<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 March 31, 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 April
30, 1999 was 4,200,300.
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TABLE OF CONTENTS
PART I -- FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page
<S> <C> <C>
Item 1. Financial statements
Condensed Statements of Financial Condition - March 31, 1999
and December 31, 1998 1
Condensed Statements of Income - three months
ended March 31, 1999 and 1998 2
Condensed Statements of Shareholders' Equity -
three months ended March 31, 1999 3
Condensed Statements of Cash Flows -
three months ended March 31, 1999 and 1998 4
Notes to Condensed Consolidated financial statements 5
Item 2. Management Discussion and Analysis of Financial Condition
and Results of Operations 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk 15
PART II -- OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 16
Signatures 17
</TABLE>
i
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PART I
ITEM 1. FINANCIAL STATEMENTS
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Condensed Consolidated Statements of Financial Condition
March 31, 1999 and December 31, 1998
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
ASSETS 1999 1998
--------- ------------
(UNAUDITED)
<S> <C> <C>
Cash and due from banks $ 13,508 12,063
Interest bearing deposits 4,886 8,089
Federal funds sold 500 4,100
-------- -------
Total cash and cash equivalents 18,894 24,252
-------- -------
Federal Home Loan Bank stock 750 736
Investment securities, available for sale 11,049 12,591
Investment securities, held to maturity 25,367 24,875
-------- -------
Total investment securities 37,166 38,202
-------- -------
Loans receivable, net 161,405 147,872
Premises and equipment, net 9,303 8,046
Other real estate owned 145 --
Deferred tax asset 444 419
Other assets 2,128 1,702
-------- -------
Total assets $229,485 220,493
======== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits $198,451 189,698
Other liabilities 1,021 1,104
-------- -------
Total liabilities 199,472 190,802
-------- -------
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 4,200,300 and 4,189,050 shares at March 31,
1999 and December 31, 1998, respectively 17,870 17,836
Retained earnings 12,140 11,805
Accumulated other comprehensive income, net 3 50
-------- -------
Total shareholders' equity 30,013 29,691
-------- -------
Total liabilities and shareholders' equity $229,485 220,493
======== =======
</TABLE>
See accompanying notes to condensed consolidated financial statements.
1
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WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Condensed Consolidated Statements of Income
Three months ended March 31, 1999 and 1998
(unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
1999 1998
---------- ---------
<S> <C> <C>
Interest income:
Interest and fees on loans $ 3,528 2,924
Interest on taxable investment securities 295 261
Interest on tax-exempt investment securities 197 136
Other 102 45
---------- ---------
Total interest income 4,122 3,366
Interest expense 1,446 1,315
---------- ---------
Net interest income 2,676 2,051
Provision for loan losses 255 195
---------- ---------
Net interest income after provision
for loan losses 2,421 1,856
---------- ---------
Noninterest income:
Service charges on deposits 350 312
Other 278 206
---------- ---------
Total noninterest income 628 518
---------- ---------
Noninterest expense:
Salaries and benefits 1,306 953
Occupancy expense 486 258
Office supplies and printing 82 65
Data processing 72 63
Consulting and professional fees 20 45
Other 418 370
---------- ---------
Total noninterest expense 2,384 1,754
---------- ---------
Income before income taxes 665 620
Provision for income taxes 162 204
---------- ---------
Net income $ 503 416
========== =========
Net income per share, basic $ 0.12 0.15
========== =========
Net income per share, diluted $ 0.11 0.14
========== =========
Average number of shares outstanding, basic 4,195,300 2,809,050
Average number of shares outstanding, diluted 4,441,880 2,961,557
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
<PAGE> 5
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Condensed Consolidated Statements of Shareholders' Equity
Three months ended March 31, 1999
(Amounts in thousands)
<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, $0.04 per share (unadudited) (168) (168)
Net income for the three months ended
March 31, 1999 (unaudited) -- -- 503 -- 503
Net change in unrealized gains/losses
for the three months ended March 31,
1999 on securities available for sale (unaudited) -- -- -- (47) (47)
Stock options exercised (unaudited) 11 34 -- -- 34
------ -------- ------ --- -------
Balances at March 31, 1999 4,200 $ 17,870 12,140 3 30,013
====== ======== ====== === =======
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE> 6
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows
Three months ended March 31, 1999 and 1998
(unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
