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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 [Fee Required]
For the fiscal year ended DECEMBER 31, 1998
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 [No Fee Required]
Commission File Number 000-24503
WASHINGTON BANKING COMPANY
(Exact name of registrant 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)
Registrant's Telephone Number, Including Area Code: (360) 679-3121
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, No Par Value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities and 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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (17 C.F.R. 229.405) is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy of
information statements incorporated by reference in Part III of this Form 10-K
or any amendments to this Form 10-K.
The aggregate market value of Common Stock held by non-affiliates of registrant
at February 26, 1999 was $33,852,394.
The number of shares of registrant's Common Stock outstanding at February 26,
1999 was 4,200,300.
Documents incorporated by reference and parts of Form 10-K into which
incorporated:
Registrant's Annual Report to Shareholders Parts I and II
for the year ended December 31, 1998
Registrant's definitive Proxy Statement Part III
dated March 26, 1999
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CROSS REFERENCE SHEET
Location in Annual Report to Shareholders and Definitive Proxy Statement
Items required by Form 10-K
<TABLE>
<CAPTION>
Annual Report to Shareholders and
Form 10-K Definitive Proxy Statement
- ---------------------------------------------------- ---------------------------------------------------
Part and Page
Item No. Caption Caption Number
- ---------------------------------------------------- ---------------------------------------- ----------
<S> <C> <C> <C>
PART I ANNUAL REPORT TO SHAREHOLDERS
Item 1 Business
Consolidated Average Balance Sheet Management Discussion - Average 28
and Analysis of Net Interest Income Balances and Average Rates Earned and
and Expenses Paid
Consolidated Analysis of Changes in Management Discussion - Rate/Volume 29
Interest Income and Expense Analysis
Commitments and Contingent Note 14, Notes to Consolidated 23
Liabilities Financial Statements
PART II ANNUAL REPORT TO SHAREHOLDERS
Item 5 Market for Registrant's Common Management Discussion - Quarterly 34
Stock and Related Stockholder Common Stock Prices and Dividend
Matters Payments
Item 7 Management's Discussion and Management Discussion 26
Analysis of Financial Condition and
Results of Operations
Item 7a Quantitative and Qualitative Management Discussion-Interest Rate 31
Disclosures about Market Risk Sensitivity
Item 8 Financial Statements and Consolidated Financial Statements 4
Supplementary Data
Item 9 Changes in and Disagreements with Management Discussion-Recent Changes 34
Accountants in Accounting and in Accounting Firms
Financial Disclosure
PART III DEFINITIVE PROXY STATEMENT
Item 10 Directors and Executive Officers of Election of Directors and Beneficial 3, 12
the Registrant Ownership and Section 16(a) Reporting
Compliance
Item 11 Executive Compensation Executive Compensation 7
Item 12 Security Ownership of Certain Security Ownership of Certain 2
Beneficial Owners and Management Beneficial Owners and Management
Item 13 Certain Relationships and Related Interest of Management in Certain 13
Transactions Transactions
</TABLE>
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I Page
----
<S> <C> <C>
Item 1. Business 1
General 1
Market Areas 2
Competition 2
Employees 3
Executive Officers of the Company 3
Effects of Governmental Monetary Policies 3
Consolidated Average Balance Sheet and Analysis of Net Interest Income and
Expense 3
Consolidated Analysis of Changes in Interest Income and Expense 3
Lending Activities 3
General 3
Commitments and Contingent Liabilities 7
Nonperforming Assets 7
Analysis of Allowance for Loan Losses 7
Investment Activities 8
Deposits 11
Short-term Borrowing 12
Supervision and Regulation 12
Item 2 Properties 13
Item 3 Legal Proceedings 14
Item 4 Submission of Matters to a Vote of Security Holders 14
PART II
Item 5 Market for Registrant's Common Stock and Related Stockholder Matters 14
Item 6 Selected Financial Data 14
Item 7 Management's Discussion and Analysis of Financial Condition and Results of 16
Operations
Item 7a Quantitative and Qualitative Disclosures about Market Risk 16
Item 8 Financial Statements and Supplementary Data 16
Item 9 Changes in and Disagreements with Accountants in Accounting and Financial
Disclosure 16
PART III
Item 10 Directors and Executive Officers of the Registrant 16
Item 11 Executive Compensation 16
Item 12 Security Ownership of Certain Beneficial Owners and Management 16
Item 13 Certain Relationships and Related Transactions 17
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 17
</TABLE>
ii
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PART I
ITEM 1. BUSINESS
GENERAL
Washington Banking Company (the "Company") is a registered bank holding
company whose wholly-owned subsidiary, Whidbey Island Bank (the "Bank"),
conducts a full-service commercial banking business. Headquartered in Oak
Harbor, Washington, the Company provides a full range of commercial banking
services to small and medium-sized businesses, professionals and other
individuals through twelve branch offices located on Whidbey Island and Camano
Island in Island County, as well as the Burlington, Anacortes (Skagit County)
and Bellingham (Whatcom County) communities in northwestern Washington. At
December 31, 1998, the Company had total assets of $220.5 million, total
deposits of $189.7 million and shareholders' equity of $29.7 million.
Effective June 23, 1998, the Company sold 1,380,000 shares of its common
stock in an initial public offering at a subscription price of $12 per share
resulting in net proceeds to the Company of $14.9 million.
The Bank began operations in 1961 on Whidbey Island. Until early 1994, the
Company limited its physical presence to Island County (Whidbey Island and
neighboring Camano Island), and particularly to Whidbey Island, a 45 mile long
island that runs parallel to the mainland area of Washington northwest of
Everett and southwest of Bellingham, but had no presence on the mainland. In
view of the threatened closure of NAS Whidbey Island, the Company determined
that it would be prudent to diversify geographically beyond Island County. With
the consolidation of the large regional banks operating in Washington, and the
resulting dislocation of customers, the Company saw an opportunity to expand
onto the mainland along the northern I-5 corridor. In February 1994, the Company
opened a loan production office in Burlington, Washington (Skagit County). Loan
growth in the Burlington office was strong and the Company determined that it
would pursue its growth strategy in and around Skagit County and north into
Whatcom County. In pursuit of that growth strategy, the Company has targeted
areas north of Everett, Washington and areas contiguous to Whidbey Island into
which it would expand.
The primary factors considered in determining the areas of geographic
expansion are customer demand and the availability of experienced managers,
lending officers and branch personnel with a long standing community presence
and extensive banking relationships. The Company also emphasizes the hiring of
experienced personnel with extensive industry knowledge when considering lending
product expansion.
Due to the favorable response in Burlington, the Company converted the
Burlington loan production office into a full service branch in August 1995. In
late 1996, the Company targeted Bellingham for expansion, hired an experienced
manager and lending officer, both with long standing community presence, and in
early 1997 opened a full service branch in downtown Bellingham. During 1998 new
full service branches were constructed and opened in Anacortes and Freeland. In
addition, a grocery store branch was opened in March 1998 on Camano Island.
The Company's objective is to continue, over the next several years, to
expand its geographical presence outside of Whidbey and Camano Islands, while
solidifying its market position on the Islands. To deliver the Company's
products more effectively and efficiently, the Company's market strategy is to
locate full service branch offices which provide all of the Company's products
and services in its targeted growth areas supported by loan production offices,
mini branches, grocery or retail store branches and/or automated teller machines
in the areas surrounding those central locations in order to further service
customers. Acquisition of banks or branches will also be used as a means of
expansion if appropriate opportunities are presented. The Company also expects
to invest in technology to facilitate telephone, personal computer and Internet
banking, but with its primary commitment being to provide exceptional personal
service.
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Currently, the Company's geographical expansion is expected to be
concentrated in the Burlington/ Mount Vernon area of the Skagit Valley, and in
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.
In pursuit of its growth strategy, in the first and second quarter,
respectively, of 1998, the Company opened a full service branch in Anacortes and
a grocery store branch on Camano Island to complement its existing Camano Island
branch. It also opened a full-service branch in Freeland, Washington which is
located in the southern part of Whidbey Island in the fourth quarter of the
year. The Company relocated the Bellingham office to a larger office in the
first quarter of 1999 and opened a residential real estate loan production
office in Port Townsend, Washington (Jefferson County).
While continuing to geographically expand, management's strategy is to
continue to provide a high level of personal service to its customers and to
expand loan, deposit and other products and services that it offers its
customers. Maintenance of asset quality will be emphasized by controlling
nonperforming assets and adhering to prudent underwriting standards. In
addition, management will strive to improve operating efficiencies to further
manage noninterest expense and will continue to improve internal operating
systems.
The Company's expansion activity can be expected to require the expenditures
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.
MARKET AREAS
The Company's market area of Island County, Skagit County and Whatcom County
encompasses three distinct economies. Island County's largest population center,
Oak Harbor, is dominated by a large military presence with naval operations at
Naval Air Station Whidbey Island ("NAS Whidbey Island"). NAS Whidbey Island and
the jobs it generates contribute significantly to the county's economy. NAS
Whidbey Island was on the federal government's list of potential base closures
in 1991 but has since been removed from that list and has not been on
recommended base closure lists prepared since 1991. Agriculture, forestry and
construction also contribute significantly to the economy of the county. Due to
its natural beauty, the county attracts tourism and has a significant number of
retirement communities. Skagit County's economy has historically been a
primarily forestry and agricultural based economy. In recent years,
manufacturing, mining, construction and service/retail businesses in Skagit
County have grown, along with the county's population. Whatcom County, which
borders Canada, has experienced an increase in population and industry over the
past several years. It is the home of Western Washington University, one of the
State of Washington's four year academic centers, and has an economy with a
strong manufacturing base, as well as a strong academic-research and
vocational-technical base. The United States Customs Service and municipal,
county and state governments give the county additional employment stability.
COMPETITION
The Company experiences strong competition in its service area from a number
of commercial banks, savings banks, savings and loan associations, and credit
unions. The Company operates in a highly competitive and concentrated banking
environment, competing for deposits, loans and other financial services with a
number of larger and well-established banks, credit unions and other financial
and non-financial institutions. Some of the financial institutions with which
the Company competes are not subject to the same regulations as the Company.
Many of the Company's competitors have substantially higher lending limits than
the Company and offer certain services, including trust and international
banking services, that the Company does not provide. There can be no assurance
that the Company's competitive efforts will continue to be successful.
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EMPLOYEES
The Company had 145 full time equivalent employees at December 31, 1998.
None of the Company's employees are covered by a collective bargaining
agreement. The Company considers its relations with its employees to be good.
EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth certain information about the executive
officers of the Company.
<TABLE>
<CAPTION>
Has served as an
executive officer
of the Company or
Name Age Position Bank since
- ----------------------- ------ -------------------------------------------- --------------------
<S> <C> <C> <C>
Michal D. Cann 50 President and Chief Executive Officer 1992
Larry Scodeller 57 Executive Vice President and Chief 1998
Operating Officer
Phyllis A. Hawkins 49 Senior Vice President and Chief Financial 1995
Officer
</TABLE>
EFFECTS OF GOVERNMENTAL MONETARY POLICIES
Profitability in banking depends on interest rate differentials. In general,
the difference between the interest earned on a bank's loans, securities and
other interest-earning assets and the interest paid on a bank's deposits and
other interest-bearing liabilities are the major source of a bank's earnings.
Thus, the earnings and growth of the Company are affected not only by general
economic conditions, but also by the monetary and fiscal policies of the United
States and its agencies, particularly the Federal Reserve. The Federal Reserve
System implements national monetary policy for such purposes as controlling
inflation and recession by its open-market operations in United States
government securities, control of the discount rate applicable to borrowing from
the Federal Reserve and the establishment of reserve requirements against
certain deposits. The actions of the Federal Reserve in these areas influence
growth of bank loans, investments, and deposits and also affect interest rates
charged on loans and paid on deposits. The nature and impact of future changes
in monetary policies and their impact on the Company are not predictable.
CONSOLIDATED AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST INCOME AND
EXPENSE
For information concerning daily average balances, along with average yields
for earning assets and average interest rates for interest-bearing liabilities
and additional details on various asset and liability categories, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operation" ("Management Discussion") - "Average Balances and Average Rates
Earned and Paid" at page 28 of the Annual Report to shareholders for the year
ended December 31, 1998 ("Annual Report"), which is incorporated herein by
reference.
CONSOLIDATED ANALYSIS OF CHANGES IN INTEREST INCOME AND EXPENSE
For information concerning the amounts of the changes in consolidated net
interest income attributable to changes in volume and changes in interest rates
for the Company, see Management Discussion at page 29 of the Annual Report.
LENDING ACTIVITIES
GENERAL. The Company provides a broad array of loan products to small and
medium-size business customers and to individuals. Since December 31, 1996, the
Company has increased commercial business loans and consumer
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loans as a percentage of its total loan portfolio and significantly decreased
one to four family real estate loans originated for the Company's portfolio as a
percentage of its total loan portfolio. The Company presently originates one to
four family real estate loans for third party long term lenders. Since December
31, 1996, the percentage of loans consisting of commercial and five or more
family real estate loans has also increased while real estate construction loans
have decreased as a percentage of the total loan portfolio.
The following table sets forth at the dates indicated the Company's loan
portfolio composition by type of loan.
LOAN PORTFOLIO COMPOSITION
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS)
DECEMBER 31,
---------------------------------------------------------------------
1998 1997 1996
---------------------- ---------------------- ---------------------
% OF % OF % OF
BALANCE TOTAL BALANCE TOTAL BALANCE TOTAL
--------- ----- --------- ------ -------- ------
<S> <C> <C> <C> <C> <C> <C>
Commercial $ 65,564 43.8% $ 48,242 41.0% $ 34,522 42.4%
Real estate mortgages:
One to four family 17,052 11.4 14,258 12.1 13,264 16.3
residential
5 or more family residential and
commercial 12,146 8.1 8,711 7.4 5,593 6.9
--------- ----- --------- ------ -------- ------
Total real estate 29,198 19.5 22,969 19.5 18,857 23.2
mortgages
Real estate construction 14,139 9.5 12,646 10.8 8,389 10.3
Consumer 40,750 27.2 33,721 28.7 19,568 24.1
--------- ----- --------- ------ -------- ------
Subtotal 149,651 100% 117,578 100.0% 81,336 100.0%
===== ====== ======
Less: allowance for loan losses (1,745) (1,296) (796)
Less: deferred loan fees and other (34) (43) (67)
--------- --------- --------
Loans, Net $ 147,872 $ 116,239 $ 80,473
========= ========= ========
</TABLE>
The following table presents at December 31, 1998 (i) the aggregate
maturities of loans in the named categories of the Company's loan portfolio and
(ii) the aggregate amounts of variable and fixed rate loans that mature after
one year:
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS) MATURING
------------- --------- ------------- ---------
WITHIN 1 YEAR 1-5 YEARS AFTER 5 YEARS TOTAL
------------- --------- ------------- ---------
<S> <C> <C> <C> <C>
Real Estate Construction:
One to four family residential $ 6,834 $ 941 $ 775 $ 8,550
5 or more family residential
and commercial 1,169 341 4,079 5,589
------- ------- ------- -------
Total real estate construction $ 8,003 $ 1,282 $ 4,854 $14,139
Commercial $18,599 $22,386 $24,579 $65,564
------- ------- -------
Total $26,602 $23,668 $29,433 $79,703
======= ======= ======= =======
Fixed-rate loans $10,429 $ 5,420 $15,849
Variable-rate loans $13,239 $24,013 $37,252
------- ------- -------
Total $23,668 $29,433 $53,101
======= ======= =======
</TABLE>
COMMERCIAL LOANS. Commercial business lending is the primary focus of the
Company's lending activities. Commercial loans increased to $65.6 million at
December 31, 1998, representing 43.8% of its total loans, from $48.2 million, or
41.0%, at December 31, 1997, and $34.5 million, or 42.4%, at December 31, 1996.
Commercial loans include both secured and unsecured loans for working capital
and expansion. Short-term working capital
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loans generally are secured by accounts receivable, inventory and/or equipment.
The Company also makes term commercial loans secured by equipment and real
estate. Lending decisions are based on an evaluation of the financial strength,
management and credit history of the borrower, and the quality of the collateral
securing the loan. With few exceptions, the Company requires personal guarantees
and secondary sources of repayment.
