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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
For the fiscal year ended DECEMBER 31, 1999
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number 000-24503
WASHINGTON BANKING COMPANY
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
WASHINGTON 91-1725825
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
</TABLE>
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 March 1, 2000 was $31,919,404.
The number of shares of registrant's Common Stock outstanding at March 20, 2000
was 4,069,285.
Documents incorporated by reference and parts of Form 10-K into which
incorporated:
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<S> <C>
Registrant's definitive Proxy Statement
dated March 31, 2000 Part III
</TABLE>
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CROSS REFERENCE SHEET
Location in Definitive Proxy Statement
Items required by Form 10-K
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<CAPTION>
Form 10-K Definitive Proxy Statement
- ----------------------------------------------- ---------------------------------------------
Part and Page
Item No. Caption Caption Number
- -------- ------------------------------------- ------------------------------------- ------
<C> <S> <C> <C>
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 6
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 12
Transactions Transactions
</TABLE>
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TABLE OF CONTENTS
PART I
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Page
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<S> <C> <C>
Item 1 Business 1
General 1
Market Areas 2
Competition 2
Executive Officers of the Company 3
Employees 3
Supervision and Regulation 3
Effects of Governmental Monetary Policies 4
Lending Activities 5
Loan Portfolio Composition 5
Commercial Loans 5
Real Estate Loans 6
Consumer Loans 7
Maturities and Sensitivities of Loans to Changes in Interest
Rates 7
Commitments and Contingent Liabilities 7
Nonperforming Assets 8
Summary of Loan Loss Experience 8
Analysis of Allowance for Loan Losses 8
Allocation of Loan Loss Allowance 9
Investment Activities 9
General 9
Held to Maturity Investment Securities 11
Available for Sale Investment Securities 12
Deposits 12
Short Term Borrowing 13
Item 2 Properties 13
Item 3 Legal Proceedings 13
Item 4 Submission of Matters to a Vote of Security Holders 13
PART II
Market for the Registrant's Common Stock and Related
Item 5 Stockholder Matters 14
Item 6 Selected Financial Data 15
Management's Discussion and Analysis of Financial Condition
Item 7 and Results of Operations 16
Overview 16
Financial Condition 17
Total Assets 17
Total Loans 17
Total Investment Securities 17
Premises and Equipment 17
Deposit Accounts 17
Shareholders' Equity 17
Net Interest Income 17
Consolidated Average Balance Sheet and Analysis of Net
Interest Income and Expense 18
Consolidated Analysis of Changes in Interest Income and
Expense 19
Results of Operations 19
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<TABLE>
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Page
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Net Income 19
Net Interest Income 19
Provision for Loan Losses 20
Noninterest Income 20
Noninterest Expense 20
Liquidity and Capital Resources 21
Capital Ratios 21
Year 2000 Issues 22
Impact of Inflation and Changing Prices 22
Asset/Liability Management 22
Item 7a Quantitative and Qualitative Disclosures about Market Risk 23
Item 8 Financial Statements and Supplementary Data 25
Independent Auditors' Report 25
Consolidated Statements of Financial Condition 26
Consolidated Statements of Income 27
Consolidated Statements of Shareholders' Equity and
Comprehensive Income 28
Consolidated Statements of Cash Flows 29
Notes to Consolidated Financial Statements 30
Changes in and Disagreements with Accountants in Accounting
Item 9 and Financial Disclosure 46
PART III
Item 10 Directors and Executive Officers of the Registrant 46
Item 11 Executive Compensation 46
Security Ownership of Certain Beneficial Owners and
Item 12 Management 46
Item 13 Certain Relationships and Related Transactions 46
PART IV
Exhibits, Financial Statement Schedules and Reports on Form
Item 14 8-K 47
</TABLE>
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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 thirteen
branch offices and three loan production offices located in Island, Skagit,
Whatcom and Jefferson Counties in northwestern Washington. At December 31, 1999,
the Company had total assets of $286.0 million, total deposits of $254.5 million
and shareholders' equity of $29.8 million.
Effective June 23, 1998, the Company sold 1,380,000 shares of its common stock
in an initial public offering at a 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
Seattle and south of the Canadian border, but had no presence on the mainland.
In view of the threatened closure of NAS Whidbey Island in 1991, the Company
determined that it would be prudent to diversify geographically beyond Island
County. With the consolidation of some 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 converted the Burlington loan production office into a full service
branch in August 1995.
Due to the favorable response in Burlington, the Company decided to 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
Seattle, Washington and areas contiguous to Whidbey Island into which it would
expand if and as the opportunities arise. In late 1996, the Company targeted
Bellingham for expansion, hired an experienced manager and lending officer, both
with longstanding 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, Washington (on Fidalgo Island), and in
Freeland, Washington, which is located on the southern part of Whidbey Island.
In addition, a grocery store branch was opened in April 1998 on Camano Island.
During the first quarter of 1999, the Company relocated the Bellingham office to
a larger office and opened a residential real estate loan production office in
Port Townsend, Washington (Jefferson County). Expansion in Skagit County
continued with the opening of a full service branch in Sedro Woolley in June
1999, and two new Mt. Vernon offices -- a grocery store branch in January 2000
and a residential real estate loan production office during February 2000.
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 those islands. Currently, the Company's
geographical expansion is expected to be concentrated in Skagit County and the
Bellingham area of Whatcom County. Additional geographic expansion areas will be
considered if they meet the Company's criteria. The primary factors considered
in determining the areas of geographic expansion are customer demand and
availability of experienced managers, lending officers and branch personnel with
a longstanding community presence and extensive banking relationships. The
Company also emphasizes the hiring of experienced personnel with extensive
industry knowledge when considering lending product expansion.
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. To deliver the Company's products more effectively and
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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 ("ATMs") in the areas
surrounding those central locations in order to further service customers.
Acquisition of banks or branches may also be used as a means of expansion if
appropriate opportunities are presented. The Company has also invested in
technology to facilitate telephone, personal computer and internet banking, but
with its primary commitment being to provide exceptional personal service.
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, Whatcom County and
Jefferson County encompasses four 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 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.
Jefferson County is situated in the upper half of the Olympic Peninsula in
northwestern Washington. Jefferson County has a growing small business
community, an industrial base of natural resources, marine trades and
manufacturing, and increasing tourism. The governmental sector provides a
significant portion of employment in the county.
COMPETITION
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 commercial banks, savings banks, savings
and loan associations, credit unions and other financial and non-financial
institutions. Some of the 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. With the passage of banking
reform legislation in late 1999, increasing competition from nonbanking
companies is expected.
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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
NAME AGE POSITION OR BANK SINCE
---- --- -------- -----------------
<S> <C> <C> <C>
Michal D. Cann 51 President and Chief Executive Officer 1992
Phyllis A. Hawkins 51 Senior Vice President and Chief Financial Officer 1995
</TABLE>
MICHAL D. CANN
Mr. Cann, 51, has been the President and Chief Executive Officer of the Company
since its inception in 1996, and the President and Chief Executive Officer of
the Bank, and President and Secretary of WIB Financial Services, Inc. since
1993. Mr. Cann has been a director of the Bank since 1992. Mr. Cann has 29 years
of banking experience, previously having served as the President of Valley Bank,
Mt. Vernon, Washington, and in other senior management positions in other banks
and/or bank holding companies.
PHYLLIS A. HAWKINS
Ms. Hawkins, 51, is the Senior Vice President and Chief Financial Officer of the
Company and Whidbey Island Bank. Prior to becoming the Senior Vice President and
Chief Financial Officer in 1996, Ms. Hawkins served as Senior Vice President and
Cashier. She began working for Whidbey Island Bank in 1969 and has held various
positions in operations, human resources and auditing since that time. Ms.
Hawkins serves as the Chairman of the Asset Liability Management and Risk
Management Committees of the Bank.
EMPLOYEES
The Company had 180 full time equivalent employees at December 31, 1999. None of
the Company's employees are covered by a collective bargaining agreement. The
Company considers its relations with its employees to be good.
SUPERVISION AND REGULATION
The Company is a bank holding company within the meaning of the Bank Holding
Company Act of 1956 ("BHC Act") registered with and subject to examination by
the Federal Reserve Board ("FRB"). The Company's bank subsidiary is a Washington
state chartered commercial bank and is subject to examination, supervision and
regulation by the Washington State Department of Financial
Institutions -- Division of Banks ("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, the Division, the FDIC and other regulators, and by local legislative
and administrative bodies and decisions of courts in Washington state. These
include limitations on the ability of the Bank to pay dividends to the Company,
and 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.
Congress enacted major federal financial institution reform legislation in 1999.
Title I of the Gramm-Leach-Bliley Act, which became effective March 11, 2000,
allows bank holding companies to elect to become financial holding companies. In
addition to activities previously permitted bank holding companies, financial
holding companies may engage in nonbanking activities that are financial in
nature, such as securities, insurance and merchant banking activities, subject
to certain limitations.
The activities of bank holding companies are generally limited to managing or
controlling banks. Nonbank acquisitions by bank holding companies such as the
Company are generally limited to 5% of voting shares of a
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company and activities previously determined by the FRB by regulation or order
to be so closely related to banking as to be a proper incident to banking or
managing or controlling banks.
Additional 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
any 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.
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.
Under longstanding FRB policy, a bank holding company is expected to act as a
source of financial strength for its subsidiary banks and to commit resources to
support such banks. The Company could be required to commit resources to its
subsidiary banks in circumstances where it might not do so, absent such policy.
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, 1999, 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. 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 nondeposit 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.
The earnings of the Company are affected by general economic conditions and the
conduct of monetary policy by the U.S. government.
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 FRB. The federal reserve system implements
national monetary policy for such purposes as controlling inflation and
recession by its open market operations
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in United States government securities, control of the discount rate applicable
to borrowing from the FRB and the establishment of reserve requirements against
certain deposits. The actions of the FRB 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.
LENDING ACTIVITIES
LOAN PORTFOLIO COMPOSITION. The Company provides a broad array of loan products
to small and medium sized businesses and to individuals. Since December 31,
1996, the Company has increased five or more family residential and commercial
real estate loans as a percentage of its total loan portfolio and decreased real
estate construction loans as a percentage of its total loan portfolio. One to
four family real estate loans originated for the Company's portfolio have
decreased as a percentage of total loans, however the Company also originates
one to four family real estate loans for third party long term lenders. Total
real estate mortgage loans grew to 24.4% of the Company's portfolio. Commercial
loans continue to compose the largest percentage of the loan portfolio at 40.5%
as of December 31, 1999. Consumer loans have grown to 28.7% of the loan
portfolio as of December 31, 1999.
