<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 September 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
October 31, 1999 was 4,106,785.
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I -- FINANCIAL INFORMATION
Page
<S> <C>
Item 1. Financial Statements
Condensed Consolidated Statements of Financial Condition - September 30, 1999
and December 31, 1998 1
Condensed Consolidated Statements of Income - Three and Nine months
ended September 30, 1999 and 1998 2
Condensed Consolidated Statements of Shareholders' Equity-
Nine months ended September 30, 1999 3
Condensed Consolidated Statements of Cash Flows -
Nine months ended September 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 6. Exhibits and Reports on Form 8-K 20
Signatures 20
</TABLE>
<PAGE> 3
PART I
Item 1. Financial Statements
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Condensed Consolidated Statements of Financial Condition
September 30, 1999 and December 31, 1998
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
September 30, December 31,
Assets 1999 1998
------------- -------------
(unaudited)
<S> <C> <C>
Cash and due from banks $ 10,163 12,063
Interest bearing deposits 3,492 8,089
Federal funds sold -- 4,100
------------- -------------
Total cash and cash equivalents 13,655 24,252
Federal Home Loan Bank stock 777 736
Investment securities, available-for-sale 10,421 12,591
Investment securities, held-to-maturity 24,481 24,875
------------- -------------
Total investment securities 35,679 38,202
Loans receivable, net 201,081 147,872
Premises and equipment, net 11,009 8,046
Other real estate owned -- --
Deferred tax asset 485 419
Other assets 2,231 1,702
------------- -------------
Total assets $ 264,140 220,493
============= =============
Liabilities and Shareholders' Equity
Liabilities:
Deposits $ 228,163 189,698
Federal funds borrowed 5,000 --
Other liabilities 1,258 1,104
------------- -------------
Total liabilities 234,421 190,802
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 4,106,785 and 4,189,050 shares at September 30,
1999 and December 31, 1998, respectively 16,839 17,836
Retained earnings 12,958 11,805
Accumulated other comprehensive income, net (78) 50
------------- -------------
Total shareholders' equity 29,719 29,691
------------- -------------
Total liabilities and shareholders' equity $ 264,140 220,493
============= =============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
1
<PAGE> 4
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Condensed Consolidated Statements of Income
Three and Nine months ended September 30, 1999 and 1998
(unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30 September 30
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Interest income:
Interest and fees on loans $ 4,439 3,354 11,892 9,429
Interest on taxable investment securities 257 286 831 816
Interest on tax-exempt investment securities 206 183 610 448
Other 69 303 237 402
--------- --------- --------- ---------
Total interest income 4,971 4,126 13,570 11,095
Interest expense 1,814 1,554 4,847 4,284
--------- --------- --------- ---------
Net interest income 3,157 2,572 8,723 6,811
Provision for loan losses 255 195 765 540
--------- --------- --------- ---------
Net interest income after provision
for loan losses 2,902 2,377 7,958 6,271
Noninterest income:
Service charges on deposits 359 283 1,053 850
Other 198 326 782 723
--------- --------- --------- ---------
Total noninterest income 557 609 1,835 1,573
Noninterest expense:
Salaries and benefits 1,421 1,186 4,046 3,116
Occupancy expense 582 402 1,526 1,033
Office supplies and printing 148 109 326 275
Data processing 79 64 230 191
Consulting and professional fees 16 37 55 98
Other 460 358 1,385 1,001
--------- --------- --------- ----------
Total noninterest expense 2,706 2,156 7,568 5,714
