<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR l5(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the transition period from ________ to ________.
Commission File Number 000-24503
WASHINGTON BANKING COMPANY
(Exact name of small business issuer as specified in its charter)
Washington 91-1725825
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1421 S.W. BARLOW STREET
OAK HARBOR, WASHINGTON 98277
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(360) 679-3121
- --------------------------------------------------------------------------------
(Issuer's telephone number, including area code)
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the issuer: (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
The number of shares of the issuer's Common Stock outstanding at July
31, 1999 was 4,108,035.
<PAGE> 2
TABLE OF CONTENTS
PART I -- FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page
----
<S> <C>
Item 1. Financial Statements
Condensed Consolidated Statements of Financial Condition - June 30, 1999
and December 31, 1998 1
Condensed Consolidated Statements of Income - Three and Six months
ended June 30, 1999 and 1998 2
Condensed Consolidated Statements of Shareholders' Equity-
Six months ended June 30, 1999 3
Condensed Consolidated Statements of Cash Flows -
Six months ended June 30, 1999 and 1998 4
Notes to Condensed Consolidated financial statements 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
PART II -- OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
</TABLE>
i
<PAGE> 3
PART I
ITEM 1. FINANCIAL STATEMENTS
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Condensed Consolidated Statements of Financial Condition
June 30, 1999 and December 31, 1998
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
ASSETS 1999 1998
--------- ---------
(UNAUDITED)
<S> <C> <C>
Cash and due from banks $ 11,533 12,063
Interest bearing deposits 3,677 8,089
Federal funds sold -- 4,100
--------- ---------
Total cash and cash equivalents 15,210 24,252
--------- ---------
Federal Home Loan Bank stock 763 736
Investment securities, available-for-sale 10,451 12,591
Investment securities, held-to-maturity 24,992 24,875
--------- ---------
Total investment securities 36,206 38,202
--------- ---------
Loans receivable, net 182,472 147,872
Premises and equipment, net 9,897 8,046
Other real estate owned 145 --
Deferred tax asset 476 419
Other assets 1,867 1,702
--------- ---------
Total assets $ 246,273 220,493
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits $ 209,791 189,698
Federal funds borrowed 5,000 --
Other funds borrowed 1,200 --
Other liabilities 889 1,104
--------- ---------
Total liabilities 216,880 190,802
--------- ---------
Shareholders' Equity:
Preferred stock, no par value. Authorized 20,000 shares; no shares
issued or outstanding -- --
Common stock, no par value. Authorized 10,000,000 shares,
issued and outstanding 4,108,035 and 4,189,050 shares at June 30,
1999 and December 31, 1998, respectively 16,875 17,836
Retained earnings 12,578 11,805
Accumulated other comprehensive income, net (60) 50
--------- ---------
Total shareholders' equity 29,393 29,691
--------- ---------
Total liabilities and shareholders' equity $ 246,273 220,493
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
1
<PAGE> 4
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Condensed Consolidated Statements of Income
Three and Six months ended June 30, 1999 and 1998
(unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Interest income:
Interest and fees on loans $ 3,926 3,151 7,453 6,075
Interest on taxable investment securities 278 269 573 530
Interest on tax-exempt investment securities 206 129 404 266
Other 68 54 170 99
---------- ---------- ---------- ----------
Total interest income 4,478 3,603 8,600 6,970
Interest expense 1,588 1,415 3,034 2,730
---------- ---------- ---------- ----------
Net interest income 2,890 2,188 5,566 4,240
Provision for loan losses 255 150 510 345
---------- ---------- ---------- ----------
Net interest income after provision
for loan losses 2,635 2,038 5,056 3,895
---------- ---------- ---------- ----------
Noninterest income:
Service charges on deposits 344 255 695 566
Other 319 238 596 445
---------- ---------- ---------- ----------
Total noninterest income 663 493 1,291 1,011
---------- ---------- ---------- ----------
Noninterest expense:
Salaries and benefits 1,328 1,021 2,634 1,974
Occupancy expense 459 373 944 631
Office supplies and printing 96 101 178 166
Data processing 79 65 151 128
Consulting and professional fees 19 15 39 61
Other 510 276 929 645
---------- ---------- ---------- ----------
Total noninterest expense 2,491 1,851 4,875 3,605
---------- ---------- ---------- ----------
Income before income taxes 807 680 1,472 1,301
Provision for income taxes 201 160 363 365
---------- ---------- ---------- ----------
Net income $ 606 520 1,109 936
========== ========== ========== ==========
Net income per share, basic $ 0.15 0.16 0.26 0.31
========== ========== ========== ==========
Net income per share, diluted $ 0.14 0.15 0.25 0.30
========== ========== ========== ==========
Average number of shares outstanding, basic 4,182,754 3,158,138 4,189,028 2,983,594
Average number of shares outstanding, diluted 4,444,995 3,354,850 4,447,809 3,171,836
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
<PAGE> 5
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Condensed Consolidated Statements of Shareholders' Equity
Six months ended June 30, 1999
(Amounts in thousands except per share data)
<TABLE>
<CAPTION>
ACCUMULATED
COMPREHENSIVE TOTAL
COMMON STOCK RETAINED INCOME, SHAREHOLDERS'
SHARES AMOUNT EARNINGS NET EQUITY
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Balances at December 31, 1998 4,189 $ 17,836 11,805 50 29,691
Cash dividend, $0.08 per share (unaudited) -- -- (336) -- (336)
Net income for the six months ended
June 30, 1999 (unaudited) -- -- 1,109 -- 1,109
Unrealized gains/losses for the six months
ended June 30, 1999, net of tax $57 (unaudited) -- -- -- (110) (110)
Repurchase of Common Stock (unaudited) (92) (995) -- -- (995)