The following table sets forth the Company's loan portfolio composition by type
of loan at the dates indicated(1):
<TABLE>
<CAPTION>
DECEMBER 31
------------------------------------------------------------------------------------------------
1999 1998 1997 1996
---------------------- ---------------------- ---------------------- ---------------------
BALANCE % OF TOTAL BALANCE % OF TOTAL BALANCE % OF TOTAL BALANCE % OF TOTAL
(DOLLARS IN THOUSANDS) --------- ---------- --------- ---------- --------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial $ 90,014 40.5% $ 65,564 43.8% $ 48,242 41.0% $ 34,522 42.4%
Real estate mortgages:
One to four family
residential 24,822 11.2% 17,052 11.4% 14,258 12.1% 13,264 16.3%
5 or more family residential
and commercial 29,527 13.2% 12,146 8.1% 8,711 7.4% 5,593 6.9%
--------- ------ --------- ------ --------- ------ -------- ------
Total real estate
mortgages $ 54,349 24.4% $ 29,198 19.5% $ 22,969 19.5% $ 18,857 23.2%
Real estate construction 14,300 6.4% 14,139 9.5% 12,646 10.8% 8,389 10.3%
Consumer 63,757 28.7% 40,750 27.2% 33,721 28.7% 19,568 24.1%
--------- ------ --------- ------ --------- ------ -------- ------
Subtotal $ 222,420 100.0% $ 149,651 100.0% $ 117,578 100.0% $ 81,336 100.0%
====== ====== ====== ======
Less: allowance for loan losses (2,182) (1,745) (1,296) (796)
Less: deferred loan fees and
other (16) (34) (43) (67)
--------- --------- --------- --------
Loans, net $ 220,222 $ 147,872 $ 116,239 $ 80,473
========= ========= ========= ========
</TABLE>
(1) Information above has been derived, in part, from the audited consolidated
financial statements of the Company and has been provided for all periods
for which it is available. The Company has requested a waiver from the Guide
3 requirement that five-year's information regarding the loan portfolio
composition be provided in this report, as (a) the Company qualifies as a
small business reporter and (b) preparation of the information would be
unduly burdensome.
COMMERCIAL LOANS. Commercial business lending is the primary focus of the
Company's lending activities. Commercial loans increased to $90.0 million at
December 31, 1999, representing 40.5% of its total loans, from $65.6 million, or
43.8%, at December 31, 1998, and $48.2 million, or 41.0%, at December 31, 1997.
Commercial loans include both secured and unsecured loans for working capital
and expansion. Short term working capital 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"), an independent agency of the Federal Government, which
guarantees up to 80% of the loan amount. SBA loans are generally made to small
and medium sized 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
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guaranteed portions of these loans are generally sold at a premium. At December
31, 1999, the Company had outstanding $2.2 million, or 2.5% of its commercial
loan portfolio, in SBA commercial business loans.
Beginning in 1997, when the Company hired a lending officer with substantial
experience with dealer inventory financing and indirect vehicle lending, the
Company increased the origination of commercial loans to automobile dealers to
finance their inventories. At December 31, 1999, the Company had outstanding
$2.5 million, or 2.7% 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.
Residential Mortgages. The Company's portfolio of residential mortgage loans is
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, 1999, the Company's
total gross loan originations of residential loans for the account of third
parties were $38.3 million, compared with $52.0 million and $12.3 million,
respectively, for the years ended December 31, 1998 and 1997. The Company
anticipates that it will continue to be an active originator of residential
loans for the account of third parties. The Company is qualified to sell
conforming residential mortgages to the Federal Home Loan Mortgage Corporation
("FHLMC"). The Company will consider originating for sale to FHLMC conforming
residential mortgage loans, depending on market conditions. The Company provides
customers access to long term conventional real estate loans through its
mortgage loan department that makes Federal National Mortgage Association
("FNMA") conforming loans for the account of third parties.
Five or more Family and Commercial Real Estate Loans. The Company has made, and
anticipates continuing to make, on a selective basis, five or more family and
commercial real estate loans. 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.
Construction Loans. The Company originates one to four family residential
construction loans for the construction of custom homes (where the homebuyer is
the borrower) and provides financing to builders for the construction of
pre-sold homes and speculative residential construction. Speculative residential
lending amounted to $2.8 million, or 19.4% of the total construction loan
portfolio at December 31, 1999. The average loan size at December 31, 1999 was
approximately $84,000. With few exceptions, the Company limits 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, it is the Company's
policy to require documentation of all draw requests and to use 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.
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CONSUMER LOANS. 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. 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 Vehicle Loans. The Company also makes automobile loans for used
vehicles originated indirectly by selected automobile dealers located in the
Company's market areas. At December 31, 1999, $30.8 million, or 48.3%, of the
Company's consumer loan portfolio consisted of indirect automobile loans
compared to $13.3 million, or 32.6% in 1998. 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. 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
increased its oversight of the approval process and uses a loan grading system
which limits the risks inherent in dealer originated loans.
Credit Cards. The Company also offers VISA credit cards to its customers. At
December 31, 1999, $1.4 million of credit card balances were outstanding
representing 2.3% of the Company's consumer loan portfolio and .7% of its total
portfolio. At December 31, 1999, approximately $2,917 or .2% of outstanding
credit card balances were past due.
MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES. The
following table presents at December 31, 1999 (1) the aggregate maturities of
loans in the named categories of the Company's loan portfolio and (2) the
aggregate amounts of variable and fixed rate loans in the named categories that
mature more than one year after inception:
<TABLE>
<CAPTION>
MATURING
---------------------------------------------------------
WITHIN 1 YEAR 1 - 5 YEARS AFTER 5 YEARS TOTAL
------------- ----------- ------------- --------
<S> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Real estate construction:
One to four family residential $ 9,216 $ 1,972 $ 576 $ 11,764
5 or more family residential and commercial 730 198 1,608 2,536
------- ------- ------- --------
Total real estate construction $ 9,946 $ 2,170 $ 2,184 $ 14,300
Commercial 28,268 26,082 35,664 90,014
------- ------- ------- --------
Total $38,214 $28,252 $37,848 $104,314
======= ======= ======= ========
Fixed rate loans $13,140 $ 9,984 $ 23,124
Variable rate loans 15,112 27,864 42,976
------- ------- --------
Total $28,252 $37,848 $ 66,100
======= ======= ========
</TABLE>
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" on page 44 of this report.
7
<PAGE> 12
NONPERFORMING ASSETS. The following table sets forth, for the periods
indicated(1), 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
-------------------------------------------
1999 1998 1997 1996
(DOLLARS IN THOUSANDS) -------- -------- -------- -------
<S> <C> <C> <C> <C>
Nonaccrual loans $ 920 $ 639 $ 498 $ 390
Restructured loans 52 208 653 781
-------- -------- -------- -------
Total nonperforming loans $ 972 $ 847 $ 1,151 $ 1,171
Real estate owned 170 -- 30 --
-------- -------- -------- -------
Total nonperforming assets $ 1,142 $ 847 $ 1,181 $ 1,171
======== ======== ======== =======
Accruing loans past due $90 days $ -- $ 32 $ -- $ 2
Potential problem loans $ -- $ 215 $ 11 $ 7
Allowance for loan losses $ 2,182 $ 1,745 $ 1,296 $ 796
Nonperforming loans to loans 0.44% 0.57% 0.98% 1.44%
Allowance for loan losses to loans 0.98% 1.17% 1.10% 0.98%
Allowance for loan losses to nonperforming loans 224.49% 206.02% 112.60% 67.98%
Nonperforming assets to total assets 0.40% 0.38% 0.74% 1.00%
</TABLE>
(1) Information above has been derived, in part, from the audited consolidated
financial statements of the Company and has been provided for all periods
for which it is available. The Company has requested a waiver from the Guide
3 requirement that five-year's information regarding nonperforming assets be
provided in this report, as (a) the Company qualifies as a small business
reporter and (b) preparation of the information would be unduly burdensome.
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 status. Loans are placed on a
nonaccrual basis when there are serious doubts about the collectibility 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
nonaccrual 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.
Interest foregone on nonaccrual loans was approximately $94,000, $60,000 and
$40,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
SUMMARY OF LOAN LOSS EXPERIENCE
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 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.
8
<PAGE> 13
ALLOCATION OF LOAN LOSS ALLOWANCE. The following table shows the allocation of
the allowance for loan losses at the periods indicated(1). The allocation is
based on an evaluation of defined loan problems, historical ratios of loan
losses and other factors that may affect future loan losses in the categories of
loans shown:
<TABLE>
<CAPTION>
DECEMBER 31
---------------------------------------------------------------------------------
1999 1998 1997 1996
------------------ ------------------ ------------------ ------------------
% OF % OF % OF % OF
TOTAL TOTAL TOTAL TOTAL
AMOUNT LOANS(2) AMOUNT LOANS(2) AMOUNT LOANS(2) AMOUNT LOANS(2)
(DOLLARS IN THOUSANDS) ------- -------- ------- -------- ------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance applicable to:
Commercial $ 704 40.5% $ 595 43.8% $ 437 41.0% $ 266 42.4%
Real estate mortgage 372 24.4% 174 19.5% 206 19.5% 139 23.2%
Real estate construction 132 6.4% 168 9.5% 115 10.8% 64 10.3%
Consumer 715 28.7% 379 27.2% 307 28.7% 157 24.1%
Unallocated 259 -- 429 -- 231 -- 170 --
------- ------ ------- ------ ------- ------ ----- ------
Total $ 2,182 100.0% $ 1,745 100.0% $ 1,296 100.0% $ 796 100.0%
======= ====== ======= ====== ======= ====== ===== ======
</TABLE>
(1) Information above has been derived, in part, from the audited consolidated
financial statements of the Company and has been provided for all periods
for which it is available. The Company has requested a waiver from the Guide
3 requirement that five-year's information regarding allocation of loan loss
allowance be provided in this report, as (a) the Company qualifies as a
small business reporter and (b) preparation of the information would be
unduly burdensome.
(2) Represents the total of all outstanding loans in each category as a percent
of total loans outstanding.
The following table sets forth for the periods indicated(1) information
regarding changes in the Company's allowance for loan losses:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
---------------------------------------
1999 1998 1997 1996
(DOLLARS IN THOUSANDS) ------- ------- ------- ------
<S> <C> <C> <C> <C>
Balance at beginning of period $ 1,745 $ 1,296 $ 796 $ 620
Charge-offs:
Commercial (328) (182) (43) (166)
Real estate (6) -- (11) --
Consumer and other (277) (131) (106) (63)
------- ------- ------- ------
Total charge-offs $ (611) $ (313) $ (160) $(229)
Recoveries:
Commercial 8 2 -- 49
Real estate -- -- -- --
Consumer 20 25 13 6
------- ------- ------- ------
Total recoveries $ 28 $ 27 $ 13 $ 55
Net charge-offs (583) (286) (147) (174)
Provision for loan losses 1,020 735 647 350
------- ------- ------- ------
Balance at end of period $ 2,182 $ 1,745 $ 1,296 $ 796
======= ======= ======= ======
</TABLE>
(1) Information above has been derived, in part, from the audited consolidated
financial statements of the Company and has been provided for all periods
for which it is available. The Company has requested a waiver from the Guide
3 requirement that five-year's information regarding changes to the
Company's loan loss allowance be provided in this report, as (a) the Company
qualifies as a small business reporter and (b) preparation of the
information would be unduly burdensome.