Commercial loans also are provided through the U.S. Small Business
Administration ("SBA loans"), an independent agency of the Federal Government,
which guarantees up to 75% - 80% of the loan amount. SBA loans are generally
made to small and medium size businesses. Once the SBA loan has been funded, the
Company has followed a practice of selling the guaranteed portions of SBA loans
in the secondary market. The guaranteed portions of these loans are generally
sold at a premium. At December 31, 1998, the Company had outstanding $1.1
million, or 1.7% of its commercial loan portfolio, in SBA commercial business
loans.
Beginning in 1997, the Company increased the origination of commercial loans
to automobile dealers to finance their inventories when the Company hired a
lending officer with substantial experience with dealer inventory financing and
indirect vehicle lending. At December 31, 1998, the Company had outstanding $1.9
million, or 2.9% of its commercial loan portfolio, in dealer inventory loans to
dealers of used automobiles. With few exceptions, these loans are personally
guaranteed by the owner of the dealership. Such loans are often riskier than
other types of commercial loans and involve a higher degree of monitoring.
Subject to market conditions, the Company anticipates increasing its lending to
automobile dealers.
Commercial loans generally provide greater yields and reprice more
frequently than other types of loans, such as real estate loans. More frequent
repricing means that commercial loans are more sensitive to changes in interest
rates.
REAL ESTATE LOANS. Real estate loans are made for purchasing, constructing
and refinancing one to four family, five or more family and commercial
properties. The Company offers fixed and adjustable rate options. The Company
provides customers access to long-term conventional real estate loans through
its mortgage loan department which makes Federal National Mortgage Association
("FNMA") -- conforming loans for the account of third parties.
Residential one to four family loans amounted to $17.1 million at December
31, 1998, representing 11.4% of total loans, compared to $14.3 million, or
12.1%, at December 31, 1997, and $13.3 million, or 16.3%, at December 31, 1996.
The Company's portfolio of residential mortgage loans are secured by properties
located within the Company's market area. In 1997, the Company hired an
experienced mortgage lender and expanded the origination of residential loans
for the account of third parties. Loans originated for the account of third
parties are closed by the third party and therefore are not shown on the
Company's financial statements. The Company receives a fee for each such loan
originated. During the year ended December 31, 1998, the Company's total gross
loan originations of residential loans for the account of third parties were
$52.0 million, compared with $12.3 million and $7.9 million, respectively for
the years ended December 31, 1997 and 1996. The Company anticipates that it will
continue to be an active originator of residential loans for the account of
third parties. The Company also anticipates taking steps to qualify to become a
seller of conforming residential mortgages to the Federal Home Loan Mortgage
Corporation ("FHLMC") and FNMA. After qualifying, the Company will consider
originating for sale to FHLMC and/or FNMA conforming residential mortgage loans,
depending on market conditions.
The Company has made, and anticipates continuing to make, on a selective
basis, five or more family and commercial real estate loans. Five or more family
and commercial real estate lending amounted to $12.1 million, or 8.1% of total
loans, at December 31, 1998, $8.7 million, or 7.4%, and $5.6 million, or 6.9%,
at December 31, 1997, and 1996, respectively. This lending has involved loans
secured principally by apartment buildings and commercial buildings for office,
storage and warehouse space. Generally in underwriting commercial real estate
loans, the Company requires the personal guaranty of borrowers and a minimum
cash flow to debt service ratio of 1.25 to 1. Loans secured by five or more
family and commercial real estate may be greater in amount and involve a greater
degree of risk than one to four family residential mortgage loans. Payments on
such loans are often dependent on successful operation or management of the
properties or a commercial business.
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Construction loans amounted to $14.1 million, or 9.5% of total loans, at
December 31, 1998 compared with $12.6 million, or 10.8%, and $8.4 million, or
10.3%, at December 31, 1997, and 1996, respectively. The Company originates one
to four family residential construction loans for the construction of custom
homes (where the home buyer is the borrower) and provides financing to builders
for the construction of pre-sold homes and speculative residential construction.
Speculative residential lending amounted to $1.7 million, or 12.3% of the total
construction loan portfolio at December 31, 1998. The average loan size at
December 31, 1998 was approximately $87,000. With few exceptions, the Company
limits to four the number of unsold homes being built by each builder. The
Company lends to builders who have demonstrated a favorable record of
performance and profitable operations and who are building in markets that
management believes it understands and in which it is comfortable with the
economic conditions. The Company also makes commercial real estate construction
loans, generally for owner-occupied properties. The Company further endeavors to
limit its construction lending risk through adherence to established
underwriting procedures. Also, the Company generally requires documentation of
all draw requests and utilizes loan officers and/or third parties to inspect the
project prior to paying any draw requests from the builder. With few exceptions,
the Company requires personal guarantees and secondary sources of repayment on
construction loans.
CONSUMER LOANS. At December 31, 1998, consumer loans constituted $40.8
million, or 27.2% of total loans, compared with $33.7 million, or 28.7%, and
$19.6 million, or 24.1%, at December 31, 1997, and 1996, respectively. Consumer
loans made by the Company include automobile loans, boat and recreational
vehicle financing, home equity and home improvement loans and miscellaneous
secured and unsecured personal loans. The Company also makes automobile loans
for used vehicles originated indirectly by selected automobile dealers located
in the Company's market areas. With the hiring of an experienced vehicle dealer
lender in 1997, the Company increased such lending. At December 31, 1998, $13.3
million, or 32.6%, of the Company's consumer loan portfolio consisted of
indirect automobile loans. The Company intends to continue to emphasize indirect
automobile loans and to gradually expand its purchase of dealer-originated
contracts to include recreational vehicles, trailers, motorcycles and other
vehicles. Consumer loans generally can carry significantly greater risks than
other loans, even if secured, if the collateral consists of rapidly depreciating
assets such as automobiles and equipment. Repossessed collateral securing a
defaulted consumer loan may not provide an adequate source of repayment of the
loan. Consumer loan collections are sensitive to job loss, illness and other
personal factors. The Company attempts to manage the risks inherent in consumer
lending by following established credit guidelines and underwriting practices
designed to minimize risk of loss. Indirect automobile and other vehicle loans
may involve greater risk than other consumer loans, including direct automobile
loans, such as dealer fraud. To mitigate these risks, the Company has limited
its indirect automobile loan purchases primarily to dealerships that are
established and well known in its market areas. In addition, the Company has put
in place systems designed to limit the risks inherent in dealer originated
loans.
The Company also offers VISA credit cards to its customers. At December 31,
1998, $1.3 million of credit card balances were outstanding representing 3.2% of
the Company's consumer loan portfolio and less than 1% of its total portfolio.
Past due amounts on the Company's credit card portfolio have been minimal. At
December 31, 1998, approximately $27,000, or 2.1% of outstanding credit card
balances were past due. Home equity loans are also available through use of VISA
credit cards. Credit card home equity loans amounted to $2.1 million at December
31, 1998.
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COMMITMENTS AND CONTINGENT LIABILITIES. In the ordinary course of business, the
Company enters into various types of transactions that include commitments to
extend credit that are not included in loans receivable, net, presented on the
Company's consolidated balance sheets. The Company applies the same credit
standards to these commitments as it uses in all its lending activities and has
included these commitments in its lending risk evaluations. The Company's
exposure to credit loss under commitments to extend credit is represented by the
amount of these commitments. See Note 14(b) of "Notes to Consolidated Financial
Statements" at page 24 of the Annual Report, which is incorporated herein by
reference.
NONPERFORMING ASSETS. The following table sets forth, for the periods indicated,
information with respect to the Company's nonaccrual loans, restructured loans,
total nonperforming loans (nonaccrual loans plus restructured loans), and total
nonperforming assets.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
(DOLLARS IN THOUSANDS) 1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Nonaccrual loans $ 639 $ 498 $ 390
Restructured loans 208 653 781
------ ------ ------
Total non-performing loans $ 847 $1,151 $1,171
Real estate owned -- 30 --
------ ------ ------
Total non-performing assets $ 847 $1,181 $1,171
Accruing loans past due (greater than or
equal to) 90 days $ 32 $ -- $ 2
Potential problem loans 215 11 7
Allowance for loan losses 1,745 1,296 796
Nonperforming loans to loans 0.57% 0.98% 1.44%
Allowance for loan losses to loans 1.17% 1.10% 0.98%
Allow. loan losses to nonperforming loans 206.02% 112.60% 67.98%
Nonperforming assets to total assets 0.38% 0.74% 1.00%
</TABLE>
The Company's consolidated financial statements are prepared on the accrual
basis of accounting, including the recognition of interest income on its loan
portfolio, unless a loan is placed on a nonaccrual basis. Loans are placed on a
nonaccrual basis when there are serious doubts about the collectability of
principal or interest. Generally, the Company's policy is to place a loan on
nonaccrual status when the loan becomes past due 90 days. Amounts received on
non-accrual loans generally are applied first to principal and then to interest
only after all principal has been collected. Restructured loans are those for
which concessions, including the reduction of interest rates below a rate
otherwise available to that borrower or the deferral of interest or principal,
have been granted due to the borrower's weakened financial condition. Interest
on restructured loans is accrued at the restructured rates when it is
anticipated that no loss of original principal will occur. Potential problem
loans are loans which are currently performing and are not included in
nonaccrual or restructured loans above, but about which there are serious doubts
as to the borrower's ability to comply with present repayment terms and,
therefore, will likely be included later in nonaccrual, past due or restructured
loans. These loans are considered by management in assessing the adequacy of the
allowance for loan losses.
At December 31, 1998, the Company had $639,000 of nonaccrual loans. Interest
on nonaccrual loans foregone was approximately $60,000, and $40,000, and $42,000
for the years ended December 31, 1998, 1997 and 1996, respectively.
ANALYSIS OF ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is
maintained at a level considered adequate by management to provide for
anticipated loan losses based on management's assessment of various
7
<PAGE> 11
factors affecting the loan portfolio, including a review of problem loans,
business conditions and loss experience and an overall evaluation of the quality
of the underlying collateral. The allowance is increased by provisions charged
to operations and reduced by loans charged off, net of recoveries.
While management believes that it uses the best information available to
determine the allowance for loan losses, unforeseen market conditions could
result in adjustments to the allowance for loan losses, and net income could be
significantly affected, if circumstances differ substantially from the
assumptions used in making the final determination.
The following table shows the allocation of the allowance for loan losses at
December 31, 1998, 1997 and 1996. The allocation is based on an evaluation of
defined loan problems, historical ratios of loan losses and other factors which
may affect future loan losses in the categories of loans shown.
<TABLE>
<CAPTION>
1998 1997 1996
----------------- ------------------- ----------------
% OF % OF % OF
TOTAL TOTAL TOTAL
(DOLLARS IN THOUSANDS) AMOUNT LOANS(1) AMOUNT LOANS(1) AMOUNT LOANS(1)
Balance applicable to: ------ -------- ------ -------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
Commercial $ 595 43.8% $ 437 41.0% $266 42.4%
Real estate mortgage 174 19.5 206 19.5 139 23.2
Real estate construction 168 9.5 115 10.8 64 10.3
Consumer 379 27.2 307 28.7 157 24.1
Unallocated 429 -- 231 -- 170 --
------ ----- ------ ----- ---- -----
Total $1,745 100.0% $1,296 100.0% $796 100.0%
====== ===== ====== ===== ==== =====
</TABLE>
- --------------
(1) Represents total of all outstanding loans in each category as a percent of
total loans outstanding.
The following table sets forth for the periods indicated information
regarding changes in the Company's allowance for loan losses:
<TABLE>
<CAPTION>
FOR THE FOR THE FOR THE
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1997 DECEMBER 31, 1996
----------------- ----------------- -----------------
<S> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Balance at beginning of period $1,296 $ 796 $ 620
Charge-offs:
Commercial (182) (43) (166)
Real estate -- (11) --
Consumer and other (131) (106) (63)
------ ------ -----
Total charge-offs (313) (160) (229)
Recoveries:
Commercial 2 -- 49
Real estate -- -- --
Consumer 25 13 6
------ ------ -----
Total recoveries 27 13 55
Net charge-offs (286) (147) (174)
Provision for loan losses 735 647 350
------ ------ -----
Balance at end of period $1,745 $1,296 $ 796
====== ====== =====
</TABLE>
INVESTMENT ACTIVITIES
The Company's portfolio of investment securities (investment securities held
to maturity and investment securities available for sale) increased by $8.5
million from December 31, 1997 to 1998. The investment portfolio
8
<PAGE> 12
consists primarily of U.S. Treasury and government agency securities, municipal
securities and corporate obligations. Municipal securities represented 43.2% or
$16.5 million, of the Company's investment portfolio at December 31, 1998. The
Company has purchased nonrated municipal obligations of local and surrounding
areas. Approximately 38.7% of the municipal securities in the Company's
investment portfolio were rated below "A", or its equivalent, or unrated.
Corporate obligations amounted to $6.9 million, or 18.0% of the Company's
investment portfolio, at December 31, 1998. At December 31, 1998, all corporate
obligations held by the Company were rated A, or its equivalent, or better. The
average maturity of the securities portfolio was approximately four years at
December 31, 1998.
Investment securities designated as held to maturity are those securities
which the Company has the ability and the intent to hold to maturity. Events
which may be reasonably anticipated are considered when determining the
Company's intent to hold investment securities for the foreseeable future.
Investment securities designated as held to maturity are carried at cost,
adjusted for amortization for premiums and accretions of discounts. Securities
to be held for indefinite periods of time and not intended to be held to
maturity are classified as available for sale and carried at fair value.
Securities held for indefinite periods of time include securities that
management intends to use as part of its asset/liability management strategy and
that may be sold in response to changes in interest rates and/or significant
prepayment risks. At December 31, 1998, the investment portfolio consisted of
33.6% available for sale securities and 66.4% held to maturity investments.
The Company expects to more actively manage its investment portfolio in the
future and would expect that available for sale securities would increase as a
percent of total investment securities.
The following table summarizes the amortized costs, gross unrealized gains
and losses and the resulting market value of securities available for sale:
SECURITIES AVAILABLE FOR SALE
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
(DOLLARS IN THOUSANDS) COST GAINS LOSSES VALUE
--------- ---------- ---------- -------
<S> <C> <C> <C> <C>
December 31, 1998:
US Treasury securities $ 5,008 $ 60 $ -- $ 5,068
US Government agency securities 7,508 18 (3) 7,523
------- ---- ---- -------
Total $12,516 $ 78 $ (3) $12,591
======= ==== ==== =======
December 31, 1997:
US Treasury securities $ 4,996 $ 26 $ -- $ 5,022
US Government agency securities 500 - -- (1) 499
------- --- ---- -------
Total $ 5,496 $ 26 $ (1) $ 5,521
======= ==== ==== =======
</TABLE>
9
<PAGE> 13
The following table summarizes the recorded value, gross unrealized gains
and losses and the resulting market value of investment securities held to
maturity as of December 31, 1998 and 1997.
SECURITIES HELD TO MATURITY
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
(DOLLARS IN THOUSANDS) COST GAINS LOSSES VALUE
--------- ---------- ---------- -------
<S> <C> <C> <C> <C>
December 31, 1998:
U.S. Treasury securities $ 500 $ 1 $ -- $ 501
U.S. Government agency securities 998 12 -- 1,010
State and political subdivisions 16,502 684 (1) 17,185
Corporate obligations 6,875 100 (4) 6,971
------- ---- -------- -------
Total $24,875 $797 $ (5) $25,667
======= ==== ======== =======
December 31, 1997:
U.S. Treasury securities $ 997 $ 2 $ -- $ 999
U.S. Government agency securities 4,996 21 (5) 5,012
State and political subdivisions 9,796 257 (3) 10,050
Corporate obligations 7,648 52 (8) 7,692
Other investments 71 -- -- 71
------- ---- -------- -------
Total $23,508 $332 $ (16) $23,824
======= ==== ======== =======
</TABLE>
The following table summarizes the amortized cost and recorded and market
values of securities available-for-sale and held-to-maturity at December 31,
1998, by contractual maturity groups:
<TABLE>
<CAPTION>
AMORTIZED MARKET RECORDED
COST VALUE VALUE
------- ------- -------
<S> <C> <C> <C>
(DOLLARS IN THOUSANDS)
AMOUNTS MATURING:
Within one year $ 8,042 $ 8,074 $ 8,065
One to five years 19,364 19,736 19,418
Six to ten years 8,407 8,803 8,407
Over ten years 1,576 1,645 1,576
------- ------- -------
Total $37,391 $38,258 $37,466
======= ======= =======
</TABLE>
10
<PAGE> 14
The following table provides the carrying values, maturities and weighted
average yields of the Company's investment portfolio at December 31, 1998:
<TABLE>
<CAPTION>
WITH 1 1 - 5 6 - 10 OVER 10
YEAR YEARS YEARS YEARS TOTAL
--------- ---------- ------ ------ ----------
<S> <C> <C> <C> <C> <C>
(DOLLARS IN
THOUSANDS)
U.S. Treasury securities
Balance $ 3,520 $ 2,048 $ -- $ -- $ 5,568
Weighted average yield 5.64% 6.28% --% --% 5.88%
U.S. Government agency securities
Balance 3,513 5,008 -- -- 8,521
Weighted average yield 5.77% 5.76% --% --% 5.76%
State and political subdivisions
Balance 525 5,994 8,407 1,576 16,502
Weighted average yield 4.74% 4.90% 4.79% 5.09% 4.86%
Corporate obligations and other
Balance 507 6,368 -- -- 6,875
Weighted average yield 8.87% 6.83% --% --% 6.99%
FHLB Stock
Balance -- -- 736 -- 736
Weighted average yield --% --% 7.00% --% 7.00%
--------- ---------- ------ ------ ----------
Total
Balance $ 8,065 $ 19,418 $9,143 $1,576 $ 38,202
Weighted average yield 5.84% 5.90% 4.97% 5.09% 5.63%
</TABLE>
The Company does not engage in, nor does it presently intend to engage in,
securities trading activities and therefore does not maintain a trading account.
