-four family
mortgage loans and one land loan. Although no assurances can be given, the
Company does not currently expect to incur a material loss on the disposition
of these assets. For additional information see "Non Performing Assets".
Deposits: Deposits decreased by 1.3% from $173.0 million at September 30, 1997
to $170.8 million at September 30, 1998. This decrease is primarily
attributable to depositors withdrawing approximately $8.0 million from their
deposit accounts to purchase stock in the Company's stock offering, and is
partially offset by growth of $5.8 million in deposits since the stock
offering.
7
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<PAGE>
Shareholders' Equity: Total shareholders' equity increased 231.8% from $24.6
million at September 30, 1997 to $81.8 million at September 30, 1998,
primarily as a result of the $65.0 million in net proceeds raised from the
January 1998 stock offering and retained net income of $4.3 million, partially
offset by the use of $7.9 million in net offering proceeds to purchase 529,000
shares of the Company's stock for the ESOP and $4.7 million used to repurchase
5% of the Company's shares in August 1998.
Comparison of Operating Results for the Years Ended September 30, 1997 and
- --------------------------------------------------------------------------
1998
- ----
Net Income: Net income increased 53.1% from $3.3 million for the year ended
September 30, 1997 to $5.1 million for the year ended September 30, 1998.
Basic earnings per share for the current year were $.84. Earnings per share
for the prior comparative period are not applicable because the Company had no
stock issued and outstanding at that time.
Net Interest Income: Net interest income increased 30.8% from $9.6 million for
the year ended September 30, 1997 to $12.5 million for the year ended
September 30, 1998 as a result of interest income increasing and interest
expense decreasing.
Total interest income increased 15.1% from $17.9 million for the year ended
September 30, 1997 to $20.7 million for the year ended September 30, 1998
primarily as a result of increased funds to invest from the Company's January
stock offering.
Total interest expense decreased from $8.4 million for the year ended
September 30, 1997 to $8.1 million for the year ended September 30, 1998,
primarily as a result of a decrease in the average rate paid on interest-
bearing liabilities from 4.91% for the year ended September 30, 1997 to 4.60%
for the year ended September 30, 1998.
Net interest margin increased from 4.84% for the year ended September 30, 1997
to 5.13% for the year ended September 30, 1998, primarily as a result of
average interest-earning assets increasing more than average interest-earning
liabilities due primarily to the receipt of proceeds from the Company's stock
offering.
Provision for Loan Losses: The provision for loan losses decreased from
$597,000 for the year ended September 30, 1997 to $200,000 for the year ended
September 30, 1998. Management decreased the provision for loan losses
because it deemed the general loan loss reserves of $1.7 million at September
30, 1998 (.86% of loans receivable, net, and 36.0% of non-performing loans)
adequate to provide for estimated losses based on an evaluation of known and
inherent risks in the loan portfolio at that date. For additional information
see "Non Performing Assets" section.
Noninterest Income: Total noninterest income increased 24.7% from $1.2 million
for the year ended September 30, 1997 to $1.5 million for the year ended
September 30, 1998. The largest portion of this increase was attributable to
a $133,000 increase in escrow fees and a $92,000 increase in servicing income
on loans sold. These increases are due to increased escrow activity and a
larger volume of fixed rate loans being sold to FHLMC. Increases in
miscellaneous fees account for the remaining portion of the increase.
Noninterest Expense: Total noninterest expense increased 25.8% from $5.0
million for the year ended September 30, 1997 to $6.3 million for the year
ended September 30, 1998. The largest portion of this increase is a result of
increased salary and employee benefit expense which increased from $2.9
million for the year ended September 30, 1997 to $3.9 million for the year
ended September 30, 1998. The release of ESOP shares accounted for $364,000
of the increased compensation expense. The remaining portion of the
increased compensation expense is a result of adding additional employees,
cost of living increases for current employees and increased health insurance
costs. The number of full-time equivalent employees increased from 86 at
September 30, 1997 to 97 at September 30, 1998 as a result of restructuring
the loan origination department and the loan servicing department, hiring
three commercial loan officers, hiring additional personnel for the Auburn
Escrow Department, elevating several part-time positions to full-time
positions, and hiring an individual to assist in preparing the reports
required of the Company as a public company.
Provision for Income Taxes: The provision for income taxes increased from $1.8
million for the year ended September 30, 1997 to $2.4 million for the year
ended September 30, 1998 primarily as a result of higher income before income
taxes.
Comparison of Financial Condition at September 30, 1996 and 1997
- ----------------------------------------------------------------
Total Assets: Total assets increased 8.9% 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.
8
<PAGE>
<PAGE>
Cash and Due from Financial Institutions: Cash and due from financial
institutions increased by 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: Investments and mortgage-backed
securities decreased by 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.
Loans Receivable, and Loans Held-for-sale, net of allowance for loan losses:
Loans receivable, including loans held-for-sale, net, increased by 6.0% from
$176.5 million at September 30, 1996 to $187.0 million at September 30, 1997,
primarily as a result of increases in one- to- four family mortgage loans and
commercial real estate loans in the Bank's portfolio. These increases were
primarily attributable the opening of the Puyallup (South Hill) branch office
in October 1996 and Lacey branch in May 1997, as well as increased demand at
other locations.
Premises and Equipment, net: Premises and equipment, 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 the construction of the Lacey branch office, which
opened in May 1997.
Deposits: Deposits increased by 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 opening of the Puyallup (South Hill) and
Lacey branch offices.
Total Capital: 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 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,
which reduced net income for the ended September 30, 1996. 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. Earnings per share for these
comparative periods are not applicable because the Company had no stock issued
and outstanding at these times.
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 $168.1 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 the 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.
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.
Total 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 promotion
associated with the opening of the Puyallup (South Hill) and Lacey branch
offices. The Bank also increased rates on deposit accounts in response to
increased competition, which also contributed to the reduction in 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. Management increased the provision due to changes in the
loan portfolio mix which included a larger percentage of non-residential
mortgage loans as well as an evaluation of nonperforming loans at September
30, 1997. Management deemed the allowance for loan losses adequate at
September 30, 1997. For additional information see "Non Performing Assets".
9
<PAGE>
<PAGE>
Noninterest Income: Total noninterest income increased 79.5% from $688,000
for the year ended September 30, 1996 to $1.2 million 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, increased gain on sale of loans, and minor increases in other
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 equipment expense increased from
$554,000 to $723,000, both as a result of the opening of the Puyallup (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 primarily as a result of higher income before
income taxes.
Non Performing Assets
- ---------------------
The following table sets forth information with respect to the Company's non
performing assets at September 30, 1998 and September 30, 1997.
At September 30, At September 30,
1998 1997
--------------- ---------------
(Dollars in thousands)
Loans accounted for on a
nonaccrual basis:
Mortgage loans:
One-to-four family $ 996 $ 776
Commercial 2,919 2,886
Construction and land development -- 3,891
Land 397 --
Consumer loans 17 2
Commercial Business Loans 81 --
Total 4,410 7,555
--------- -----------
Accruing loans which are contractually
past due 90 days or more:
Mortgage loans:
Construction and land development 396 109
--------- -----------
Total 396 109
Total of nonaccrual and
90 days past due loans $ 4,806 $ 7,664
Real estate owned and other
repossessed assets 1,724 434
--------- -----------
Total nonperforming assets $ 6,530 $ 8,098
Restructured loans 236 70
Nonaccrual and 90 days or more past
due loans as a percentage of loans
receivable, (including loans held
for sale)(1) 2.39% 4.06%
Nonaccrual and 90 days or more past
due loans as a percentage of total
assets 1.81% 3.62%
Nonperforming assets as a percentage
of total assets 2.46% 3.83%
Loans receivable, (including loans
held for sale)(1) $ 200,949 $ 188,743
Total assets $ 265,709 $ 211,553
- ---------------
(1) Loans receivable is before the allowance for loan losses.