INVESTMENT ACTIVITIES
GENERAL. The Company's total portfolio of investment securities decreased by
$7.0 million from December 31, 1998 to December 31, 1999 and increased $8.5
million from December 31, 1997 to December 31, 1998. The investment portfolio
consists primarily of U.S. Treasury and government agency securities,
9
<PAGE> 14
municipal securities and corporate obligations. Municipal securities represented
55.2%, or $17.2 million, of the Company's investment portfolio at December 31,
1999 as compared to 43.2%, or $16.5 million, at December 31, 1998 and 33.0%, or
$9.8 million, at December 31, 1997. The Company has purchased nonrated municipal
obligations of local and surrounding areas. Approximately 37.8% at December 31,
1999, 38.7% at December 31, 1998 and 32.0% at December 31, 1997 of the municipal
securities in the Company's investment portfolio were rated below "A", or its
equivalent, or unrated. Corporate obligations were $6.3 million, or 20.3% of the
Company's investment portfolio, at December 31, 1999, $6.9 million, or 18.0% of
the investment portfolio, at December 31, 1998 and $7.6 million, or 25.7% of the
investment portfolio at December 31, 1997. At December 31, 1999, 1998 and 1997
all corporate obligations held by the Company were rated "A", or its equivalent,
or better. The average maturity of the securities portfolio was approximately
4.4 years and 4.2 years as of December 31, 1999 and 1998, respectively.
The following table summarizes the amortized cost and recorded and market values
of securities in the Company's portfolio by contractual maturity groups:
<TABLE>
<CAPTION>
DECEMBER 31, 1999
--------------------------------
AMORTIZED MARKET RECORDED
COST VALUE VALUE
(DOLLARS IN THOUSANDS) --------- ------- --------
<S> <C> <C> <C>
AMOUNTS MATURING:
Within one year $ 4,442 $ 4,446 $ 4,445
One to five years 15,423 15,181 15,256
Six to ten years 10,077 9,903 10,077
Over ten years 1,476 1,421 1,476
------- ------- -------
Total $31,418 $30,951 $31,254
======= ======= =======
</TABLE>
The following table provides the carrying values, maturities and weighted
average yields of the Company's investment portfolio:
<TABLE>
<CAPTION>
DECEMBER 31, 1999
-------------------------------------------------------
WITHIN 1 1 - 5 6 - 10 OVER 10
YEAR YEARS YEARS YEARS TOTAL
(DOLLARS IN THOUSANDS) -------- -------- -------- ------- --------
<S> <C> <C> <C> <C> <C>
U.S. Treasury securities
Balance $ 1,503 $ 501 $ -- $ -- $ 2,004
Weighted average yield 6.23% 5.95% -- -- 6.16%
U.S. Government agency securities
Balance $ 499 $ 4,369 -- -- $ 4,868
Weighted average yield 6.09% 5.68% -- -- 5.72%
State and political subdivisions
Balance $ 442 $ 6,045 $ 9,286 $ 1,476 $ 17,249
Weighted average yield 5.20% 4.67% 4.62% 5.00% 4.68%
Corporate obligations and other
Balance $ 2,000 $ 4,342 -- -- $ 6,342
Weighted average yield 6.10% 6.28% -- -- 6.23%
FHLB Stock
Balance -- -- $ 791 -- $ 791
Weighted average yield -- -- 7.00% -- 7.00%
------- -------- -------- ------- --------
Total Balance $ 4,444 $ 15,257 $ 10,077 $ 1,476 $ 31,254
======= ======== ======== ======= ========
Weighted average yield 6.05% 5.46% 4.80% 5.00% 5.31%
</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, 1999, there were no securities of any issuer (other than U.S.
government agencies) that exceeded 10% of the Company's shareholders' equity.
10
<PAGE> 15
HELD TO MATURITY INVESTMENT SECURITIES. Investment securities designated as held
to maturity are those securities that the Company has the ability and the intent
to hold to maturity. Events that 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
market 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, 1999, the investment portfolio
consisted of 22.92% available for sale securities and 77.08% held to maturity
investments.
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, 1999, 1998 and 1997:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
(DOLLARS IN THOUSANDS) --------- ---------- ---------- -------
<S> <C> <C> <C> <C>
December 31, 1999:
U.S. Government agency securities $ 499 $ -- $ (2) $ 497
State and political subdivisions 17,249 3 (235) 17,017
Corporate obligations 6,342 1 (70) 6,273
------- ---- ------ -------
Total $24,090 $ 4 $(307) $23,787
======= ==== ====== =======
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>
11
<PAGE> 16
AVAILABLE FOR SALE INVESTMENT SECURITIES. The Company expects in the future 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 as of
December 31, 1999, 1998 and 1997:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
(DOLLARS IN THOUSANDS) --------- ---------- ---------- -------
<S> <C> <C> <C> <C>
December 31, 1999:
U.S. Treasury securities $ 2,003 $ 2 $ (1) $ 2,004
U.S. Government agency securities 4,534 -- (165) 4,369
------- --- ------ -------
Total $ 6,537 $ 2 $(166) $ 6,373
======= === ====== =======
December 31, 1998:
U.S. Treasury securities $ 5,008 $60 $ -- $ 5,068
U.S. Government agency securities 7,508 18 (3) 7,523
------- --- ------ -------
Total $12,516 $78 $ (3) $12,591
======= === ====== =======
December 31, 1997:
U.S. Treasury securities $ 4,996 $26 $ -- $ 5,022
U.S. Government agency securities 500 -- (1) 499
------- --- ------ -------
Total $ 5,496 $26 $ (1) $ 5,521
======= === ====== =======
</TABLE>
DEPOSITS
The Company provides a range of deposit services, including noninterest 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 noninterest
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:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-----------------------------------------------------------------
1999 1998 1997
------------------- ------------------- -------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
(DOLLARS IN THOUSANDS) -------- ------- -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
Interest bearing demand and
money market deposits $ 73,505 2.98% $ 55,320 2.87% $ 40,600 2.94%
Savings deposits 25,242 2.55% 23,227 3.13% 21,789 3.57%
Time deposits 80,770 5.18% 61,361 5.62% 42,220 5.65%
-------- ----- -------- ----- -------- -----
Total interest bearing
deposits $179,517 3.91% $139,908 4.12% $104,609 4.17%
Demand and other noninterest
bearing deposits 33,956 27,939 23,310
-------- -------- --------
Total average deposits $213,473 $167,847 $127,919
======== ======== ========
</TABLE>
12
<PAGE> 17
The following table sets forth the amounts and maturities of certificates of
deposit with balances of $100,000 or more at December 31, 1999:
<TABLE>
<CAPTION>
DECEMBER 31, 1999
(DOLLARS IN THOUSANDS) -----------------
<S> <C>
Remaining maturity:
Less than three months $26,141
Three to six months 8,076
Six to twelve months 9,343
Over twelve months 1,007
-------
$44,567
=======
</TABLE>
SHORT TERM BORROWING
At December 31, 1999, 1998 and 1997, there were no short term (original maturity
of one year or less) borrowings that exceeded an average of 30% of shareholders'
equity during those periods.
ITEM 2. PROPERTIES
The Company owns the property and buildings of its two Oak Harbor branches and
its branches at Coupeville, Burlington, Camano Island, Clinton, Bellingham and
Freeland. The Company leases the building and property of its branch at Langley.
The Company owns the building housing its Anacortes branch, which is situated on
land leased to the Company. The Company also leases space for its grocery store
branch on Camano Island, which opened in the second quarter of 1998, and its
College Way (Mt. Vernon) branch, which opened January 24, 2000. The Company
leases property for the dealer center and real estate mortgage office in Oak
Harbor, real estate mortgage offices in Port Townsend and Mt. Vernon, and
approximately 4,000 square feet for its administrative offices in Oak Harbor.
The Company owns the remaining approximately 6,000 square feet of the
administrative offices. A land parcel in Bellingham has been purchased for a
potential future branch location.
ITEM 3. LEGAL PROCEEDINGS
The Company and its subsidiaries are from time to time defendants in and are
threatened with various legal proceedings arising from regular business
activities. Management believes that its liability for damages, if any, arising
from such claims or contingencies will not 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
13
<PAGE> 18
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the Nasdaq National Market under the
symbol "WBCO".
The Company is aware that blocks of its stock are held in street name by
brokerage firms. At March 1, 2000, the number of shareholders of record was 335.
The following are the high and low sales prices for the Company's stock as
reported by the Nasdaq National Market during 1999 and 1998:
<TABLE>
<CAPTION>
1999 1998
------------------- --------------------
HIGH LOW HIGH LOW
-------- ------- -------- --------
<S> <C> <C> <C> <C>
First quarter $ 9.0435 $8.3481 $ -- $ --
Second quarter(1) 11.0490 8.3481 13.3557 12.2629
Third quarter 10.5960 9.4015 12.7486 9.2546
Fourth quarter 9.6900 7.9508 9.7767 8.3102
</TABLE>
(1) The Company's common stock became listed on the Nasdaq National Market on
June 23, 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>
DIVIDEND
YEAR PER SHARE
---- ---------
<S> <C>
1999 $0.16
1998 $0.14
1997 $0.13
</TABLE>
The Company's dividend policy requires the Board of Directors to review the
Company's financial performance, capital adequacy, cash resources, regulatory
restrictions, economic conditions and other factors, and if such review is
favorable, the Board may declare and pay a cash dividend. For 1997 and prior
years, dividends were paid on an annual basis. After completion of the initial
public offering in 1998, the Company has paid dividends on a quarterly basis.
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.