At December 31, 1998, there were no securities of any issuer (other than
U.S. government agencies) that exceeded 10% of the Company's shareholders'
equity.
DEPOSITS
The Company provides a range of deposit services, including non-interest
bearing checking accounts, interest bearing checking and savings accounts, money
market accounts and certificates of deposit. These accounts generally earn
interest at rates established by management based on competitive market factors
and management's desire to increase or decrease certain types or maturities of
deposits. The Company does not pay brokerage commissions to attract deposits. It
strives to establish customer relations to attract core deposits in non-interest
bearing transactional accounts and thus to reduce its costs of funds.
The following table sets forth for the periods indicated the average
balances outstanding and average interest rates for each major category of
deposits.
11
<PAGE> 15
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------
1998 1997 1996
-------------------- ------------------- -------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
-------- ----- -------- ----- ------- -------
<S> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Interest bearing demand & money
market accounts $ 55,320 2.87% $ 40,600 2.94% $28,753 2.57%
Savings 23,227 3.13 21,789 3.57 20,036 3.51
Time deposits 61,361 5.62 42,220 5.65 26,777 5.61
-------- ----- -------- ----- ------- -----
Total interest bearing deposits $139,908 $104,609 $75,566
Demand and other noninterest bearing
deposits 27,939 23,310 17,487
-------- -------- -------
Total average deposits $167,847 4.12% $127,919 4.17% $93,053 3.90%
======== ===== ======== ===== ======= =====
</TABLE>
The following table sets forth at the dates indicated the amounts and
maturities of certificates of deposit with balances of $100,000 or more at
December 31, 1998:
<TABLE>
<CAPTION>
DECEMBER 31, 1998
--------------------
<S> <C>
(DOLLARS IN THOUSANDS)
Remaining maturity:
Less than three months $ 6,930
Three to six months 3,101
Six to twelve months 7,570
Over twelve months 2,057
-------
$19,658
=======
</TABLE>
SHORT-TERM BORROWING
At December 31, 1998, 1997 and 1996, there were no short-term (original
maturity of one year or less) borrowings that exceeded 30 percent of
shareholders' equity at the end of the period.
SUPERVISION AND REGULATION
The Company is a bank holding company within the meaning of the Bank Holding
Company Act of 1956 registered with and subject to examination by the Federal
Reserve Board ("FRB"). The Company's Bank subsidiary is a Washington state
chartered bank and is subject to examination, supervision, and regulation by the
Division. The Federal Deposit Insurance Corporation ("FDIC") insures the Bank's
deposits and in that capacity, also regulates the Bank.
The Company's earnings and activities are affected by legislation, by
actions of the FRB, FDIC and other regulators, and by local legislative and
administrative bodies and decisions of courts in Washington state. For example,
these include limitations on the ability of the Bank to pay dividends to the
Company, numerous federal and state consumer protection laws imposing
requirements on the making, enforcement, and collection of consumer loans, and
restrictions by regulators on the sale of mutual funds and other uninsured
investment products to customers.
12
<PAGE> 16
Legislation may be enacted or regulations imposed to further regulate
banking and financial services or to limit finance charges or other fees or
charges earned in such activities. There can be no assurance whether any such
legislation or regulation will place additional limitations on the Company's
operations or adversely affect its earnings.
Federal law imposes certain restrictions on transactions between the Company
and its nonbank subsidiaries, on the one hand, and the Bank on the other. With
certain exceptions, federal law also imposes limitations on, and requires
collateral for, extensions of credit by insured depository institutions, such as
the Bank, to their nonbank affiliates, such as the Company.
Subject to certain limitations and restrictions, a bank holding company,
with prior approval of the FRB, may acquire an out-of-state bank. Banks in
states that do not prohibit out-of-state mergers may merge with the approval of
the appropriate federal banking agency. A state bank may establish a de novo
branch out of state if such branching is expressly permitted by the other state.
The activities of bank holding companies are generally limited to managing
or controlling banks. Nonbank acquisitions are generally limited to 5% of voting
shares unless the FRB determines that the acquisition is so closely related to
banking as to be a proper incident to banking or managing or controlling banks.
Among other things, applicable federal and state statutes and regulations
which govern a bank's activities relate to minimum capital requirements,
required reserves against deposits, investments, loans, legal lending limits,
mergers and consolidations, borrowings, issuance of securities, payment of
dividends, establishment of branches and other aspects of its operations. The
Division and the FDIC also have authority to prohibit banks under their
supervision from engaging in what they consider to be unsafe and unsound
practices.
The Company and the Bank are subject to risk-based capital and leverage
guidelines issued by federal banking agencies for banks and bank holding
companies. These agencies are required by law to take specific prompt corrective
actions with respect to institutions that do not meet minimum capital standards
and have defined five capital tiers, the highest of which is "well-capitalized."
As of December 31, 1998, the Company and the Bank were "well capitalized."
The Bank is required to file periodic reports with the FDIC and the Division
and is subject to periodic examinations and evaluations by those regulatory
authorities. These examinations must be conducted every 12 months, except that
certain well-capitalized banks may be examined every 18 months. The FDIC and the
Division may each accept the results of an examination by the other in lieu of
conducting an independent examination.
In the liquidation or other resolution of a failed insured depository
institution, deposits in offices and certain claims for administrative expenses
and employee compensation are afforded a priority over other general unsecured
claims, including non-deposit claims, and claims of a parent company such as the
Company. Such priority creditors would include the FDIC, which succeeds to the
position of insured depositors.
The Company is also subject to the information, proxy solicitation, insider
trading restrictions and other requirements of the Securities Exchange Act of
1934.
ITEM 2. PROPERTIES
The Company owns the property and buildings of its branches at Oak Harbor
(2), Coupeville, Burlington, Camano Island, Clinton and Bellingham, and leases
the building and property of its branch at Langley. The property and building of
the Company's Whidbey City branch were sold in 1998. The Company owns the
building housing its Anacortes branch, which is situated on land leased to the
Company. The Company also owns separate parcels of real property in Freeland
(where the Company opened a full service branch during 1998) and Bellingham
(where the Company has relocated its current Bellingham office March 1999).
The Company also leases space for its grocery store branch on Camano Island,
which opened in the second quarter of 1998. In addition to the branch offices
and leased property for the real estate mortgage dpartment and dealer center
building, the Company's administrative offices in Oak Harbor occupy
approximately 10,000 square feet, of which approximately 6,000 square feet are
13
<PAGE> 17
situated on property owned by the Company and approximately 4,000 square feet
are situated on property leased by the Company.
ITEM 3. LEGAL PROCEEDINGS
The Company is currently subject and party to various legal actions arising
out of the normal course of business. Management believes the ultimate
liability, if any, arising from such claims or contingencies is not likely to
have a material adverse effect on the Company's results of operations or
financial conditions
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
For information concerning the Company's common stock and related security
holder matters, see "Quarterly Common Stock Prices and Dividend Payments" at
page 34 of the Annual Report, which is incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
The following sets forth selected consolidated financial unaudited
information about the Company. This information is derived in part from the
audited consolidated financial statements and notes thereto of the Company
included in the Annual Report and should be read in conjunction with the
Company's financial statements and the Management Discussion in the Annual
Report.
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
OPERATING DATA:
Total interest income $ 15,236 $ 11,901 $ 8,858
Total interest expense 5,765 4,358 2,946
---------- ---------- ----------
Net interest income 9,471 7,543 5,912
Provisions for loan losses 735 647 350
---------- ---------- ----------
Net interest income after provision 8,736 6,896 5,562
Service charges on deposits 1,172 1,116 1,024
Other noninterest income 763 550 400
---------- ---------- ----------
Total noninterest income 1,935 1,666 1,424
Noninterest expense 7,535 5,840 4,684
---------- ---------- ----------
Income before income taxes 3,136 2,722 2,302
Provision for income taxes 924 818 738
---------- ---------- ----------
Net income $ 2,212 $ 1,904 $ 1,564
========== ========== ==========
Average number of shares outstanding, basic 3,525,883 2,810,881 2,796,000
Average number of shares outstanding, diluted 3,769,244 2,935,972 2,858,100
</TABLE>
14
<PAGE> 18
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31,
-------------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
PER SHARE DATA:
Net income per share, basic $ 0.63 $ 0.68 $ 0.56
Net income per share, diluted 0.59 0.65 0.55
Book value 7.09 4.64 4.14
Dividends 0.14 0.13 0.12
BALANCE SHEET DATA:
Total assets $ 220,493 $ 160,068 $ 117,280
Loans receivable, net of unearned fees 149,617 117,535 81,269
Allowance for loan losses 1,745 1,296 796
Real estate owned -- 30 --
Fed funds sold 4,100 1,750 500
Deposits 189,698 146,394 105,212
Shareholders' equity 29,691 13,035 11,570
SELECTED PERFORMANCE RATIOS:
Return on average assets 1.16% 1.35% 1.49%
Return on average equity 10.31 15.21 13.91
Net interest margin 5.56 5.94 6.27
Net interest spread 4.74 5.13 5.44
Noninterest expense to average assets 3.96 4.13 4.46
Efficiency ratio 66.06 63.42 63.85
Dividend payout ratio 22.22 19.12 21.43
ASSET QUALITY RATIOS:
Nonperforming loans to period-end loans 0.57% 0.98% 1.44%
Allowance for loan losses to period-end loans 1.17 1.10 0.98
Allowance for loan losses to nonperforming loans 206.02 112.60 67.98
Nonperforming assets to total assets 0.38 0.74 1.00
Net loan charge-offs to average loans outstanding
CAPITAL RATIOS:
Tier 1 risk-based capital 15.99% 11.63% 14.97%
Total risk-based capital 14.93 10.67 14.00
Leverage ratio 11.67 8.08 10.19
Equity to assets ratio 13.47 8.14 9.87
OTHER DATA:
Number of banking offices 12 9 8
Number of full time equivalent employees(1) 145 116 90
</TABLE>
(1) The increase in full-time equivalent employees in 1998 reflected branch
openings and additional increases in lending personnel and executive and
administative personnel.
15
<PAGE> 19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
For management's discussion and analysis of the Company's financial
condition and results of operations, see Management Discussion at pages 26
through 34 of the Annual Report which is incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For a discussion of interest rate sensitivity see Management Discussion at
pages 31 and 32 of the Annual Report, which is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
For consolidated financial statements of the Company, see the consolidated
financial statements beginning at page 4 of the Annual Report which is
incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS IN ACCOUNTING AND
FINANCIAL DISCLOSURE
For discussion of the Company's change in accountants in 1997, see "Recent
Changes in Accounting Firms" at page 34 of the Annual Report which is
incorporated herein by reference.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning directors of the registrant is incorporated herein by
reference to the section entitled "Election of Directors" beginning at page 3 of
the Company's definitive Proxy Statement dated March 26, 1999 (the "Proxy
Statement") for the annual meeting of shareholders to be held April 29, 1999.
The required information with respect to the executive officers of the
Company is included under the caption "Executive Officers of the Company" in
Part I of this report. Part I of this report is incorporated herein by
reference.
The required information with respect to compliance with Section 16(a) of
the Exchange Act is incorporated herein by reference to the section entitled
"Beneficial Ownership and Section 16(a) Reporting Compliance" beginning at page
12 of the Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
For information concerning executive compensation see "Executive
Compensation" beginning at page 7 of the Proxy Statement, which is incorporated
herein by reference. The Report of the Compensation Committee on Executive
Compensation which is contained in the Proxy Statement is not incorporated by
this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
For information concerning security ownership of certain beneficial owners
and management see "Security Ownership of Certain Beneficial Owners and
Management" beginning at page 2 of the Proxy Statement, which is incorporated
herein by reference.
16
<PAGE> 20
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
For information concerning certain relationships and related transactions,
see "Interest of Management in Certain Transactions" beginning at page 13 of the
Proxy Statement, which is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
List of Financial Statements and Financial Statement Schedules.
(a) (1) Financial Statements:
The following consolidated financial statements of the Company,
included in the Annual Report of the registrant to its
shareholders for the year ended December 31, 1998, are
incorporated by reference in Item 8:
<TABLE>
<CAPTION>
PAGE
- ----
<S> <C>
2&3 Reports of Independent Auditors
4 Consolidated Statements of Financial Condition--December 31, 1998 and 1997
5 Consolidated Statements of Income--Years ended December 31, 1998, 1997 and 1996
6 Consolidated Statements of Shareholders' Equity and Comprehensive
Income--Years ended December 31, 1998, 1997 and 1996
7 Consolidated Statements of Cash Flows--Years ended December 31, 1998, 1997 and 1996
8 Notes to Consolidated Financial Statements
(2) Exhibits:
See "Index of Exhibits" at page 20 of this Form 10-K.
(b) Reports on Form 8-K:
None
</TABLE>
17
<PAGE> 21
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on the 29th day of March,
1999.
Washington Banking Company
(Registrant)
By /s/ Michal D. Cann
-------------------------------------
Michal D. Cann
President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated, on the 29th day of March, 1999.
Principal Executive Officer:
By /s/ Michal D. Cann
-------------------------------------
Michal D. Cann
President and
Chief Executive Officer
Principal Financial Officer:
By /s/ Phyllis A. Hawkins
-------------------------------------
Phyllis A. Hawkins
Senior Vice President and
Chief Financial Officer
18
<PAGE> 22
Michal D. Cann, pursuant to a power of attorney which is being filed with this
Annual Report on Form 10-K, has signed this report on March 29, 1999, as
attorney-in-fact for the following directors who constitute a majority of the
board of directors.
Orlan D. Dean Anthony B. Pickering
Marlen L. Knutson Larry Scodeller
Karl C. Krieg, III Edward J. Wallgren
Jay T. Lien
By /s/ Michal D. Cann
-------------------------------------
Michal D. Cann
Attorney-in-fact
March 29, 1999
19
<PAGE> 23
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT DESCRIPTION
----------- -------------------
<S> <C>
3 (a) Articles of Amendment to Articles of Incorporation of the Company(1)
(b) Amended and Restated Articles of Incorporation of the Company(1)
(c) Bylaws of the Company(1)
10 (a) 1992 Employee Stock Option Plan(2)
(b) 1993 Director Stock Option Plan(1)
(c) 1998 Stock Option and Restricted Stock Award Plan(2)
(d) Form of Severance Agreement(1)
13 The Company's Annual Report to Shareholders for fiscal year ended December 31, 1998(3)
21 Subsidiaries of the Company are:
(a) Whidbey Island Bank, Oak Harbor, Washington
24 Power of Attorney dated March 18, 1999
27 Financial Data Schedule
</TABLE>
- ---------------
(1) Incorporated by reference to the Form SB-2 (Registration No. 333-49925)
previously filed by the Company, declared effective on June 22, 1998.
(2) Incorporated by reference to the definitive proxy statement dated
August 19, 1998 for the Annual Meeting of Shareholders held September 24,
1998.
(3) Portions of the Annual Report to Shareholders have been specifically
incorporated by reference elsewhere in this report.