--------- --------- --------- ---------
Income before income taxes 753 830 2,225 2,130
Provision for income taxes 209 217 572 581
--------- --------- --------- ---------
Net income $ 544 613 1,653 1,549
========= ========= ========= =========
Net income per share, basic $ 0.13 0.15 0.40 0.47
========= ========= ========= =========
Net income per share, diluted $ 0.12 0.14 0.37 0.44
========= ========= ========= =========
Average number of shares outstanding, basic 4,108,932 4,189,050 4,161,733 3,304,828
Average number of shares outstanding, diluted 4,361,093 4,487,518 4,408,329 3,544,084
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
<PAGE> 5
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Condensed Consolidated Statements of Shareholders' Equity
Nine months ended September 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, $0.12 per share (unaudited) -- -- (500) -- (500)
Net income for the nine months ended
September 30, 1999 (unaudited) -- -- 1,653 -- 1,653
Unrealized gains/losses for the nine months
ended September 30, 1999, net of tax $40 (unaudited) -- -- -- (128) (128)
Repurchase of common stock (unaudited) (97) (1,043) -- -- (1,043)
Stock options exercised (unaudited) 15 46 -- -- 46
--------- -------- --------- --------- ---------
Balances at September 30, 1999 (unaudited) 4,107 $ 16,839 12,958 (78) 29,719
========= ========= ========= ========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE> 6
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows
Nine months ended September 30, 1999 and 1998
(unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Nine months ended
September 30
1999 1998
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,653 1,549
Adjustments to reconcile net income to net cash
provided by operating activities:
Federal Home Loan Bank stock dividends (41) (40)
Amortization (accretion) of investment premiums (discounts), net 48 (16)
Provision for loan losses 765 540
Depreciation of premises and equipment 466 297
Net increase in other assets (529) (720)
Net (decrease) / increase in other liabilities 154 341
------------- -------------
Net cash provided by operating activities 2,516 1,951
------------- -------------
Cash flows from investing activities:
Purchases of investment securities, available-for-sale (1,033) (6,000)
Maturities of investment securities, available-for-sale 3,000 1,000
Purchases of investment securities, held-to-maturity (1,790) (5,630)
Maturities of investment securities, held-to-maturity 2,145 6,107
Net increase in loans (53,974) (23,207)
Proceeds from the sale of real estate owned -- 30
Purchases of premises and equipment (3,429) (2,911)
------------- -------------
Net cash used in investing activities (55,081) (30,611)
------------- -------------
Cash flows from financing activities:
Net increase in deposits 38,465 36,120
Federal funds borrowed 5,000 --
Dividends paid on common stock (500) (335)
Proceeds from stock options exercised 46 --
Proceeds from stock issued -- 14,893
Repurchase of common stock (1,043) --
------------- -------------
Net cash provided by financing activities 41,968 50,678
------------- -------------
Net (decrease) / increase in cash and cash equival (10,597) 22,018
Cash and cash equivalents at beginning of period 24,252 8,013
------------- -------------
Cash and cash equivalents at end of period $ 13,655 30,031
============= =============
Supplemental information:
Cash paid for interest $ 4,739 4,220
Cash paid for taxes 632 645
============= =============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE> 7
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements
Nine months ended September 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 nine months ended September 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.