14
<PAGE> 19
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial audited
information and significant financial ratios for the Company. This information
is derived in part from the audited consolidated financial statements and notes
thereto of the Company set forth in Part II, Item 8 and should be read in
conjunction with the Company's financial statements and the Management
Discussion set forth in Part II, Item 7:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-----------------------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ----------- ----------- -----------
<S> <C> <C> <C>
OPERATING DATA:
Total interest income $ 19,076 $ 15,236 $ 11,901
Total interest expense 7,016 5,765 4,358
----------- ----------- -----------
Net interest income 12,060 9,471 7,543
Provisions for loan losses 1,020 735 647
----------- ----------- -----------
Net interest income after provision 11,040 8,736 6,896
Service charges on deposits 1,417 1,172 1,116
Other noninterest income 1,036 1,206 373
----------- ----------- -----------
Total noninterest income 2,453 2,378 1,489
Noninterest expense 10,318 7,978 5,663
----------- ----------- -----------
Income before income taxes 3,175 3,136 2,722
Provision for income taxes 823 924 818
----------- ----------- -----------
Net income $ 2,352 $ 2,212 $ 1,904
=========== =========== ===========
Average number of shares outstanding, basic 4,142,953 3,525,883 2,810,881
Average number of shares outstanding, diluted 4,387,192 3,769,244 2,935,972
PER SHARE DATA:
Net income per share, basic $ 0.57 $ 0.63 $ 0.68
Net income per share, diluted 0.54 0.59 0.65
Book value 7.34 7.09 4.64
Dividends 0.16 0.14 0.13
BALANCE SHEET DATA:
Total assets $ 285,970 $ 220,493 $ 160,068
Loans receivable, net of unearned fees 222,404 149,617 117,535
Allowance for loan losses 2,182 1,745 1,296
Real estate owned 170 -- 30
Federal funds sold 4,300 4,100 1,750
Deposits 254,475 189,698 146,394
Shareholders' equity 29,798 29,691 13,035
SELECTED PERFORMANCE RATIOS:
Return on average assets 0.95% 1.16% 1.35%
Return on average equity 7.91% 10.31% 15.21%
Net interest margin 5.52% 5.56% 5.94%
Net interest spread 4.75% 4.74% 5.13%
Noninterest expense to average assets 4.18% 4.19% 4.00%
Efficiency ratio 71.09% 67.33% 62.70%
Dividend payout ratio 28.07% 22.22% 19.12%
</TABLE>
15
<PAGE> 20
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-----------------------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ----------- ----------- -----------
<S> <C> <C> <C>
ASSET QUALITY RATIOS:
Nonperforming loans to period-end loans 0.44% 0.57% 0.98%
Allowance for loan losses to period-end loans 0.98% 1.17% 1.10%
Allowance for loan losses to nonperforming loans 224.49% 206.02% 112.60%
Nonperforming assets to total assets 0.40% 0.38% 0.74%
Net loan charge-offs to average loans
outstanding 0.32% 0.22% 0.15%
CAPITAL RATIOS:
Tier 1 risk-based capital 11.73% 14.93% 10.67%
Total risk-based capital 12.67% 15.99% 11.63%
Leverage ratio 9.83% 11.67% 8.08%
Equity to assets ratio 10.42% 13.47% 8.14%
OTHER DATA:
Number of banking offices 12 12 9
Number of full time equivalent employees(1) 180 145 116
</TABLE>
(1) The increase in full time equivalent employees in 1999 reflected branch
openings and additional increases in lending personnel and executive and
administrative personnel.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
NOTE: 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 Company's consolidated
financial statements 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 changes, risks of acquiring or opening new branches, controlling
expenses, and general economic conditions.
OVERVIEW
The Company continued its strategy of growth and enhancing its market
penetration throughout 1999. This resulted in the creation of a full service
office in Sedro Woolley (Skagit County), relocation of two offices to larger
more convenient locations (Island and Whatcom Counties), the opening of a
residential real estate loan production office in Port Townsend (Jefferson
County), and consolidation of the Whidbey City branch with the remaining three
South Whidbey offices (Island County). The Company has also added two offices in
Mount Vernon (Skagit County) -- a grocery store branch that opened in January
2000 and a real estate loan production office in February 2000.
Also in 1999, the Company developed a Private Banking Division, implemented an
internet online banking system, added business cash management products and
services for commercial customers, enhanced its website, expanded its real
estate lending service locations, continued to develop its retail investment
division, and substantially increased its number of ATMs from five at year end
1997 to 19 currently.
Washington Banking Company's objective is to continue its strategy of growth,
enhance its market penetration in the areas it currently serves, and improve its
profitability and operating efficiencies. The Company looks for expansion
opportunities that meet its criteria primarily in the geographic areas north and
northwest of Seattle to the Canadian border. Growth can be expected to require
the expenditure of substantial sums to purchase or lease real property and
equipment and to hire experienced personnel. New branch offices are often not
profitable for at least the first eighteen months after opening and management
expects that earnings will be negatively affected as the Company pursues its
growth strategy.
16
<PAGE> 21
FINANCIAL CONDITION
TOTAL ASSETS. Total assets increased to $286.0 million at December 31, 1999 from
$220.5 million at December 31, 1998, an increase of 29.7%. This increase
resulted primarily from growth in the loan portfolio, mostly funded by deposit
growth.
TOTAL LOANS. Total loans amounted to $222.4 million and $149.6 million at
December 31, 1999 and 1998, respectively. Commercial loans grew to $90.0 million
at December 31, 1999 from $65.6 million at December 31, 1998, while consumer
loans increased to $63.8 million from $40.8 million during that same period.
Commercial loans as a percentage of total loans decreased to 40.5% at December
31, 1999 from 43.8% at December 31, 1998, and consumer loans increased to 28.7%
of total loans from 27.2% at those dates. Real estate loans increased to 24.4%
of total loans at December 31, 1999 from 19.5% at December 31, 1998, while real
estate construction loans decreased to 6.4% from 9.5% as of those dates.
TOTAL INVESTMENT SECURITIES. Total investment securities were $31.3 million and
$38.2 million at December 31, 1999 and 1998, respectively. In 1999 the
availability of excess funds for long term investment purchases was
significantly reduced by the need for funding the strong loan demand.
PREMISES AND EQUIPMENT. Premises and equipment, net, were $11.2 million and $8.0
million at December 31, 1999 and 1998, respectively. The increase in 1999 over
1998 reflects upgrading computer systems, remodeling of offices, purchase of
land for branch offices, construction of branch offices, and related furniture,
fixture and equipment purchases.
DEPOSIT ACCOUNTS. Deposit accounts totaled $254.5 million and $189.7 million at
December 31, 1999 and 1998, respectively. Management attributes this increase to
a combination of its efforts to attract deposits through competitive pricing,
delivery of quality service and the expansion of its market area.
SHAREHOLDERS' EQUITY. Shareholders' equity was $29.8 million and $29.7 million
at December 31, 1999 and 1998, respectively. This slight 1999 increase reflects
earnings of $2.4 million, cash dividends of $664,000 and $1.5 million for
repurchase of approximately 142,000 shares of common stock.
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,
1999, 1998 and 1997, average interest earning assets were $223.6 million, $174.4
million and $129.7 million, respectively. During these same periods, the
Company's net interest margins were 5.52%, 5.56% and 5.94%, respectively.
17
<PAGE> 22
CONSOLIDATED AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST INCOME AND
EXPENSE
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-----------------------------------------------------------------------------------------------------------
1999 1998 1997
--------------------------------- --------------------------------- ---------------------------------
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
BALANCE EARNED/PAID YIELD BALANCE EARNED/PAID YIELD BALANCE EARNED/PAID YIELD
(DOLLARS IN THOUSANDS) --------- ----------- ------- --------- ----------- ------- --------- ----------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Loans $ 181,472 $ 16,856 9.29% $ 131,359 $ 12,910 9.83% $ 100,243 $ 10,207 10.18%
Federal funds sold 1,671 86 5.15% 5,609 298 5.31% 2,187 116 5.30%
Interest bearing cash 4,534 205 4.52% 5,066 243 4.80% -- -- --
Investments:
Taxable 18,520 1,114 6.02% 19,144 1,151 6.01% 17,986 1,118 6.22%
Non-taxable(1) 17,387 1,092 6.28% 13,189 850 6.44% 9,241 616 6.67%
--------- -------- ----- --------- -------- ----- --------- -------- ------
Interest earning
assets $ 223,584 $ 19,353 8.66% $ 174,367 $ 15,452 8.86% $ 129,657 $ 12,057 9.30%
Noninterest earning
assets 23,098 16,048 11,775
Total assets $ 246,682 $ 190,415 $ 141,432
========= ========= =========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Deposits
Interest demand and
money market $ 73,505 $ 2,187 2.98% $ 55,320 $ 1,589 2.87% $ 40,600 $ 1,193 2.94%
Savings 25,242 644 2.55% 23,227 726 3.13% 21,789 778 3.57%
Time deposits 80,770 4,185 5.18% 61,361 3,450 5.62% 42,220 2,387 5.65%
--------- -------- ----- --------- -------- ----- --------- -------- ------
Interest bearing
liabilities $ 179,517 $ 7,016 3.91% $ 139,908 $ 5,765 4.12% $ 104,609 $ 4,358 4.17%
Noninterest bearing
liabilities 37,420 29,045 24,301
--------- --------- ---------
Total liabilities $ 216,937 $ 168,953 $ 128,910
Shareholders' equity 29,745 21,462 12,522
--------- --------- ---------
Total liabilities and
shareholders' equity $ 246,682 $ 190,415 $ 141,432
========= ========= =========
Net interest income(1) $ 12,337 $ 9,687 $ 7,699
-------- -------- --------
Net interest spread 4.75% 4.74% 5.13%
----- ----- ------
Net interest margin(1) 5.52% 5.56% 5.94%
----- ----- ------
</TABLE>
(1) Interest income on non-taxable investments is presented on a fully
taxable-equivalent basis using the federal statutory rate of 34%. These
adjustments were $277,000, $216,000 and $156,000, for the years ended
December 31, 1999, 1998 and 1997, respectively.
18
<PAGE> 23
CONSOLIDATED ANALYSIS OF CHANGES IN INTEREST INCOME AND EXPENSE
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 of loans and
deposits and interest rate have been allocated proportionately to the changes
due to volume and the changes due to interest rate:
<TABLE>
<CAPTION>
1999 COMPARED TO 1998 1998 COMPARED TO 1997
---------------------------- ----------------------------
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
---------------------------- ----------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
(DOLLARS IN THOUSANDS) ------- -------- ------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Loans:
Total loans $ 4,926 $ (980) $ 3,946 $3,168 $(465) $ 2,703
Federal funds sold (209) (3) (212) 182 -- 182
Interest bearing cash (26) (12) (38) 243 -- 243
Securities(1) 221 (16) 205 325 (58) 267
------- -------- ------- ------ ------ -------
Total interest income $ 4,912 $(1,011) $ 3,901 $3,918 $(523) $ 3,395
======= ======== ======= ====== ====== =======
Interest bearing demand deposits $ 523 $ 75 $ 598 $ 433 $ 37 $ 396
Savings accounts 63 (145) (82) 51 (103) (52)
Certificates of deposit 1,091 (356) 735 1,082 (19) 1,063
------- -------- ------- ------ ------ -------
Total interest expense $ 1,677 $ (426) $ 1,251 $1,566 $(159) $ 1,407
======= ======== ======= ====== ====== =======
</TABLE>
(1) Interest income on non-taxable investments is presented on a fully
taxable-equivalent basis using the federal statutory rate of 34%. These
adjustments were $277,000, $216,000 and $156,000, for the years ended
December 31, 1999, 1998 and 1997, respectively.
RESULTS OF OPERATIONS
NET INCOME. The Company reported net income of $2.4 million, $2.2 million and
$1.9 million for the years ended December 31, 1999, 1998 and 1997, respectively.
Diluted net income per share was $0.54, $0.59 and $0.65 for 1999, 1998 and 1997,
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 and from 1998 to 1999 was
primarily attributable to the increased number of average 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, 1999,
1998 and 1997 was $12.1 million, $9.5 million and $7.5 million, respectively.
The increase in fiscal year 1999 was $2.6 million, or 27.3%, and in 1998 was
$1.9 million, or 25.6%, as a result of average interest earning assets
increasing more in actual total dollars than average interest bearing
liabilities. The difference was funded by growth in noninterest bearing
deposits, shareholders' equity, and maturing investment securities. Average
interest earning assets increased $49.2 million and $44.7 million for fiscal
years ended 1999 and 1998, respectively, while average interest bearing
liabilities increased by $39.6 million and $35.3 million for the same periods.