Stock options exercised (unaudited) 11 34 -- -- 34
-------- -------- -------- -------- --------
Balances at June 30, 1999 (unaudited) 4,108 $ 16,875 12,578 (60) 29,393
======== ======== ======== ======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE> 6
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows
Six months ended June 30, 1999 and 1998
(unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30
1999 1998
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,109 936
Adjustments to reconcile net income to net cash
provided by operating activities:
Federal Home Loan Bank stock dividends (27) (27)
Amortization (accretion) of investment premiums (discounts), net 34 (6)
Provision for loan losses 510 345
Depreciation of premises and equipment 253 186
Net increase in other assets (165) (112)
Net (decrease) / increase in other liabilities (215) 427
-------- --------
Net cash provided by operating activities 1,499 1,749
-------- --------
Cash flows from investing activities:
Purchases of investment securities, available-for-sale (1,033) (2,500)
Maturities of investment securities, available-for-sale 3,000 1,000
Purchases of investment securities, held-to-maturity (1,790) (3,290)
Maturities of investment securities, held-to-maturity 1,645 3,500
Net increase in loans (35,255) (14,415)
Proceeds from the sale of real estate owned -- (1,909)
Purchases of premises and equipment (2,104) --
-------- --------
Net cash used in investing activities (35,537) (17,614)
-------- --------
Cash flows from financing activities:
Net increase in deposits 20,093 27,430
Federal funds borrowed 6,200 --
Dividends paid on common stock (336) (187)
Proceeds from stock options exercised 34 --
Proceeds from stock issued -- 14,893
Repurchase of common stock (995) --
-------- --------
Net cash provided by financing activities 24,996 42,136
-------- --------
Net (decrease) / increase in cash and cash
equivalents (9,042) 26,271
Cash and cash equivalents at beginning of period 24,252 8,013
-------- --------
Cash and cash equivalents at end of period $ 15,210 34,284
======== ========
Supplemental information:
Loans foreclosed and transferred to real estate owned $ 145 85
Cash paid for interest 3,079 2,700
Cash paid for taxes 430 445
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE> 7
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements
Six months ended June 30, 1999 and 1998
(unaudited)
(Dollars in thousands, except per share data)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Washington Banking Company (WBCO or Company), a Washington State bank
holding company, was formed on April 30, 1996. Whidbey Island Bank (WIB or
Bank), the principal subsidiary of WBCO, is a Washington State commercial
bank. The business of the Bank, which is focused in the northern area of
Western Washington, consists primarily of attracting deposits from the
general public and originating loans. Although WIB has a diversified loan
portfolio and its market area currently enjoys a stable economic climate,
a substantial portion of its borrowers' ability to repay their loans is
dependent upon the economic conditions affecting this area related to the
agricultural, forestry and manufacturing industries, and the large
military base presence in Oak Harbor, Washington.
BASIS OF PRESENTATION
The accompanying consolidated interim financial statements include the
accounts of Washington Banking Company and its wholly-owned subsidiary,
Whidbey Island Bank. The accompanying condensed consolidated interim
financial statements have been prepared, without audit, pursuant to
generally accepted accounting principles and instructions to Form 10-Q for
interim financial information. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. These condensed consolidated
financial statements should be read in conjunction with the Company's
December 1998 audited consolidated financial statements and notes thereto
included in the Company's Form 10-K filed with the Securities and Exchange
Commission. In the opinion of management, all adjustments (consisting of
normal recurring adjustments) considered necessary for a fair presentation
have been included. Operating results for the three and six months ended
June 30, 1999 are not necessarily indicative of the results that may be
expected for the year ending December 31, 1999.
Certain amounts in 1998 have been reclassified to conform with the 1999
financial statement presentation.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June of 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133 ("SFAS 133"),
"Accounting for Derivative Instruments and Hedging Activities." The
Statement is effective for the Company in the year 2001 and requires all
derivatives to be recorded on the balance sheet at fair value and
establishes accounting standards for different types of hedging
5
<PAGE> 8
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements
Six months ended June 30, 1999 and 1998
(unaudited)
(Dollars in thousands, except per share data)
activities, including fair value hedges, cash flow hedges and hedges of
foreign currency exposures. The Company currently has no activity in
derivative instruments and hedging activities and does not expect adoption
of SFAS 133 to have a material impact on the Company's financial position
or results of operations.
In October 1998, the FASB issued SFAS 134 (which amended SFAS 65
"Accounting for Certain Mortgage Banking Activities"). This Statement
establishes accounting and reporting standards for securities retained
after the securitization of mortgage loans. Under this Statement, any
retained mortgage-based securities (after the securitization of a mortgage
loan held for sale) will need to be classified as either
"available-for-sale" or "trading". The Statement was effective for the
Company beginning January 1, 1999. The Company currently has no activity
in securitizing mortgage loans held for sale. The adoption of the
Statement did not have a material impact on the Company's financial
position or results of operations.