5
<PAGE> 8
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements
Nine months ended September 30, 1999 and 1998
(unaudited)
(Dollars in thousands, except per share data)
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
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, "Accounting for
Mortgage-Backed Securities Retained After the Securitization of Mortgage
Loans Held For Sale," (which amended SFAS 65 "Accounting for Certain
Mortgage Banking Activities"). 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
Nine months ended September 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 September 30, 1999
------------------------------------------------
Weighted Per share
Income average shares amount
-------------- -------------- --------------
<S> <C> <C> <C>
Basic EPS
Income available to common shareholders $ 544 4,108,932 0.13
Effect of dilutive securities; stock options __ 252,161 __
-------------- -------------- --------------
Diluted EPS $ 544 4,361,093 0.12
============== ============== ==============
</TABLE>
<TABLE>
<CAPTION>
Three months ended September 30, 1998
------------------------------------------------
Weighted Per share
Income average shares amount
-------------- -------------- --------------
<S> <C> <C> <C>
Basic EPS
Income available to common shareholders $ 613 4,189,050 0.15
Effect of dilutive securities; stock options __ 298,468 __
-------------- -------------- --------------
Diluted EPS $ 613 4,487,518 0.14
============== ============== ==============
</TABLE>
7
<PAGE> 10
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements
Nine months ended September 30, 1999 and 1998
(unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Nine months ended September 30, 1999
------------------------------------------------
Weighted Per share
Income average shares amount
-------------- -------------- --------------
<S> <C> <C> <C>
Basic EPS
Income available to common shareholders $ 1,653 4,161,733 0.40
Effect of dilutive securities; stock options __ 246,596 __
-------------- -------------- --------------
Diluted EPS $ 1,653 4,408,329 0.37
============== ============== ==============
</TABLE>
<TABLE>
<CAPTION>
Nine months ended September 30, 1998
------------------------------------------------
Weighted Per share
Income average shares amount
-------------- -------------- --------------
<S> <C> <C> <C>
Basic EPS
Income available to common shareholders $ 1,549 3,304,828 0.47
Effect of dilutive securities; stock options -- 239,256 --
-------------- -------------- --------------
Diluted EPS $ 1,549 3,544,084 0.44
============== ============== ==============
</TABLE>
8
<PAGE> 11
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements
Nine months ended September 30, 1999 and 1998
(unaudited)
(Dollars in thousands, except per share data)
For three and nine months ended September 30, 1999 there were options to
purchase 41,000 shares of common stock outstanding, which were
antidilutive and therefore not included in the computation of diluted net
income per share. There were 0 and 82,950 antidilutive shares outstanding
for the three and nine month periods ended September 30, 1998,
respectively.
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 September 30, 1999, the Company had
repurchased 97,265 shares of the Company's common stock.
(3) Comprehensive Income
Comprehensive income for the three and nine months ended September 30,
1999 was $526 and $1,525, respectively, and for the three and nine months
ended September 30, 1998 was $661 and $1,600, respectively. Total
comprehensive income for the three and nine months ended September 30,
1999 and 1998 consisted of net income and the change in the unrealized
gain/loss on investments.
(4) Subsequent Event
On October 27, 1999, the Board of Directors declared a cash
dividend of $0.04 per share to shareholders of record as of
November 8, 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 twelve 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 to look for expansion
opportunities in communities north of Seattle, to Vancouver, BC while
solidifying its market position in Island (Whidbey and Camano Islands), Skagit,
Whatcom and Jefferson Counties. Currently, the geographical expansion has been
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). Third quarter accomplishments included the consolidation of the Whidbey
City branch with the remaining three South Whidbey offices and the relocation of
the North Whidbey branch in Oak Harbor (Island County). Such expansion and
relocation 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. The Company has
added several experienced personnel, branches and/or loan production offices
since June 30, 1998.
10
<PAGE> 13
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
implemented an internet online banking system.
FINANCIAL CONDITION
Total assets increased to $264.1 million at September 30, 1999 from
$220.5 million at December 31, 1998, an increase of 19.8%. Net loans totaled
$201.1 million at September 30, 1999, an increase of 36.0% from December 31,
1998. Deposits were $228.2 million at September 30, 1999, an increase of 20.3%
from December 31, 1998.
The Company's shareholders' equity increased only slightly to $29.72
million at September 30, 1999 from $29.69 million at December 31, 1998. The
primary reasons for the slight increase were that the earnings were offset by
the repurchase of approximately 97,000 shares of common stock for $1,043,000 and
the payment of cash dividends of $500,000 during the first nine months of 1999.