The average yield on interest earning assets decreased to 8.66% for the year
ended December 31, 1999 from 8.86% for the year ended December 31, 1998 and
9.30% for the year ended December 31, 1997. This decrease is due primarily to a
decrease in the rates earned on loans. Average yield on loans decreased to 9.29%
for the year ended December 31, 1999 from 9.83% for the year ended December 31,
1998 and 10.18% for the year ended December 31, 1997. 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
increased to 6.02% for the year ended December 31, 1999 from 6.01% for the year
ended December 31, 1998 and decreased from 6.22% for the year ended December 31,
1997. Average yields on non-taxable investments decreased to 6.28% for the year
ended December 31, 1999 from 6.44% and 6.67%, respectively, for the years ended
December 31, 1998 and 1997. The average yield on interest bearing liabilities
also decreased in 1999 to 3.91% for the year ended December 31, 1999 from 4.12%
for the year ended December 31, 1998 as rates on most deposit types
19
<PAGE> 24
decreased during the year. For the year ended 1998, the yield on average
interest bearing liabilities decreased from 4.17% for the year ended December
31, 1997. Average interest earning assets increased 28.2% from December 31, 1998
to December 31, 1999 and 34.5% from December 31, 1997 to December 31, 1998, and
average interest bearing liabilities increased 28.3% and 33.7%, respectively,
during the same periods. The overall result of these changes was an increase in
the net interest spread to 4.75% for the year ended December 31, 1999 from 4.74%
for the year ended December 31, 1998 and a decrease from 5.13% for the year
ended December 31, 1997 and a decrease in net interest margin to 5.52% from
5.56% and 5.94%, respectively, for the same periods.
PROVISION FOR LOAN LOSSES. The Company's provision for loan losses for the years
ended December 31, 1999, 1998 and 1997 totaled $1,020,000, $735,000 and
$647,000, respectively. The allowance for loan losses is maintained at a level
considered by management to be adequate to provide for possible loan losses
based on management's assessment of various factors affecting the loan
portfolio. These factors include the quality of the loan portfolio, problem
loans, business conditions, loss experience, underlying collateral and the local
economy. The provision for loan losses was increased in 1999, 1998 and 1997 to
keep pace with the strong growth and losses inherent in the loan portfolio.
During 1999, the allowance for loan losses increased by $437,000. The allowance
represented .98% of loans and 224.49% of nonperforming loans at December 31,
1999. During 1998, the allowance for loan losses increased by $449,000. The
allowance represented 1.17% of loans and 206.02% of nonperforming loans at
December 31, 1998. The allowance represented 1.10% of loans at December 31,
1997. For the years ended December 31, 1999, 1998 and 1997, net loan charge-offs
amounted to $583,000, $286,000 and $147,000, respectively.
NONINTEREST INCOME. Noninterest income for the years ended December 31, 1999,
1998 and 1997 was $2.5 million, $2.4 million and $1.5 million, respectively. The
increases of $75,000 in 1999 and $889,000 in 1998 are primarily related to fees
received on third party originated real estate loans and reflect the upsurge of
the mortgage loan market in 1998 and the less favorable 1999 market.
NONINTEREST EXPENSE. Noninterest expense for the years ended December 31, 1999,
1998 and 1997 was $10.3 million, $8.0 million and $5.7 million, respectively. An
increase of 29.3% in 1999 and 40.9% in 1998. These increases were primarily
related to compensation and employee benefits, occupancy expense, office
supplies and printing, and data processing expenses. This reflects the rapid
expansion of the Company which began in late 1995 and is more fully reflected in
1997, 1998 and 1999. Included in increased salaries and benefits expense were
expanded staffing levels in executive and administrative personnel, branch
personnel and additions to mortgage lending and consumer lending departments.
The Company expects this trend in increased noninterest expense to continue to
slow as total asset growth slows and total operating efficiencies improve.
Set forth below is a schedule showing additional detail concerning increases in
the Company's noninterest expense for 1999 compared with 1998 and for 1998
compared with 1997:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31 INCREASE/ INCREASE/
----------------------------- DECREASE DECREASE
1999 1998 1997 1999 VS. 1998 1998 VS. 1997
(DOLLARS IN THOUSANDS) ------- ------- ------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Salaries and benefits $ 6,967 $ 6,167 $ 3,944 $ 800 $2,223
Less: loan origination costs (1,508) (1,879) (1,109) 371 (770)
------- ------- ------- ------------ ------------
Net salaries and benefits (as
reported) $ 5,459 $ 4,288 $ 2,835 $1,171 $1,453
Occupancy expense 2,141 1,455 1,033 686 422
Office supplies and printing 439 365 275 74 90
Data processing 312 260 219 52 41
Consulting and professional fees 88 175 202 (87) (27)
Other 1,879 1,435 1,099 444 336
------- ------- ------- ------------ ------------
Total noninterest expense $10,318 $ 7,978 $ 5,663 $2,340 $2,315
======= ======= ======= ============ ============
</TABLE>
20
<PAGE> 25
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, 1999 the Company had unused lines of credit with the Federal Home Loan Bank
of Seattle ("FHLB") of $42.5 million and unused lines of credit with financial
institutions in the amount of $12.0 million, with no advances on these lines of
credit at December 31, 1999. The Company expects to use FHLB advances to
supplement its funding sources.
Total deposits were $254.5 million, $189.7 million and $146.4 million at
December 31, 1999, 1998 and 1997, respectively. Deposits increased 34.1% from
December 31, 1998 to December 31, 1999 and 29.6% from December 31, 1997 to
December 31, 1998. The Company, by policy, has not accepted brokered deposits.
It has made a concerted effort to attract deposits in the market area it serves
through competitive pricing and 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, 1999, the Company had
$119.4 million in certificates of deposit of which approximately $115.4 million,
or 96.7%, are scheduled to mature on or prior to December 31, 2000. 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. Additional funds are
available through established FHLB lines of credit.
The Company's shareholders' equity increased to $29.8 million at December 31,
1999 from $29.7 million at December 31, 1998 and from $13.0 million at December
31, 1997. The increase from year end 1998 to year end 1999 was from net income
less dividends and Company stock repurchases. 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. At December 31,
1999, shareholders' equity was 10.42% of total assets compared to 13.47% and
8.14% of total assets at December 31, 1998 and 1997, respectively. The decrease
in this ratio from year end 1998 primarily results from strong asset growth and
Company stock repurchases in 1999. The Company approved a stock repurchase plan
in April 1999 which allows the Company to repurchase up to 210,000 shares of the
Company's common stock. As of December 31, 1999, the Company had repurchased
142,000 shares at an average price of $10.32.
CAPITAL RATIOS
The Bank is subject to minimum capital requirements. See "Supervision and
Regulation" on page 3 of this report. As the following table indicates, the Bank
exceeded regulatory capital requirements:
<TABLE>
<CAPTION>
DECEMBER 31, 1999
-----------------------------------------
MINIMUM WELL-CAPITALIZED ACTUAL
REQUIREMENT REQUIREMENT RATIO
----------- ---------------- ------
<S> <C> <C> <C>
Total risk-based capital ratio 8% 10% 12.67%
Tier 1 risk-based capital ratio 4% 6% 11.73%
Leverage ratio 4% 5% 9.83%
</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.
21
<PAGE> 26
YEAR 2000 ISSUES
The Company experienced no failure of mission-critical systems and no
significant issues with external vendors or customers associated with the Year
2000 rollover date change. Quality control reviews were performed following the
event and were continued through February 29, 2000, without incident.
In 1999, the Company incurred approximately $35,700 in direct, specifically
identifiable expense, associated with Year 2000 issues. Soft costs for personnel
hours associated with the project are estimated at approximately $72,000 for
1999. Costs for the project total approximately $170,700. In addition, the
Company upgraded the generator at its administrative office and purchased
generators for hub branches as part of contingency plans for its business
operations in general and not specifically related to Year 2000 issues.
The Company does not anticipate any significant issues or additional costs in
fiscal 2000 associated with the Year 2000 rollover date change.
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.
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.
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 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.
22
<PAGE> 27
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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 precisely predict the impact of higher or lower interest
rates on net interest income. Actual results will differ from simulated results
due to timing, magnitude and frequency of interest rate changes and changes in
market conditions and management strategies, among other factors.
Based on the results of the income simulation model as of December 31, 1999, the
Company would expect an increase in net interest income of $40,000 if interest
rates increase from current rates by 100 basis points and a decrease in net
interest income of $111,000 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, 1999. 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>
(DOLLARS IN THOUSANDS) 0 - 3 MONTHS 4 - 12 MONTHS 1 - 5 YEARS OVER 5 YEARS TOTAL
---------------------- ------------ ------------- ----------- ------------ ---------
<S> <C> <C> <C> <C> <C>
Interest earning assets:
Federal funds sold $ 4,300 $ -- $ -- $ -- $ 4,300
Investment securities 2,111 2,334 15,256 11,553 31,254
Loans 63,940 27,643 87,606 43,215 222,404
---------- ----------- ----------- -------- ---------
Total interest earning assets $ 70,351 $ 29,977 $ 102,862 $ 54,768 $ 257,958
Interest earning assets to
total assets 27.27% 11.62% 39.88% 21.23% 100.00%
Interest bearing liabilities:
Interest bearing demand
deposits $ 40,858 $ -- $ -- $ -- $ 40,858
Money market deposits 33,831 -- -- -- 33,831
Savings deposits 25,045 -- -- -- 25,045
Time deposits 60,201 55,182 3,970 -- 119,353
---------- ----------- ----------- -------- ---------
Total interest bearing
liabilities $ 159,935 $ 55,182 $ 3,970 $ -- $ 219,087
Interest bearing liabilities
to total liabilities 73.00% 25.19% 1.81% -- 100.00%
Interest sensitivity gap (89,584) (25,205) 98,892 54,768 38,871
Cumulative interest sensitivity
gap (89,584) (114,789) (15,897) 38,871 --
Cumulative interest sensitivity
gap, as a percentage of total
assets (31.33%) (40.14%) (5.56%) 13.59% --
</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
23
<PAGE> 28
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 that 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, prepayment 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.
24
<PAGE> 29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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, 1999 and 1998,
and the related consolidated statements of income, shareholders' equity and
comprehensive income and cash flows for each of the years in the three-year
period ended December 31, 1999. 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 1999 and 1998 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, 1999 and 1998, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 1999 in conformity with generally
accepted accounting principles.
