SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[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 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 005-57091
FIRST MUTUAL BANCSHARES, INC.
-----------------------------
(Exact name of registrant as specified in its charter)
State of Washington 91-2005970
- --------------------------------------------- --------------------
(State or other jurisdiction of incorporation (I.R.S.Employer
or organization) Identification No.)
400 108th Avenue N.E., Bellevue, Washington 98004
- ------------------------------------------- --------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (425)455-7300
--------------------
Securities registered pursuant to Section 12(b) of the Act: None
----
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $1.00 per share
----------------------------------------
(Title of Class)
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ X ]
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 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
--- ---
As of March 8, 2000, there were issued and outstanding 4,664,396 shares
of the registrant's common stock. The aggregate market value of the voting
stock held by nonaffiliates (2,051,676 shares) of the registrant was
$19,490,922 based on the closing sales price of the registrant's common stock
as quoted on the NASDAQ National Market System which on March 8, 2000 was
$9.50.
DOCUMENTS INCORPORATED BY REFERENCE
1. Annual Report to Shareholders for the fiscal year ended December 31,
1999.
2. Proxy Statement dated March 20, 2000 for the 2000 Annual Meeting of
Shareholders.
<PAGE>
PART I
Item 1. Business
- ----------------
(a) General
First Mutual Bancshares, Inc. (the "Company") is a Washington
corporation, which was formed for the purpose of becoming the bank holding
company for First Mutual Bank ("First Mutual" or the "Bank"). The Bank's
reorganization was completed on October 26, 1999, on which date the Bank
became the wholly-owned subsidiary of the Company, and the stockholders of the
Bank became stockholders of the Company. Prior to completion of the
reorganization, the Company had no material assets or liabilities and engaged
in no business activities. Subsequent to the reorganization, the Company has
engaged in no significant activity other than holding the stock of the Bank
and engaging in certain passive investment activities. Accordingly, the
information set forth in this report, including financial statements and
related data, relates primarily to the Bank.
First Mutual was incorporated as a Washington state-chartered mutual
savings bank in 1968 known as First Mutual Savings Bank and was the successor
to Eastside Savings and Loan Association, which was organized in 1952 and
commenced operations in 1953. The Bank converted from mutual to stock form
through the sale and issuance of 966,000 shares of Common Stock in December
1985. In connection with the holding company reorganization, the Bank changed
its name to First Mutual Bank. The Bank is subject to regulation by the State
of Washington Department of Financial Institutions and the Federal Deposit
Insurance Corporation ("FDIC"). The Company is subject to regulation by the
Federal Reserve Board.
The business of the Bank consists of attracting deposits from the general
public as well as wholesale funding sources and investing those funds
primarily in commercial and residential real estate loans, mid-sized business
loans, loans secured by savings accounts, and consumer loans. The Bank also
invests in federal government and agency obligations; structured notes; real
estate mortgage investment conduits ("REMICs"); mortgage-backed securities;
and corporate and municipal securities. In addition to portfolio lending, the
Bank conducts a significant mortgage banking operation, which encompasses the
selling of primarily fixed-rate loans into the secondary mortgage market. The
Bank generally sells the right to service the loans sold (i.e., collection of
principal and interest payments) for which it receives a fee.
The principal sources of funds for the Bank's lending and investment
activities are deposits, repayment of loans, loan sales and Federal Home Loan
Bank ("FHLB") of Seattle advances. The Bank's primary sources of income are
interest on loans, gains on sales of loans and loan servicing rights,
servicing fees on loans, service-charge income on deposit accounts and
interest and dividends on investment securities. Its principal expenses are
interest paid on deposits and borrowings, and general and administrative
costs.
The Bank's savings and lending operations are conducted through nine full
service facilities located in Bellevue(3), Redmond, Seattle(2), Issaquah,
Bellingham, and Monroe, Washington, and two income property loan production
offices located in Salem, Oregon, and Tacoma, Washington. The Bank's main
office is currently located at 400 108th Avenue N.E., Bellevue, Washington.
See "Item 2. - Properties" herein for additional information on the Bank's
facilities.