10
<PAGE>
<PAGE>
The following is a discussion of the Bank's major problem assets at September
30, 1998:
Convenience store/retail space and mini-storage, Kitsap County, Washington.
The 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. These two loans had a combined balance of $2.9 million
at September 30, 1998. These loans became delinquent primarily because of a
dispute between the two borrowers. These loans were classified as
"substandard" at September 30, 1998. The Bank initiated foreclosure
proceedings which were stayed due to a bankruptcy filing by the borrowers in
January of 1998. The Bank's attorneys have now secured a dismissal of the
bankruptcy and a receiver has been appointed to manage the properties. The
Bank is currently pursuing foreclosure on the properties. Although no
assurances can be given, the Bank does not expect to incur any material loss
on these two loans.
Real Estate Owned: Condominiums, Southern King County, Washington. The Bank
accepted a deed in lieu of foreclosure on two delinquent loans for the
construction and sale of a 61-unit condominium complex. These loans were
classified as "substandard" at September 30, 1997 and had a balance of $2.9
million. They were classified by the Bank as "Real Estate Owned" of $752,000
at September 30, 1998. The Bank has been actively marketing the project and,
as of December 1, 1998, had accepted earnest money agreements for 29 of the 30
units. As of December 1, 1998, 26 of these sales had closed and the remaining
REO balance was $484,000. The Bank does not expect to incur a material loss
on the disposition of these assets based on the prices at which the units are
currently selling.
Average Balances, Interest and Average Yields/Cost
- --------------------------------------------------
The earnings of the Company depend largely on the spread between the yield on
interest-earning assets and the cost of interest-bearing liabilities, as well
as the relative amount of the Company's interest-earning assets and interest-
bearing liability portfolios.
The following table sets forth, for the periods indicated, information
regarding average balances of assets and liabilities as well as the total
dollar amounts of interest income from average interest-earning assets and
interest expense on average interest-bearing liabilities 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.
11
<PAGE>
<PAGE>
<TABLE>
Year Ended September 30,
---------------------------------------------------------------------------------
1998 1997 1996
--------------------------- --------------------------- -------------------------
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). $192,082 $17,712 9.22% $188,729 $17,418 9.23% $168,060 $15,880 9.45%
Mortgage-backed and
investment securities.. 17,013 1,067 6.27 4,484 279 6.22 6,689 397 5.94
FHLB stock and equity
securities............. 2,824 189 6.69 1,550 116 7.48 1,499 126 8.41
Interest-bearing
deposits............... 31,901 1,682 5.27 2,758 134 4.86 2,072 97 4.68
Total interest- -------- ------- -------- ------- -------- -------
earning assets....... 243,820 20,650 8.47 197,521 17,947 9.09 178,320 16,500 9.25
Non-interest-earning
assets................... 12,816 7,598 5,674
-------- -------- --------
Total assets.......... $256,636 $205,119 $183,994
======== ======== ========
Interest-bearing liabilities:
Passbook accounts....... $ 33,025 906 2.74 $ 25,068 750 2.99 $ 24,800 738 2.98
Money market accounts... 14,299 543 3.80 12,985 514 3.96 13,182 520 3.94
NOW accounts............ 20,139 390 1.94 17,997 445 2.47 17,377 421 2.42
Certificates of deposit. 97,434 5,631 5.78 98,842 5,807 5.88 89,024 5,271 5.92
FHLB advances-other
borrowed money......... 11,991 674 5.62 15,980 870 5.44 11,005 679 6.17
Total interest bearing -------- ------- -------- ------- -------- -------
liabilities.......... 176,888 8,144 4.60 170,872 8,386 4.91 155,388 7,629 4.91
Non-interest bearing
liabilities.............. 12,337 11,107 8,330
-------- -------- --------
Total liabilities..... 189,225 181,979 163,718
Shareholders' Equity...... 67,411 23,140 20,276
-------- -------- --------
Total liabilities and
shareholders' equity $256,636 $205,119 $183,994
======== ======== ========
Net interest income....... $12,506 $ 9,561 $ 8,871
======= ======= =======
Interest rate spread...... 3.87% 4.18% 4.34%
==== ==== ====
Net interest margin (3)... 5.13% 4.84% 4.97%
==== ==== ====
Ratio of interest-earning
assets to Average
interest-bearing
liabilities.............. 137.84% 115.60% 114.76%
====== ====== ======
- ----------------------
(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.
12
</TABLE>
<PAGE>
<PAGE>
<TABLE>
Rate / Volume Analysis
The following table sets forth the effects of changing rates and volumes on net interest income on the
Company. Information is provided with respect to the (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,
1998 Compared to Year 1997 Compared to Year
Ended September 30, 1997 Ended September 30, 1996
Increase (Decrease) Increase (Decrease)
Due to Due to
---------------------------------- ----------------------------------
Rate/ Net Rate/ Net
Rate Volume Volume Change Rate Volume Volume Change
---- ------ ------ ------ ---- ------ ------ ------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable (1) $ (18) $ 310 $ -- $ 292 $(370) $1,954 $(46) $1,538
Mortgage-backed securities and
investment securities 3 780 8 791 19 (131) (6) (118)
FHLB stock and equity securities (12) 95 (10) 73 (14) 4 -- (10)
Interest-bearing deposits 11 1,416 120 1,547 4 32 1 37
------ ------ ---- ------ ----- ------ ---- ------
Total net change in income
on interest-earning assets (16) 2,601 118 2,703 (361) 1,859 (51) 1,447
Interest-bearing liabilities:
Passbook accounts (62) 238 (20) 156 3 9 -- 12
NOW accounts (95) 53 (11) (53) 9 15 -- 24
Money market accounts (20) 52 (2) 30 3 (9) -- (6)
Certificate accounts (99) (82) 1 (180) (36) 576 (4) 536
FHLB advances and other
borrowed money 29 (217) (7) (195) (80) 307 (36) 191
------ ------ ---- ------ ----- ------ ---- ------
Total net change in expense
on interest-bearing liabilities (247) 44 (39) (242) (101) 898 (40) 757
------ ------ ---- ------ ----- ------ ---- ------
Net change in net interest income $ 231 $2,557 $157 $2,945 $(260) $ 961 $(11) $ 690
====== ====== ==== ====== ===== ====== ==== ======
- ------------------
(1) Excludes interest on loans 90 days or more past due. Includes loans originated for sale.
</TABLE>
13
<PAGE>
<PAGE>
Liquidity and Capital Resources
- -------------------------------
The Company'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. The Company also raised $65.0 million in net proceeds from
the January 1998 stock offering. While the maturity 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 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 Bank generally maintains sufficient cash and
short-term investments to meet short-term liquidity needs. At September 30,
1998, the Bank's regulatory liquidity ratio (net cash, and short-term and
marketable assets, as a percentage of net deposits and short-term liabilities)
was 25.6%. At September 30, 1998, the Bank also maintained an uncommitted
credit facility with the FHLB of Seattle that provided for immediately
available advances up to an aggregate amount of $49.0 million, under which
$11.6 million was outstanding.
Liquidity management is both a short- and long-term responsibility of the
Bank's management. The 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 Bank requires funds beyond its ability to generate them internally, it has
additional borrowing capacity with the FHLB and collateral for repurchase
agreements.