LOGO
Seattle, Washington
January 28, 2000
25
<PAGE> 30
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Consolidated Statements of Financial Condition
December 31, 1999 and 1998
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
1999 1998
--------- --------
<S> <C> <C>
ASSETS
Cash and due from banks $ 10,651 $ 12,063
Interest bearing deposits 5,842 8,089
Federal funds sold 4,300 4,100
--------- --------
Total cash and cash equivalents 20,793 24,252
--------- --------
Federal Home Loan Bank stock 791 736
Investment securities, available for sale 6,373 12,591
Investment securities, held to maturity 24,090 24,875
--------- --------
Total investment securities 31,254 38,202
--------- --------
Loans receivable, net 220,222 147,872
Premises and equipment, net 11,177 8,046
Other real estate owned 170 --
Deferred tax assets 434 419
Other assets 1,920 1,702
--------- --------
Total assets $ 285,970 $220,493
========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits $ 254,475 $189,698
Other liabilities 1,697 1,104
--------- --------
Total liabilities 256,172 190,802
--------- --------
Shareholders' equity:
Preferred stock, no par value: Authorized 20,000 shares;
no shares issued or outstanding -- --
Common stock, no par value: Authorized 10,000,000 shares,
issued and outstanding 4,061,785, 4,189,050 and
2,809,050 shares in 1999, 1998 and 1997, respectively 16,413 17,836
Retained earnings 13,493 11,805
Accumulated other comprehensive income, net (108) 50
--------- --------
Total shareholders' equity 29,798 29,691
--------- --------
Total liabilities and shareholders' equity $ 285,970 $220,493
========= ========
</TABLE>
See accompanying notes to consolidated financial statements.
26
<PAGE> 31
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Consolidated Statements of Income
Years ended December 31, 1999, 1998 and 1997
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Interest income:
Interest and fees on loans $ 16,856 $ 12,910 $ 10,207
Interest on taxable investment securities 1,058 1,097 1,082
Interest on tax exempt investment securities 815 634 460
Other 347 595 152
---------- ---------- ----------
Total interest income 19,076 15,236 11,901
Interest expense 7,016 5,765 4,358
---------- ---------- ----------
Net interest income 12,060 9,471 7,543
Provision for loan losses 1,020 735 647
---------- ---------- ----------
Net interest income after provision for loan
losses 11,040 8,736 6,896
---------- ---------- ----------
Noninterest income:
Service charges on deposits 1,417 1,172 1,116
Other 1,036 1,206 373
---------- ---------- ----------
Total noninterest income 2,453 2,378 1,489
---------- ---------- ----------
Noninterest expense:
Salaries and benefits 5,459 4,288 2,835
Occupancy expense 2,141 1,455 1,033
Office supplies and printing 439 365 275
Data processing 312 260 219
Consulting and professional fees 88 175 202
Other 1,879 1,435 1,099
---------- ---------- ----------
Total noninterest expense 10,318 7,978 5,663
---------- ---------- ----------
Income before income taxes 3,175 3,136 2,722
Provision for income taxes 823 924 818
---------- ---------- ----------
Net income $ 2,352 $ 2,212 $ 1,904
========== ========== ==========
Net income per share, basic $ 0.57 $ 0.63 $ 0.68
========== ========== ==========
Net income per share, diluted $ 0.54 $ 0.59 $ 0.65
========== ========== ==========
Average number of shares outstanding, basic 4,142,953 3,525,883 2,810,881
Average number of shares outstanding, diluted 4,387,192 3,769,244 2,935,972
</TABLE>
See accompanying notes to consolidated financial statements.
27
<PAGE> 32
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Consolidated Statements of Shareholders' Equity
and Comprehensive Income
Years ended December 31, 1999, 1998 and 1997
(Dollars and shares in thousands, except per share data)
<TABLE>
<CAPTION>
ACCUMULATED
COMMON STOCK OTHER TOTAL
----------------- RETAINED COMPREHENSIVE SHAREHOLDERS'
SHARES AMOUNT EARNINGS INCOME, NET EQUITY
------ -------- -------- ------------- -------------
<S> <C> <C> <C> <C> <C>
BALANCES AT DECEMBER 31, 1996 2,796 $ 3,032 $ 8,527 $ 11 $ 11,570
Cash dividend, $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
Repurchase of common 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, $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
Cash dividend, $0.16 per share -- -- (664) -- (664)
Net change in unrealized gain (loss) on
securities available for sale -- -- -- (158) (158)
Net income -- -- 2,352 -- 2,352
Repurchase of common stock (142) (1,469) -- -- (1,469)
Stock options exercised 15 46 -- -- 46
------ -------- -------- ------ --------
BALANCES AT DECEMBER 31, 1999 4,062 $ 16,413 $ 13,493 $(108) $ 29,798
====== ======== ======== ====== ========
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
---------------------------------
1999 1998 1997
--------- -------- --------
<S> <C> <C> <C>
COMPREHENSIVE INCOME:
Net income $ 2,352 $2,212 $1,904
Increase in unrealized gain on securities available for
sale, net of tax of $81, $17 and $3, respectively (158) 33 6
------- ------ ------
Comprehensive income $ 2,194 $2,245 $1,910
======= ====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
28
<PAGE> 33
WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years ended December 31, 1999, 1998 and 1997
(Dollars in thousands)
<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 2,352 $ 2,212 $ 1,904
Adjustments to reconcile net income to net cash
provided by operating activities:
Federal Home Loan Bank stock dividends (55) (54) (36)
Deferred income tax expense (benefit) 67 (67) (99)
Amortization (accretion) of investment premiums
(discounts), net 61 90 271
Provision for loan losses 1,020 735 647
Depreciation of premises and equipment 734 416 323
Loss (gain) on sale of premises and equipment (34) (49) 2
Net increase in other assets (218) (284) (324)
Net (decrease) increase in other liabilities 593 465 141
--------- --------- ---------
Net cash provided by operating activities 4,520 3,464 2,829
--------- --------- ---------
Cash flows from investing activities:
Purchases of investment securities, available for sale (1,033) (9,000) (2,860)
Maturities of investment securities, available for
sale 7,000 2,000 2,000
Purchases of investment securities, held to maturity (1,790) (8,031) (6,770)
Maturities of investment securities, held to maturity 2,525 6,555 3,980
Net increase in loans (73,540) (32,368) (36,443)
Purchases of premises and equipment (3,967) (4,359) (1,097)
Proceeds from the sale of premises and equipment 136 233 6
Purchases of Federal Home Loan Bank stock -- -- (324)
Proceeds from the sale of real estate owned -- 30 --
--------- --------- ---------
Net cash used in investing activities (70,669) (44,940) (41,508)
--------- --------- ---------
Cash flows from financing activities:
Net increase in deposits 64,777 43,304 41,182
Dividends paid on common stock (664) (482) (356)
Proceeds from stock options exercised 46 -- 111
Proceeds from stock issued -- 14,893 --
Repurchase of common stock (1,469) -- (200)
--------- --------- ---------
Net cash provided by financing activities 62,690 57,715 40,737
--------- --------- ---------
Net (decrease) increase in cash and cash
equivalents (3,459) 16,239 2,058
Cash and cash equivalents at beginning of period 24,252 8,013 5,955
--------- --------- ---------
Cash and cash equivalents at end of period $ 20,793 $ 24,252 $ 8,013
========= ========= =========
Supplemental information:
Loans foreclosed and transferred to real estate owned 170 -- 30
Cash paid for interest 6,710 5,689 4,236
Cash paid for taxes 630 945 1,000
</TABLE>
See accompanying notes to consolidated financial statements.
29
<PAGE> 34
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, WBCO sold 1,380,000 shares of its common stock at a
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.
(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 Company 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).
30
<PAGE> 35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 period the loan is placed in nonaccrual status.
Payments received are generally applied to principal. However, based on
management's assessment of the ultimate collectibility of an impaired or
nonaccrual loan, interest income may be recognized on a cash basis. Nonaccrual
loans are returned to an accrual status when management determines the
circumstances have improved to the extent there has been a sustained period of
repayment performance and both principal and interest are deemed collectible.
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 is 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 losses inherent in the loans.
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 judgment 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 based upon recent appraisal 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 deferred tax assets and liabilities of a
change in tax rate is recognized in income in the period that includes the
enactment date.
31
<PAGE> 36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(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 assets or FHLB
advances. At December 31, 1999, 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 plan activity.
(l) Recent Financial Accounting Pronouncements
In June 1998, FASB issued SFAS Statement No. 133 ("SFAS 133"), Accounting for
Derivative Instruments and Hedging Activities, which 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. In May 1999,
the FASB delayed the effective date of SFAS 133 to fiscal years beginning after
June 15, 2000 with interim reporting required. 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 and was adopted by the Company on January 1, 1999. The Company's adoption
of SFAS 134 did not 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",
which requires costs of start-up activities and organization costs to be
expensed as incurred was adopted by the Company effective January 1, 1999. The
adoption of this statement did not have a material effect on the Company's
operating results of financial condition.
(m) Reclassifications
Certain amounts in 1997 and 1998 have been reclassified to conform to the 1999
financial statement presentation.
(2) RESTRICTIONS ON CASH BALANCE
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 the
required reserve balance on December 31, 1999 and 1998 was approximately $1,123
and $1,236, respectively, and was met by holding cash and maintaining an average
balance with the Federal Reserve Bank.
32
<PAGE> 37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) INVESTMENT SECURITIES
The amortized costs and estimated market values of investment securities at
December 31, 1999 and 1998 are as summarized:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
(DOLLARS IN THOUSANDS) --------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
December 31, 1999:
Investments available for sale:
U.S. Treasury securities $ 2,003 $ 2 $ (1) $ 2,004
U.S. Government agency securities 4,534 -- (165) 4,369
------- ---- ------ -------
Total investment securities
available for sale $ 6,537 $ 2 $(166) $ 6,373
======= ==== ====== =======
Investments held to maturity:
U.S. Government agency securities $ 499 $ -- $ (2) $ 497
State and political subdivisions 17,249 3 (235) 17,017
Corporate obligations 6,342 1 (70) 6,273
------- ---- ------ -------
Total investment securities held
to maturity $24,090 $ 4 $(307) $23,787
======= ==== ====== =======
December 31, 1998:
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>
The amortized cost and fair value of investment securities by contractual
maturity at December 31, 1999 are as shown below:
<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 $1,501 $ 502 $-- $-- $2,003
Market value 1,503 501 -- -- 2,004
U.S. Government agency
securities:
Amortized cost -- 4,534 -- -- 4,534
Market value -- 4,369 -- -- 4,369
------ ------ -- -- ------
Total:
Amortized cost $1,501 $5,036 $-- $-- $6,537
Market value 1,503 4,870 -- -- 6,373
====== ====== == == ======
</TABLE>
33
<PAGE> 38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<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 $ -- $ -- $ -- $ -- $ --
Market value -- -- -- -- --
U.S. Government agency securities:
Amortized cost 499 -- -- -- 499
Market value 497 -- -- -- 497
State and political subdivisions:
Amortized cost 442 6,045 9,286 1,476 17,249
Market value 445 6,039 9,112 1,421 17,017
Corporate bonds and other:
Amortized cost 2,000 4,342 -- -- 6,342
Market value 2,001 4,272 -- -- 6,273
------ ------- ------ ------ -------
Total:
Amortized cost $2,941 $10,387 $9,286 $1,476 $24,090
Market value 2,943 10,311 9,112 1,421 23,787
====== ======= ====== ====== =======
</TABLE>
Included in other assets is accrued interest on investment securities amounting
to $297 and $385 as of December 31, 1999 and 1998, respectively.
At December 31, 1999 and 1998, investment securities with amortized cost values
of $7,712 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,
1999, 1998 and 1997.