Forward-Looking Statements
- --------------------------
In this Form 10-K, the Company has included certain forward-looking
statements concerning its future operations. It is the Company's desire to
take advantage of the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995. This statement is for the express purpose of
availing the Company of the protections of such safe harbor with respect to
all forward-looking statements contained in this Annual Report to
Shareholders. Sentences containing the words such as "may," "will," "expect,"
"anticipate," "believe," "estimate," "optimistic," "hopeful," "should,"
"projected," or similar words may constitute forward-looking statements.
Although the Company
2
<PAGE>
believes that the expectations expressed in these forward-looking statements
are based on reasonable assumptions within the bounds of its knowledge of its
business and operations, risks and uncertainties may cause actual results to
differ materially from these expectations. Factors which could affect actual
results include interest rate trends, the general state of the economy in the
Company's market area and the country as a whole, the impact of competitive
products, services and pricing, the ability of the Company to control costs
and expenses, loan delinquency rates, and legislative, regulatory and
accounting changes affecting the banking and financial services industry.
These risks and uncertainties should be considered in evaluating the forward-
looking statements and undue reliance should not be placed on such statements.
The Company and the Bank disclaim any obligation publicly to announce future
events or developments which affect the forward-looking statements herein.
Selected Financial Data
- -----------------------
The information under the section captioned "Selected Financial Data" in
the 1999 Annual Report to Shareholders ("Annual Report") is incorporated
herein by reference.
Yields Earned and Rates Paid
- ----------------------------
The Bank's pretax earnings depend significantly on its net interest
income, which is the difference between the income it receives on its loan
portfolio and other investments and its cost of money, consisting primarily of
interest paid on savings deposits and FHLB advances. Net interest income is
affected by: (i) the difference between rates of interest earned on its
interest-earning assets and rates paid on its interest-bearing liabilities
("interest rate spread") and (ii) the relative amounts of its interest-earning
assets and interest-bearing liabilities. When interest-earning assets
approximate or exceed interest-bearing liabilities, any positive interest rate
spread will generate net interest income.
The average yields received on long-term, fixed-rate real estate loans
change slowly and generally do not keep pace with changes in interest rates on
deposit funds and borrowings. At December 31, 1999, the Bank's portfolio of
loans consisted of 84% adjustable-rate and 16% fixed-rate loans. The Bank has
employed various measures designed to make yields on its loan portfolio and
investments interest-rate sensitive. They have included: (i) adoption of a
policy under which the Bank generally originates and sells long-term,
fixed-rate mortgage loans which have been written to specifications
promulgated by the Federal Home Loan Mortgage Corporation ("FHLMC") and
Federal National Mortgage Association ("FNMA") and qualify for sale in the
secondary market, (ii) emphasis on origination of adjustable-rate mortgage
loans on residential and commercial properties, (iii) origination of
construction loans secured by residential and commercial properties, at
interest rates subject to periodic adjustment based upon the prevailing market
rates, and (iv) origination of business loans at interest rates subject ot
periodic adjustment. See "Lending Activities" and "Interest Rate Risk
Management."
3
<PAGE>
AVERAGE BALANCE SHEET
---------------------
The following table presents for the periods indicated, information
regarding average balances of assets and liabilities as well as the total
dollar amounts of interest income from average interest-earning assets and
interest expense on average interest-bearing liabilities, resulting interest
rate spread, and ratio of interest-earning assets to interest-bearing
liabilities. Averages are calculated using monthly averages. The Bank
follows the practice of stopping interest accruals on loans past due 90 days
and over unless it is reasonably assured that all principal and interest due
on the loan will be fully recovered. The interest income on loans for all
years presented below excludes the interest beyond the 90 day period. These
amounts were immaterial for all periods presented. Interest income on
tax-free municipal bonds are not shown on a tax-equivalent basis.