The 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, 1996, 1997 and 1998, the Bank originated $24.5
million, $27.1 million, and $45.4 million of one- to- four family mortgage
loans and $29.7 million, $35.2 million and $58.1 million of construction and
land development loans, respectively. At September 30, 1998, the Bank had
mortgage loan commitments totaling $8.9 million and undisbursed loans in
process totaling $28.9 million. The 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,
1998 totaled $72.3 million. Historically, the 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. Under current FDIC regulations, insured state-
chartered banks generally must maintain (i) a ratio of Tier 1 leverage capital
to total assets of at least 3.0% (4.0% to 5.0% for all but the most highly
rated banks), (ii) a ratio of Tier 1 capital to risk weighted assets of at
least 4.0% and (iii) a ratio of total capital to risk weighted assets of at
least 8.0%. At September 30, 1998, the Bank was in compliance with all
applicable capital requirements. For additional details see the regulatory
capital table in Note 15 to the Notes to Consolidated Financial Statements.
Year 2000 Issues
- ----------------
The Year 2000 issue exists because many computer systems and applications use
two-digit date fields to designate a year. As the century date change occurs,
date-sensitive systems may recognize the year 2000 as 1900, or not at all.
This inability to recognize or properly treat the year 2000 may cause systems
to fail or process financial and operational information incorrectly.
The Bank has established a committee to address Year 2000 issues. The
committee has conducted a comprehensive review of its computer systems and
equipment to identify applications that could be affected by Year 2000 issues
and has implemented a plan designed to ensure that all software used in
connection with the Bank's business will function correctly with dates past
1999.
The Bank has an in-house data processing department, which maintains the
Bank's main system on an IBM AS400. The Bank has completed the extensive
project of reprogramming all of its internal codes on this system to be Year
2000 compliant. The Bank also completed testing of the system with regulatory
suggested dates in November 1998. The test results have indicated that this
system is compliant in all material respects.
14
<PAGE>
<PAGE>
The Bank also uses software from third party vendors for applications such as
accounts payable, fixed assets, loan processing, and wire transfers. To date,
the Bank has received Year 2000 compliant software updates for all mission
critical software except Fedline Two software for wire transfers and SMS
Systems software for our Escrow Division. Both software companies have
indicated that they will have Year 2000 compliant versions completed by
December 31, 1998.
The Bank's Year 2000 committee is also in the process of addressing the credit
risk within the Bank's lending activities. The Bank realizes that current and
prospective commercial borrowers, like itself, must address the Year 2000
issue. Recently, the Bank sent out questionnaires to its largest commercial
borrowers asking them if they were aware of the Year 2000 issues and if they
were taking steps to address the issue. The Bank has received responses back
from approximately half of the commercial borrowers. All responses have
indicated that they are aware of the Year 2000 issue and are taking the
necessary steps to prepare for it or that they have no mission critical
computer systems. In addition, when underwriting a prospective commercial
loan, the Bank considers what effect, if any, the Year 2000 issue may have on
the business of the prospective borrower as well as the borrower's ability to
meet its contractual obligations with the Bank in the event the Year 2000
issue affects the borrower's business.
The Bank's Year 2000 committee is currently developing contingency plans for
other areas which may be affected by Year
2000 issues, such as the loss of electrical power for sustained periods.
The Bank has budgeted approximately $157,000 towards its Year 2000 compliance
efforts, which generally would have been incurred in the normal course of
business. To date, the Bank has expended approximately $109,000 towards Year
2000 compliance issues. The Bank does not believe that the ultimate costs
associated with its Year 2000 compliance efforts will be material to the Bank.
However, no assurances can be given that such costs will not be higher and
have a material adverse effect on the Bank's financial condition and results
of operations.
The above discussion contains certain forward-looking statements. The
discussion is based on the Bank's current assessment and is subject to
uncertainties that could cause the implementation schedule, the costs and the
results contemplated by the plan to differ materially from the Bank's
expectation.
Effect of Inflation and Changing Prices
- ---------------------------------------
The consolidated financial statements and related financial data presented
herein have been prepared in accordance with generally accepted accounting
principles 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 on the operation of the Company is reflected in increased
operating costs. Unlike most industrial companies, virtually all the assets
and liabilities of a financial institution are monetary in nature. As a
result, interest rates generally have a more significant impact on a financial
institution's performance than do general levels of inflation. Interest rates
do not necessarily move in the same direction or to the same extent as the
prices of goods and services.
15
PAGE
<PAGE>
KNIGHT 1145 Broadway Plaza 253 572 7111
VALE & Suite 900 Fax 253 272 3143
GREGORY Tacoma, Washington 98402-3523
INC., P.S.
Certified Public Accountants
Independent Auditors' Report
The Board of Directors
Timberland Bancorp, Inc.
Hoquiam, Washington
We have audited the accompanying consolidated balance sheet of Timberland
Bancorp, Inc. and Subsidiaries (formerly known as Timberland Savings Bank, SSB
and Subsidiaries prior to the conversion in January 1998, as discussed in Note
1) as of September 30, 1998, and the related consolidated statements of
income, shareholders' equity, and cash flows for the year then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit. The consolidated balance sheet of Timberland Bancorp, Inc. and
Subsidiaries as of September 30, 1997, and the related consolidated statements
of income, shareholders' equity, and cash flows for the years ended September
30, 1997 and 1996 were audited by other auditors whose report, dated November
13, 1997, expressed an unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the 1998 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Timberland
Bancorp, Inc. and Subsidiaries as of September 30, 1998, and the results of
their operations and their cash flows for the year then ended, in conformity
with generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standards No. 133, Accounting for
Derivative Instruments and Hedging Activities, as of September 30, 1998.
/s/ Knight, Vale & Gregory, Inc., P.S.
Tacoma, Washington
October 22, 1998
16
<PAGE>
<PAGE>
Consolidated Balance Sheets
- ------------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc.
September 30, 1998 and 1997
1998 1997
Assets
Cash and due from financial institutions:
Noninterest bearing deposits $ 7,039 $ 4,996
Interest bearing deposits 14,745 6,450
21,784 11,446
Investments and mortgage-backed securities:
Held to maturity, at cost; fair value:
1997 - $3,982 - - 3,990
Available for sale, at fair value; cost:
1998 - $35,234; 1997 - $1,587 35,415 1,587
35,415 5,577
Loans receivable 191,007 183,171
Loans held for sale 8,214 3,856
199,221 187,027
Accrued interest receivable 1,389 1,137
Premises and equipment 5,340 5,431
Real estate owned 1,724 434
Other assets 836 501
Total assets $265,709 $211,553
Liabilities and Shareholders' Equity
Liabilities
Deposits $170,834 $173,003
Federal Home Loan Bank advances 11,618 12,241
Other liabilities and accrued expenses 1,477 1,664
Total liabilities 183,929 186,908
Shareholders' Equity
Preferred stock, $0.01 par value; 1,000,000
shares authorized; none issued - - - -
Common stock, $0.01 par value; 50,000,000
shares authorized; 6,281,875 shares issued 63 - -
Additional paid-in capital 60,183 - -
Unearned shares issued to employee stock
ownership trust (7,534) - -
Retained earnings - substantially restricted 28,948 24,645
Net unrealized gain on securities available for sale 120 - -
Total shareholders' equity 81,780 24,645
Total liabilities and shareholders' equity $265,709 $211,553
See notes to consolidated financial statements.
17
<PAGE>
<PAGE>
Consolidated Statements of Income
- ------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc.
Years Ended September 30, 1998, 1997 and 1996
1998 1997 1996
Interest and Dividend Income
Loans receivable $17,712 $17,418 $15,880
Investments and mortgage-backed securities 1,067 279 397
Dividends 189 116 126
Deposits in other financial institutions 1,682 134 97
Total interest and dividend income 20,650 17,947 16,500
Interest Expense
Deposits 7,470 7,516 6,950
Federal Home Loan Bank advances 674 870 679
Total interest expense 8,144 8,386 7,629
Net interest income 12,506 9,561 8,871
Provision for Loan Losses 200 597 70
Net interest income after provision for
loan losses 12,306 8,964 8,801
Non-Interest Income
Service charges on deposits 317 314 278
Gain on sale of loans, net 298 339 34
Gain on sale of securities available
for sale 22 - - - -
Escrow and annuity fees 242 109 132
Servicing income on loans sold 252 160 - -
Other 409 313 244
Total non-interest income 1,540 1,235 688
Non-Interest Expense
Salaries and employee benefits 3,872 2,894 2,506
Premises and equipment 730 723 554
Deposit insurance premiums 116 76 1,203
Advertising 234 234 136
Other 1,388 1,113 993
Total non-interest expense 6,340 5,040 5,392
Income before income taxes 7,506 5,159 4,097
Provision for Income Taxes 2,410 1,830 1,419
Net income $5,096 $ 3,329 $ 2,678
Earnings Per Common Share
Basic $.84 N/A N/A
See notes to consolidated financial statements.