(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
--------------------
1999 1998
-------- --------
<S> <C> <C>
Commercial loans $ 90,014 $ 65,564
Real estate loans 54,349 29,198
Real estate construction loans 14,300 14,139
Consumer loans 63,757 40,750
-------- --------
$222,420 $149,651
Less:
Allowance for loan losses 2,182 1,745
Net deferred loan fees 16 34
-------- --------
Net loans $220,222 $147,872
======== ========
</TABLE>
As of December 31, 1999 and 1998, the Company had loans to persons serving as
directors and executive officers, and to entities related to such individuals
aggregating $2,001 and $1,890, 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.
34
<PAGE> 39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company's legal lending limit was approximately $5,376 and $4,900 as of
December 31, 1999 and 1998, respectively.
Included in other assets is accrued interest on loans receivable amounting to
$1,308 and $960 as of December 31, 1999 and 1998, respectively.
The following is an analysis of the changes in the allowance for loan losses:
<TABLE>
<CAPTION>
DECEMBER 31
-----------------------------
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Beginning balance $ 1,745 $ 1,296 $ 796
Provision for loan losses 1,020 735 647
Recoveries 28 27 13
Charge-offs (611) (313) (160)
------- ------- -------
Ending balance $ 2,182 $ 1,745 $ 1,296
======= ======= =======
</TABLE>
At December 31, 1999 and 1998, the Company had impaired loans of $972 and
$1,094, respectively. Of these impaired loans, $972 and $847 have related
valuation allowances of $319 and $291, while $0 and $247 did not require a
valuation allowance. Average impaired loans for 1999 and 1998 totaled $1,033 and
$1,128, respectively. The Company has no commitment to extend additional credit
on loans which are nonaccrual or impaired at December 31, 1999.
If interest income on impaired loans had been accrued in accordance with their
original terms, approximately $94, $60 and $40 of interest income would have
been recorded for the years ended December 31, 1999, 1998 and 1997,
respectively.
(5) PREMISES AND EQUIPMENT
Premises and equipment consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31
------------------
1999 1998
------- -------
<S> <C> <C>
Land and buildings $ 8,064 $ 5,226
Furniture and equipment 4,519 2,508
Land improvements 1,015 263
Computer software 663 512
Construction in progress 141 2,029
------- -------
$14,402 $10,538
Less accumulated depreciation 3,225 2,492
------- -------
$11,177 $ 8,046
======= =======
</TABLE>
(6) DEPOSITS
Deposits are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31
--------------------
1999 1998
-------- --------
<S> <C> <C>
Certificates of deposit ("CDs") $119,353 $ 64,697
Savings 25,045 25,517
Money market 33,831 29,821
NOW 40,858 36,214
Noninterest bearing demand 35,388 33,449
-------- --------
$254,475 $189,698
======== ========
</TABLE>
35
<PAGE> 40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Certificates of deposits mature as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1999
--------------------------------------------------------
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>
CDs of $100,000 or more $ 43,560 $ 538 $ 332 $137 $-- $ 44,567
All other CDs 71,823 1,983 719 218 43 74,786
-------- ------ ------ ---- --- --------
$115,383 $2,521 $1,051 $355 $43 $119,353
======== ====== ====== ==== === ========
</TABLE>
(7) INCOME TAXES
Federal income tax expense (benefit) consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31
----------------------
1999 1998 1997
---- ----- -----
<S> <C> <C> <C>
Current tax expense $756 $ 991 $ 917
Deferred tax expense (benefit) 67 (67) (99)
---- ----- -----
$823 $ 924 $ 818
==== ===== =====
</TABLE>
The following table presents major components of the net deferred federal income
tax asset resulting from differences between financial reporting and tax bases:
<TABLE>
<CAPTION>
DECEMBER 31
------------
1999 1998
---- ----
<S> <C> <C>
Deferred tax assets:
Loan loss allowances $589 $506
Deferred compensation 68 75
Market value adjustment of investment securities available
for sale 56 --
---- ----
Total deferred tax assets $713 $581
Deferred tax liabilities:
Premises and equipment 183 97
FHLB stock 58 39
Market value adjustment of investment securities available
for sale -- 26
Deferred loan fees 38 --
---- ----
Total deferred tax liabilities $279 $162
Deferred tax assets, net $434 $419
==== ====
</TABLE>
A reconciliation between the statutory federal income tax rate and the effective
tax rate is as follows:
<TABLE>
<CAPTION>
DECEMBER 31
----------------------------
1999 1998 1997
------- ------- ------
<S> <C> <C> <C>
Income tax expense at federal statutory rate $ 1,079 $ 1,066 $ 925
Interest income on tax exempt securities (247) (216) (129)
Other, net (9) 74 22
------- ------- ------
$ 823 $ 924 $ 818
======= ======= ======
</TABLE>
There was no valuation allowance for deferred tax assets as of December 31,
1999, 1998 and 1997. 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 $713 and $581
at December 31, 1999 and 1998, 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.
36
<PAGE> 41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) EARNINGS PER SHARE
The following illustrates the reconciliation of the numerators and denominators
of the basic diluted earnings per share ("EPS") computations:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999
---------------------------------------------------
INCOME WEIGHTED AVERAGE SHARES PER SHARE AMOUNT
------ ----------------------- ----------------
<S> <C> <C> <C>
BASIC EPS
Income available to common shareholders $2,352 4,142,953 $0.57
Effect of dilutive securities: stock options -- 244,239 --
------ --------- -----
DILUTED EPS $2,352 4,387,192 $0.54
====== ========= =====
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
---------------------------------------------------
INCOME WEIGHTED AVERAGE SHARES PER SHARE AMOUNT
------ ----------------------- ----------------
<S> <C> <C> <C>
BASIC EPS
Income available to common shareholders $2,212 3,525,883 $0.63
Effect of dilutive securities: stock options -- 243,361 --
------ --------- -----
DILUTED EPS $2,212 3,769,244 $0.59
====== ========= =====
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
---------------------------------------------------
INCOME WEIGHTED AVERAGE SHARES PER SHARE 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>
At December 31, 1999 and 1998 there were options to purchase 41,000 and 123,950
shares of common stock outstanding, respectively, which were antidilutive and
therefore not included in the computation of diluted net income per share. There
were no antidilutive securities outstanding for the year ended December 31,
1997.
(9) EMPLOYEE BENEFIT PLANS
(a) Severance Agreements
The Company has entered into contracts with seven 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 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, 1999, 1998 and 1997
under the employee matching feature of the plan were $80, $64 and $50,
respectively. This represents a match of the participating employees' salary
deferral up to 50% of the first 5% of the compensation deferred in 1999, 1998
and 1997, respectively. The Company also contributed $0, $0 and $16 for the
years ended December 31, 1999, 1998 and 1997 under the profit sharing feature of
the plan.
37
<PAGE> 42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(10) SHAREHOLDERS' EQUITY
(a) Stock Repurchase Plan
During the fiscal year 1999 the Company approved a stock repurchase plan which
allows the Company to repurchase up to 210,000 shares of the Company's common
stock. As of December 31, 1999, the Company had repurchased 142,000 shares at an
average price of $10.32.
(b) Stock Option Plan
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 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:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
------------------------------------------------------------------------------
1999 1998 1997
------------------------ ------------------------ ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE OPTION AVERAGE OPTION AVERAGE OPTION
SHARES PRICE SHARES PRICE SHARES PRICE
------- -------------- ------- -------------- ------- --------------
<S> <C> <C> <C> <C> <C> <C>
Balance at beginning of year 395,000 $5.05 354,000 $ 4.25 302,250 $3.39
Options granted -- -- 41,000 12.00 51,750 9.25
------- ----- ------- ------ ------- -----
Balance at end of year 395,000 $5.05 395,000 $ 5.05 354,000 $4.25
======= ===== ======= ====== ======= =====
</TABLE>
38
<PAGE> 43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Financial data pertaining to outstanding incentive stock options under the 1992
and 1998 plans were as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1999
- -----------------------------------------------------------------
TOTAL SHARES VESTED SHARES EXERCISE PRICE EXPIRATION
- ------------ ------------- -------------- -----------------
<C> <C> <C> <S>
165,000 165,000 $ 2.93 February 22, 2003
22,500 22,500 3.07 March 24, 2004
40,500 40,500 3.37 December 15, 2004
45,000 36,000 4.08 December 31, 2005
3,750 2,250 4.23 April 1, 2006
25,500 15,300 5.37 December 31, 2006
51,750 20,700 9.25 December 31, 2007
41,000 8,200 12.00 December 31, 2008
------- -------
395,000 310,450
======= =======
</TABLE>
The following table summarizes stock option activity of the nonqualified shares
under the 1993 director stock option plan:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
--------------------------------------------------------------------------
1999 1998 1997
----------------------- ---------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES OPTION PRICE SHARES OPTION PRICE SHARES OPTION PRICE
-------- ------------ ------- ------------ -------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balance at beginning of year 113,700 $4.79 113,700 $4.79 120,750 $3.13
Options granted -- -- -- -- 31,200 9.25
Less exercised (15,000) 3.02 -- -- (35,550) 3.14
Expired or canceled -- -- -- -- (2,700) 3.57
-------- ----- ------- ----- -------- -----
Balance at end of year 98,700 $5.06 113,700 $4.79 113,700 $4.79
======== ===== ======= ===== ======== =====
</TABLE>
Financial data pertaining to outstanding nonqualified stock options under the
1993 plan were as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1999
- -----------------------------------------------------------------
TOTAL SHARES VESTED SHARES EXERCISE PRICE EXPIRATION
- ------------ ------------- -------------- -----------------
<C> <C> <C> <S>
45,000 45,000 $3.00 February 22, 2003
15,000 15,000 3.07 March 24, 2004
7,500 6,000 4.08 December 31, 2005
31,200 12,480 9.25 December 31, 2007
------ ------
98,700 78,480
====== ======
</TABLE>
The Company applies APB Opinion No. 25 in accounting for its plans and,
accordingly, no compensation cost has been recognized for its stock options
granted to employees 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
--------------------------
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Net income, as reported $2,352 $2,212 $1,904
Net income, pro forma 2,307 2,167 1,862
Basic EPS, as reported 0.57 0.63 0.68
Basic EPS, pro forma 0.56 0.61 0.66
Diluted EPS, as reported 0.54 0.59 0.65
Diluted EPS, pro forma 0.53 0.57 0.64
</TABLE>
39
<PAGE> 44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) REGULATORY CAPITAL MATTER
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 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.
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 Tier 1 capital to risk-weighted assets (as defined in
the regulations), and of Tier 1 capital to average assets (as defined in the
regulations). Management believes, as of December 31, 1999, that the Bank meets
all capital adequacy requirements to which it is subject.