6
<PAGE> 9
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements
Six months ended June 30, 1999 and 1998
(unaudited)
(Dollars in thousands, except per share data)
(2) SHAREHOLDERS' EQUITY
The following illustrates the reconciliation of the numerators and
denominators of the basic and diluted EPS computations:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, 1999
---------------------------------------------
WEIGHTED PER SHARE
INCOME AVERAGE SHARES AMOUNT
--------- -------------- ---------
<S> <C> <C> <C>
BASIC EPS
Income available to common $ 606 4,182,754 .15
shareholders
Effect of dilutive -- 262,241 --
securities; stock options
--------- --------- ---
DILUTED EPS $ 606 4,444,995 .14
========= ========= ===
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, 1998
-----------------------------------------------
WEIGHTED PER SHARE
INCOME AVERAGE SHARES AMOUNT
--------- -------------- -----------
<S> <C> <C> <C>
BASIC EPS
Income available to common $ 520 3,158,138 0.16
shareholders
Effect of dilutive -- 196,712 --
securities; stock options
--------- --------- ----
DILUTED EPS $ 520 3,354,850 0.15
========= ========= ====
</TABLE>
7
<PAGE> 10
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements
Six months ended June 30, 1999 and 1998
(unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1999
---------------------------------------------
WEIGHTED PER SHARE
INCOME AVERAGE SHARES AMOUNT
--------- -------------- ---------
<S> <C> <C> <C>
BASIC EPS
Income available to common $ 1,109 4,189,028 .26
shareholders
Effect of dilutive -- 258,781 --
securities; stock options
--------- --------- ---
DILUTED EPS $ 1,109 4,447,809 .25
========= ========= ===
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1998
----------------------------------------------
WEIGHTED PER SHARE
INCOME AVERAGE SHARES AMOUNT
---------- -------------- ---------
<S> <C> <C> <C>
BASIC EPS
Income available to common $ 936 2,983,594 0.31
shareholders
Effect of dilutive -- 188,242 --
securities; stock options
--------- --------- ----
DILUTED EPS $ 936 3,171,836 0.30
========= ========= ====
</TABLE>
For three and six months ended June 30, 1999 there were options to
purchase 41,000 shares and 123,950 shares of common stock outstanding,
respectively, which were antidilutive and therefore not included in the
computation of diluted net income per share. There were 82,950
antidilutive shares outstanding for the three and six month periods ended
June 30, 1998.
On April 29, 1999, the Board of Directors approved a stock repurchase
plan, which allows the Company to repurchase up to 210,000 shares of the
Company's common stock. As of June 30, 1999, the Company had repurchased
92,265 shares of the Company's common stock.
8
<PAGE> 11
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements
Six months ended June 30, 1999 and 1998
(unaudited)
(Dollars in thousands, except per share data)
(3) COMPREHENSIVE INCOME
Comprehensive income for the three and six months ended June 30, 1999 and
1998 was $543 and $999, respectively, and $527 and $938, respectively.
Total comprehensive income for the three and six months ended June 30,
1999 and 1998 consisted of net income and the change in the unrealized
gain on investments.
(4) SUBSEQUENT EVENT
On July 15, 1999, the Board of Directors declared a cash dividend of $0.04
per share to shareholders of record as of August 5, 1999.
9
<PAGE> 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Washington Banking Company
THIS DISCUSSION CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS WITHIN THE
MEANING OF THE FEDERAL SECURITIES LAWS. ACTUAL RESULTS AND THE TIMING OF CERTAIN
EVENTS COULD DIFFER MATERIALLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING
STATEMENTS DUE TO A NUMBER OF FACTORS. SPECIFIC FACTORS INCLUDE, AMONG OTHERS,
THE EFFECT OF INTEREST RATE CHANGES, RISK ASSOCIATED WITH OPENING NEW BRANCHES,
CONTROLLING EXPENSES AND GENERAL ECONOMIC CONDITIONS. READERS ARE CAUTIONED NOT
TO PLACE UNDUE RELIANCE ON FORWARD LOOKING STATEMENTS SINCE THEY REFLECT
MANAGEMENT'S ANALYSIS ONLY AS OF THE DATE OF THE STATEMENT.
OVERVIEW
The Bank began operations in 1961, with its headquarters at Coupeville,
Washington, located on Whidbey Island. The Company was formed as a bank holding
company in April of 1996 and currently holds all of the issued and outstanding
common stock of the Bank. The Company and the Bank are headquartered in Oak
Harbor, Washington. The Company's only significant business activity has been to
hold the common stock of the Bank and invest its available funds. The Company
currently has thirteen full service bank branches and two loan production
offices located in Island, Skagit, Jefferson and Whatcom counties in Northwest
Washington State.
The Company's objective is to continue, over the next several years, to
expand its geographical presence outside of Island County (Whidbey and Camano
Islands), while solidifying its market position in Island County. Currently, the
geographical expansion is expected to be concentrated in the Burlington / Mt.