20
<PAGE> 1
EXHIBIT 13
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Washington Banking Company:
We have audited the accompanying consolidated statements of financial condition
of Washington Banking Company and subsidiary as of December 31, 1998 and 1997,
and related consolidated statements of income, sahreholders' equity and
comprehensive income and cash flows for the years then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the 1998 and 1997 consolidated financial statements referred
to above, present fairly, in all material respects, the financial position of
Washington Banking Company and subsidiary as of December 31, 1998 and 1997, and
the results of their operations and their cash flows for the years then ended
in conformity with generally accepted accounting principles.
/s/ KPMG LLP
Seattle, Washington
February 5, 1999
[KPMG logo]
2
<PAGE> 2
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Washington Banking Company:
We have audited the accompanying consolidated statements of income,
stockholders' equity, and cash flows of Washington Banking Company and
subsidiaries for the year ended December 31, 1996. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on the financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatements. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and the significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of operations and the cash
flows of Washington Banking Company and subsidiaries for the year ended December
31, 1996 in conformity with generally accepted accounting principles.
/s/ DAVID O. CHRISTENSEN
- ----------------------------------------
David O. Christensen
Vancouver, Washington
January 31, 1997
3
<PAGE> 3
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION -
December 31, 1998 and 1997
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
ASSETS
Cash and due from banks $ 12,063 6,263
Interest bearing deposits 8,089 --
Federal funds sold 4,100 1,750
-------- --------
Total cash and cash equivalents 24,252 8,013
-------- --------
Federal Home Loan Bank stock 736 682
Investment securities, available for sale 12,591 5,521
Investment securities, held to maturity 24,875 23,508
-------- --------
Total investment securities 38,202 29,711
-------- --------
Loans receivable, net 147,872 116,239
Premises and equipment, net 8,046 4,287
Other real estate owned -- 30
Deferred tax asset 419 370
Other assets 1,702 1,418
-------- --------
Total assets $220,493 160,068
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits $189,698 146,394
Other liabilities 1,104 639
-------- --------
Total liabilities 190,802 147,033
-------- --------
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 4,189,050 and
2,809,050 shares in 1998 and 1997, respectively 17,836 2,943
Retained earnings 11,805 10,075
Accumulated other comprehensive income, net 50 17
-------- --------
Total shareholders' equity 29,691 13,035
-------- --------
Total liabilities and shareholders' equity $220,493 160,068
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 4
CONSOLIDATED STATEMENTS OF INCOME -
Years ended December 31, 1998, 1997, and 1996
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Income:
Interest and fees on loans $ 12,910 10,207 7,334
Interest on taxable investment securities 1,097 1,082 1,055
Interest on tax-exempt investment securities 634 460 318
Dividends on FHLB stock 54 36 25
Interest on Federal funds sold 298 116 126
Interest on interest bearing deposits 243 -- --
---------- ---------- ----------
Total interest income 15,236 11,901 8,858
Interest expense 5,765 4,358 2,946
---------- ---------- ----------
Net interest income 9,471 7,543 5,912
Provision for loan losses 735 647 350
---------- ---------- ----------
Net interest income after provision
for loan losses 8,736 6,896 5,562
---------- ---------- ----------
Noninterest income:
Service charges on deposits 1,172 1,116 1,024
Other 763 550 400
---------- ---------- ----------
Total noninterest income 1,935 1,666 1,424
---------- ---------- ----------
Noninterest expense:
Salaries and benefits 3,189 2,434 2,019
Occupancy expense 1,455 1,033 745
Office supplies and printing 365 275 220
Insurance expense 373 271 251
Data processing 260 219 125
Consulting and professional fees 175 202 165
Other 1,718 1,406 1,159
---------- ---------- ----------
Total noninterest expense 7,535 5,840 4,684
---------- ---------- ----------
Income before income taxes 3,136 2,722 2,302
Provision for income taxes 924 818 738
---------- ---------- ----------
Net income $ 2,212 1,904 1,564
========== ========== ==========
Net income per share, basic $ 0.63 0.68 0.56
========== ========== ==========
Net income per share, diluted $ 0.59 0.65 0.55
========== ========== ==========
Average number of shares outstanding, basic 3,525,883 2,810,881 2,796,000
========== ========== ==========
Average number of shares outstanding, diluted 3,769,244 2,935,972 2,858,100
========== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 5
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
Years ended December 31, 1998, 1997, and 1996
(Dollars and shares in thousands, except per share data)
<TABLE>
<CAPTION>
COMMON STOCK ACCUMULATED OTHER TOTAL
---------------------- RETAINED COMPREHENSIVE INCOME, SHAREHOLDERS'
SHARES AMOUNT EARNINGS NET OF TAX EQUITY
------ ------ -------- ---------- ------
<S> <C> <C> <C> <C> <C>
Balances at December 31, 1995 2,796 $ 3,032 7,299 26 10,357
Cash dividend at $0.12 per share -- -- (336) -- (336)
Net change in unrealized gain (loss)
on securities available for sale -- -- -- (15) (15)
Net income -- -- 1,564 -- 1,564
----- -------- ------ --- ------
Balances at December 31, 1996 2,796 3,032 8,527 11 11,570
Cash dividend at $0.13 per share -- -- (356) -- (356)
Net change in unrealized gain (loss)
on securities available for sale -- -- -- 6 6
Net income -- -- 1,904 -- 1,904
Repurchased and retired stock (23) (200) -- -- (200)
Stock options exercised 36 111 -- -- 111
----- -------- ------ --- ------
Balances at December 31, 1997 2,809 2,943 10,075 17 13,035
Cash dividend at $0.14 per share -- -- (482) -- (482)
Net change in unrealized gain (loss)
on securities available for sale -- -- -- 33 33
Net income -- -- 2,212 -- 2,212
Net offering proceeds 1,380 14,893 -- -- 14,893
----- -------- ------ --- ------
Balances at December 31, 1998 4,189 $ 17,836 11,805 50 29,691
===== ======== ====== === ======
</TABLE>
Comprehensive Income:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
----------------------------------
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Net income $2,212 1,904 1,564
Increase in unrealized gain on securities
available for sale, net of tax 33 6 (15)
------ ------ ------
Comprehensive income $2,245 1,910 1,549
====== ====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE> 6
CONSOLIDATED STATEMENTS OF CASH FLOWS -
Years ended December 31, 1998, 1997, and 1996
(Dollars in thousands)
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 2,212 1,904 1,564
Adjustments to reconcile net income to net cash
provided by operating activities:
Federal Home Loan Bank stock dividends (54) (36) (25)
Deferred income tax benefit (67) (99) (11)
Amortization/accretion of investment
premiums/discounts, net 90 271 (4)
Provision for loan losses 735 647 350
Depreciation of premises and equipment 416 323 248
Loss (gain) on sale of premises and equipment (49) 2 --
Net increase in other assets (284) (324) (132)
Net increase (decrease) in other liabilities 465 141 (93)
Gain on the sale of other real estate owned -- -- (30)
-------- -------- --------
Net cash provided by operating activities 3,464 2,829 1,867
-------- -------- --------
Cash flows from investing activities:
Purchases of investment securities, available for sale (9,000) (2,860) (3,500)
Maturities of investment securities, available for sale 2,000 2,000 4,000
Purchases of investment securities, held to maturity (8,031) (6,770) (8,455)
Maturities of investment securities, held to maturity 6,555 3,980 4,715
Net increase in loans (32,368) (36,443) (18,411)
Purchases of premises and equipment (4,359) (1,097) (641)
Proceeds from sale of premises and equipment 233 6 --
Purchases of Federal Home Loan Bank stock -- (324) (22)
Proceeds from sales of other real estate owned 30 -- 138
-------- -------- --------
Net cash used in investing activities (44,940) (41,508) (22,176)
-------- -------- --------
Cash flows from financing activities:
Net increase in deposits 43,304 41,182 16,706
Dividends paid on common stock (482) (356) (336)
Proceeds from stock options exercised -- 111 --
Cash paid for common stock retired -- (200) --
Net proceeds from stock issued 14,893 -- --
-------- -------- --------
Net cash provided by financing activities 57,715 40,737 16,370
-------- -------- --------
Net increase (decrease) in cash and
cash equivalents 16,239 2,058 (3,939)
Cash and cash equivalents at beginning of year 8,013 5,955 9,894
-------- -------- --------
Cash and cash equivalents at end of year $ 24,252 8,013 5,955
======== ======== ========
Supplemental information:
Loans foreclosed and transferred to real estate owned $ -- 30 --
Cash paid for interest 5,689 4,236 2,907
Cash paid for taxes 945 1,000 736
-------- -------- --------
</TABLE>
See accompanying notes to consolidated financial statements.
7
<PAGE> 7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Description of Business
Washington Banking Company (WBCO), 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-chartered 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.
Effective June 23, 1998, the Company sold 1,380,000 shares of its
common stock at a subscription price of $12 per share, resulting in
net proceeds to the Company of $14,893.
(b) Basis of Presentation
The accompanying consolidated financial statements include the
accounts of Washington Banking Company and its wholly-owned
subsidiary, Whidbey Island Bank (Company). The consolidated
financial statements of the Company have been prepared in conformity
with generally accepted accounting principles. In preparing the
consolidated financial statements, management makes estimates and
assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
income and expense during the reported periods. Actual results could
differ from these estimates. All significant intercompany balances
and transactions have been eliminated in consolidation.
(c) Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents
include cash on hand and due from banks and Federal funds sold,
having original maturities of three months or less.
(d) Investment Securities
Investment securities available for sale include securities that
management intends to use as part of its overall asset/liability
management strategy and that may be sold in response to changes in
interest rates and resultant prepayment risk and other related
factors. Securities available for sale are carried at fair value,
and unrealized gains and losses (net of related tax effects) are
excluded from net income but are included in comprehensive income.
Upon realization, such gains and losses will be included in net
income using the specific identification method.
Investment securities held to maturity are comprised of debt
securities for which the Bank has positive intent and ability to
hold to maturity and are carried at cost, adjusted for amortization
of premiums and accretion of discounts using the interest method
over the estimated lives of the securities.
Management determines the appropriate classification of investment
securities at the purchase date.
(e) Loans Receivable, Net
Loans receivable, net, are stated at the unpaid principal balance,
net of premiums, unearned discounts, net deferred loan origination
fees, and the allowance for loan losses.
Loans are placed on nonaccrual status when collection of principal
or interest is considered doubtful (generally loans past due 90 days
or more).
8
<PAGE> 8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A loan is considered impaired when, based upon currently known
information, it is deemed probable that the Company will be unable
to collect all amounts due according to the original terms of the
agreement. Impaired loans are measured based on the present value of
expected future cash flows discounted at the loan's effective
interest rate or, as a practical expedient, based on the loan's
observable market price or the fair value of collateral, if the loan
is collateral dependent.
Interest income previously accrued on nonaccrual and impaired loans,
but not yet received, is reversed in the current period. Interest
subsequently recovered is credited to income in the period
collected.
Loan fees and certain direct loan origination costs are deferred,
and the net fee or cost is recognized in interest income using the
interest method over the estimated life of the individual loans,
adjusted for actual prepayments. Amortization of deferred loan
origination fees are suspended during periods in which the related
loan is in nonaccrual status.
(f) Allowance for Loan Losses
A valuation allowance for loans is based on management's estimate of
the amount necessary to recognize possible losses inherent in the
loan portfolio. In determining the level to be maintained,
management evaluates many factors including the borrowers' ability
to repay, the value of underlying collateral, historical loss
experience, delinquency analyses, and economic and market trends and
conditions. In the opinion of management, the allowance is adequate
to absorb reasonably foreseeable loan losses.
While management uses available information to recognize losses on
these loans, future additions to the allowance may be necessary
based on changes in economic conditions. In addition, various
regulatory agencies, as an integral part of their examination
process, periodically review the Bank's allowance for loan losses.
Such agencies may require the Bank to make additions to the
allowance based on their judgments about information available to
them at the time of their examinations.
(g) Other Real Estate Owned
All real estate acquired in satisfaction of a loan is considered
held for sale and reported as "real estate owned." Real estate owned
is carried at the lower of cost or fair value less estimated cost of
disposal.
(h) Premises and Equipment
Premises and equipment are stated at cost less accumulated
depreciation. Depreciation and amortization are computed using the
straight-line method over the estimated useful lives of the assets.
The estimated useful lives used to compute depreciation include
buildings and building improvements, 15 to 40 years; land
improvements, 10 to 25 years; and furniture, fixtures, and
equipment, 3 to 15 years.
(i) Federal Income Taxes
The Company files a consolidated federal income tax return. Deferred
tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income
in the periods in which those temporary differences are expected to
be recovered or settled. The effect on the deferred tax assets and
liabilities of a change in tax rate is recognized in income in the
period that includes the enactment date.
(j) Federal Home Loan Bank Stock
The Company's investment in Federal Home Loan Bank (FHLB) stock is
carried at par value, which approximates its fair value. As a member
of the FHLB system, the Company is required to maintain a minimum
level of investment in FHLB stock based on specific percentages of
its outstanding mortgages, total
9
<PAGE> 9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
assets or FHLB advances. At December 31, 1998, the Company's minimum
required investment was approximately $647. The Company may request
redemption at par value of any stock in excess of the minimum
required investment. Stock redemptions are at the discretion of the
FHLB.
(k) Stock Based Compensation
The Company measures its employee stock-based compensation
arrangements using the provisions outlined in Accounting Principles
Board (APB) Opinion No.25, Accounting for Stock Issued to Employees,
which is an intrinsic value-based method of recognizing compensation
costs. As none of the Company's stock options have any intrinsic
value at grant date, no compensation cost has been recognized for
its stock option plans.
(l) Comprehensive Income
Effective January 1, 1998, the Company adopted Statement of
Financial Accounting Standards (SFAS) No. 130, Reporting
Comprehensive Income. This SFAS establishes standards for reporting
and displaying comprehensive income and its components in
general-purpose financial statements. For the Company comprehensive
net income includes net income and changes in unrealized gains or
losses on available for sale investment securities, net of tax.
(m) Recent Financial Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 131,
"Disclosures about Segments of and Enterprise and Related
Information" ("SFAS 131"). SFAS 131 requires public companies to
report financial and descriptive information about its operating
segments. Operating segments are components of a business about
which separate financial information is available that is evaluated
regularly by the chief operating decision-maker in deciding how to
allocate resources and in assessing performance. The Company
implemented SFAS 131 in fiscal year 1998. The adoption of SFAS 131
did not have a material impact on the financial position or results
of operations of the Company.
In June 1998, the FASB issued SFAS Statement No. 133 ("SFAS 133"),
Accounting for Derivative Instruments and Hedging Activities, which
is required to be adopted by the Company in the year 2000. SFAS 133
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. Management does not expect
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 Mortgagee 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 securities."
However, if the mortgage banking enterprise plans on selling
mortgage backed securities before or during the securitization
process, it must be classified as "trading securities." This
statement is effective for the first quarter beginning after
December 15, 1998. The Company does not expect that the adoption of
SFAS 134 will have a material impact on its financial position or
results of operations.
Statement of Position No. 98-5 "Reporting on the Costs of Start-Up
Activities," effective for the Company January 1, 1999, requires
costs of start-up activities and organization costs to be expensed
as incurred. It is not expected that the adoption of this statement
will have a material effect on the Company's operating results of
financial condition.
(n) Reclassifications
Certain amounts in 1996 and 1997 have been reclassified to conform
with the 1998 financial statement presentation.
(2) RESTRICTIONS ON CASH BALANCES
The Company is required to maintain an average reserve with the Federal
Reserve Bank or maintain such reserve balance in the form of cash. The
amount of required reserve balance on December 31, 1998 and 1997 was
approximately $1,236 and $511, respectively, and was met by holding cash
and maintaining an average balance with the Federal Reserve Bank.