18
<PAGE>
<PAGE>
<TABLE>
Consolidated Statements of Shareholders' Equity
- ------------------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Share Data)
Timberland Bancorp, Inc.
Years Ended September 30, 1998, 1997 and 1996
Unearned Net
Shares Unrealized
Issued to Gain (Loss)
Addi- Employee on
Common Stock tional Stock Securities
Paid-in Ownership Retained Available
Shares Amount Capital Trust Earnings for Sale Total
<S> <C> <C> <C> <C> <C> <C> <C>
Balance,
September 30, 1995 - - $- - $ - - $ - - $18,638 $ 14 $18,652
Net income - - - - - - - - 2,678 - - 2,678
Unrealized loss on securities
available for sale, net of tax - - - - - - - - - - (1) (1)
Balance,
September 30, 1996 - - - - - - - - 21,316 13 21,329
Net income - - - - - - - - 3,329 - - 3,329
Realized gain on sale of
securities, net of tax - - - - - - - - - - (13) (13)
Balance,
September 30, 1997 - - - - - - - - 24,645 - - 24,645
Issuance of common stock 6,612,500 66 64,884 - - - - - - 64,950
Net income - - - - - - - - 5,096 - - 5,096
Repurchase of common stock (330,625) (3) (4,732) - - - - - - (4,735)
Cash dividends
($.06 per share) - - - - - - - - (793) - - (793)
Shares acquired for ESOP - - - - - - (7,930) - - - - (7,930)
ESOP compensation expense - - - - 31 396 - - - - 427
Unrealized gain on securities
available for sale, net of tax - - - - - - - - - - 120 120
Balance,
September 30, 1998 6,281,875 $63 $60,183 ($7,534) $28,948 $120 $81,780
See notes to consolidated financial statements.
19
</TABLE>
<PAGE>
<PAGE>
Consolidated Statements of Cash Flows
- ------------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc.
Years Ended September 30, 1998, 1997 and 1996
1998 1997 1996
Cash Flows from Operating Activities
Net income $ 5,096 $ 3,329 $ 2,678
Noncash revenues, expenses, gains and
losses included in income:
Depreciation 348 304 243
Deferred federal income taxes (33) (42) (188)
Noncash compensation expense related
to ESOP benefit 427 - - - -
Federal Home Loan Bank stock dividends (126) (116) (107)
Market value adjustment - loans held for
sale (19) (70) 87
(Gain) loss on sale of real estate owned,
net 25 (12) - -
Gain on sale of securities available for
sale (22) - - - -
Loss on sale of loans 94 - - - -
Provision for loan and real estate owned
losses 200 598 72
Net (increase) decrease in loans originated
for sale (4,433) 2,341 (690)
Net change in accrued interest receivable
and other assets, and other liabilities
and accrued expenses (714) (755) 1,181
Net cash provided by operating activities 843 5,577 3,276
Cash Flows from Investing Activities
Purchases of securities available for sale (17,025) - - - -
Purchases of securities held to maturity (20,371) - - - -
Proceeds from maturities of securities
held to maturity - - 948 4,905
Proceeds from maturities of securities
available for sale 7,548 101 - -
Proceeds from sales of securities
available for sale 312 - - - -
Increase in loans receivable, net (11,846) (13,400) (19,437)
Additions to premises and equipment (257) (879) (1,492)
Additions to real estate owned (663) (568) (99)
Proceeds from sale of real estate owned 3,097 271 181
Net cash used in investing activities (39,205) (13,527) (15,942)
Cash Flows from Financing Activities
Increase (decrease) in deposits (2,169) 16,454 13,465
Decrease in Federal Home Loan Bank
advances (623) (2,113) (604)
Proceeds from the issuance of common
stock, net of related costs 64,950 - - - -
Repurchase of common stock (4,735) - - - -
Payment of dividends (793) - - - -
Common stock purchased for ESOP (7,930) - - - -
Net cash provided by financing
activities 48,700 14,341 12,861
Net increase in cash 10,338 6,391 195
Cash and Due from Financial Institutions
Beginning of year 11,446 5,055 4,860
End of year $21,784 $11,446 $ 5,055
(continued)
See notes to consolidated financial statements.
20
<PAGE>
<PAGE>
Consolidated Statements of Cash Flows
- ------------------------------------------------------------------------------
(concluded) (Dollars in Thousands)
Timberland Bancorp, Inc.
Years Ended September 30, 1998, 1997 and 1996
1998 1997 1996
Supplemental Disclosures of Cash Flow
Information
Income taxes paid $3,012 $1,578 $1,545
Interest paid 8,202 8,377 7,628
Supplemental Disclosures of Non-Cash
Investing Activities Transfer of
securities from held to maturity to
available for sale $20,375 $ - - $ - -
Market value adjustment of securities
held for sale, net of tax 120 (13) (1)
Loans transferred to real estate owned 3,909 507 85
See notes to consolidated financial statements.
21
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 1 - Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Timberland
Bancorp, Inc. (the Company) and its wholly owned subsidiary, Timberland
Savings Bank, SSB (the Bank), and the Bank's wholly owned subsidiary,
Timberland Service Corp. All significant intercompany transactions and
balances have been eliminated.
Nature of Operations
The Company is a holding company which operates primarily through its
subsidiary, the Bank. The Bank was established in 1915 and, through its eight
branches located in Grays Harbor, Pierce, Thurston, and King Counties in
Washington State, attracts deposits from the general public, and uses those
funds, along with other borrowings, to provide primarily real estate loans to
borrowers in western Washington, and to invest in investment securities and
mortgage-backed securities.
Consolidated Financial Statement Presentation
The accounting principles followed by the Company and the methods of applying
them conform with generally accepted accounting principles and with general
industry practice. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities,
and the disclosure of contingent assets and liabilities, as of the date of the
balance sheet, and the reported amounts of revenues and expenses during the
reporting period. Actual amounts could differ significantly from those
amounts.
Certain prior year amounts have been reclassified to conform to the 1998
presentation.
Conversion
In connection with the January 1998 conversion of Timberland Savings Bank, SSB
from a Washington-chartered mutual savings bank to a Washington-chartered
stock savings bank, a holding company, Timberland Bancorp, Inc., was formed.
The simultaneous conversion of the savings bank to stock form, the issuance of
the savings bank's common stock to the holding company, and the offering and
sale of the holding company's common stock to the public are referred to
herein as "the conversion."
In the conversion, 6,612,500 common shares were sold at a subscription price
of $10 per share, resulting in net proceeds of approximately $64,950,000 to
the Company after $1,175,000 in offering expenses.
(continued)
22
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 1 - Summary of Significant Accounting Policies (continued)
Investments and Mortgage-Backed Securities
In accordance with Statement of Financial Accounting Standards No. 115, the
Bank has classified its investments and mortgage-backed securities as follows:
Held to Maturity
Debt securities for which management has the positive intent and ability to
hold until maturity are reported at cost, adjusted for amortization of
premiums or accretion of discounts, which are recognized in interest income
over the period to maturity.
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 considered
securities available for sale, and are reported at fair value. Fair value
is determined using published quotes as of the close of business.