Vernon and other areas of Skagit County and the Bellingham area of Whatcom
County. Additional geographic expansion areas will be considered if they meet
the Company's criteria which include the availability of experienced managers,
lending officers and branch personnel with long-standing presence in the area
and extensive banking relationships. Requisite customer demand must also exist.
In pursuit of this growth strategy, during the first quarter of 1999, the
Company relocated its Bellingham office to a larger office and opened a
residential real estate loan production office in Port Townsend, Washington
(Jefferson County). In the second quarter of 1999, the Company opened a full
service office in Sedro Woolley, Washington (Skagit County). Such expansion
activity can be expected to require the expenditure of substantial sums to
purchase or lease real property and equipment and hire experienced personnel.
New branch offices are often not profitable for at least the first eighteen
months after opening and management expects that any earnings will be negatively
affected as the Company pursues its growth strategy.
10
<PAGE> 13
FINANCIAL CONDITION
Total assets increased to $246.3 million at June 30, 1999 from $220.5
million at December 31, 1998, an increase of 11.7%. Net loans totaled $182.5
million at June 30, 1999, an increase of 23.4% from December 31, 1998. Deposits
were $209.8 million at June 30, 1999, an increase of 10.6% from December 31,
1998.
The Company's shareholders' equity decreased 1.0% to $29.4 million
at June 30, 1999 compared to $29.7 million at December 31, 1998. The major
reasons for this decrease were the repurchase of approximately 92,000 shares of
common stock for $995,000 and the payment of cash dividends of $336,000 during
the first six months of 1999.
The Company's allowance for loan losses at June 30, 1999 was $2.0
million, or 1.09% of total loans, compared to $1.7 million, or 1.17% of total
loans, at December 31, 1998. Nonperforming assets amounted to $1.1 million at
June 30, 1999, or 0.43% of total assets, compared to $847,000 or 0.38% of total
assets, at December 31, 1998.
RESULTS OF OPERATIONS
The Company's results of operations are dependent to a large degree on
net interest income. Interest income and cost of funds are affected
significantly by general economic conditions, particularly changes in market
interest rates, and by government policies and the actions of regulatory
authorities. The Company also generates noninterest income primarily through
service charges and fees and other sources. The Company's noninterest expenses
consist primarily of compensation and employee benefit expense, and occupancy
expense.
Net income for the second quarter of 1999 increased 16.5% to $606,000,
or $0.14 per diluted share, from $520,000, or $0.15 per diluted share, for the
second quarter of 1998. Net income for the six months ended June 30, 1999
increased 18.5% to $1.1 million, or $0.25 per diluted share, from $936,000, or
$0.30 per diluted share, for the same period in 1998. There were 40% more
diluted average shares outstanding for the six months ended June 30, 1999
compared to June 30, 1998 due to the Company's public offering of 1.38 million
shares in June, 1998. The increase in net income was primarily due to increased
net interest income resulting from continued loan growth and increased
noninterest income, principally due to increases in service charges on deposits
caused by deposit growth and other income including fees on real estate loans
originated for third parties. These increases were partially offset by increased
expenses due principally to growth and expansion.
NET INTEREST INCOME
Net interest income for the second quarter of 1999 increased to $2.9
million, or 32.1%, from $2.2 million in the second quarter of 1998. For the
first six months of 1999, net interest income increased to $5.6 million, or
31.3%, from $4.2 million for the same period in 1998. The increase in net
interest income is largely due to the overall growth of the Company.
11
<PAGE> 14
Average interest earning assets for the second quarter increased to
$213.7 million at June 30, 1999, compared to $165.8 million at June 30, 1998, a
growth of $47.9 million, or 28.9%, while the average yield on interest earning
assets decreased to 8.51%, compared with 8.69% in second quarter of the prior
year. The slight decrease in yield on interest earning assets was caused by a
decline in yields on loans. The average yield on loans decreased to 9.15% for
the quarter ended June 30, 1999 from 9.91% for the quarter ended June 30, 1998.
The average cost of interest bearing liabilities also decreased slightly in the
second quarter of 1999 to 3.85% from 3.88% for the quarter ended June 30, 1998.
Average interest bearing liabilities for the quarter increased to $165.1 million
at June 30, 1999 compared to $145.2 million at June 30, 1998, a growth of $19.9
million, or 13.7%. The overall result of these changes was a decrease in the net
interest spread to 4.66% for the quarter ended June 30, 1999 from 4.81% for the
quarter ended June 30, 1998.
Average shareholders' equity increased to $29.7 million for the
quarter ended June 30, 1999 from $14.3 million in the same period for 1998, an
increase of 107.7%, which positively impacted the increase in net interest
income. Net interest margin (net interest income divided by average interest
earning assets) increased to 5.53% in the second quarter of 1999 from 5.28% in
the second quarter of 1998.
NONINTEREST INCOME AND EXPENSE
Noninterest income increased $170,000, or 34.5%, in the second quarter
of 1999, and $280,000, or 27.7%, for the first six months of 1999, compared with
the same periods in 1998.