1999 1998
-------- -------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 503 416
Adjustments to reconcile net income to net cash
provided by operating activities:
Federal Home Loan Bank stock dividends (14) (13)
Amortization(accretion) of investment premiums(discounts), net 17 (3)
Provision for loan losses 255 195
Depreciation of premises and equipment 118 92
Net increase in other assets (426) (252)
Net (decrease) increase in other liabilities (83) 380
-------- -------
Net cash provided by operating activities 370 815
-------- -------
Cash flows from investing activities:
Purchases of investment securities, available for sale (1,033) (1,000)
Maturities of investment securities, available for sale 2,500 500
Purchases of investment securities, held to maturity (1,151) (775)
Maturities of investment securities, held to maturity 645 1,500
Net increase in loans (13,933) (5,845)
Purchases of premises and equipment (1,375) (1,351)
-------- -------
Net cash used in investing activities (14,347) (6,971)
-------- -------
Cash flows from financing activities:
Net increase in deposits 8,753 9,983
Dividends paid on common stock (168) --
Proceeds from stock options exercised 34 --
-------
Net cash provided by financing activities 8,619 9,983
-------- -------
Net increase (decrease) in cash and cash equivalents (5,358) 3,827
Cash and cash equivalents at beginning of period 24,252 8,013
-------- -------
Cash and cash equivalents at end of period $ 18,894 11,840
======== =======
Supplemental information:
Loans foreclosed and transferred to real estate owned $ 145 85
Cash paid for interest 1,473 1,319
Cash paid for taxes 200 200
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE> 7
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements
Three months ended March 31, 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 consolidated interim financial
statements have been prepared, without audit, pursuant to generally
accepted accounting principles and instructions to Form 10-Q for interim
financials. 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 recent 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 months ended March 31,
1999 are not necessarily indicative of the results that may be expected
for the year ended 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 2000 and requires all
derivatives to be recorded on the balance sheet at fair value and
establishes accounting standards for different types of hedging
activities,
5
<PAGE> 8
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.
(2) EARNINGS PER SHARE
The following illustrates the reconciliation of the numerators and
denominators of the basic and diluted EPS computations:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, 1999
--------------------------------------
WEIGHTED PER SHARE
INCOME AVERAGE SHARES AMOUNT
------ -------------- ------
<S> <C> <C> <C>
BASIC EPS
Income available to common
shareholders 503 4,195,300 0.12
Effect of dilutive
securities; stock options 246,580 --
--- --------- ----
DILUTED EPS 503 4,441,880 0.11
=== ========= ====
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, 1998
--------------------------------------
WEIGHTED PER SHARE
INCOME AVERAGE SHARES AMOUNT
------ -------------- ------
<S> <C> <C> <C>
BASIC EPS
Income available to common
shareholders 416 2,809,050 0.15
Effect of dilutive
securities; stock options -- 152,507 --
--- --------- ----
DILUTED EPS 416 2,961,557 0.14
=== ========= ====
</TABLE>
At March 31, 1999 there were options to purchase 123,950 shares of common
stock outstanding which were antidilutive and therefore not included in
the computation of diluted net income per share. There were no
antidilutive securities outstanding for the first quarter ended March 31,
1998.
6
<PAGE> 9
(3) COMPREHENSIVE INCOME
Comprehensive income for the three months ended March 31, 1999 and 1998
was $456 and $411, respectively. Total comprehensive income for the three
months ended March 31, 1999 and 1998 consisted of net income and the
change in the unrealized gain on investments.
(4) SUBSEQUENT EVENT
On April 29, 1999, the Board of Directors declared a cash dividend of
$0.04 per share and approved a stock repurchase plan, which allows the
Company to repurchase up to 210,000 shares of the Company's common stock.
7
<PAGE> 10
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.
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. Currently, 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 fourteen banking 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 on the Islands. 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 loan
production 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.
FINANCIAL CONDITION
Total assets increased to $229.5 million at March 31, 1999 from $220.5
million at December 31, 1998, an increase of 4.1%. Net loans totaled $161.4
million at March 31, 1999, an increase of 9.2% from December 31, 1998. Deposits
were $198.5 million at March 31, 1999, an increase of 4.6% from December 31,
1998.