Unrealized gains and losses are excluded from earnings, and are reported as
a separate component of shareholders' equity, net of the related deferred
tax effect. Realized gains and losses on securities available for sale,
determined using the specific identification method, are included in
earnings. Amortization of premiums and accretion of discounts are
recognized in interest income over the period to maturity.
Loans Receivable
Loans are stated at the amount of unpaid principal, reduced by the undisbursed
portion of loans in process, unearned income and an allowance for loan losses.
Allowances for Losses
Allowances for losses on specific problem loans and 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 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 Bank's control, which may result in losses or recoveries differing
significantly from those provided in the consolidated financial statements.
(continued)
23
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 1 - Summary of Significant Accounting Policies (continued)
Allowances for Losses (concluded)
The 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.
These statements address the disclosure requirements and allocation 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 Bank excludes smaller balance
homogenous loans, including single-family residential and consumer loans, from
the scope of these statements.
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 unamortized
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, 1998 and 1997,
the Bank had no loans deemed to be impaired for which specific allocation of
the allowance for loan losses was required.
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 unamortized deferred loan
fees.
Premises and Equipment
Premises and equipment 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. Gains and losses on dispositions are reflected in
earnings.
(continued)
24
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 1 - Summary of Significant Accounting Policies (continued)
Real Estate Owned
Real estate owned (REO) consists of properties acquired through, or in lieu
of, foreclosure and is initially recorded at the fair value of the properties
less estimated costs of disposal. Costs relating to development and
improvement of the properties are capitalized, whereas costs relating to
holding the properties are expensed.
Valuations are periodically performed by management, and an allowance for
losses is established by a charge to earnings 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 when 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 the collectibility
of principal and interest is no longer doubtful.
The Bank charges fees for originating loans. That portion of loan fees
exceeding the estimated direct cost of originating 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 unamortized deferred loan fee
is recognized in income at the time of repayment.
Loan Servicing Fees
Effective for loans originated after December 31, 1996, the Bank records its
mortgage servicing rights at fair value in accordance with SFAS No. 125,
Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities, which requires the Bank to allocate the total cost of all
mortgage loans, whether originated or purchased, to the loans (without the
mortgage servicing rights), and to mortgage servicing rights based on their
relative fair values. The Bank is amortizing the mortgage servicing assets,
which totaled $374,000 and $158,000 at September 30, 1998 and 1997,
respectively, over the period of the estimated servicing income.
Prior to December 31, 1996, fees were reported as income when the related
mortgage loan payments were collected. Loan servicing costs were charged to
expense as incurred.
(continued)
25
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 1 - Summary of Significant Accounting Policies (continued)
Income Taxes
The Company files a consolidated federal income tax return with its
subsidiaries. Prior to fiscal year 1997, the Bank qualified under provisions
of the Internal Revenue Code which permitted, 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% for the year ended
September 30, 1996.
In 1996, the percentage-of-income bad debt deduction for federal tax purposes
was eliminated. In addition, federal tax bad debt reserves which had 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 Bank satisfies a mortgage origination test. As of September 30,
1998, the 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. As
changes in tax laws or rates are enacted, deferred tax assets and liabilities
are adjusted through the provision for income taxes.
Employee Stock Ownership Plan
The Bank sponsors a leveraged Employee Stock Ownership Plan (ESOP). The ESOP
is accounted for in accordance with the American Institute of Certified Public
Accountants Statement of Position 93-6, Employers' Accounting for Employee
Stock Ownership Plan. Accordingly, the debt of the ESOP is recorded as other
borrowed funds of the Bank and the shares pledged as collateral are reported
as unearned shares issued to the employee stock ownership trust in the balance
sheets. The debt of the ESOP is with the Company and is thereby eliminated in
the consolidated financial statements. As shares are released from
collateral, compensation expense is recorded equal to the average market price
of the shares for the period, and the shares become outstanding for earnings
per share calculations. Cash dividends on unallocated shares which are
collateral for debt are used to reduce scheduled principal and interest
payments, and are recorded as a reduction of compensation expense.
Cash Equivalents
The Company considers all amounts included in the balance sheet caption "Cash
and due from financial institutions" to be cash equivalents.
(continued)
26
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 1 - Summary of Significant Accounting Policies (concluded)
Earnings Per Share
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, Earnings Per Share (SFAS No. 128),
which the Company adopted in the second quarter of 1998 upon formation of the
holding company and issuance of stock. SFAS No. 128 requires a dual
presentation of basic and diluted earnings per share. Basic earnings per
share exclude dilution and are computed by dividing net income by the weighted
average number of common shares outstanding. Diluted earnings per share are
not applicable because the Company has no common stock equivalents
outstanding.
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards Nos. 130, Reporting Comprehensive Income, and
131, Disclosures about Segments of an Enterprise and Related Information, both
of which are effective for fiscal years beginning after December 15, 1997.
SFAS No. 130 establishes standards for reporting and presenting comprehensive
income and its components in a full set of general-purpose financial
statements. All items that are required to be recognized under accounting
standards as components of comprehensive income will be reported in a
financial statement that is displayed with the same prominence as other
financial statements. Also, the accumulated balance of other comprehensive
income will be presented separately from retained earnings and additional
paid-in capital in the equity section of the balance sheet. SFAS No. 131
requires that public enterprises report financial and descriptive information
about their reportable operating segments. Both of these pronouncements will
require additional disclosures about the Company's operations, but are not
anticipated to have any effect on financial position or results of operations.
Note 2 - Accounting Changes
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities, which is effective for years beginning after June 15,
1999, with early adoption encouraged. The Company has adopted this standard
as of September 30, 1998. SFAS No. 133 establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the
balance sheet and measure those instruments at fair value. Accounting for
changes in the fair value of the derivative depends on the intended use of the
derivative and the resulting designation.
27
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 3 - Investments and Mortgage-Backed Securities
Investments and mortgage-backed securities have been classified according to
management's intent. The recorded amounts and approximate fair values by
contractual maturity are shown below (dollars in thousands). Actual
maturities may differ from contractual maturities because borrowers may have
the right to prepay obligations, with or without prepayment penalties.
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Values
Available for Sale
September 30, 1998
U.S. agency securities $ 8,915 $ 22 $ - - $ 8,937
Mortgage-backed securities 17,457 140 (42) 17,555
Mutual Funds 7,028 93 - - 7,121
FHLB Stock 1,713 - - - - 1,713
Equity securities 121 - - (32) 89
Total $ 35,234 $255 ($74) $ 35,415
September 30, 1997
FHLB stock $ 1,587 $- - $ - - $ 1,587
Held to Maturity
September 30, 1997
Mortgage-backed securities $ 3,990 $ 44 ($52) $ 3,982
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 $1,327,000 and $1,663,000 at September 30, 1998 and 1997,
respectively.
(continued)
28
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 3 - Investments and Mortgage-Backed Securities (concluded)
Effective September 30, 1998, the Company transferred securities with an
amortized cost of $20,375,000 from the "held to maturity" category to the
"available for sale" category under one-time reassessment guidelines allowable
under SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities. The related unrealized gain associated with this transfer was
$69,000, which is included in the "unrealized gain (loss) on securities
available for sale, net of tax" component of shareholders' equity.
The scheduled maturity of debt securities at September 30, 1998 follows
(dollars in thousands). Expected maturities may differ from scheduled
maturities due to the prepayment of principal or call provisions.