Noninterest expense increased $640,000, or 34.6%, in the second quarter
of 1999 and $1.3 million, or 35.2%, in the first six months of 1999 compared
with the same periods in 1998, as the Company pursued its strategy of growth
through branching and product expansion. Two major components of noninterest
expense, employee compensation and occupancy, increased 30.1% and 23.1%,
respectively, for the quarter compared with the same period in 1998 and 33.4%
and 49.6%, respectively, for the first six months of 1999 compared with the same
period in 1998. These increases reflect the Company's growth on Whidbey and
Camano Islands, Port Townsend, Anacortes, Burlington, Bellingham and Sedro
Woolley in Northwestern Washington. The Company has added experienced personnel,
branches and/or loan production offices in these areas since June 30, 1998. In
addition, the Company has started a Private Banking division, increased its real
estate mortgage division personnel and products, added business cash management
services including business sweep accounts and business internet online banking,
and implemented an internet online banking system which the Company expects to
make available to its customer base in September, 1999. The efficiency ratio
(the sum of net interest income plus noninterest income less non-recurring
gains) was 70.1% for both the second quarter and first six months of 1999 and
69.0% and 68.7% for the same periods in 1998, respectively.
12
<PAGE> 15
INCOME TAXES
For the second quarter and first six months of 1999, the Company
recorded an income tax provision of $201,000 and $363,000, respectively. The
overall effective tax rate has decreased for the six months ended June 30, 1999
compared to the same period in 1998 due to the increase in interest income on
tax-exempt investment securities.
LENDING ACTIVITIES
The Company originates a wide variety of loans including commercial,
real estate and consumer loans. The following table sets forth at the dates
indicated the Company's loan portfolio composition by type of loan:
<TABLE>
<CAPTION>
(amounts in thousands) June 30, December 31, % of
1999 % of Total 1998 Total
--------- ---------- ----------- -----
<S> <C> <C> <C> <C>
Commercial $ 97,433 52.8% $ 65,564 43.8%
Real estate mortgages:
One to four family residential 13,303 7.2% 17,052 11.4%
5 or more family residential
and commercial 11,833 6.4% 12,146 8.1%
--------- --------- --------- ---------
Total real estate mortgages 25,136 13.6% 29,198 19.5%
Real estate construction 11,523 6.2% 14,139 9.5%
Consumer 50,457 27.4% 40,750 27.2%
--------- --------- --------- ---------
Subtotal 184,549 100.0% 149,651 100.0%
========= =========
Less: allowance for loan losses (2,020) (1,745)
Less: deferred loan fees and other (57) (34)
--------- ---------
Total loans, net $ 182,472 $ 147,872
========= =========
</TABLE>
Total loans, net, increased to $182.5 million at June 30, 1999,
representing a 23.4% increase from year-end 1998. Total commercial and consumer
loans increased 48.6%, and 23.8%, respectively, at June 30, 1999 from year-end
1998. Total real estate mortgage and construction loans decreased 13.9% and
18.5% for the same period. These changes reflect continuing commercial loan
growth, seasonal trends, the Company's geographical expansion and increased
average loan size.
13
<PAGE> 16
NONPERFORMING ASSETS
The following table sets forth at the dates indicated an analysis of the
composition of the Company's nonperforming assets:
<TABLE>
<CAPTION>
(amounts in thousands) June 30, 1999 December 31, 1998
------------- -----------------
<S> <C> <C>
Nonaccrual loans $ 923 $ 639
Restructured loans -- 208
------ ------
Total nonperforming loans 923 847
Real estate owned 145 --
------ ------
Total nonperforming assets 1,068 847
Accruing loans past due (equal to or greater
than) 90 days 95 32
Potential problem loans -- 215
Allowance for loan losses 2,020 1,745
Nonperforming loans to loans .50% 0.57%
Allowance for loan losses to loans 1.09% 1.17%
Allowance for loan losses to nonperforming
loans 218.85% 206.02%
Nonperforming assets to total assets 0.43% 0.38%
</TABLE>
Nonperforming loans increased to $923,000, or .50% of total loans, at
June 30, 1999 from $847,000 at December 31, 1998.
Real estate owned increased $145,000 at June 30, 1999 from $0 at
December 31, 1998.
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The Company recorded a $255,000 provision for loan losses for the second
quarter of 1999, compared with $150,000 for the same period a year ago. There
were $61,000 in net loan charge-offs during the second quarter of 1999, compared
to $113,000 in net charge-offs for the same period in 1998.
The allowance for loan losses increased to $2.0 million at June 30, 1999
from $1.7 million at December 31, 1998, or 1.09% of total outstanding loans and
218.85% of nonperforming loans at the end of the second quarter 1999 as compared
to 1.17% of total loans and 206.02% of nonperforming loans at December 31, 1998.
For the six months ended June 30, 1999, the provision for loan losses
was $510,000 compared to $345,000 for the same period in 1998. Net charge-offs
for the first six months of 1999 totaled $235,000 compared to $115,000 for the
same period of 1998.
The allowance for loan losses is maintained at a level considered by
management to be adequate to provide for possible loan losses based on
management's assessment of various factors affecting the loan portfolio. These
factors include assessing the quality of the loan portfolio, a reviewing of
problem loans, business conditions and loss experience, and evaluating the
underlying collateral.