<TABLE>
<CAPTION>
TO BE WELL CAPITALIZED
UNDER PROMPT
FOR CAPITAL ADEQUACY CORRECTIVE ACTION
PURPOSES PROVISIONS
WHIDBEY ISLAND BANK -------------------- ----------------------
-------------------- MINIMUM MINIMUM
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
--------- ------- -------- -------- --------- ---------
December 31, 1999: (ACTUAL)
<S> <C> <C> <C> <C> <C> <C>
Total risk-based capital (to
risk-weighted assets) $29,226 12.67% $18,447 8% $23,059 10%
Tier 1 capital (to risk-weighted
assets) 27,044 11.73% 9,224 4% 13,835 6%
Leverage ratio $27,044 9.83% $10,999 4% $13,749 5%
</TABLE>
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED
UNDER PROMPT
FOR CAPITAL ADEQUACY CORRECTIVE ACTION
PURPOSES PROVISIONS
WHIDBEY ISLAND BANK -------------------- ------------------
-------------------- MINIMUM MINIMUM
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
--------- ------- -------- -------- ------- -------
December 31, 1998: (ACTUAL)
<S> <C> <C> <C> <C> <C> <C>
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%
</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
40
<PAGE> 45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
(b) Investment Securities
The fair value of all investment securities excluding FHLB stock is 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 value. 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.
41
<PAGE> 46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The table below presents the book value amount of the Company's financial
instruments and their corresponding fair values:
<TABLE>
<CAPTION>
DECEMBER 31
----------------------------------------------------
1999 1998
------------------------ ------------------------
BOOK VALUE FAIR VALUE BOOK VALUE FAIR VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Financial assets:
Cash and due from banks $ 10,651 $ 10,651 $ 12,063 $ 12,063
Interest bearing deposits 5,842 5,842 8,089 8,089
Federal funds sold 4,300 4,300 4,100 4,100
FHLB stock 791 791 736 736
Investment securities available for sale 6,373 6,373 12,591 12,591
Investment securities held to maturity 24,090 23,787 24,875 25,667
Loans 222,420 221,660 149,651 156,965
Financial liabilities -- deposits 254,475 254,000 189,698 189,829
Off-balance sheet items:
Loan commitments 37,359 37,359 24,889 24,889
Standby letters of credit 109 109 688 688
</TABLE>
(13) WASHINGTON BANKING COMPANY INFORMATION
The summarized condensed financial information for Washington Banking Company
(parent company only) are presented below:
<TABLE>
<CAPTION>
DECEMBER 31
-------------------
1999 1998
-------- -------
<S> <C> <C>
CONDENSED BALANCE SHEETS
Assets:
Cash and cash equivalents $ 2,801 $ 4,960
Other assets 80 54
Investment in subsidiary 26,936 24,683
-------- -------
Total assets $ 29,817 $29,697
======== =======
Liabilities -- other $ 19 $ 6
-------- -------
Shareholders' equity:
Common stock 16,412 17,836
Retained earnings 13,494 11,805
Accumulated other comprehensive income, net (108) 50
-------- -------
Total shareholders' equity $ 29,798 $29,691
-------- -------
Total liabilities and shareholders' equity $ 29,817 $29,697
======== =======
</TABLE>
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-----------------------------
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
CONDENSED STATEMENTS OF INCOME
Noninterest expense $ (268) $ (99) $ (45)
Income tax (expense) benefit 30 (5) 15
------- ------- -------
Loss before undistributed earnings of subsidiary (238) (104) (30)
Interest income 179 115 --
Undistributed earnings of subsidiary 2,411 2,201 1,934
------- ------- -------
Net income $ 2,352 $ 2,212 $ 1,904
======= ======= =======
</TABLE>
42
<PAGE> 47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
---------------------------------
1999 1998 1997
-------- --------- --------
<S> <C> <C> <C>
CONDENSED STATEMENTS OF CASH FLOWS
Operating activities:
Net income $ 2,352 $ 2,212 $ 1,904
Adjustments to reconcile net income to net cash used in
operating activities:
Equity in undistributed earnings of subsidiaries (2,442) (2,201) (1,934)
Other assets 5 (38) 10
Other liabilities 13 6 --
-------- --------- --------
Net cash used in operating activities (72) (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 (664) (482) (356)
Proceeds from exercise of stock options and stock
issuances 46 -- 111
Repurchased and retired stock (1,469) -- (200)
Proceeds from stock issued -- 14,893 --
-------- --------- --------
Net cash provided by (used in) financing
activities (2,087) 14,411 (445)
-------- --------- --------
Increase in cash and cash equivalents (2,159) 4,860 92
Cash and cash equivalents at beginning of year 4,960 100 8
-------- --------- --------
Cash and cash equivalents at end of year $ 2,801 $ 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:
<TABLE>
<CAPTION>
DECEMBER 31,
1999
------------
<S> <C>
2000 $ 200
2001 168
2002 211
2003 187
2004 148
Thereafter 2,290
------
Total $3,204
======
</TABLE>
43
<PAGE> 48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Rent expense applicable to operating leases for the years ended December 31,
1999, 1998 and 1997 was $214, $178 and $87, 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,
1999
------------
<S> <C>
Loan commitments
Fixed rate $12,500
Variable rate $24,859
Standby letters of credit $ 109
</TABLE>
(c) Lines of Credit
The Company had unused lines of credit with the FHLB of $42.5 million at
December 31, 1999. The Company also had unused lines of credit with financial
institutions amounting to $12.0 million at December 31, 1999.
(15) CONTINGENCIES
The Company and its subsidiaries are from time to time defendants in and are
threatened with various legal proceedings arising from regular business
activities. Management believes the ultimate liability, if any, arising from
such claims or contingencies will not have a material adverse effect on the
Company's results of operations or financial condition.
(16) SUBSEQUENT EVENTS
On January 20, 2000, the Board of Directors declared a cash dividend of $0.05
per share for the first quarter of 2000.
44
<PAGE> 49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(17) SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Results of operations on a quarterly basis were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999
----------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ------- ------- ------- -------
<S> <C> <C> <C> <C>
Interest income $ 4,122 $ 4,478 $ 4,971 $ 5,505
Interest expense 1,446 1,588 1,814 2,168
------- ------- ------- -------
Net interest income 2,676 2,890 3,157 3,337
Provision for loan losses (255) (255) (255) (255)
------- ------- ------- -------
Net interest income after provision for loan
losses 2,421 2,635 2,902 3,082
Noninterest income 628 663 557 605
Noninterest expense 2,384 2,491 2,706 2,737
------- ------- ------- -------
Income before provision for income taxes 665 807 753 950
------- ------- ------- -------
Provision for income taxes (162) (201) (209) (251)
------- ------- ------- -------
Net income $ 503 $ 606 $ 544 $ 699
======= ======= ======= =======
Basic earnings per share $ 0.12 $ 0.15 $ 0.13 $ 0.17
Diluted earnings per share 0.11 0.14 0.12 0.16
Cash dividends declared 0.04 0.04 0.04 0.04
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
----------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER 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 518 493 609 758
Noninterest expense 1,754 1,851 2,156 2,217
------- ------- ------- -------
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>
45
<PAGE> 50
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS IN ACCOUNTING AND
FINANCIAL DISCLOSURE
None
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 31, 2000 (the "Proxy
Statement") for the annual meeting of shareholders to be held May 25, 2000.
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 6 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.
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 12 of the
Proxy Statement, which is incorporated herein by reference.
46
<PAGE> 51
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Financial Statements:
The following Financial Statements of the Company are located on pages 25 to 30
of this Form 10-K.
<TABLE>
<CAPTION>
PAGE
- ----
<C> <S>
25 Independent Auditors' Report
26 Consolidated Statements of Financial Condition -- December
31, 1999 and 1998
27 Consolidated Statements of Income -- Years ended December
31, 1999, 1998 and 1997
28 Consolidated Statements of Shareholders' Equity and
Comprehensive Income -- Years ended December 31, 1999, 1998
and 1997
29 Consolidated Statements of Cash Flows -- Years ended
December 31, 1999, 1998 and 1997
30 Notes to Consolidated Financial Statements
</TABLE>
Exhibits:
See "Index to Exhibits" at page 49 of this Form 10-K.
Reports on Form 8-K:
None
47
<PAGE> 52
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 28th of March,
2000.
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 28th of March, 2000.
Principal Executive Officer:
By /s/ Michal D. Cann
------------------------------------
Michal D. Cann
President and
Chief Executive Officer
Principal Financial Officer:
/s/ Phyllis A. Hawkins
--------------------------------------
Phyllis A. Hawkins
Senior Vice President and
Chief Financial Officer
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 28, 2000, as
attorney-in-fact for the following directors who constitute a majority of the
board of directors.
Marlen L. Knutson
Karl C. Krieg, III
Jay T. Lien
Anthony B. Pickering
Edward J. Wallgren
By /s/ Michal D. Cann
------------------------------------
Michal D. Cann
Attorney-in-fact
March 28, 2000
48
<PAGE> 53
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT DESCRIPTION
<C> <S>
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)
21 Subsidiaries of the Company are:
(a) Whidbey Island Bank, Oak Harbor, Washington
24 Power of Attorney dated March 16, 2000
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.
49
<PAGE> 1
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 16th day of March, 2000.
<TABLE>
<CAPTION>
Signature Title
- --------- -----
<S> <C>
/s/ Michal D. Cann Director
- -----------------------------------
Michal D. Cann
/s/ Marlen L. Knutson Director
- -----------------------------------
Marlen L. Knutson
/s/ Karl C. Krieg, III Director
- -----------------------------------
Karl C. Krieg, III
Director
- -----------------------------------
Robert B. Olson
/s/ Jay T. Lien Director
- -----------------------------------
Jay T. Lien
/s/ Anthony B. Pickering Director
- -----------------------------------
Anthony B. Pickering
Director
- -----------------------------------
Alvin J. Sherman
/s/ Edward J. Wallgren Director
- -----------------------------------
Edward J. Wallgren
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 10,651
<INT-BEARING-DEPOSITS> 5,842
<FED-FUNDS-SOLD> 4,300
<TRADING-ASSETS> 791
<INVESTMENTS-HELD-FOR-SALE> 6,373
<INVESTMENTS-CARRYING> 24,090
<INVESTMENTS-MARKET> 23,787
<LOANS> 222,404
<ALLOWANCE> 2,182
<TOTAL-ASSETS> 285,970
<DEPOSITS> 254,457
<SHORT-TERM> 0
<LIABILITIES-OTHER> 1,697
<LONG-TERM> 0
0
0
<COMMON> 16,413
<OTHER-SE> 13,385
<TOTAL-LIABILITIES-AND-EQUITY> 285,970
<INTEREST-LOAN> 16,856
<INTEREST-INVEST> 1,873
<INTEREST-OTHER> 347
<INTEREST-TOTAL> 19,076
<INTEREST-DEPOSIT> 7,016
<INTEREST-EXPENSE> 7,016
<INTEREST-INCOME-NET> 12,060
<LOAN-LOSSES> 1,020
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 10,318
<INCOME-PRETAX> 3,175
<INCOME-PRE-EXTRAORDINARY> 2,352
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,352
<EPS-BASIC> .57
<EPS-DILUTED> .54
<YIELD-ACTUAL> 4.61
<LOANS-NON> 920
<LOANS-PAST> 0
<LOANS-TROUBLED> 52
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,745
<CHARGE-OFFS> 611
<RECOVERIES> 28
<ALLOWANCE-CLOSE> 2,182
<ALLOWANCE-DOMESTIC> 1,923
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 259
</TABLE>