The Company's allowance for loan losses at September 30, 1999 was $2.2
million, or 1.06% of total loans, compared to $1.7 million, or 1.17% of total
loans, at December 31, 1998. Nonperforming assets amounted to $943,000 at
September 30, 1999, or .36% 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 third quarter of 1999 decreased 11.3% to $544,000 or
$0.12 per diluted share, from $613,000, or $0.14 per diluted share, for the
third quarter of 1998. Net income for the nine months ended September 30, 1999
increased 6.7% to $1,653,000, or $0.37 per diluted share, from $1,549,000, or
$0.44 per diluted share, for the same period in 1998. There were 24.4% more
diluted average shares outstanding for the nine months ended September 30, 1999
compared to September 30, 1998 due to the Company's public offering of 1.38
million shares in June 1998. The third quarter net income decline reflects
expenses related to the Company's expansion strategy of adding branches and key
personnel. In addition, noninterest income for the third quarter 1999 declined
$52,000 from the like period a year ago primarily due to decreased mortgage loan
fees. The increase in net income for the nine month period was primarily due to
increased net interest income (resulting from continued loan growth) which more
than offset the increase in noninterest expense.
11
<PAGE> 14
NET INTEREST INCOME
Net interest income for the third quarter of 1999 increased to $3.2
million, or 22.7%, from $2.6 million in the third quarter of 1998. For the first
nine months of 1999, net interest income increased to $8.7 million, or 28.1%,
from $6.8 million for the same period in 1998. The increase in net interest
income is largely due to the overall growth of the Company.
Average interest earning assets for the third quarter increased to
$229.4 million at September 30, 1999, compared to $189.6 million at September
30, 1998, a growth of $39.8 million, or 21.0%, while the average yield on
interest earning assets decreased to 8.79%, compared with 8.83% in third 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
9.4% for the quarter ended September 30, 1999 from 9.96% for the quarter ended
September 30, 1998. The average cost of interest bearing liabilities also
decreased in the third quarter of 1999 to 3.90% from 4.24% for the quarter ended
September 30, 1998. Average interest bearing liabilities for the quarter
increased to $186.0 million at September 30, 1999 compared to $146.6 million at
September 30, 1998, a growth of $39.4 million, or 26.9%. The overall result of
these changes was an increase in the net interest spread to 4.89% for the
quarter ended September 30, 1999 from 4.59% for the quarter ended September 30,
1998.
Average shareholders' equity increased to $29.6 million for the
quarter ended September 30, 1999 from $29.0 million in the same period for 1998,
an increase of 2.1%, which positively impacted the increase in net interest
income. Net interest margin (net interest income divided by average interest
earning assets) increased to 5.63% in the third quarter of 1999 from 5.56% in
the third quarter of 1998.
NONINTEREST INCOME AND EXPENSE
Noninterest income decreased $52,000, or 8.5%, in the third
quarter of 1999 compared to the same period 1998 reflecting the decrease in fees
received on third party originated real estate loans due to a less favorable
1999 mortgage loan market. Noninterest income increased $262,000, or 16.7% for
the first nine months of 1999 compared with the same period in 1998, primarily
due to increases in service charge income.
Noninterest expense increased $550,000, or 25.5%, in the third quarter
of 1999 and $1.9 million, or 32.4%, in the first nine 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 19.8% and 44.8%,
respectively, for the quarter compared with the same period in 1998 and 29.8%
and 47.7%, respectively, for the first nine months of 1999 compared with the
same period in 1998. These increases reflect the Company's geographic growth on
Whidbey and Camano Islands, Port Townsend, Anacortes, Burlington, Bellingham and
Sedro Woolley in Northwestern Washington and the addition of new products and
services. The efficiency ratio (noninterest expense divided by the sum of net
interest income plus noninterest income less non-recurring gains) was 72.86% for
12
<PAGE> 15
the third quarter and 71.68% for the first nine months of 1999 compared to
67.78% and 68.15% for the same periods in 1998, respectively.