14
<PAGE> 17
The following table sets forth at the dates indicated the changes in the
Company's allowance for loan losses:
<TABLE>
<CAPTION>
(amounts in thousands)
For the three month For the three month
period ended period ended
June 30, 1999 June 30, 1998
------------------- ---------------------
<S> <C> <C>
Balance at beginning of period $ 1,826 $ 1,489
Charge offs:
Commercial -- (52)
Real estate (6) --
Consumer (60) (64)
------- -------
Total charge offs (66) (116)
Recoveries:
Commercial -- --
Real estate -- --
Consumer 5 3
------- -------
Total recoveries 5 3
Net charge-offs (61) (113)
Provision for loan losses 255 150
------- -------
Balance at end of period $ 2,020 $ 1,526
======= =======
</TABLE>
<TABLE>
<CAPTION>
(amounts in thousands)
For the six month For the six month
period ended period ended
June 30, 1999 June 30,1998
-------------------- ------------------
<S> <C> <C>
Balance at beginning of period $ 1,745 $ 1,296
Charge offs:
Commercial (117) (52)
Real estate (6) --
Consumer (126) (82)
------- -------
Total charge offs (249) (134)
Recoveries:
Commercial 7 1
Real estate -- --
Consumer 7 18
------- -------
Total recoveries 14 19
Net charge-offs (235) (115)
Provision for loan losses 510 345
------- -------
Balance at end of period $ 2,020 $ 1,526
======= =======
</TABLE>
15
<PAGE> 18
LIQUIDITY AND SOURCES OF FUNDS
The Company's sources of funds are customer deposits, cash and demand
balances due from other banks, federal funds sold, short-term investments and
investment securities available-for-sale. These funds, together with loan
repayments, are used to make loans and to fund continuing operations. In
addition, at June 30, 1999, the Company has unused lines of credit with the
Federal Home Loan Bank of Seattle (FHLB) of $36.4 million and lines of credit
with financial institutions in the amount of $12.0 million, with $5.0 and $1.2
million in advances from the Federal Home Loan Bank of Seattle (FHLB) and
financial institutions, respectively, on these lines of credit as of June 30,
1999.
Total deposits increased 20.7% to $209.8 million at June 30, 1999 from
$173.8 million at June 30, 1998. The Company, by policy, has not accepted
brokered deposits. It has made a concerted effort to attract deposits in the
market area it serves through competitive pricing and delivery of quality
service. In addition, the Company has been able to retain a significant amount
of its deposits as they mature.
Management anticipates that the Company will rely primarily upon
customer deposits, loan repayments and current earnings to provide liquidity,
and will use such funds primarily to make loans and to purchase securities,
primarily issued by the federal government and state and local governments. In
addition, the Company may use Federal Home Loan Bank advances to supplement
funding sources.
CAPITAL
The Company's shareholders' equity was $29.4 million at June 30, 1999
compared to $29.7 million at December 31, 1998, a decrease of 1.0%. On April 29,
1999 the Company's Board of Directors approved the repurchase of up to
approximately 5% or 210,000 shares of outstanding company stock. The Board
deemed this action prudent given the company's strong equity ratios and market
conditions. For the first six months ended June 30, 1999, approximately 92,000
shares have been repurchased for $995,000. Management anticipates continued
repurchases of company stock as it deems appropriate up to the approximate 5%
level previously approved. The company also paid cash dividends of $336,000
during the first six months ended June 30, 1999. These actions, along with
$110,000 in unrealized losses were the primary reasons for the Company's
decreased shareholders' equity at June 30, 1999. Total assets increased to
$246.3 million at June 30, 1999 from $220.5 million at December 31, 1998, an
increase of 11.7%. The result of these changes was a shareholders' equity to
total assets of 11.9% at June 30, 1999 compared to 13.5% at December 31, 1998.
Banking regulations require bank holding companies and banks to maintain
a minimum "leverage" ratio of core capital to adjusted average total assets of
at least 3%. At June 30, 1999, the Company's leverage ratio was 11.17%, compared
with 11.67% at December 31, 1998. In addition, banking regulators have adopted
risk-based capital guidelines, under which risk percentages are assigned to
various categories of assets and off-balance sheet items to calculate a
risk-adjusted capital ratio. Tier I capital generally consists of common
shareholders' equity (which does not include unrealized gains and losses on
16
<PAGE> 19
securities), less goodwill and certain identifiable intangible assets, while
Tier II capital includes the allowance for loan losses and subordinated debt
both subject to certain limitations. Regulatory minimum risk-based capital
guidelines require Tier I capital of 4% of risk-adjusted assets and total
capital (combined Tier I and Tier II) of 8%. The Company's Tier I and total
capital ratios were 13.04% and 14.06%, respectively, at June 30,1999, compared
with 14.93% and 15.99%, respectively, at December 31, 1998.
The Federal Deposit Insurance Corporation (the "FDIC") established
the qualifications necessary to be classified as a "well-capitalized" bank,
primarily for assignment of FDIC insurance premium rates. To qualify as
"well-capitalized," banks must have a Tier I risk-adjusted capital ratio of at
least 6%, a total risk-adjusted capital ratio of at least 10%, and a leverage
ratio of at least 5%. Whidbey Island Bank qualified as "well-capitalized" at
June 30, 1999.