Available for Sale
Estimated
Amortized Fair
Cost Value
Due within one year $ 333 $ 326
Due from one year to five years 8,986 9,008
Due from five to ten years 1,993 2,008
Due after ten years 15,060 15,150
Total $26,372 $26,492
Note 4 - Loans Receivable and Loans Held for Sale
Loans receivable, including loans held for sale, consisted of the following at
September 30 (dollars in thousands):
1998 1997
Mortgage loans:
One-to four-family $ 92,707 $ 96,252
Multi-family 12,432 12,177
Commercial 32,906 29,410
Construction and land development 64,172 45,031
Land 7,749 6,937
Total mortgage loans 209,966 189,807
(continued)
29
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 4 - Loans Receivable and Loans Held for Sale (continued)
1998 1997
Consumer loans:
Home equity and second mortgage $ 8,740 $ 8,143
Other 4,066 2,824
Total consumer loans 12,806 10,967
Commercial business loans 1,105 694
Total loans receivable 223,877 201,468
Less:
Undisbursed portion of loans in process 28,886 14,820
Unearned income 2,256 1,761
Allowance for loan losses 1,728 1,716
32,870 18,297
Loans receivable, net 191,007 183,171
Loans held for sale (one- to four-family) 8,214 3,875
Market value adjustment - - (19)
Loans held for sale, net 8,214 3,856
Loans receivable and loans held for sale, net $ 199,221 $ 187,027
The weighted average interest rate on all loans at September 30, 1998 and 1997
was 8.62% and 8.79%, respectively.
Loans serviced for the Federal Home Loan Mortgage Corporation and others at
September 30, 1998 and 1997 were $60,347,000 and $54,353,000, respectively.
A summary of the Bank's commitments outstanding at September 30 is as follows
(dollars in thousands):
1998 1997
Mortgage loans $ 8,859 $6,011
Nonmortgage loans 2,397 2,922
Credit card lines 2,786 N/A
$14,042 $8,933
(continued)
30
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 4 - Loans Receivable and Loans Held for Sale (concluded)
Certain related parties of the Bank, principally Bank directors and officers,
were loan customers of the Bank in the ordinary course of business during 1998
and 1997. An analysis of the loans outstanding at September 30 to key
officers and directors is as follows (dollars in thousands):
1998 1997
Balance, beginning of year $805 $845
New loans 377 18
Repayments (414) (58)
Balance, end of year $768 $805
At September 30, 1998 and 1997, the Bank had non-accruing loans totaling
approximately $4,410,000 and $7,555,000, respectively. At September 30, 1998
and 1997, approximately $396,000 and $109,000, respectively, of loans were 90
days or more past due and still accruing interest. Unrecorded interest on the
non-accrual loans totaled approximately $544,000 and $402,000 at September 30,
1998 and 1997, respectively. No interest income was recorded on non-accrual
loans for the years ended September 30, 1998, 1997 and 1996. The average
investment in non-accrual loans for the years ended September 30, 1998, 1997
and 1996 was $5,014, $4,788, and $1,159, respectively.
An analysis of the allowance for loan losses for the years ended September 30
follows (dollars in thousands):
1998 1997 1996
Balance, beginning of year $1,716 $1,133 $1,119
Provision for loan losses 200 597 70
Transfers to allowance for possible
losses on REO (180) (3) (55)
Loans charged off (8) (19) (1)
Recoveries - - 8 - -
Balance, end of year $1,728 $1,716 $1,133
Note 5 - Premises and Equipment
Premises and equipment consisted of the following at September 30 (dollars in
thousands):
1998 1997
Land $1,804 $1,804
Buildings and improvements 4,271 4,261
Furniture and equipment 1,866 1,898
Automobiles 22 22
Property held for future expansion 21 21
Construction and purchases in progress 34 6
8,018 8,012
Less accumulated depreciation 2,678 2,581
Total premises and equipment $5,340 $5,431
31
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 6 - Real Estate Owned
Real estate owned consisted of the following at September 30 (dollars in
thousands):
1998 1997
Real estate acquired through foreclosure $1,916 $466
Allowance for possible losses (192) (32)
Total $1,724 $434
An analysis of the allowance for possible losses follows (dollars in
thousands):
1998 1997 1996
Balance, beginning of year $ 32 $70 $13
Provision for additional losses - - 1 2
Transfers from allowance for loan losses 180 3 55
Write-downs (20) (42) - -
Balance, end of year $192 $32 $70
Note 7 - Accrued Interest Receivable
Accrued interest receivable consisted of the following at September 30
(dollars in thousands):
1998 1997
Loans receivable $1,718 $1,574
Less reserve for uncollected interest 573 480
1,145 1,094
Investment securities and interest bearing
deposits 244 43
Total $1,389 $1,137
32
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 8 - Deposits
Deposits consisted of the following at September 30 (dollars in thousands):
1998 1997
Non-interest bearing $ 5,839 $ 5,164
N.O.W. checking 21,595 19,587
Passbook savings 27,315 26,269
Money market accounts 15,013 14,424
Certificates of deposit 97,561 104,758
Other 3,511 2,801
Total $170,834 $173,003
The weighted average interest rate on all deposits at September 30, 1998 and
1997 was 4.29% and 4.64%, respectively.
Deposits of $100,000 or greater totaled $18,563,000 and $22,897,000 at
September 30, 1998 and 1997, respectively.
Scheduled maturities of certificates of deposit at September 30, 1998 are as
follows (dollars in thousands):
Within one year $72,330
Over one to two years 19,393
Over two to five years 5,748
After five years 90
Total $97,561
Interest expense by account type is as follows for the years ended September
30 (dollars in thousands):
1998 1997 1996
Certificates of deposit $5,631 $5,807 $5,271
Money market accounts 543 514 520
Passbook savings 906 750 738
N.O.W. checking 390 445 421
Total $7,470 $7,516 $6,950
33
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 9 - Federal Home Loan Bank Advances
The Bank has been approved for participation in the Federal Home Loan Bank of
Seattle Cash Management Advance Program, maturing July 1999, with a maximum
facility of $14,664,000. 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, 1998 or
1997.
The Advances, Security and Deposit Agreement, which includes the Cash
Management Advance Program, is maintained at 20% of total assets. The Bank
had advances at September 30, 1998, as follows (dollars in thousands):
Interest Maturity
Borrowing Rate Date Balance
Fixed rate callable 5.39% 6/03/02 $10,000
Fixed rate (monthly amortization) 6.55 2/22/06 1,230
Fixed rate (monthly amortization) 6.11 2/22/02 388
$11,618
The weighted average rate for all advances at September 30, 1998 was 5.54%.
Under the Advances, Security and Deposit Agreement, virtually all of the
Bank's assets, not otherwise encumbered, are pledged as collateral for
advances.
At September 30, 1998, annual repayments of FHLB advances, total $10,388,000
for the year ending September 30, 2002, and $1,230,000 for the year ending
September 30, 2006.
Note 10 - Other Liabilities and Accrued Expenses
1998 1997
Federal income taxes $ 168 $ 483
Accrued pension and profit sharing 628 493
Accrued interest on deposits and FHLB advances 89 147
Accounts payable and accrued expenses - other 592 541
Total $1,477 $1,664
34
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 11 - Federal Income Taxes
The 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, retained earnings include approximately
$2,200,000 for which no provision for federal income taxes has been made. If
in the future this portion of retained earnings 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 (dollars in thousands):
1998 1997 1996
Current $2,443 $1,872 $1,607
Deferred benefit (33) (42) (188)
Total $2,410 $1,830 $1,419
The components of the Company's deferred tax assets and liabilities at
September 30 are as follows (dollars in thousands):
1998 1997
Deferred Tax Assets
Accrued interest on loans $ 25 $ 87
Depreciation 30 27
Accrued vacation 26 24
Deferred compensation 75 60
Unearned ESOP shares 55 - -
Allowance for loan losses 63 - -
Loans held for sale market value adjustment - - 6
Total deferred tax assets 274 204
Deferred Tax Liabilities
FHLB stock dividends 349 307
Real estate sale, installment basis 32 33
Unrealized securities gains 61 - -
Other - - 4
Total deferred tax liabilities 442 344
Net deferred tax liabilities $168 $140
(continued)
35
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 11 - Federal Income Taxes (concluded)
The provision for federal income taxes differs from that computed at the
statutory corporate tax rate as follows (dollars in thousands):
1998 1997 1996
Amount Percent Amount Percent Amount Percent
Tax provision at
statutory rate $2,552 34.0% $1,754 34.0% $1,393 34.0%
Other - net (142) (1.9) 76 1.5 26 .6
Total tax expense $2,410 32.1% $1,830 35.5% $1,419 34.6%
Note 12 - Profit Sharing Plans
The Bank maintains a tax-qualified profit sharing plan for the benefit of all
eligible employees who are at least 21 years of age and work a minimum of 501
hours. The Bank contributed $226,000, $172,000 and $178,000 to the plan for
the years ended September 30, 1998, 1997 and 1996, respectively.