8
<PAGE> 11
The Company's allowance for loan losses at March 31, 1999 was $1.8
million, or 1.12% 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
March 31, 1999, or 0.48% 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 first quarter of 1999 was $503,000, or $0.11 per
diluted share, compared to $416,000, or $0.14 per diluted share, for the first
quarter of 1998, an increase in net income of 20.9%. The increase in net income
was primarily due to increased net interest income resulting from continued loan
growth and noninterest income, partially offset by increased expenses due
principally to expansion.
NET INTEREST INCOME
Net interest income for the first quarter of 1999 increased to $2.7
million, or 30.5%, from $2.1 million in the first quarter of 1998. The increase
in net interest income is largely due to the overall growth of the Company.
Average interest earning assets increased to $198.0 million at March 31,
1999, compared to $151.6 million at March 31, 1998, a growth of $46.4 million,
or 30.6%, while the average yield on interest earning assets decreased to 8.46%,
compared with 9.00% in first quarter of the prior year. The decrease in yield on
interest earning assets was caused by a decline in yields on both loans and
nontaxable investments. The average yield on loans decreased to 9.26% for the
first quarter ended March 31, 1999 from 9.81% for the first quarter ended March
31, 1998. Average yields on non-taxable investments decreased to 6.30% for the
first quarter ended March 31, 1999 from 6.74% for the first quarter ended March
31, 1998.
The average yield on interest bearing liabilities also decreased in the
first quarter of 1999 to 3.67% from 4.15% for the first quarter ended March 31,
1998 as rates on all deposit types decreased from first quarter of the prior
year. Average interest bearing liabilities increased to $157.4 million at March
31, 1999 compared to $126.7 million at March 31, 1998, a growth of $30.7
million, or 24.2%. The overall result of these changes was a decrease in the net
interest spread to 4.79% for the first quarter ended March 31, 1999 from 4.85%
for the first quarter ended March 31, 1998 and a stable net interest margin of
5.54% and 5.53%, respectively, for the first quarters ended March 31, 1999 and
1998.
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NONINTEREST INCOME AND EXPENSE
Noninterest income increased $110,000, or 21.2%, in the first quarter of
1999 compared with the same period in 1998. Increases were primarily through
service charges on deposits and other fees including fees on secondary market
real estate loans.
Noninterest expense increased $630,000, or 35.9%, in the first quarter
of 1999 compared with the same period 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 37.0% and
88.4%, respectively, for the quarter 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. Total noninterest expense was 72.2% and 68.28% of total revenues
(the sum of net interest income plus noninterest income less non-recurring
gains) for the first quarter of 1999 and 1998, respectively.
INCOME TAXES
For the first quarter of 1999, the Company recorded an income tax
provision of $162,000. The overall effective tax rate has decreased in 1999 as
compared to 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
business, 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) March 31, December 31,
1999 % of Total 1998 % of Total
---- ---------- ---- ----------
<S> <C> <C> <C> <C>
Commercial $ 80,271 49.1% $ 65,564 43.8%
Real estate mortgages:
One to four family residential 17,968 11.0% 17,052 11.4%
5 or more family residential
and commercial 12,219 7.5% 12,146 8.1%
-------- ----- -------- -----
Total real estate mortgages 30,187 18.5% 29,198 19.5%
Real estate construction 11,372 7.0% 14,139 9.5%
Consumer 41,433 25.4% 40,750 27.2%
-------- ----- -------- -----
Subtotal 163,263 100.0% 149,651 100.0%
===== =====
Less: allowance for loan losses (1,826) (1,745)
Less: deferred loan fees and other (32) (34)
-------- --------
Total loans, net $161,405 $147,872
======== ========
</TABLE>
Total loans, net increased to $161.4 million at March 31, 1999,
representing a 9.2% increase from year-end 1998. Commercial, total real estate
mortgages and consumer loans
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<PAGE> 13
increased 22.4%, 3.4% and 1.7%, respectively, at March 31, 1999 from year end
1998. Real estate construction loans decreased 19.6% for the same period. These
changes reflect continuing commercial loan growth and some seasonal slowdown in
real estate and consumer loans.