INCOME TAXES
For the third quarter and first nine months of 1999, the Company
recorded an income tax provision of $209 and $572, respectively. The overall
effective tax rate has decreased for the nine months ended September 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) September 30, December 31,
1999 % of Total 1998 % of Total
--------------- ------------ -------------- ------------
<S> <C> <C> <C> <C>
Commercial $ 89,160 43.9% $ 65,564 43.8%
Real estate mortgages:
One to four family residential 20,320 10.0% 17,052 11.4%
5 or more family residential and
commercial 22,941 11.3% 12,146 8.1%
--------------- ------------ -------------- ------------
Total real estate mortgages 43,261 21.3% 29,198 19.5%
Real estate construction 12,911 6.4% 14,139 9.5%
Consumer 57,910 28.5% 40,750 27.2%
--------------- ------------ -------------- ------------
Subtotal 203,242 100.0% 149,651 100.0%
============ ============
Less: allowance for loan losses (2,161) (1,745)
Less: deferred loan fees and other 0 (34)
=============== ==============
Total loans, net $201,081 $147,872
=============== ==============
</TABLE>
Total loans, net, increased to $201.1 million at September 30, 1999,
representing a 36.0% increase from year-end 1998. Total commercial, real estate
mortgage, and consumer loans increased 36.0%, 48.2%, and 42.1%, respectively, at
September 30, 1999 from year-end 1998. Total real estate construction loans
decreased 8.7% for the same period. These changes reflect continuing commercial
and real estate 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) September 30, 1999 December 31, 1998
-------------------- -------------------
<S> <C> <C>
Nonaccrual loans $891 $639
Restructured loans 52 208
-------------------- -------------------
Total nonperforming loans $943 $847
Real estate owned -- --
-------------------- -------------------
Total nonperforming assets $943 $847
Accruing loans past due => 90 days $ -- $ 32
Potential problem loans -- 215
Allowance for loan losses 2,161 1,745
Nonperforming loans to loans .46% 0.57%
Allowance for loan losses to loans 1.06% 1.17%
Allowance for loan losses to nonperforming loans 229.16% 206.02%
Nonperforming assets to total assets 0.36% 0.38%
</TABLE>
Nonperforming loans increased to $943,000, or .46% of total loans, at
September 30, 1999 from $847,000 at December 31, 1998.
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The Company recorded a $255,000 provision for loan losses for the third
quarter of 1999, compared with $195,000 for the same period a year ago. There
were $114,000 in net loan charge-offs during the third quarter of 1999, compared
to $28,000 in net charge-offs for the same period in 1998.
The allowance for loan losses increased to $2.2 million at September
30, 1999 from $1.7 million at December 31, 1998, or 1.06% of total outstanding
loans and 229.16% of nonperforming loans at the end of the third quarter 1999 as
compared to 1.17% of total loans and 206.02% of nonperforming loans at December
31, 1998.
For the nine months ended September 30, 1999, the provision for loan
losses was $765,000 compared to $540,000 for the same period in 1998. Net
charge-offs for the first nine months of 1999 totaled $349,000 compared to
$143,000 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 the quality of the loan portfolio, problem loans, business
conditions, loss experience, and 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
September 30, 1999 September 30, 1998
-------------------- -------------------
<S> <C> <C>
Balance at beginning of period $ 2,020 $ 1,526
Charge offs:
Commercial (52) --
Real estate -- --
Consumer (69) (49)
-------------------- -------------------
Total charge offs (121) (49)
Recoveries:
Commercial 1 1
Real estate -- --
Consumer 6 20
-------------------- -------------------
Total recoveries 7 21
Net charge-offs (114) (28)
Provision for loan losses 255 195
-------------------- -------------------
Balance at end of period $ 2,161 $ 1,693
==================== ===================
</TABLE>
<TABLE>
<CAPTION>
(amounts in thousands)
For the nine month For the nine month
period ended period ended
September 30, 1999 September 30,1998
-------------------- -------------------
<S> <C> <C>
Balance at beginning of period $ 1,745 $ 1,296
Charge offs:
Commercial (169) (52)
Real estate (6) --
Consumer (195) (114)
-------------------- -------------------
Total charge offs (370) (166)
Recoveries:
Commercial 8 1
Real estate -- --
Consumer 13 22
-------------------- -------------------
Total recoveries 21 23
Net charge-offs (349) (143)
Provision for loan losses 765 540
-------------------- -------------------
Balance at end of period $ 2,161 $1,693
==================== ===================
</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 September 30, 1999, the Company has unused lines of credit with the
Federal Home Loan Bank of Seattle (FHLB) of $39.1 million, the Federal Reserve
Bank of San Francisco of $6.7 million and correspondent financial institutions
in the amount of $12 million. As of September 30, 1999, there were $5.0 million
in advances from the financial institutions on these lines of credit.