<TABLE>
At December 31, Years Ended December 31,
--------------- -------------------------------------------------------------------
1999 1999 1998 1997
--------------- -------------------- ---------------------- -----------------------
Average Average Average Average
Yield/ Average Yield/ Average Yield/ Average Yield/
Balance Cost Balance Interest Cost Balance Interest Cost Balance Interest Cost
------- ---- ------- -------- ---- ------- -------- ---- ------- -------- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning
assets:
Loans
receivable... $454,381 8.29% $411,406 $35,481 8.62% $386,422 $34,519 8.93% $344,293 $31,202 9.06%
Mortgage-backed
securities... 59,595 6.14 60,609 3,678 6.07 24,560 1,652 6.73 28,714 2,070 7.21
Corporate and
municipal
bonds........ 3,159 5.89 3,165 173 5.47 746 37 4.96 -- -- --
Short-term
investments.. 401 4.99 860 37 4.30 939 62 6.60 7,525 470 6.25
U.S.
securities... 42,653 6.06 42,231 2,564 6.10 40,084 2,588 6.46 36,776 2,323 6.32
Other equity
investments.. 7,020 7.25 5,339 385 7.21 4,680 357 7.63 4,333 331 7.64
-------- -------- ------- -------- ------- -------- -------
Total inter-
est earning
assets...... 567,209 7.87 523,610 42,318 8.08 457,431 39,215 8.57 421,641 36,396 8.63
Non-interest
earning
assets....... 13,907 -- 11,563 -- -- 10,065 -- -- 9,656 -- --
-------- -------- -------- --------
Total assets.. $581,116 -- $535,173 -- -- $467,496 -- -- $431,297 -- --
======== ======== ======== ========
Interest-bearing
liabilities:
Deposits..... $396,958 4.70 $393,372 18,601 4.73 $387,720 19,880 5.13 $344,500 17,779 5.16
FHLB advances
and other
borrowed
money....... 134,487 5.51 94,202 4,692 4.98 34,402 1,939 5.64 46,935 2,811 5.99
-------- -------- ------- -------- ------- -------- -------
Total interest-
bearing liabil-
ities........ 531,445 4.90 487,574 23,293 4.78 422,122 21,819 5.17 391,435 20,590 5.26
Non-interest-
bearing liabil-
ities-deposits
and other.... 10,335 -- 10,599 -- -- 12,717 -- -- 10,838 -- --
-------- -------- -------- --------
Total
liabilities. 541,780 -- 498,173 -- -- 434,839 -- -- 402,273 -- --
Shareholders'
equity....... 39,336 -- 37,000 -- -- 32,657 -- -- 29,024 -- --
-------- -------- -------- --------
Total liabilities
and share-
holders'
equity....... $581,116 -- $535,173 -- -- $467,496 -- -- $431,297 -- --
======== ======== ======== ========
Net interest
income....... $19,025 -- $17,396 -- -- $15,806 --
Ratio of average ======= ======= ==== =======
interest-earning
assets to average
interest-bearing
liabilities.. 1.08x 1.08x - -- 1.08x -- --
Interest rate
spread....... 3.30% -- -- 3.40% -- -- 3.37%
Net yield (net
interest income
as a percentage
of average
interest-earning
assets)...... 3.63% -- 3.80% -- -- 3.75%
Amortized loan
fees included
in loan
receivable
interest
income....... $1,083 $1,000 $ 809
</TABLE>
4
<PAGE>
Rate Volume Analysis
- --------------------
The "Rate Volume Analysis" table is contained in the section captioned
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in the Annual Report, which is incorporated herein by reference.
Key Operating Ratios
- --------------------
The following table provides certain performance ratios of the Bank for
the periods indicated.
Years Ended December 31,
-----------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
Return on average assets
(net income divided
by average total assets).......... 1.12% 1.11% 1.05% 1.01% 1.03%
Return on average equity
(net income divided
by average equity)................ 16.22 15.95 15.57 15.33 15.40
Average equity to average
assets ratio (average
equity divided by average
total assets)..................... 6.91 6.99 6.73 6.56 6.67
Dividend payout ratio............... 15.30% 49.00% 45.80% 12.50% 26.22%
Lending Activities
- ------------------
General. The Bank's loan portfolio and loans held for sale totaled $454.4
million at December 31, 1999 (loans held for sale totaled $2.7 million of this
amount). On that date before deductions, $96.4 million, or 21%, of total
outstanding loans, including loans held for sale, consisted of loans secured
by one-to-four-unit residential properties; $148 million, or 33%, consisted of
loans secured by mortgages on over-four-unit residential properties;
construction loans constituted $42.9 million, or 9%; and $146.8 million, or
32%, consisted of commercial real estate loans. The balance of the Bank's
outstanding loans was comprised of consumer and business loans.
The Bank's principal lending activities have focused on the origination
of conventional permanent loans on residential and commercial real estate.