10
<PAGE> 10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) INVESTMENT SECURITIES
The amortized costs and estimated market values of investment securities
at December 31, 1998 and 1997 are summarized as follows:
<TABLE>
<CAPTION>
1998
AMORTIZED GROSS UNREALIZED GROSS UNREALIZED ESTIMATED MARKET
COST GAINS LOSSES VALUE
--------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Investments available for sale:
U.S. Treasury securities $ 5,008 60 -- 5,068
U.S. Government agency securities 7,508 18 (3) 7,523
------- ------- ------- -------
Total investment securities
available for sale $12,516 78 (3) 12,591
======= ======= ======= =======
Investments held to maturity:
U.S. Treasury securities $ 500 1 -- 501
U.S. Government agency securities 998 12 -- 1,010
State and political subdivisions 16,502 684 (1) 17,185
Corporate obligations 6,875 100 (4) 6,971
------- ------- ------- -------
Total investment securities
held to maturity $24,875 797 (5) 25,667
======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
1997
AMORTIZED GROSS UNREALIZED GROSS UNREALIZED ESTIMATED MARKET
COST GAINS LOSSES VALUE
--------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Investments available for sale:
U.S. Treasury securities $ 4,996 26 -- 5,022
U.S. Government agency securities 500 -- (1) 499
------- ------- ------- -------
Total investment securities
available for sale $ 5,496 26 (1) 5,521
======= ======= ======= =======
Investments held to maturity:
U.S. Treasury securities $ 997 2 -- 999
U.S. Government agency securities 4,996 21 (5) 5,012
State and political subdivisions 9,796 257 (3) 10,050
Corporate obligations 7,648 52 (8) 7,692
Other investments 71 -- -- 71
------- ------- ------- -------
Total investment securities
held to maturity $23,508 332 (16) 23,824
======= ======= ======= =======
</TABLE>
The amortized cost and fair value of investment securities by contractual
maturity at December 31, 1998 are as shown below:
11
<PAGE> 11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Dates of maturities
--------------------------------------------------------------
Under 1 1-5 Over 5 to Over 10
year years 10 years years Total
------ ------ -------- ------ ------
<S> <C> <C> <C> <C> <C>
Investments available for sale:
U.S. Treasury securities:
Amortized cost $3,003 2,005 -- -- 5,008
Market value 3,020 2,048 -- -- 5,068
U.S. Government agency securities: -- --
Amortized cost 3,008 4,500 -- -- 7,508
Market value 3,013 4,510 -- -- 7,523
Total:
------ ------ ------ ------ ------
Amortized cost $6,011 6,505 -- -- 12,516
Market value 6,033 6,558 -- -- 12,591
====== ====== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
Dates of maturities
--------------------------------------------------------------
Under 1 1-5 Over 5 to Over 10
year years 10 years years Total
------ ------ -------- ------ ------
<S> <C> <C> <C> <C> <C>
Investments held to maturity:
U.S. Treasury securities:
Amortized cost $ 500 -- -- -- 500
Market value 501 -- -- -- 501
U.S. Government agency securities:
Amortized cost 500 498 -- -- 998
Market value 503 507 -- -- 1,010
State and political subdivisions:
Amortized cost 525 5,994 8,407 1,576 16,502
Market value 530 6,206 8,802 1,647 17,185
Corporate bonds and other:
Amortized cost 507 6,368 -- -- 6,875
Market value 507 6,464 -- -- 6,971
------ ------ ------ ------ ------
Total:
Amortized cost $2,032 12,860 8,407 1,576 24,875
Market value 2,041 13,177 8,802 1,647 25,667
====== ====== ====== ====== ======
</TABLE>
Included in other assets is accrued interest on investment securities
amounting to $385 and $407 as of December 31, 1998 and 1997, respectively.
At December 31, 1998 and 1997, investment securities with amortized cost
values of $997 and $997, respectively, were pledged to secure public
deposits and for other purposes as required or permitted by law.
There were no sales of investment securities during the years ended
December 31, 1998, 1997, and 1996.
12
<PAGE> 12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4) LOANS AND ALLOWANCE FOR LOAN LOSSES
The loan-portfolio composition, based upon the purpose and primary source
of repayment of the loans, is as follows:
<TABLE>
<CAPTION>
DECEMBER 31
------------------------
1998 1997
-------- --------
<S> <C> <C>
Commercial loans $ 65,564 48,242
Real estate loans 29,198 22,969
Real estate construction loans 14,139 12,646
Consumer loans 40,750 33,721
-------- --------
149,651 117,578
Less:
Allowance for loan losses 1,745 1,296
Net deferred loan fees 34 43
-------- --------
Net loans $147,872 116,239
======== ========
</TABLE>
As of December 31, 1998 and 1997, the Company had loans to persons serving
as directors and executive officers, and to entities related to such
individuals aggregating $1,890 and $1,752, respectively. All loans were
made on essentially the same terms and conditions as comparable
transactions with other persons, and do not involve more than the normal
risk of collectibility.
The Company's legal lending limit was approximately $4,900 and $2,700 as
of December 31, 1998 and 1997, respectively.
Included in other assets is accrued interest on loans receivable amounting
to $960 and $772 as of December 31, 1998 and 1997, respectively.
The following is an analysis of the changes in the allowance for loan
losses:
<TABLE>
<CAPTION>
DECEMBER 31
---------------------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Beginning balance $ 1,296 796 620
Provision for loan losses 735 647 350
Recoveries 27 13 55
Charge-offs (313) (160) (229)
------- ------- -------
Ending balance $ 1,745 1,296 796
======= ======= =======
</TABLE>
At December 31, 1998 and 1997, the Company had impaired loans of $1,094
and $1,162, respectively. Of these impaired loans, $215 and $285 have
related valuation allowances of $261 and $112, while $838 and $877 did not
require a valuation allowance. Average impaired loans for 1998 and 1997
totaled $1,128 and $1,350, respectively. The Company has no commitment to
extend additional credit on loans which are nonaccrual or impaired at
December 31, 1998.
If interest income on impaired loans had been accrued in accordance with
their original terms, approximately $60, $40 and $42 of interest income
would have been recorded for the years ended December 31, 1998, 1997 and
1996, respectively.
13
<PAGE> 13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) PREMISES AND EQUIPMENT
Premises and equipment consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31
----------------------
1998 1997
------- -------
<S> <C> <C>
Land and buildings $ 5,226 3,063
Furniture and equipment 2,508 2,011
Land improvements 263 218
Computer software 512 359
Construction in progress 2,029 898
------- -------
10,538 6,549
Less accumulated depreciation 2,492 2,262
------- -------
$ 8,046 4,287
======= =======
</TABLE>
(6) DEPOSITS
Deposits at December 31 are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31
------------------------
1998 1997
-------- --------
<S> <C> <C>
Certificates of deposit $ 64,697 56,148
Passbook and savings accounts 25,517 21,710
Money market accounts 29,821 20,602
NOW accounts 36,214 23,917
Non-interest bearing demand 33,449 24,017
-------- --------
$189,698 146,394
======== ========
</TABLE>
Certificates of deposit at December 31, 1998 mature as follows:
<TABLE>
<CAPTION>
LESS THAN 1 TO 2 2 TO 3 3 TO 4 4 TO 5
1 YEAR YEARS YEARS YEARS YEARS TOTAL
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Time deposits of $100,000 or more $17,601 1,624 103 201 129 19,658
All other time deposits 39,205 4,726 293 596 219 45,039
------- ------- ------- ------- ------- -------
$56,806 6,350 396 797 348 64,697
======= ======= ======= ======= ======= =======
</TABLE>
(7) INCOME TAXES
Federal income tax expense (benefit) at December 31 consists of the
following:
14
<PAGE> 14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
1998 1997 1996
----- ----- -----
<S> <C> <C> <C>
Current tax expense $ 991 917 750
Deferred tax benefit (67) (99) (12)
----- ----- -----
$ 924 818 738
===== ===== =====
</TABLE>
The following table presents major components of the net deferred federal
income tax asset resulting from differences between financial reporting
and tax bases at December 31:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Deferred tax assets:
Loan loss allowances $506 374
Deferred compensation 75 76
Deferred loan fees -- 15
Other -- --
---- ----
Total deferred tax assets 581 465
---- ----
Deferred tax liabilities:
Premises and equipment 97 66
FHLB stock 39 21
Market value adjustment of investment securities available for sale 26 8
---- ----
Total deferred tax liabilities 162 95
---- ----
Deferred tax assets, net $419 370
==== ====
</TABLE>
A reconciliation between the statutory federal income tax rate and the
effective tax rate is as follows:
<TABLE>
<CAPTION>
DECEMBER 31
---------------------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Income tax expense at federal statutory rate $ 1,066 925 783
Interest income on tax-exempt securities (216) (129) (99)
Other, net 74 22 54
------- ------- -------
$ 924 818 738
======= ======= =======
</TABLE>
There was no valuation allowance for deferred tax assets as of December
31, 1998, 1997 and 1996. The Company has determined that it is not
required to establish a valuation allowance for the deferred tax assets as
management believes it is more likely than not that the deferred tax asset
of $581 and $465 at December 31, 1998 and 1997, respectively, will be
realized principally through carryback to taxable income in prior years,
future reversals of existing taxable temporary differences and, to a minor
extent, future taxable income.
(8) EARNINGS PER SHARE
The following illustrates the reconciliation of the numerators and
denominators of the basic and diluted earnings per share (EPS)
computations:
15
<PAGE> 15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
-----------------------------------------------
AVERAGE
WEIGHTED PER SHARE
INCOME SHARES AMOUNT
--------- --------- ---------
<S> <C> <C> <C>
BASIC EPS
Income available to common shareholders $ 2,212 3,525,883 $ .63
Effect of dilutive securities: stock options -- 243,361 --
--------- --------- -----
DILUTED EPS $ 2,212 3,769,244 $ .59
========= ========= =====
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
-----------------------------------------------
AVERAGE
WEIGHTED PER SHARE
INCOME SHARES AMOUNT
--------- --------- ---------
<S> <C> <C> <C>
BASIC EPS
Income available to common shareholders $ 1,904 2,810,881 $0.68
Effect of dilutive securities: stock options -- 125,091 --
--------- --------- -----
DILUTED EPS $ 1,904 2,935,972 $0.65
========= ========= =====
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
-----------------------------------------------
AVERAGE
WEIGHTED PER SHARE
INCOME SHARES AMOUNT
--------- --------- ---------
<S> <C> <C> <C>
BASIC EPS
Income available to common shareholders $ 1,564 2,796,000 $0.56
Effect of dilutive securities: stock options -- 62,100 --
--------- --------- -----
DILUTED EPS $ 1,564 2,858,100 $0.55
========= ========= =====
</TABLE>
At December 31, 1998 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
antidiluted securities outstanding for the years ended December 31, 1997
and 1996.
(9) EMPLOYEE BENEFIT PLANS
(a) Severance Agreements
The Company has entered into employment contracts with six senior
officers that provide benefits under certain conditions following a
termination without cause, following a change of control of the
Company.
(b) 401(k) Profit Sharing Plan
During 1993, the Board of Directors approved a 401(k)/profit sharing
plan. The plan covers substantially all full-time employees and many
part-time employees once they meet the age and length of service
requirements. Employees vest in the plan over a six-year period. The
401(k) plan allows for a voluntary
16
<PAGE> 16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
salary reduction, under which eligible employees are permitted to
defer a portion of their salaries, with the Company contributing a
percentage of the employee's contribution to the employee's account.
In addition, the amount of the profit sharing is discretionary and
determined each year by the Board of Directors.
The Company's contributions for the years ended December 31, 1998,
1997 and 1996 under the employee matching feature of the plan were
$64, $50 and $37, respectively. This represents a match of the
participating employees' salary deferral up to 50% of the first 5%
of the compensation deferred in 1998, 1997 and 1996, respectively.
The Company also contributed $0, $16 and $24 for the years ended
December 31, 1998, 1997 and 1996 under the profit sharing feature of
the plan.
(10) SHAREHOLDERS' EQUITY
Stock Option Plans
In 1992, the WIB shareholders approved the adoption of an employee stock
option plan, providing for the award of up to 450,000 shares of Company
common stock pursuant to nonqualified or incentive stock options to
employees of WIB at the discretion of a committee appointed by the Board
of Directors. In addition to the employee stock option plan adopted in
1992, in 1993 the Bank's shareholders approved the adoption of a director
stock option plan, providing for the award of up to 150,000 shares of
Company common stock pursuant to nonqualified stock options to directors
of the Bank at the discretion of the Board of Directors. The 1993 plan
does not affect any options granted under the 1992 plan. In 1996, the
shareholders of WIB approved the transfer of both stock option plans to
WBCO.
In 1998 the shareholders of WBCO approved the adoption of the 1998 stock
option and restricted stock award plan, which is generally similar to the
1992 and 1993 plans and allows for the award of up to 161,000 shares of
Company common stock plus any shares subject to stock options under the
1992 and 1993 plans that are forfeited, expire or are cancelled. The 1998
plan terminated the 1992 and 1993 plans as to further stock option grants.
Under these stock option plans, on the date of grant, the exercise price
of nonqualified stock options must at least equal the Company's net book
value per share issued, and the exercise price of incentive stock options
must at least equal the market value of the Company's common stock.
Stock options vest in 20% increments over five years and expire five years
after they become fully vested.
The following table summarizes incentive or nonqualified stock option
activity under the 1992 and 1998 plans for the years ended December 31,
1998, 1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------- -------------------------- ---------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES OPTION PRICE SHARES OPTION PRICE SHARES OPTION PRICE
------- ---------------- ------- ---------------- ------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Balance at beginning
of year 354,000 $ 4.25 302,250 $ 3.39 273,000 $ 3.20
Options granted 41,000 12.00 51,750 9.25 29,250 5.22
------- ------ ------- ------ ------- ------
Balance at end of year 395,000 $ 5.05 354,000 $ 4.25 302,250 $ 3.39
======= ====== ======= ====== ======= ======
</TABLE>
17
<PAGE> 17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial data pertaining to outstanding incentive stock options under the
1992 and 1998 plans at December 31, 1998 were as follows:
<TABLE>
<CAPTION>
TOTAL VESTED EXERCISE
SHARES SHARES PRICE EXPIRATION
------- ------- --------- ----------
<S> <C> <C> <C>
165,000 165,000 $ 2.93 February 22, 2003
22,500 18,000 3.07 March 24, 2004
40,500 32,400 3.37 December 15, 2004
45,000 27,000 4.08 December 31, 2005
3,750 1,500 4.23 April 1, 2006
25,500 10,200 5.37 December 31, 2006
51,750 10,350 9.25 December 31, 2007
41,000 -- 12.00 December 31, 2008
------- -------
395,000 264,450
======= =======
</TABLE>
The following table summarizes stock option activity of the nonqualified
shares under the 1993 director stock option plan for the years ended
December 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------- -------------------------- ---------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES OPTION PRICE SHARES OPTION PRICE SHARES OPTION PRICE
------- ---------------- ------- ---------------- ------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Balance at beginning
of year 113,700 $ 4.79 120,750 $ 3.13 120,750 $ 3.13
Options granted -- -- 31,200 9.25 -- --
Less exercised -- -- (35,550) 3.14 -- --
Expired or canceled -- -- (2,700) 3.57 -- --
------- ------- ------- ------ ------- ------
Balance at end of year 113,700 $ 4.79 113,700 $ 4.79 120,750 $ 3.13
======= ======= ======= ====== ======= ======
</TABLE>
Financial data pertaining to outstanding nonqualified stock options under
the 1993 plan at December 31, 1998 were as follows:
<TABLE>
<CAPTION>
Total Vested Exercise
shares shares price Expiration
------ ------ ----- ----------
<S> <C> <C> <C>
56,250 56,250 $ 3.00 February 22, 2003
18,750 15,000 3.07 March 24, 2004
7,500 5,400 4.08 December 31, 2005
31,200 6,240 9.25 December 31, 2007
------- ------
113,700 82,890
======= ======
</TABLE>
18
<PAGE> 18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company applies APB Opinion No.25 in accounting for its plan and,
accordingly, no compensation cost has been recognized for its stock
options in the accompanying consolidated financial statements. Had the
Company determined compensation cost using the fair value method,
consistent with SFAS No.123, the Company's net income and earnings per
share would have been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-------------------------------------------
1998 1997 1996
--------- -------- --------
<S> <C> <C> <C>
Net income, as reported $ 2,212 1,904 1,564
Net income, pro forma 2,167 1,862 1,550
Basic EPS, as reported .63 0.68 0.56
Basic EPS, pro forma .61 0.66 0.55
Diluted EPS, as reported .59 0.65 0.55
Diluted EPS, pro forma .57 0.64 0.55
</TABLE>
The fair value of options granted during 1998 is estimated on the date of
grant using the Black-Scholes pricing model. For grants in 1997 and 1996,
the fair value of options granted is estimated on the date of grant using
the minimum value method. The following assumptions were used to calculate
the fair value of the options granted:
EMPLOYEE STOCK OPTION PLAN
<TABLE>
<CAPTION>
YEAR OF GRANT RISK-FREE INTEREST RATE EXPECTED LIFE IN YEARS EXPECTED VOLATILITY EXPECTED DIVIDEND FAIR VALUE
- ------------- ----------------------- ---------------------- ------------------- ----------------- ----------
<S> <C> <C> <C> <C> <C>
1998 4.63% 7 10% 2% $0.35
1997 5.84% 9 N/A 3% 1.83
1996 6.43% 9 N/A 3% 1.05
</TABLE>
DIRECTOR STOCK OPTION PLAN
<TABLE>
<CAPTION>
YEAR OF GRANT RISK-FREE INTEREST RATE EXPECTED LIFE IN YEARS EXPECTED VOLATILITY EXPECTED DIVIDEND FAIR VALUE
- ------------- ----------------------- ---------------------- ------------------- ----------------- ----------
<S> <C> <C> <C> <C> <C>
1998 N/A N/A N/A N/A $N/A
1997 5.79% 7 N/A 3% 1.58
1996 N/A N/A N/A N/A N/A
</TABLE>
(11) REGULATORY CAPITAL MATTERS
The Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could
have a direct material effect on the Bank's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Bank must meet specific capital guidelines that
involve quantitative measures of the Bank's assets, liabilities and
certain off balance sheet items as calculated under regulatory accounting
practices. The Bank's capital amounts and classification are also subject
to qualitative judgments by the regulators about risk components, asset
risk weighting and other factors.