IMPACT OF THE YEAR 2000 ISSUE (Y2K)
The Company, like all financial institutions, is faced with the
challenges that the year 2000 brings. The Year 2000 issue relates to the
inability of many computer systems to recognize dates for the year 2000 and
beyond. Computers programmed with a two-digit field for identifying the year
interpret "99", as "1999", but may interpret "00" as "1900" rather than "2000",
resulting in incorrect calculations in date sensitive programs. The failure of
any of these systems to recognize the Year 2000 could have a material effect on
the Company's business, results of operations and financial condition. In order
to meet these challenges, the Company is going through a multi-phase program to
assure a state of readiness for Year 2000.
The Company's State of Readiness
Awareness Phase
The Company began the awareness phase of its Year 2000 program in early
1997. The Board of Directors formed a readiness team in consultation with
senior management. This team has the responsibility for identifying all
systems, application software and supporting equipment for information and
non-information technology that might have an impact on the Company from a
Year 2000 perspective. The Company has also developed a customer awareness
program that provides information on its Y2K readiness efforts. This program
includes training staff to address customer concerns about Y2K issues.
Communications have been promoted through public meetings, mailing
informational brochures and the Company's Year 2000 Readiness Disclosure
statements.
Assessment Phase
This phase involves the process of identifying and prioritizing providers
and vendors using a "business critical" methodology. The readiness team
began the assessment phase of the program early in 1997. The team completed
its assessment of all the Company's computer systems, hardware, software,
networks, telecommunications, ATMs, and property and equipment that could
potentially be impacted by the Year 2000. The Company continues to assess
and monitor, on an ongoing basis, systems, software and equipment as the
Company makes purchases or changes in these areas to assure Year 2000
readiness.
17
<PAGE> 20
The Company does not have in-house programs and relies upon third party
vendors to provide software applications used. The team contacted the
Company's service providers and software/hardware vendors identified through
the awareness phase to determine their approach to the Year 2000 issue and
to receive commitment dates for the delivery of their readiness plans and/or
compliant releases of software packages. In addition, the Company analyzed
the extent that Year 2000 issues could adversely impact its borrowers'
business operations, particularly its large commercial borrowers.
The Company performed an initial assessment of each major borrower and
established an ongoing assessment as part of the Company's credit granting
and loan review process. Tracking and monitoring the progress of these
providers, vendors and high-balance customers is coordinated by the team and
regularly reported to the Company's Board of Directors. On a quarterly basis
these customers are reviewed and classified as having low, medium or high
Year 2000 risk. This analysis is then incorporated into the Bank's quarterly
loan loss reserve analysis and reported to the Board of Directors. As of
June 30, 1999, the Company has no evidence of potential Y2K loss as related
to its borrowing customers.
Renovation Phase
This phase involves upgrading and replacing mission-critical systems where
appropriate. As of March 31, 1999, renovation had been completed for all
systems, software and hardware that have been deemed "business critical."
The Company's renovation of non "business critical" systems is ongoing.
Validation and Testing Phase
This phase involves verifying and validating that systems and equipment will
operate correctly and that calculations regarding dates will be accurate
even if the dates occur during or after the year 2000. The validation and
testing phase of the program to date has emphasized the Company's most
critical third party vendors - those that provide the mainframe software and
hardware. These vendors have assured the Company that they have successfully
completed their Year 2000 internal testing. The Company has chosen to test
the software and hardware via group testing. Software and hardware from
other third party providers were tested internally or externally with
oversight by members of the team. Internal testing included creation of a
test environment specifically dedicated to Year 2000 testing. This
environment allowed simulation of the Year 2000 change in each of our
critical systems by rolling dates forward to validate vendor testing prior
to the actual Year 2000 date change. External testing strategies were
determined by the type of interfaces with providers. The Company had an
independent, external audit performed in late 1998 to evaluate the testing
and overall readiness on Year 2000. An additional independent review of the
Company's test results and contingency planning was completed in May, 1999.
No significant findings were noted in either review.
Implementation Phase
The implementation phase is ongoing and incorporates the development of
contingency plans for ongoing business operations. The Company is preparing
contingency plans to minimize disruption to its operations due to Year 2000
issues. The plans prescribe alternative processes to mitigate potential
problems should critical systems fail despite the
18
<PAGE> 21
Company's extensive preparations. Such processes will be augmented by the
Company's existing disaster recovery plan, which enables it to function
under unusual circumstances. In addition, the Plan includes management's
preparations to accommodate the liquidity and cash needs of the Company
during the fourth quarter of 1999.
Contingency plans are complete and testing is in process as of June 30,
1999. Although the Company has taken precautions to assure its technology is
Year 2000 ready, it will continue to address possible emergency scenarios.
Review and validation of these plans will continue through the remainder of
1999. The Company has determined to further mitigate potential business
disruption resulting from possible power interruptions by installing
generators in its hub branches during the second and third quarters of 1999.
The Costs to Address the Company's Year 2000 Issues
The Company has expended approximately $109,000 in addressing the Year
2000 issue. The majority of these costs have been spent on managing the Year
2000 project and educating employees and customers of the Company. Remaining
estimated costs for completion of the Year 2000 readiness project are
estimated at approximately $84,800. Costs related to renovating and testing
will be expensed in the period incurred. Costs related to addressing Year
2000 issues are not anticipated to be material.