Contributions are made on a discretionary basis.
In addition, the Bank has an employee bonus plan based on net income. Bonuses
accrued for the years ended September 30, 1998, 1997 and 1996 totaled
$181,000, $144,000 and $107,000, respectively.
Note 13 - Employee Stock Ownership Plan
In 1998, the Bank established an Employee Stock Ownership Plan (ESOP) that
benefits all employees with at least one year of service who are 21 years of
age or older. The ESOP is funded by Bank contributions in cash or stock.
Employee vesting occurs over six years. The amount of the annual contribution
is discretionary, except that it must be sufficient to enable the ESOP to
service its debt.
In January 1998 the ESOP borrowed $7,930,000 from the Company to purchase
529,000 shares of common stock of the Company. The loan will be repaid
primarily from the Company's contributions to the ESOP over 15 years. The
interest rate on the loan is 8.5%.
Shares held by the ESOP as of September 30, 1998 were classified as follows:
Unallocated shares 502,550
Shares released for allocation 26,450
Total ESOP shares 529,000
The approximate fair market value of the Bank's unallocated shares (including
those released for allocation) at September 30, 1998 is $7,633,000.
36
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 14 - Deferred Compensation/Noncompetition Agreement and Severance
Compensation Agreement
The Bank has a deferred compensation/noncompetition arrangement with its chief
executive officer which will provide monthly payments of $1,600 if retirement
occurs prior to age 65 or $2,000 per month if retirement occurs at age 65.
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 60
months. The present value of the payments, based on the life expectancy of
the chief executive officer, is being accrued based on a retirement age of 65
and is included in other liabilities in the consolidated financial statements.
As of September 30, 1998 and 1997, $221,000 and $177,000, respectively, has
been accrued under the agreement.
In connection with the January 1998 conversion, the Bank adopted an Employee
Severance Compensation Plan, which expires in ten years, to provide benefits
to eligible employees in the event of a change in control of the Company or
the Bank (as defined in the plan). In general, all employees with two or more
years of service will be eligible to participate in the plan. Under the plan,
in the event of a change in control of the Company or the Bank, eligible
employees who are terminated or who terminate employment (but only upon the
occurrence of events specified in the plan) within 12 months of the effective
date of a change in control would be entitled to a payment based on years of
service with the Bank. The maximum payment for any eligible employee would be
equal to 24 months of their current compensation.
Note 15 - Regulatory Matters
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory -- and possibly
additional discretionary -- actions by regulators that, if undertaken, could
have a direct material effect on the Company's consolidated financial
statements. Under capital adequacy guidelines of the regulatory framework for
prompt corrective action, the Bank must meet specific capital adequacy
guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance- sheet items as calculated under
regulatory accounting practices. The Bank's capital classification is also
subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios as
defined in the regulations (set forth in the table below) of Tier 1 capital to
average assets, and minimum ratios of Tier 1 and total capital to risk-
weighted assets. Under the regulatory framework for prompt corrective action,
the Bank must maintain minimum Tier 1 leverage, Tier 1 risk-based, and total
risk-based ratios as set forth in the table.
As of September 30, 1998, the most recent notification from the Bank's
regulator categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well
capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-
based, and Tier 1 leverage ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed the Bank's category.
(continued)
37
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 15 - Regulatory Matters (concluded)
The Company's and the Bank's actual capital amounts and ratios are also
presented in the table.
To be Well
Capitalized
Under Prompt
Capital Corrective
Adequacy Action
Actual Purposes Provisions
Amount Ratio Amount Ratio Amount Ratio
September 30, 1998
Tier 1 capital (to
average assets):
Consolidated $81,780 31.0% $10,541 4.0% N/A N/A
Timberland Savings
Bank, SSB 53,865 22.4 9,636 4.0 $12,045 5.0%
Tier 1 capital (to
risk-weighted assets):
Consolidated 81,780 49.9 6,560 4.0 N/A N/A
Timberland Savings
Bank, SSB 53,865 33.4 6,453 4.0 9,680 6.0
Total capital (to
risk-weighted assets):
Consolidated 83,508 50.9 13,121 8.0 N/A N/A
Timberland Savings
Bank, SSB 55,593 33.9 12,906 8.0 16,133 10.0
September 30, 1997
Tier 1 capital (to
average assets):
Timberland Savings
Bank, SSB $24,645 12.0% $8,205 4.0% $10,269 5.0%
Tier 1 capital (to
risk-weighted assets):
Timberland Savings
Bank, SSB 24,645 16.3 6,050 4.0 9,074 6.0
Total capital (to
risk-weighted assets):
Timberland Savings
Bank, SSB 26,361 17.4 12,099 8.0 15,124 10.0
Restrictions on Retained Earnings
The Bank is subject to certain restrictions on the amount of dividends that it
may declare without prior regulatory approval.
At the time of conversion, the Bank established a liquidation account in an
mount equal to its retained earnings as of June 30, 1997, the date of the
latest statement of financial condition used in the final conversion
prospectus. The liquidation account will be maintained for the benefit of
eligible withdrawable account holders who have maintained their deposit
accounts in the Bank after conversion. The liquidation account will be
reduced annually to the extent that eligible account holders have reduced
their qualifying deposits 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 Bank (and only in such
an event), eligible depositors who have continued to maintain accounts will be
entitled to receive a distribution from the liquidation account before any
liquidation may be made with respect to common stock. The Bank may not
declare or pay cash dividends if the effect thereof would reduce its
regulatory capital below the amount required for the liquidation account.
38
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 16 - Condensed Financial Information - Parent Company Only
Condensed Balance Sheet - September 30, 1998
(Dollars in Thousands)
Assets
Noninterest bearing deposits $ 3
Interest bearing deposits 6,904
Investments and mortgage-backed securities available for sale 13,222
Loan receivable from Bank 7,697
Investment in Bank 53,865
Other assets 134
Total assets $81,825
Liabilities and Shareholders' Equity
Other liabilities and accrued expenses $ 45
Shareholders' equity 81,780
Total liabilities and shareholders' equity $81,825
Condensed Statement of Income - Year Ended September 30, 1998
(Dollars in Thousands)
Operating Income
Interest on investment and mortgage-backed securities $ 907
Interest on loan receivable from Bank 469
Dividends 63
Gain on sale of investment securities available for sale 22
Total operating income 1,461
Operating Expenses 70
Income before income taxes and equity
in undistributed income of Bank 1,391
Income Taxes 473
Income before equity in undistributed income of Bank 918
Equity in Undistributed Income of Bank 4,178
Net income $5,096
(continued)
39
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 16 - Condensed Financial Information - Parent Company Only (concluded)
Condensed Statement of Cash Flows - Year Ended September 30, 1998
(Dollars in Thousands)
Cash Flows from Operating Activities
Net income $ 5,096
Adjustments to reconcile net income to net cash provided:
Equity in undistributed income of Bank (4,178)
Gain on sale of securities available for sale (22)
Accretion of discount on securities available for sale (3)
Other, net (115)
Net cash provided by operating activities 778
Cash Flows from Investing Activities
Investment in Bank (32,475)
Purchases of securities available for sale (17,224)
Proceeds from maturities of securities available for sale 3,700
Proceeds from sale of securities available for sale 403
Funding provided to the Bank for purchase of common stock
for ESOP (7,930)
Principal repayments on loan receivable from the Bank 233
Net cash used in investing activities (53,293)
Cash Flows from Financing Activities
Proceeds from the issuance of common stock, net of related costs 64,950
Repurchase of common stock (4,735)
Payment of dividends (793)
Net cash provided by financing activities 59,422
Net increase in cash 6,907
Cash and Due from Financial Institutions
Beginning of year - -
End of year $ 6,907
40
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 17 - Earnings Per Share Disclosures
Information regarding the calculation of basic earnings per share for the year
ended September 30, 1998 is as follows (dollars in thousands, except per share
amount).