Risk based capital guidelines issued by the Federal Deposit Insurance
Corporation establish a risk adjusted ratio relating capital to different
categories of assets and off balance sheet exposures for banks. The Bank's
Tier 1 capital is comprised primarily of common equity, and excludes the
equity impact of adjusting available for sale securities to fair value.
Total capital also includes a portion of the allowance for loan losses, as
defined according to regulatory guidelines.
19
<PAGE> 19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Quantitative measures established by regulation to ensure capital adequacy
require the Company to maintain minimum amounts and ratios (set forth in
the table below) of total and Tier1 capital to risk-weighted assets (as
defined in the regulations), and of Tier1 capital to average assets (as
defined in the regulations). Management believes, as of December 31, 1998,
that the Bank meets all capital adequacy requirements to which it is
subject.
<TABLE>
<CAPTION>
TO BE WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
WHIDBEY ISLAND BANK ADEQUACY PURPOSES ACTION PROVISIONS
-------------------- --------------------- ----------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
(actual)
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998:
Total risk-based capital
(to risk-weighted assets) 26,378 15.99% 13,196 >=8% 16,494 >=10%
Tier 1 capital (to risk-weighted assets) 24,633 14.93% 6,598 >=4% 9,897 >=6%
Leverage ratio 24,633 11.67% 8,443 >=4% 10,554 >=5%
As of December 31, 1997:
Total risk-based capital
(to risk-weighted assets) 14,160 11.63% 9,736 >=8% 12,170 >=10%
Tier 1 capital (to risk-weighted assets) 12,986 10.67% 4,868 >=4% 7,302 >=6%
Leverage ratio 12,986 8.08% 6,429 >=4% 8,036 >=5%
</TABLE>
In addition, under Washington State Banking Regulations, the Bank is
limited as to the ability to declare or pay dividends to the Company up to
the amount of the Bank's net profits then on hand.
(12) FAIR VALUE OF FINANCIAL INSTRUMENTS
Because broadly traded markets do not exist for most of the Company's
financial instruments, the fair value calculations attempt to incorporate
the effect of current market conditions at a specific time. Fair
valuations are management's estimates of values. These calculations are
subjective in nature, involve uncertainties and matters of significant
judgment and do not include tax ramifications; therefore, the results
cannot be determined with precision, substantiated by comparison to
independent markets and may not be realized in an actual sale or immediate
settlement of the instruments. There may be inherent weaknesses in any
calculation technique, and changes in the underlying assumptions used,
including discount rates and estimates of future cash flows, could
significantly affect the results. For all of these reasons, the
aggregation of the fair value calculations presented herein do not
represent, and should not be construed to represent, the underlying value
of the Company.
When possible, quoted market prices are used to determine fair value. In
cases where a quoted market price is not available, the fair value of
financial instruments is estimated using the present value of future cash
flows or other valuation methods.
(a) Financial Instruments With Book Value Equal to Fair Value
The fair value of financial instruments that are short-term or
reprice frequently and that have little or no risk are considered to
have a fair value equal to book value.
20
<PAGE> 20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(b) Investment Securities
The fair value of all investment securities excluding FHLB stock was
based upon quoted market prices. FHLB stock is not publicly traded;
however it may be redeemed on a dollar-for-dollar basis, for any
amount the Bank is not required to hold. The fair value is therefore
equal to the book value.
(c) Loans
The loan portfolio is composed of commercial, consumer, real estate
construction and real estate loans. The book value of variable rate
loans approximate their fair values. The fair value of fixed rate
loans is estimated by discounting the estimated future cash flows of
loans, sorted by type and security, by the weighted average rate of
such loans, adjusted for credit risk.
(d) Deposits
For deposits with no contractual maturity such as demand accounts,
checking accounts, money market accounts and passbook savings
accounts, fair values approximate book values. The fair value of
certificates of deposit is based on discounted cash flows using the
difference between the deposit rate and an alternative cost of funds
rate.
(e) Off-Balance Sheet Financial Instruments
The fair value of off-balance sheet commitments to extend credit is
considered equal to its notional amount due primarily to the
short-term nature of these items.
The table below presents the book value amount of the Company's
financial instruments and their corresponding fair values at
December 31, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
--------------------------- ----------------------------
Book value Fair value Book value Fair value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Financial assets:
Cash and due from banks $ 12,063 12,063 6,263 6,263
Interest bearing deposits 8,089 8,089 -- --
Federal funds sold 4,100 4,100 1,750 1,750
FHLB stock 736 736 682 682
Investment securities available for sale 12,591 12,591 5,521 5,521
Investment securities held to maturity 24,875 25,667 23,508 23,824
Loans 149,651 156,965 117,578 116,752
Financial liabilities - deposits 189,698 189,829 146,394 143,074
Off-balance-sheet items:
Loan commitments 24,889 24,889 20,959 20,959
Standby letters of credit 688 688 648 648
</TABLE>
21
<PAGE> 21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(13) WASHINGTON BANKING COMPANY INFORMATION
The summarized condensed financial information for Washington Banking
Company (parent company only) as of and for the years ended December 31,
1998 and 1997 are presented below: As of December 31
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
AS OF DECEMBER 31
--------------------------
1998 1997
-------- --------
<S> <C> <C>
Assets:
Cash and cash equivalents $ 4,960 100
Other assets 54 16
Investment in subsidiary 24,683 12,919
-------- --------
Total assets $ 29,697 13,035
======== ========
Liabilities - other $ 6 --
-------- --------
Shareholders' equity:
Common stock 17,836 2,943
Retained earnings 11,805 10,075
Accumulated other comprehensive income, net 50 17
-------- --------
Total shareholders' equity 29,691 13,035
-------- --------
Total liabilities & shareholders' equity $ 29,697 13,035
======== ========
</TABLE>
CONDENSED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------
1998 1997
-------- --------
<S> <C> <C>
Noninterest expense $ (99) (45)
Income tax (expense) benefit (5) 15
-------- --------
Loss before undistributed earnings of subsidiary (104) (30)
Interest income 115 --
Undistributed earnings of subsidiary 2,201 1,934
-------- --------
Net income $ 2,212 1,904
======== ========
</TABLE>
22
<PAGE> 22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------
1998 1997
-------- --------
<S> <C> <C>
Operating activities:
Net income $ 2,212 1,904
Adjustments to reconcile net income to net cash used
in operating activities:
Equity in undistributed earnings of subsidiaries (2,201) (1,934)
Other (32) 10
-------- --------
Net cash used in operating activities (21) (20)
-------- --------
Investing activities:
Dividends received from subsidiary 470 557
Cash invested in subsidiary (10,000) --
-------- --------
Net cash provided by (used in) investing activities (9,530) 557
-------- --------
Financing activities:
Dividends paid to shareholders (482) (356)
Proceeds from exercise of stock options and stock issuances -- 111
Repurchased and retired stock -- (200)
Proceeds from stock issued 14,893 --
-------- --------
Net cash provided by (used in) financing activities 14,411 (445)
-------- --------
Increase in cash and cash equivalents 4,860 92
Cash and cash equivalents at beginning of year 100 8
-------- --------
Cash and cash equivalents at end of year $ 4,960 100
======== ========
</TABLE>
(14) COMMITMENTS
(a) Leasing Arrangements
The Company is obligated under a number of noncancelable operating
leases for land and buildings. The majority of these leases have
renewal options. In addition, some of the leases contain escalation
clauses tied to the consumer price index with caps.
In 1997, the Company entered into a lease for land. The lease
includes options to purchase the property which may be exercised at
the end of each fifth year during the term of the lease. The lease
expires in 2027.
The Company's future minimum rental payments required under land,
buildings and equipment operating leases that have initial or
remaining noncancelable lease terms of one year or more are as
follows:
23
<PAGE> 23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31
-----------
<S> <C>
1999 $ 168
2000 101
2001 90
2002 90
2003 66
Thereafter 1,251
--------
Total $ 1,766
========
</TABLE>
Rent expense applicable to operating leases for the years ended
December 31, 1998, 1997 and 1996 was $178, $87 and $9, respectively.
(b) Commitments to Extend Credit
In the normal course of business, the Company enters into financial
instruments with off-balance-sheet risk to meet the financing needs
of its customers. These instruments, which include commitments to
extend credit and standby letters of credit, involve varying degrees
of credit and interest rate risk that are not reflected in the
financial statements. These instruments generally have fixed
expiration dates and do not necessarily represent future cash
requirements since they often expire without being drawn upon. The
Company's criteria for issuing such instruments are the same as
those for loans made in the normal course of business.
Commitments to extend credit are as follows:
<TABLE>
<CAPTION>
DECEMBER 31
-----------------------
1998 1997
------- ------
<S> <C> <C>
Loan commitments $24,889 20,959
Standby letters of credit 688 648
</TABLE>
(c) Lines of Credit
The Company had unused lines of credit with the FHLB of $32,870 at
December 31, 1998. The Company also had unused lines of credit with
financial institutions amounting to $11,400 at December 31, 1998.
(15) CONTINGENCIES
The Company is currently subject and party to various legal actions
arising out of the normal course of business. Management believes the
ultimate liability, if any, arising from such claims or contingencies is
not likely to have a material adverse effect on the Company's results of
operations or financial condition.
(16) SUBSEQUENT EVENTS
On January 21, 1999, the Board of Directors declared a cash dividend of
$0.04 per share for the first quarter of 1999.
24
<PAGE> 24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(17) SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Results of operations on a quarterly basis were as follows (dollars in
thousands, except per share amounts):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
-----------------------------------------------------------------
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
Interest income $3,366 3,603 4,126 4,141
Interest expense 1,315 1,415 1,554 1,481
------ ------ ------ ------
Net interest income 2,051 2,188 2,572 2,660
Provision for loan losses 195 150 195 195
------ ------ ------ ------
Net interest income after provision for loan losses 1,856 2,038 2,377 2,465
Noninterest income 480 430 548 477
Noninterest expense 1,716 1,788 2,095 1,937
------ ------ ------ ------
Income before provision for income taxes 620 680 830 1,005
------ ------ ------ ------
Provision for income taxes 204 160 217 342
------ ------ ------ ------
Net income $ 416 520 613 663
------ ------ ------ ------
Basic earnings per share $ 0.15 0.16 0.15 0.16
Diluted earnings per share 0.14 0.15 0.14 0.15
Cash dividends declared 0.07 -- 0.035 0.035
------ ------ ------ ------
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
-----------------------------------------------------------------
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
Interest income $2,473 2,844 3,159 3,424
Interest expense 870 1,021 1,162 1,305
------ ------ ------ ------
Net interest income 1,603 1,823 1,997 2,119
Provision for loan losses 105 105 165 272
------ ------ ------ ------
Net interest income after provision for loan losses 1,498 1,718 1,832 1,847
Noninterest income 362 385 409 510
Noninterest expense 1,271 1,332 1,491 1,746
------ ------ ------ ------
Income before provision for income taxes 589 771 750 611
------ ------ ------ ------
Provision for income taxes 261 261 195 100
------ ------ ------ ------
Net income $ 328 510 555 511
------ ------ ------ ------
Basic earnings per share $ 0.12 0.18 0.20 0.18
Diluted earnings per share 0.11 0.17 0.18 0.17
Cash dividends declared -- -- -- 0.13
------ ------ ------ ------
</TABLE>
25
<PAGE> 25
MANAGEMENT DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion is intended to assist in understanding the financial condition
and results of operations of the Company. The information contained in this
section should be read in conjunction with the consolidated financial statements
of Washington Banking Company and notes thereto contained elsewhere in this
report.
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 impact
of interest rates charges, risks of acquiring or opening new branches,
controlling expenses, and general economic conditions.
OVERVIEW
Washington Banking Company (the "Company") is a registered bank holding company
whose wholly-owned subsidiary, Whidbey Island Bank (the "Bank"), conducts a
full-service commercial banking business. Headquartered in Oak Harbor,
Washington, the Company provides a full range of commercial banking services to
small and medium-sized businesses, professionals and other individuals through
twelve branch offices located on Whidbey Island and Camano Island in Island
County, as well as the Burlington, Anacortes (Skagit County) and Bellingham
(Whatcom County) communities in northwestern Washington.
Effective June 23, 1998, the Company sold 1,380,000 shares of its common stock
in an initial public offering at a subscription price of $12 per share resulting
in net proceeds to the Company of $14.9 million. Its stock now trades on the
Nasdaq National Market under the symbol "WBCO".
The Bank began operations in 1961 on Whidbey Island. Until early 1994, the
Company limited its physical presence to Island County (Whidbey Island and
neighboring Camano Island), and particularly to Whidbey Island, a 45-mile long
island that runs parallel to the mainland area of Washington northwest of
Everett and southwest of Bellingham, but had no presence on the mainland. In
view of the threatened closure of NAS Whidbey Island, the Company determined
that it would be prudent to diversify geographically beyond Island County. With
the consolidation of the large regional banks operating in Washington, and the
resulting dislocation of customers, the Company saw an opportunity to expand
onto the mainland along the northern I-5 corridor. In February 1994, the Company
opened a loan production office in Burlington, Washington (Skagit County). Loan
growth in the Burlington office was strong and the Company determined that it
would pursue its growth strategy in and around Skagit County and north into
Whatcom County. In pursuit of that growth strategy, the Company has targeted
areas north of Everett, Washington and areas contiguous to Whidbey Island into
which it would expand.
The primary factors considered in determining the areas of geographic expansion
are customer demand and the availability of experienced managers, lending
officers and branch personnel with a long standing community presence and
extensive banking relationships. The Company also emphasizes the hiring of
experienced personnel with extensive industry knowledge when considering lending
product expansion.
Due to the favorable response in Burlington, the Company converted the
Burlington loan production office into a full service branch in August 1995. In
late 1996, the Company targeted Bellingham for expansion, hired an experienced
manager and lending officer, both with long standing community presence, and in
early 1997 opened a full service branch in downtown Bellingham. During 1998 new
full service branches were constructed and opened in Anacortes and Freeland. In
addition, a grocery store branch was opened in March 1998 on Camano Island.
The Company's objective is to continue, over the next several years, to expand
its geographical presence outside of Whidbey and Camano Islands, while
solidifying its market position on the Islands. To deliver the Company's
products more effectively and efficiently, the Company's market strategy is to
locate full service branch offices which provide all of the Company's products
and services in its targeted growth areas supported by loan production offices,
mini branches, grocery or retail store branches and/or automated teller machines
in the areas surrounding those central locations in order to further service
customers. Acquisition of banks or branches will also be used as a means of
expansion if appropriate opportunities are presented. The Company also expects
to invest in technology to facilitate telephone, personal computer and Internet
banking, but with its primary commitment being to provide exceptional personal
service.
Currently, the Company's geographical expansion is expected to be concentrated
in the Burlington/ Mount Vernon area of the Skagit Valley, and in 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.
In pursuit of its growth strategy, in the first and second quarter,
respectively, of 1998, the Company opened a full service branch in Anacortes and
a grocery store branch on Camano Island to complement its existing Camano Island
branch. It also opened a full-service branch in Freeland, Washington, which is
located in the southern part of
26
<PAGE> 26
Whidbey Island in the fourth quarter of the year. The Company relocated the
Bellingham office to a larger office in the first quarter of 1999 and opened a
residential real estate loan production office in Port Townsend, Washington
(Jefferson County).