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) March 31, 1999 December 31, 1998
-------------- -----------------
<S> <C> <C>
Nonaccrual loans $ 954 $ 639
Restructured loans -- 208
------ ------
Total nonperforming loans 954 847
Real estate owned 145 --
------ ------
Total nonperforming assets 1,099 847
Accruing loans past due => 90 days 47 32
Potential problem loans 68 215
Allowance for loan losses 1,826 1,745
Nonperforming loans to loans 0.59% 0.57%
Allowance for loan losses to loans 1.12% 1.17%
Allowance for loan losses to nonperforming loans 191.40% 206.02%
Nonperforming assets to total assets 0.48% 0.38%
</TABLE>
Nonperforming loans increased to $954,000, or 0.59% of total loans, at
March 31,1999 from $847,000 at December 31,1998.
Real estate owned increased $145,000 at March 31, 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 first
quarter of 1999, compared with $195,000 for the same period a year ago. There
were $174,000 in net loan charge-offs during the first quarter of 1999, compared
to $2,000 in net charge-offs for the same period in 1998.
The allowance for loan losses increased to $1.8 million at March 31,
1999 from $1.7 million at December 31, 1998, or 1.12% of total outstanding loans
and 191.4% of nonperforming loans at the end of the first quarter 1999 as
compared to 1.17% of total loans and 206.02% of nonperforming loans at December
31, 1998.
The allowance for loan losses is maintained at a level considered by
management to be adequate to provide for anticipated loan losses based on
management's assessment of various factors affecting the loan portfolio. These
factors include assessing the quality of the loan
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<PAGE> 14
portfolio, reviewing problem loans, business conditions and loss experience, and
evaluating underlying collateral.
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
March 31, 1999 March 31, 1998
------------------- -------------------
<S> <C> <C>
Balance at beginning of period $ 1,745 $ 1,296
Charge offs:
Commercial (117) --
Real estate -- --
Consumer (66) (18)
------- -------
Total charge offs (183) (18)
Recoveries:
Commercial 7 1
Real estate -- --
Consumer 2 15
------- -------
Total recoveries 9 16
------- -------
Net charge-offs (174) (2)
Provision for loan losses 255 195
------- -------
Balance at end of period $ 1,826 $ 1,489
======= =======
</TABLE>
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 March 31, 1999, the Company had unused lines of credit with the
Federal Home Loan Bank of Seattle (FHLB) of $33.7 million and unused lines of
credit with financial institutions in the amount of $12.0 million, with no
advances on these lines of credit as of March 31, 1999.
Total deposits increased 4.6% to $198.5 million at March 31, 1999 from
$189.7 million at March 31, 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.
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<PAGE> 15
CAPITAL
The Company's shareholders' equity increased to $30.0 million at March
31, 1999 from $29.7 million at December 31, 1998. At March 31, 1999,
shareholders' equity was 13.1% of total assets compared to 13.5% of total assets
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 March 31,1999, the Company's leverage ratio was 11.76%, 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
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 14.12% and 15.15%, respectively, at March 31,1999, 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
March 31,1999.
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
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 lending officers and other staff to address customer concerns about Y2K
issues. Communications have
13
<PAGE> 16
been promoted through public meetings, mailing informational brochures and the
Company's Year 2000 Readiness Disclosure statement.
The readiness team began the assessment phase of the program early in
1997. The team completed its assessment of all of 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.
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 borrower's 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. The loan loss reserve
was increased by $137,000 at March 31, 1999, based upon the Company's evaluation
of the Year 2000 readiness of its major borrowers.
The renovation phase of the program involves prioritizing providers and
vendors using a "business critical" methodology. As of March 31, 1999,
renovation has 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.
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. No significant findings were noted. An additional independent review of
the Company's test results is expected to be completed by June 30, 1999.
14
<PAGE> 17
The Costs to Address the Company's Year 2000 Issues
The Company has expended approximately $90,000 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 $128,800. 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 assuring 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.
The Company's Contingency Plans
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 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 expected to be substantially completed with
testing in process by 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.
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
15
<PAGE> 18
timing, magnitude and frequency of interest rate changes, changes in market
conditions and management strategies, among other factors. At March 31, 1999,
based on the measures used to monitor and manage interest rate risk, there has
not been a material 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 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 27 - Financial Data Schedule
(b) No reports on Form 8-K were filed during the quarter ended March 31,
1999.
16
<PAGE> 19
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 May 14, 1999 By /s/ Michal D. Cann
------------------------------------
Michal D. Cann
President and Chief
Executive Officer
Date May 14, 1999 By /s/ Phyllis A. Hawkins
------------------------------------
Phyllis A. Hawkins
Senior Vice President and
Chief Financial Officer
17
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