Weighted
Average
Net Income Shares Per Share
(Numerator) (Denominator) Amount
Basic earnings per share:
Net income $5,096 6,036,597 $.84
The weighted average number of shares outstanding has been reduced by
unallocated ESOP shares for this calculation. Diluted earnings per share are
not applicable because the Company has no common stock equivalents
outstanding.
Note 18 - Subsequent Event
Subsequent to September 30, 1998, the Company completed a repurchase of 5% of
the outstanding common stock, or 314,094 shares, at an average price of $12.19
per share.
Note 19 - Fair Values of Financial Instruments
Statement of Financial Accounting Standards No. 107, Disclosures About Fair
Value of Financial Instruments, 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 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, Mortgage-Backed Securities and Loans Held for Sale
The fair value of investments, mortgage-backed securities and loans held
for sale has been based on quoted market prices or dealer quotes.
(continued)
41
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 19 - Fair Values of Financial Instruments (concluded)
Loans Receivable
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
on the historical experience of the Bank.
Deposits
The fair value of deposits with no stated maturity date is included at the
amount payable on demand. The fair value of fixed maturity certificates of
deposit is estimated by discounting future cash flows using the rates
currently offered by the Bank for deposits of similar remaining maturities.
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, 1998 and
1997 were as follows (dollars in thousands):
1998 1997
Recorded Fair Recorded Fair
Amount Value Amount Value
Financial Assets
Cash and due from financial
institutions $ 21,784 $ 21,784 $ 11,446 $ 11,446
Investments and mortgage
backed securities 35,415 35,415 5,577 5,569
Loans receivable 199,221 200,912 187,027 191,655
Financial Liabilities
Deposits $170,834 $171,129 $173,003 $173,468
Federal Home Loan Bank
advances 11,618 11,945 12,241 12,176
42
<PAGE>
<PAGE>
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc.
September 30, 1998 and 1997
Note 20 - Selected Quarterly Financial Data (Unaudited)
The following selected financial data are presented for the quarters ended
(dollars in thousands, except per share amounts):
December March June September
31, 31, 30, 30,
1997 1998 1998 1998
Interest and dividend income $4,655 $5,274 $5,319 $5,402
Interest expense 2,241 2,019 1,928 1,956
Net interest income 2,414 3,255 3,391 3,446
Provision for loan losses (60) (50) (45) (45)
Noninterest income 324 457 418 341
Noninterest expense (1,491) (1,532) (1,571) (1,746)
Income before income taxes 1,187 2,130 2,193 1,996
Provision for income taxes 383 716 742 569
Net income $ 804 $1,414 $1,451 $1,427
Basic earnings per share $.13 $.23 $.24 $.24
December March June September
31, 31, 30, 30,
1997 1998 1998 1998
Interest and dividend income $4,441 $4,461 $4,468 $4,577
Interest expense 2,067 2,072 2,098 2,149
Net interest income 2,374 2,389 2,370 2,428
Provision for loan losses (88) (131) (115) (263)
Noninterest income 233 307 297 398
Noninterest expense (1,187) (1,222) (1,243) (1,388)
Income before income taxes 1,332 1,343 1,309 1,175
Provision for income taxes 485 502 447 396
Net income $ 847 $ 841 $ 862 $ 779
Basic earnings per share N/A N/A N/A N/A
43
<PAGE>
<PAGE>
DIRECTORS AND OFFICERS
TIMBERLAND BANCORP, INC.
OFFICERS:
Clarence E. Hamre
President and Chief Executive Officer
Michael R. Sand
Executive Vice President
Paul G. MacLeod
Treasurer
DIRECTORS:
Clarence E. Hamre
Chairman of the Board, President and Chief Executive Officer of Timberland
Bancorp, Inc. and Timberland Savings Bank
Michael R. Sand
Secretary, Executive Vice President of Timberland Bancorp, Inc. and Timberland
Savings Bank
Peter J. Majar
Retired. Former general manager of Hoquiam Plywood Co., Inc.
Robert Backstrom
Retired. Former owner of Price & Price Real Estate and Insurance
Richard R. Morris, Jr.
Retired. Former owner of Dick's Food Centers, Inc.
Alan E. Smith
Retired. Former owner of Harbor Drug, Inc, a retail pharmacy
James C. Mason
President and owner of Mason Timber Co.
Andrea M. Clinton
Owner of AMC Interiors
Jon C. Parker
Member the law firm of Parker, Johnson & Parker P.S.
44
<PAGE>
<PAGE>
CORPORATE INFORMATION
MAIN OFFICE INDEPENDENT AUDITORS
624 Simpson Avenue Knight Vale & Gregory Inc., P.S.
Hoquiam, Washington 98550 Tacoma, Washington
Telephone: (360) 533-4747
GENERAL COUNSEL SPECIAL COUNSEL
Parker Johnson & Parker PS Breyer & Associates PC
Hoquiam, Washington Washington, D.C.
TRANSFER AGENT
For stockholder inquiries concerning dividend checks, transferring ownership,
address changes or lost or stolen certificates please contact our transfer
agent:
American Stock Transfer & Trust Company
40 Wall Street, 46th Floor
New York, New York 10005
(800) 937-5449
ANNUAL MEETING
The Annual Meeting of Stockholder will be held at the Elks Lodge, 624 K
Street, Hoquiam, Washington on Monday, January 25, 1999 at 1:00 p.m., Pacific
Time.
10-K
INFORMATION A COPY OF THE FORM 10-K, INCLUDING CONSOLIDATED FINANCIAL
STATEMENTS, AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION WILL BE
FURNISHED WITHOUT CHARGE TO STOCKHOLDERS AS OF THE RECORD DATE FOR VOTING AT
THE ANNUAL MEETING OF STOCKHOLDERS UPON WRITTEN REQUEST TO MICHAEL R. SAND,
EXECUTIVE VICE PRESIDENT AND SECRETARY, TIMBERLAND BANCORP, INC., 624 SIMPSON
AVENUE, HOQUIAM, WASHINGTON 98550.
45
<PAGE>
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<ARTICLE> 9
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<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-END> SEP-30-1998
<CASH> 7039
<INT-BEARING-DEPOSITS> 14745
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 35415
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<INVESTMENTS-MARKET> 0
<LOANS> 200949
<ALLOWANCE> 1728
<TOTAL-ASSETS> 265709
<DEPOSITS> 170834
<SHORT-TERM> 0
<LIABILITIES-OTHER> 1477
<LONG-TERM> 11618
0
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<COMMON> 63
<OTHER-SE> 81717
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<EXPENSE-OTHER> 6340
<INCOME-PRETAX> 7506
<INCOME-PRE-EXTRAORDINARY> 7506
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5096
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<YIELD-ACTUAL> 8.47
<LOANS-NON> 4410
<LOANS-PAST> 396
<LOANS-TROUBLED> 236
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<ALLOWANCE-OPEN> 1716
<CHARGE-OFFS> 188
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 1728
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</TABLE>