While continuing to geographically expand, management's strategy is to continue
to provide a high level of personal service to its customers and to expand loan,
deposit and other products and services that it offers its customers.
Maintenance of asset quality will be emphasized by controlling nonperforming
assets and adhering to prudent underwriting standards. In addition, management
will strive to improve operating efficiencies to further manage noninterest
expense and will continue to improve internal operating systems.
The Company's expansion activity can be expected to require the expenditures 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 $220.5 million at December 31, 1998 from $160.1
million at December 31, 1997, an increase of 37.7%. This increase resulted from
growth in the loan and investment portfolios, which was funded by Company
proceeds received in the IPO and deposit growth. Total loans amounted to $149.6
million, and $117.6 million, December 31, 1998, and 1997, respectively.
Commercial loans grew to $65.6 million at December 31, 1998 from $48.2 million
at December 31, 1997, while consumer loans increased to $40.8 million from $33.7
million during that same period. Commercial loans as a percentage of total loans
increased to 43.8% at December 31, 1998 from 41.0% at December 31, 1997, and
consumer loans decreased to 27.2% of total loans from 28.7% at those dates. Real
estate loans remained consistent at 19.5% of total loans, at December 31, 1998
and 1997, while real estate construction loans decreased to 9.5% from 10.8%.
Total investment securities were $38.2 million, and $29.7 million at December
31, 1998 and 1997, respectively. The increase over 1997 reflects the investment
of excess liquidity, including proceeds from the Company's initial public
offering in June 1998. Premises and equipment, net, were $8.0 million, and $4.3
million at December 31, 1998, and 1997, respectively. The increase over 1997
reflects upgrading computer systems, remodeling of the administrative and other
offices, purchase of land for branch offices and construction of branch offices.
Deposit accounts totaled $189.7 million, and $146.4 million, at December 31,
1998, and 1997, respectively. Management attributes this increase to an increase
in deposits resulting from expanding commercial and other loan relationships and
increasing visibility in its' market areas. Shareholders' equity was $29.7
million, and $13.0 million, at December 31, 1998, and 1997, respectively. These
increases primarily reflect proceeds received from the initial public offering,
and net income less dividends paid to shareholders.
NET INTEREST INCOME Like most financial institutions, the primary component of
earnings for the Company is net interest income. Net interest income is the
difference between interest income, principally from loan and investment
securities portfolios, and interest expense, principally on customer deposits
and Company borrowings. Changes in net interest income result from changes in
volume, spread and margin. For this purpose, volume refers to the average dollar
level of interest earning assets and interest bearing liabilities, spread refers
to the difference between the average yield on interest earning assets and the
average cost of interest bearing liabilities, and margin refers to net interest
income divided by average interest earning assets and is influenced by the level
and relative mix of interest earning assets and interest bearing liabilities as
well as levels of noninterest bearing liabilities. During the fiscal years ended
December 31, 1998, 1997 and 1996, average interest earning assets were $174.4
million, $129.7 million, and $96.0 million, respectively. During these same
periods, the Company's net interest margins were 5.56%, 5.94%, and 6.27%,
respectively.
AVERAGE BALANCES AND AVERAGE RATES EARNED AND PAID The following table sets
forth for the periods indicated information with regard to average balances of
assets and liabilities, as well as the total dollar amounts of interest income
from interest earning assets and interest expense on interest bearing
liabilities, resultant yields or costs, net interest income, net interest
spread, net interest margin and ratio of average interest earning assets to
average interest bearing liabilities.
27
<PAGE> 27
<TABLE>
<CAPTION>
(Dollars in thousands) DECEMBER 31
---------------------------------------------------------------------------------------------------------
1998 1997 1996
-------------------------------- ------------------------------- --------------------------------
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
BALANCE EARNED/PAID YIELD BALANCE EARNED/PAID YIELD BALANCE EARNED/PAID YIELD
------- ----------- ----- ------- ----------- ----- ------- ----------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets
Loans $131,359 $ 12,910 9.83% $100,243 $ 10,207 10.18% $ 69,237 $ 7,334 10.59%
Federal funds sold 5,609 298 5.31% 2,187 116 5.30% 2,343 126 5.38%
Interest bearing
cash 5,066 243 4.80%
Investments:
Taxable 19,144 1,151 6.01% 17,986 1,118 6.22% 18,315 1,080 5.90%
Non-taxable(1) 13,189 850 6.44% 9,241 616 6.67% 6,132 426 6.95%
-------- -------- ---- -------- -------- ----- -------- -------- -----
Interest earning
assets $174,367 $ 15,452 8.86% $129,657 $ 12,057 9.30% $ 96,027 $ 8,966 9.34%
Noninterest
earning assets 16,048 11,775 8,917
-------- -------- --------
Total assets $190,415 $141,432 $104,944
======== ======== ========
Liabilities &
Shareholders'
Equity
Deposits
Interest demand
and money mkt $ 55,320 $ 1,589 2.87% $ 40,600 $ 1,193 2.94% $ 28,753 $ 739 2.57%
Savings 23,227 726 3.13% 21,789 778 3.57% 20,036 704 3.51%
Time deposits 61,361 3,450 5.62% 42,220 2,387 5.65% 26,777 1,503 5.61%
-------- -------- ---- -------- -------- ----- -------- -------- -----
Interest bearing
liabilities $139,908 $ 5,765 4.12% $104,609 $ 4,358 4.17% $ 75,566 $ 2,946 3.90%
Noninterest
bearing
liabilities 29,045 24,301 18,133
-------- -------- --------
Total liabilities $168,953 $128,910 $ 93,699
Shareholders'
equity 21,462 12,522 11,245
-------- -------- --------
Total liabilities
and shareholder's
equity $190,415 $141,432 $104,944
======== ======== ========
Net interest income $ 9,687 $ 7,699 $ 6,020
-------- ------- --------
Net interest spread 4.74% 5.13% 5.44%
---- ---- ----
Net interest margin(1) 5.56% 5.94% 6.27%
---- ---- ----
</TABLE>
(1) Interest income on non-taxable investments is presented on a fully
taxable-equivalent basis using the federal statutory rate of 34% in 1998,
1997, and 1996. These adjustments were $216,000, $156,000, and $108,000,
for the years ended December 31, 1998, 1997 and 1996, respectively.
28
<PAGE> 28
RATE/VOLUME ANALYSIS The following table sets forth the amounts of the changes
in consolidated net interest income attributable to changes in volume and to
changes in interest rates. Changes attributable to the combined effect of volume
and interest rate have been allocated proportionately to the changes due to
volume and the change due to interest rate.
<TABLE>
<CAPTION>
1998 COMPARED TO 1997 1997 COMPARED TO 1996
------------------------------------ -------------------------------------
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
VOLUME RATE TOTAL VOLUME RATE TOTAL
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Loans:
Total loans $ 3,168 ($ 465) $ 2,703 $ 3,284 ($ 411) $ 2,873
Federal funds sold 182 -- 182 (8) (2) (10)
Interest bearing cash 243 -- 243 -- -- --
Securities (1) 325 (58) 267 171 57 228
------- ------- ------- ------- ------- -------
Total interest income $ 3,918 ($ 523) $ 3,395 $ 3,447 ($ 356) $ 3,091
======= ======= ======= ======= ======= =======
Interest bearing demand deposits 433 (37) 396 304 150 454
Savings accounts 51 (103) (52) 62 12 74
Certificates of deposit 1,082 (19) 1,063 867 17 884
------- ------- ------- ------- ------- -------
Total Interest Expense $ 1,566 ($ 159) $ 1,407 $ 1,233 $ 179 $ 1,412
======= ======= ======= ======= ======= =======
</TABLE>
(1) Interest income on non-taxable investments is presented on a fully
taxable-equivalent basis using the federal statutory rate of 34% in 1998,
1997, and 1996. These adjustments were $216,000, $156,000, and $108,000,
for the years ended December 31, 1998, 1997 and 1996, respectively.
RESULTS OF OPERATIONS
NET INCOME The Company reported net income of $2.2 million, $1.9 million and
$1.6 million for the years ended December 31, 1998, 1997 and 1996, respectively.
Diluted net income per share was $0.59, $0.65, and $0.55, in each case adjusted
for stock splits, for 1998, 1997 and 1996, respectively. The increase in net
income for each year was primarily attributable to an increase in net interest
income and to a lesser extent increases in noninterest income partially offset
by increases in noninterest expenses and an increase in the provision for loan
losses. The decrease in diluted net income per share from 1997 to 1998 was
primarily attributable to the increased number of outstanding shares as a result
of the initial public offering in June 1998.
NET INTEREST INCOME Net interest income for the years ended December 31, 1998,
1997 and 1996 was $9.5 million, $7.5 million, and $5.9 million, respectively.
The increase in fiscal year 1998 was $2.0 million, or 26.7% and in, 1997 was
$1.6 million, or 27.6%. Net interest income was favorably affected by average
interest earning assets increasing more rapidly than average interest bearing
liabilities, with the difference funded by growth in noninterest bearing
deposits and shareholders' equity. Average interest earning assets increased
$44.7 million and $33.6 million for fiscal years ended 1998 and 1997,
respectively, while average interest bearing liabilities increased by $35.3
million and $29.0 million for the same periods.
The average yield on interest earning assets decreased to 8.86% for the year
ended December 31, 1998 from 9.30% for the year ended December 31, 1997 and
9.34% for the year ended December 31, 1996. This decrease is due primarily to a
decrease in the rates earned on loans. Average yield on loans decreased to 9.83%
for the year ended December 31, 1998 from 10.18% for the year ended December 31,
1997 and 10.59% for the year ended December 31, 1996. In addition, an overall
decrease in rates earned on investments contributed to the decrease in average
yield on interest earning assets. Average yields on taxable investments
decreased to 6.01% for the year ended December 31, 1998 from 6.22% for the year
ended December 31, 1997 and increased at December 31, 1997 from 5.90% for the
year ended December 31, 1996. Average yields on non-taxable investments
decreased to 6.44% for the year ended December 31, 1998 from 6.67% and 6.95%,
respectively, for the years ended December 31, 1997 and 1996. The average yield
on interest bearing liabilities also decreased in 1998 to 4.12% for the year
ended December 31, 1998 from 4.17% for the year ended December 31, 1997 as rates
on all deposit types decreased during the year. For the year ended 1997, the
yield on average interest bearing liabilities increased from 3.90% for the year
ended December 31, 1996. Average interest earning assets increased 34.5% from
December 31, 1997 to December 31, 1998 and 35.0% from December 31, 1996 to
December 31, 1997, and average interest bearing liabilities increased 33.7% and
38.4%, respectively, during the same periods. The overall result of these
changes was a decrease in the net interest spread to 4.74% for the year ended
December 31, 1998 from 5.13% for the year ended December 31, 1997 and 5.44% for
the year ended December 31, 1996 and a decrease in net interest margin to 5.56%
from 5.94% and 6.27%, respectively, for the same periods.
29
<PAGE> 29
PROVISION FOR LOAN LOSSES Provision for loan losses are charges to earnings to
bring the total allowance for loan losses to a level considered by management as
adequate to provide for estimated loan losses based on management's evaluation
of the collectability of the loan portfolio, including the nature of the
portfolio, credit concentrations, trends in historical loss experience, specific
impaired loans and economic conditions. For the years ended December 31, 1998,
1997 and 1996, net loan charge-offs amounted to $286,000, $147,000, and
$174,000, respectively. The Company's provision for loan losses for the years
ended December 31, 1998, 1997 and 1996 totaled $735,000, $647,000, and $350,000,
respectively. The provision for loan losses was increased substantially in 1998,
1997 and 1996 to keep pace with the strong growth and losses inherent in the
loan portfolio. During 1998, the allowance for loan losses increased by $449,000
to 1.17% of loans and 206.02% of nonperforming loans at December 31, 1998.
During 1997, the allowance for loan losses increased by $500,000 to 1.10% of
loans and 112.60% of nonperforming loans at December 31, 1997. The allowance
represented 0.98% of loans at December 31, 1996.
NONINTEREST INCOME Noninterest income for the years ended December 31, 1998,
1997 and 1996 was $1.9 million, $1.7 million, and $1.4 million, respectively.
The increases of $269,000 in 1998, $242,000 in 1997 and $364,000 in 1996,
reflecting an increase in service charges on deposit accounts and other fees and
an increase in merchant credit card account fees due to an expansion of that
program in late 1995.
NONINTEREST EXPENSE Noninterest expense for the years ended December 31, 1998,
1997, and 1996 was $7.5 million, $5.8 million, and $4.7 million, respectively.
Increases in noninterest expense were primarily related to compensation and
employee benefits, occupancy expense and data processing expenses. These
increases reflect the rapid expansion of the Company which began in late 1995
and is more fully reflected in 1996, 1997, and 1998. Included in increased
salaries and benefits expense in 1998 and 1997 were increased staffing levels in
executive and administrative personnel, branch personnel and additions to
mortgage lending and consumer lending departments. A portion of the preopening
expenses for two new branches opening in the first half of fiscal 1998 were also
reflected in 1997 noninterest expense. The Company expects this trend in
increased noninterest expense to continue as a result of continued planned
expansion. Set forth below is a schedule showing additional detail concerning
increases in the Company's noninterest expense for 1998 compared with 1997 and
for 1997 compared with 1996:
<TABLE>
<CAPTION>
INCREASE/ INCREASE/
FOR THE YEARS ENDING DECEMBER 31 DECREASE DECREASE
1998 1997 1996 1998 VS. 1997 1997 VS. 1996
------ ------ ------ ------------- -------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Salaries and benefits $5,068 3,543 2,678 1,525 865
Less: loan origination costs 1,879 1,109 659 770 450
------ ------ ------ ------ ------
Net salaries and benefits (as reported) 3,189 2,434 2,019 755 415
Occupancy expense 1,455 1,033 745 422 288
Office supplies and printing 365 275 220 90 55
Insurance expense 373 271 251 102 20
Data processing 260 219 125 41 94
Consulting and professional fees 175 202 165 (27) 37
Other 1,718 1,406 1,159 312 247
------ ------ ------ ------ ------
Total noninterest expense $7,535 5,840 4,684 1,695 1,156
====== ====== ====== ====== ======
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
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 December
31, 1998 the Company had unused lines of credit with the Federal Home Loan Bank
of Seattle ("FHLB") of $32.9 million and unused lines of credit with financial
institutions in the amount of $11.4 million, with no advances on these lines of
credit at December 31, 1998. The Company expects to use FHLB advances to
supplement its funding sources.
Total deposits were $189.7 million, $146.4 million, and $105.2 million December
31, 1998, 1997, and 1996, respectively. The increases in deposits were 29.6% in
1998 and 39.2% and 18.9%, respectively, in 1997 and 1996. 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
the delivery of quality service.
The Company's deposits are expected to fluctuate according to the level of the
Company's deposit market share, economic conditions, and normal seasonal
variations, among other things. Certificates of deposit are the only deposit
group that have stated maturity dates. At December 31, 1998, the Company had
$64.7 million in certificates of deposit of which approximately $56.8 million,
or 88%, are scheduled to mature on or prior to December 31, 1999. Based on prior
experience, the Company anticipates that a substantial portion of outstanding
certificates of deposit will renew upon maturity.
Management anticipates that the Bank 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.
30
<PAGE> 30
The Company's shareholders' equity increased to $29.7 million at December 31,
1998 from $13.0 million at December 31, 1997 and from $11.6 million at December
31, 1996. The increase from year end 1997 to year end 1998 was from net income
less dividends plus $14.9 million in proceeds from the Company's initial public
offering in June of 1998. The increase from year end 1996 to year end 1997 was
from net income less dividends. At December 31, 1998, shareholders' equity was
13.47% of total assets compared to 8.14% and 9.87% of total assets at December
31, 1997 and 1996, respectively. The increase in this ratio from year end 1997
primarily results from offering proceeds received in June of 1998. The decrease
in this ratio at year end 1997 from year end 1996 was primarily a result of an
increase in total assets of $42.8 million from December 31, 1996 to December 31,
1997. The increase in total assets was due primarily to an increase in total
loans, and to a lesser extent, to an increase in cash equivalents and other
assets.
CAPITAL RATIOS
The Bank is subject to minimum capital requirements. See "Supervision and
Regulation." As the following table indicates, at December 31, 1998 the Bank
exceeded regulatory capital requirements.