Total deposits increased 25.0% to $228.2 million at September 30, 1999
from $182.5 million at September 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 increased slightly to $29.72 million
at September 30, 1999 from $29.69 million at December 31, 1998. 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. During the nine months ended September 30, 1999, approximately
97,000 shares have been repurchased for $1,043,000. 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 $500,000 during the first nine months ended September 30, 1999. These
actions, along with $128,000 in unrealized losses on available for sale
securities, were the primary reasons for the Company's nearly unchanged
shareholders' equity at September 30, 1999. Total assets increased to $264.1
million at September 30, 1999 from $220.5 million at December 31, 1998, an
increase of 19.8%. The result of these changes was a shareholders' equity to
total assets ratio of 11.3% at September 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 September 30, 1999, the Company's leverage ratio was
10.52%, 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
16
<PAGE> 19
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 12.40% and 13.42%, respectively, at September
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
September 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
high-balance 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. 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. As of September 30, 1999, the
Company has no evidence of potential Y2K loss as related to its borrowing
customers. 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.
Renovation Phase
This phase involved upgrading and replacing mission-critical systems if
needed. 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 expected to
be completed by November 15, 1999.
Validation and Testing Phase
This phase involved 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 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 chose
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 Company's extensive
18
<PAGE> 21
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 the final stages as of
September 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 $134,500 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 $59,300. 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.
19
<PAGE> 22
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 September 30, 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) Reports on Form 8-K
None
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 November 12, 1999 By /s/ Michal D. Cann
--------------------
Michal D. Cann
President and Chief
Executive Officer
Date November 12, 1999 By /s/ Phyllis A. Hawkins
-----------------------
Phyllis A. Hawkins
Senior Vice President and
Chief Financial Officer
20
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JUN-30-1999
<PERIOD-END> SEP-30-1999
<CASH> 10,163
<INT-BEARING-DEPOSITS> 3,492
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 777
<INVESTMENTS-HELD-FOR-SALE> 10,421
<INVESTMENTS-CARRYING> 24,481
<INVESTMENTS-MARKET> 24,265
<LOANS> 203,242
<ALLOWANCE> 2,161
<TOTAL-ASSETS> 264,140
<DEPOSITS> 228,163
<SHORT-TERM> 5,000
<LIABILITIES-OTHER> 1,258
<LONG-TERM> 0
0
0
<COMMON> 16,839
<OTHER-SE> 12,880
<TOTAL-LIABILITIES-AND-EQUITY> 264,140
<INTEREST-LOAN> 4,439
<INTEREST-INVEST> 463
<INTEREST-OTHER> 69
<INTEREST-TOTAL> 4,971
<INTEREST-DEPOSIT> 1,814
<INTEREST-EXPENSE> 1,814
<INTEREST-INCOME-NET> 3,157
<LOAN-LOSSES> 255
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 2,706
<INCOME-PRETAX> 753
<INCOME-PRE-EXTRAORDINARY> 544
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 544
<EPS-BASIC> 0.13
<EPS-DILUTED> 0.12
<YIELD-ACTUAL> 1.31
<LOANS-NON> 943
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2,020
<CHARGE-OFFS> 121
<RECOVERIES> 7
<ALLOWANCE-CLOSE> 2,161
<ALLOWANCE-DOMESTIC> 1,714
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 447
</TABLE>