The Risks of the Company's Year 2000 Issues
The Company purchases systems, equipment and data processing services
from vendors and suppliers. It also depends on many other vendors for
various services needed for day-to-day operations. Although the Company can
and will prepare its operations for the century change, there can be no
assurance that forces beyond its control will not impact its operations. The
Company's customers could also be impacted adversely by the century change
and thereby impact the financial performance of the Company. In spite of the
Company's diligent efforts in confirming its outside suppliers, vendors and
customers are Year 2000 ready, there can be no assurance that when the
century changes, certain systems, technology and equipment of the Company,
its vendors and its customers will not be impacted and consequently impact
the operations of the Company.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
A number of measures are used to monitor and manage interest rate risk,
including income simulations and interest sensitivity (gap) analysis. An income
simulation model is the primary tool used to assess the direction and magnitude
of changes in net interest income resulting from changes in interest rates. Key
assumptions in the model include prepayment speeds on mortgage related assets,
cash flows and maturities of other investment securities, loan and deposit
volumes and pricing. These assumptions are inherently uncertain and, as a
result, the model cannot precisely estimate net interest income or precisely
predict the impact of higher or lower interest rates on net interest income.
Actual results will differ from simulated results due to timing, magnitude and
frequency of interest rate changes, changes in market conditions and management
strategies, among other factors. At June 30, 1999, based on the measures used to
monitor and manage interest rate risk, there has not been a material
19
<PAGE> 22
change in the Company's interest rate risk since December 31, 1998. For
additional information, refer to the Company's Form 10-K for year ended December
31, 1998.
PART II
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of shareholders was held at Oak Harbor, Washington
on April 29, 1999 at 3:00 p.m. 3,334,954 shares of common stock were represented
in person or by proxy at the meeting. This represented 79.4% of the 4,200,300
shares held by shareholders as of March 10, 1999 and entitled to vote at the
meeting. The following issue came before the shareholders for vote:
Election of directors to serve on the Board of Directors until the
Annual meeting of shareholders in the year 2002, or until their successors are
duly elected and qualified - three of the ten director positions had expired and
were open for election. The nominees for these positions were Jay T. Lien, Alvin
J. Sherman and Edward J. (Bud) Wallgren. All these were elected with the
following vote totals:
<TABLE>
<CAPTION>
FOR AGAINST ABSTAIN
--- ------- -------
<S> <C> <C> <C>
Jay T. Lien 3,312,955 0 21,999
Alvin J. Sherman 3,312,955 0 21,999
Edward J. (Bud) Wallgren 3,312,705 0 22,249
</TABLE>
The other seven directors who continue in office are: Michal D. Cann,
Orlan D. Dean, Marlen L. Knutson, Karl C. Krieg III, Robert B. Olson, Anthony B.
Pickering and Larry Scodeller.
With much sadness, the Company announced on July 16, 1999 that Chief
Operating Officer and director, Larry Scodeller, passed away July 2, 1999.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 27 - Financial Data Schedule
(b) A Form 8-K was filed on April 30, 1999 announcing the Company's stock
repurchase plan.
20
<PAGE> 23
SIGNATURES
Pursuant to the requirements 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.
WASHINGTON BANKING COMPANY
Date August 10, 1999 By /s/ Michal D. Cann
--------------------------------------
Michal D. Cann
President and Chief Executive Officer
Date August 10, 1999 By /s/ Phyllis A. Hawkins
--------------------------------------
Phyllis A. Hawkins
Senior Vice President and
Chief Financial Officer
21
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> MAR-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 11,533
<INT-BEARING-DEPOSITS> 3,677
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 763
<INVESTMENTS-HELD-FOR-SALE> 10,451
<INVESTMENTS-CARRYING> 24,992
<INVESTMENTS-MARKET> 24,920
<LOANS> 184,492
<ALLOWANCE> 2,020
<TOTAL-ASSETS> 246,273
<DEPOSITS> 209,791
<SHORT-TERM> 6,200
<LIABILITIES-OTHER> 889
<LONG-TERM> 0
0
0
<COMMON> 16,875
<OTHER-SE> 12,518
<TOTAL-LIABILITIES-AND-EQUITY> 246,273
<INTEREST-LOAN> 3,926
<INTEREST-INVEST> 484
<INTEREST-OTHER> 68
<INTEREST-TOTAL> 4,478
<INTEREST-DEPOSIT> 1,588
<INTEREST-EXPENSE> 1,588
<INTEREST-INCOME-NET> 2,890
<LOAN-LOSSES> 255
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 2,491
<INCOME-PRETAX> 807
<INCOME-PRE-EXTRAORDINARY> 606
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 606
<EPS-BASIC> 0.15
<EPS-DILUTED> 0.14
<YIELD-ACTUAL> 1.30
<LOANS-NON> 923
<LOANS-PAST> 95
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,826
<CHARGE-OFFS> 66
<RECOVERIES> 5
<ALLOWANCE-CLOSE> 2,020
<ALLOWANCE-DOMESTIC> 1,616
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 404
</TABLE>