<TABLE>
<CAPTION>
AT DECEMBER 31, 1998
--------------------------------------------
MINIMUM WELL-CAPITALIZED ACTUAL
REQUIREMENT REQUIREMENT RATIO
----------- ----------- -----
<S> <C> <C> <C>
Total risk-based capital ratio 8.00% 10.00% 15.99%
Tier 1 risk-based capital ratio 4.00% 6.00% 14.93%
Leverage ratio 4.00% 5.00% 11.67%
</TABLE>
Management expects the Bank to remain "well-capitalized" for regulatory
purposes, although there can be no assurance that additional capital will not be
required in the near future due to greater-than-expected growth, or otherwise.
ASSET/LIABILITY MANAGEMENT
The Company's results of operations depend substantially on its net interest
income. Like most financial institutions, the Company's interest income and cost
of funds are affected by general economic conditions and by competition in the
market place. The purpose of asset/liability management is to provide stable net
interest income growth by protecting the Company's earnings from undue interest
rate risk, which arises from volatile interest rates and changes in the balance
sheet mix, and by managing the risk/return relationships between liquidity,
interest rate risk, market risk, and capital adequacy. The Company maintains an
asset/liability management policy that provides guidelines for controlling
exposure to interest rate risk by utilizing the following ratios and trend
analysis: liquidity, equity, volatile liability dependence, portfolio
maturities, maturing assets and maturing liabilities. The Company's policy is to
control the exposure of its earnings to changing interest rates by generally
endeavoring to maintain a position within a narrow range around an "earnings
neutral position," which is defined as the mix of assets and liabilities that
generate a net interest margin that is least affected by interest rate changes.
INTEREST RATE SENSITIVITY When suitable lending opportunities are not sufficient
to utilize available funds, the Company has generally invested such funds in
securities, primarily U.S. Treasury securities, securities issued by
governmental agencies, municipal securities and corporate obligations. The
securities portfolio contributes to the Company's profits and plays an important
part in the overall interest rate management. However, management of the
securities portfolio alone cannot balance overall interest rate risk. The
securities portfolio must be used in combination with other asset/liability
techniques to actively manage the balance sheet. The primary objectives in the
overall management of the securities portfolio are safety, liquidity, yield,
asset/liability management (interest rate risk), and investing in securities
that can be pledged for public deposits.
In reviewing the needs of the Company with regard to proper management of its
asset/liability program, the Company's management estimates its future needs,
taking into consideration historical periods of high loan demand and low deposit
balances, estimated loan and deposit increases (due to increased demand through
marketing), and forecasted interest rate changes.
The Company is exposed to interest rate risk. Interest rate risk is the risk
that financial performance will decline over time due to changes in prevailing
interest rates and resulting yields on interest earning assets and costs of
interest bearing liabilities. A number of measures are used to monitor and
manage interest rate risk, including income simulations and interest sensitivity
(gap) analyses. 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 pre-
31
<PAGE> 31
cisely 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 and changes in market
conditions and management strategies, among other factors.
Based on the results of the income simulation model as of December 31, 1998, the
Company would expect an increase in net interest income of $73,000 if interest
rates increase from current rates by 100 basis points and a decrease in net
interest income of $73,000 if interest rates decrease from current rates by 100
basis points.
The analysis of an institution's interest rate gap (the difference between the
repricing of interest earning assets and interest bearing liabilities during a
given period of time) is another standard tool for the measurement of the
exposure to interest rate risk. The Company believes that because interest rate
gap analysis does not address all factors that can affect earnings performance,
it should be used in conjunction with other methods of evaluating interest rate
risk.
The following table sets forth the estimated maturity or repricing, and the
resulting interest rate gap of the Company's interest earning assets and
interest earning liabilities at December 31, 1998. The interest rate gaps
reported in the table arise when assets are funded with liabilities having
different repricing intervals. The amounts shown below could be significantly
affected by external factors such as changes in prepayment assumptions, early
withdrawals of deposits and competition.
<TABLE>
<CAPTION>
0-3 MONTHS 4-12 MONTHS 1-5 YEARS OVER 5 YRS TOTAL
---------- ----------- --------- ---------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Interest earning assets:
Federal funds sold $ 4,100 $ -- $ -- $ -- $ 4,100
Investment securities 1,145 6,920 19,418 10,719 38,202
Loans 51,755 24,562 55,515 17,785 149,617
---------- ---------- --------- --------- --------
Total interest earning assets $ 57,000 $ 31,482 $ 74,933 $ 28,504 $ 191,919
Interest earning assets to total assets 29.70% 16.40% 39.04% 14.85% 100.00%
Interest bearing liabilities:
Interest bearing demand accounts $ 36,213 -- -- -- $ 36,213
Money market accounts 29,821 -- -- -- 29,821
Savings accounts 25,517 -- -- -- 25,517
Time deposits 21,882 34,925 7,891 -- 64,698
---------- ---------- --------- --------- --------
Total interest bearing liabilities $ 113,433 $ 34,925 $ 7,891 -- $ 156,249
Interest bearing liab. to total liabilities 72.60% 22.35% 5.05% 0.00% 100.00%
Interest sensitivity gap ($ 56,433) ($ 3,443) $ 67,042 $ 28,504 $ 35,670
Cumulative interest sensitivity gap ($ 56,433) ($ 59,876) $ 7,166 $ 35,670
Cumulative interest sensitivity gap,
as a percentage of total assets (25.59%) (27.16%) 3.25% 16.18%
</TABLE>
The table illustrates that if assets and liabilities reprice in the time
intervals indicated in the table, the Company is liability sensitive 0-12 months
and asset sensitive thereafter. Thus the table indicates that in an environment
of increasing interest rates, the net interest income of the Company would be
adversely affected and in a declining interest rate environment, the Company's
net interest income would be favorably affected. As stated above, certain
shortcomings are inherent in the method of analysis presented in the foregoing
table. For example, although certain assets and liabilities may have similar
maturities or periods to repricing, they may react in different degrees to
changes in market interest rates. Also, the interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
interest rates. For instance, while the table is based on the assumption that
interest bearing demand accounts, money market accounts and savings accounts are
immediately sensitive to movements in rates, the Company expects that in a
changing rate environment the amount of the adjustment in interest rates for
such accounts would be less than the adjustment in categories of assets which
are considered to be immediately sensitive. Additionally, certain assets have
features which restrict changes in the interest rates of such assets both on a
short-term basis and over the lives of such assets. Further, in the event of a
change in market interest rates, pre-payment and early withdrawal levels could
deviate significantly from those assumed in calculating the tables. Finally, the
ability of many borrowers to service their adjustable-rate debt may decrease in
the event of an increase in market interest rates. Due to these shortcomings,
the Company places primary emphasis on its income simulation model when managing
its exposure to changes in interest rates.
32
<PAGE> 32
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. 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 working on Year 2000
readiness 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 initial portion of this phase was
completed February 1998 and the team continues to monitor on an ongoing basis
systems, software and equipment as the Company makes purchases or changes in
these areas to identify Year 2000 issues.
The Company has completed several projects designed to promote awareness of Year
2000 issues throughout the organization and customer base. These projects
include providing training for lending officers and other staff, sponsoring
public informational meetings and mailing information brochures to deposit and
loan customers.
The readiness team began initial assessment of our systems in early 1997. The
Company does not have in-house programs and relies upon third party vendors to
provide the software applications we use. The team identified the Company's
service providers and software/hardware vendors through the awareness phase and
contacted them 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 has analyzed the extent
that Year 2000 issues could adversely impact its borrower's business operations,
particularly its commercial borrowers. The Company has performed an initial
assessment of each major borrower and has 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 large customers is
coordinated by the team and regularly reported to the Company's Board of
Directors.
The team completed the assessment portion of this phase in February 1998, but
continues to monitor new or any changes in providers or vendors. The renovation
portion of this phase is still in process. The team has prioritized providers
and vendors using a "business critical" methodology. The Company is in the
process of testing all systems, software and hardware that have been deemed
"business critical."
The Company's most critical third party vendors are those that provide the main
frame software and hardware. These vendors have successfully completed their
Year 2000 internal testing. Our Company has chosen to test the software and
hardware via group testing. Software and hardware from other third party vendors
is being tested internally with oversight by members of the team. Internal
testing includes creation of a test environment specifically dedicated to Year
2000 testing. This environment allows 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. We expect to complete this testing by
April 1999. 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.
THE COSTS TO ADDRESS THE COMPANY'S YEAR 2000 ISSUES The Company has expended
approximately $63,000 in addressing the Y2K 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 $130,800. These costs will
be for completion of the phases in process under direction of the readiness
team. Costs related to renovating and testing will be expensed in the period
incurred. Actual costs for replacing equipment and software can not be
established until the renovation and testing phases are fully completed. Thus
far these costs and costs related to fixing Year 2000 issues have been minimal
and future costs are not anticipated to be material.
THE RISKS OF THE COMPANY'S YEAR 2000 ISSUES The Company has taken steps to
mitigate the risks associated with Year 2000 issues by testing software and
hard- ware and following the progress of vendors, service providers and large
customers. The most reasonably likely worst case scenario would be that testing
of software and hardware reveals the need for additional Year 2000 expenditures.
Management believes that should this scenario occur, that impact of such
expenditures would not be material to the Company's financial position and
results of 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 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. 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 Y2K 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 has developed a comprehensive Year
2000 contingency plan. The Plan is in the process of revision with information
generated from working through the phases. Contingency processes will be
augmented by the Company's existing disaster recovery plan, which enables it to
function under unusual circumstances. The Plan includes management's
preparations to accommodate the potentially increased liquidity needs of the
Company during the fourth quarter of 1999. Although the Company has taken
precautions to assure its technology is Y2K ready, it will continue to address
possible emergency scenarios.
33
<PAGE> 33
IMPACT OF INFLATION AND CHANGING PRICES
The primary impact of inflation on the Company's operations is increased
operating costs. Unlike most industrial companies, virtually all the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates generally have a more significant impact on a financial
institution's performance than the effects of general levels of inflation.
Although interest rates do not necessarily move in the same direction or to the
same extent as the prices of goods and services, increases in inflation
generally have resulted in increased interest rates.
QUARTERLY COMMON STOCK PRICES AND DIVIDEND PAYMENTS
The Company's common stock is traded on the Nasdaq National Market under the
symbol WBCO. On December 31, 1998, the last sale price was $8.50.
The Company is aware that blocks of its stock are held in street name by
brokerage firms. At December 31, 1998, the number of shareholders of record was
364.
The following are the high and sales prices for the Company's stock in the
over-the-counter market during 1998 since the Company's initial public offering
as reported on Nasdaq.
<TABLE>
<CAPTION>
1998
--------------------------
HIGH LOW
---- ---
<S> <C> <C>
Second Quarter $14 $12 3/8
Third Quarter 13 7/16 9
Fourth Quarter 10 1/4 8 3/8
For the year 14 8 3/8
</TABLE>
Since 1998, the Company has paid the following annual amounts on a per share
basis, as adjusted for splits, as dividends to its shareholders:
<TABLE>
<CAPTION>
Year Amount
---- ------
<S> <C>
1998 $0.14
1997 0.13
1996 0.12
</TABLE>
The Board of Directors dividend policy is to review the Company's financial
performance, capital adequacy, cash resources, regulatory restrictions, economic
conditions and other factors, and if such review is favorable, to declare and
pay a cash dividend. For 1997 and prior years, dividends have been paid on an
annual basis. After completion of the initial public offering, the Company paid
dividends on a quarterly basis. As a transition to quarterly dividends, on March
26, 1998, the Board of Directors of the Company declared a dividend in the
amount of $0.07 per outstanding share of Common Stock (adjusted for the 1998
stock splits) for the first half of 1998, and dividends in the amount of $0.035
per outstanding share during each of the last two quarters of the year. The
ability of the Company to pay dividends will depend on the profitability of the
Bank, the need to retain or increase capital, and the dividend restrictions
imposed upon the Bank by applicable banking law. Although the Company
anticipates payment of a regular quarterly cash dividend, future dividends are
subject to these limitations and to the discretion of the Board of Directors,
and could be reduced or eliminated.
RECENT CHANGE IN ACCOUNTING FIRMS
On December 15, 1997, the Company engaged KPMG LLP as the Company's principal
accountant. Prior to KPMG LLP's engagement, David Christensen, CPA & Consultant,
PLLC ("David O. Christensen") independent certified public accountants, had
served as the principal independent accountant for the Company and rendered its
report with respect to the Company's consolidated financial statements for the
year ended December 31, 1996. The recommendation to dismiss David O. Christensen
was made by management of the Company and was approved by the Board of Directors
effective November 20, 1997.
In the two most recent fiscal years preceding the Board's action, and through
December 15, 1997, there were no disagreements with David O. Christensen on any
matter of accounting principles or practices, financial statement disclosure, or
auditing scope or procedure, which, if not resolved to David O. Christensen's
satisfaction, would have caused them to make reference to the subject matter of
the disagreement in connection with their report. David O. Christensen's reports
on the Company's statements for such fiscal year did not contain any adverse
opinion or disclaimer of opinion, nor were such reports modified or qualified in
any respect.
<PAGE> 1
EXHIBIT 24
POWER OF ATTORNEY
The director of Washington Banking Company (the "Company"), whose
signature appears below, hereby appoints Michal D. Cann or Karl C. Krieg, III,
or either of them, as his attorney to sign, in his name and behalf and in any
and all capacities stated below, the Company's Form 10-K Annual Report pursuant
to Section 13 of the Securities Exchange Act of 1934, and likewise to sign any
and all amendments and other documents relating thereto as shall be necessary,
such person hereby granting to each such attorney power to act with or without
the other and full power of substitution and revocation, and hereby ratifying
all that any such attorney or his substitute may do by virtue hereof.
This Power of Attorney has been signed by the following person in the
capacity indicated, on the 18 day of March, 1999.
<TABLE>
<CAPTION>
Signature Title
- --------- -----
<S> <C>
/s/ Michal D. Cann Director
- ----------------------------------
Michal D. Cann
/s/ Orlan D. Dean Director
- ----------------------------------
Orlan D. Dean
/s/ Marlen L. Knutson Director
- ----------------------------------
Marlen L. Knutson
/s/ Karl C. Krieg, III Director
- ----------------------------------
Karl C. Krieg, III
/s/ Jay T. Lien Director
- ----------------------------------
Jay T. Lien
Director
- ----------------------------------
Robert C. Olson
</TABLE>
<PAGE> 2
<TABLE>
<S> <C>
/s/ Anthony B. Pickering Director
- ----------------------------------
Anthony B. Pickering
/s/ Larry Scodeller Director
- ----------------------------------
Larry Scodeller
Director
- ----------------------------------
Alvin J. Sherman
/s/ Edward J. Wallgren Director
- ----------------------------------
Edward J. Wallgren
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 12,063
<INT-BEARING-DEPOSITS> 8,089
<FED-FUNDS-SOLD> 4,100
<TRADING-ASSETS> 736
<INVESTMENTS-HELD-FOR-SALE> 12,591
<INVESTMENTS-CARRYING> 24,875
<INVESTMENTS-MARKET> 25,667
<LOANS> 149,617
<ALLOWANCE> 1,745
<TOTAL-ASSETS> 220,493
<DEPOSITS> 189,698
<SHORT-TERM> 0
<LIABILITIES-OTHER> 1,104
<LONG-TERM> 0
0
0
<COMMON> 17,836
<OTHER-SE> 11,855
<TOTAL-LIABILITIES-AND-EQUITY> 220,493
<INTEREST-LOAN> 12,910
<INTEREST-INVEST> 1,731
<INTEREST-OTHER> 595
<INTEREST-TOTAL> 15,236
<INTEREST-DEPOSIT> 5,765
<INTEREST-EXPENSE> 5,765
<INTEREST-INCOME-NET> 9,471
<LOAN-LOSSES> 735
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 7,535
<INCOME-PRETAX> 3,136
<INCOME-PRE-EXTRAORDINARY> 2,212
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,212
<EPS-PRIMARY> .63
<EPS-DILUTED> .59
<YIELD-ACTUAL> 4.78
<LOANS-NON> 639
<LOANS-PAST> 32
<LOANS-TROUBLED> 208
<LOANS-PROBLEM> 215
<ALLOWANCE-OPEN> 1,296
<CHARGE-OFFS> 313
<RECOVERIES> 27
<ALLOWANCE-CLOSE> 1,745
<ALLOWANCE-DOMESTIC> 1,316
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 429
</TABLE>