Total loans originated were $213.2 million and $380.2 million for the years
ended December 31, 1997 and 1998, respectively, and $310.4 million for the
year ended December 31, 1999.
In order to maintain the interest rate sensitivity of its loan portfolio
and investments, the Bank observes a number of measures, which include: (i)
adoption of a policy under which the Bank generally originates long-term,
fixed-rate mortgage loans only when such loans qualify for and are sold in the
secondary market, (ii) an emphasis on origination of adjustable-rate mortgage
loans on residential and commercial properties, and (iii) origination of
construction and business loans at interest rates subject to periodic
adjustment based upon the prevailing prime rate. At December 31, 1999, $382.8
million, or 84% of net loans receivable, including loans held for sale, were
comprised of loans that were other than long-term, fixed-rate mortgage loans.
This amount consists of $48.1 million in residential mortgage loans with rates
adjustable at periods ranging from one to five years, $288.7 million in
business loans and loans secured by income-producing and multifamily
residential properties, $34.7 million in net construction loans, and $11.3
million in consumer loans.
5
<PAGE>
<TABLE>
The following tables provide selected data relating to the composition of the Bank's loan portfolio by
type of loan and type of security on the dates indicated.
At December 31,
-------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
--------------- --------------- --------------- --------------- ---------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Type of Loan:
Conventional
Real Estate Loans:
Interim
construction
loans............ $ 72,906 16.05% $ 60,641 15.67% $ 44,494 12.35% $ 35,706 10.74% $27,953 9.23%
Loans on existing
property......... 186,632 41.07 160,068 41.37 139,846 38.81 136,676 41.11 124,105 41.00
Loans
refinanced....... 204,630 45.03 174,691 45.15 183,165 50.83 169,244 50.91 158,874 52.49
Insured or
guaranteed real
estate loans....... 275 0.06 320 0.08 604 0.17 1,278 0.39 1,494 0.49
Consumer loans...... 24,435 5.38 17,465 4.51 11,831 3.28 7,121 2.14 1,875 0.62
Business loans...... 3,347 0.74 2,629 0.68 1,583 0.44 169 0.05 -- --
Less -
Loans
in process........ (29,959) (6.59) (21,765) (5.63) (14,934) (4.14) (12,283) (3.69) (7,818) (2.58)
Reserve for
loan losses....... (6,309) (1.39) (5,569) (1.44) (4,858) (1.35) (3,882) (1.17) (2,223) (0.73)
Deferred
loan fees and
other discounts (1,576) (0.35) (1,574) (0.41) (1,400) (0.39) (1,583) (0.48) (1,569) (0.52)
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
TOTAL............... $454,381 100.00% $386,906 100.00% $360,331 100.00% $332,446 100.00% $302,691 100.00%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======
</TABLE>
<TABLE>
At December 31,
-------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
--------------- --------------- --------------- --------------- ---------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Type of Security:
Residential:
One-to-four-
family............ $ 96,418 21.22% $ 95,807 24.76% $117,285 32.55% $131,894 39.68% $144,819 47.84%
Multifamily....... 148,354 32.65 118,015 30.50 101,317 28.12 85,042 25.58 71,008 23.46
Construction........ 72,906 16.04 60,641 15.67 44,494 12.35 35,706 10.74 27,953 9.23
Commercial
real estate........ 146,765 32.30 121,257 31.34 105,013 29.14 90,262 27.15 68,646 22.68
Consumer loans...... 24,435 5.38 17,465 4.51 11,831 3.28 7,121 2.14 1,875 0.62
Business loans...... 3,347 0.74 2,629 0.68 1,583 0.44 169 0.05 -- --
Less -
Loans in process... (29,959) (6.59) (21,765) (5.63) (14,934) (4.14) (12,283) (3.69) (7,818) (2.58)
Reserve for
loan losses....... (6,309) (1.39) (5,569) (1.44) (4,858) (1.35) (3,882) (1.17) (2,223) (0.73)
Deferred loan fees
and other
discounts......... (1,576) (0.35) (1,574) (0.41) (1,400) (0.39) (1,583) (0.48) (1,569) (0.52)
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
TOTAL............... $454,381 100.00% $386,906 100.00% $360,331 100.00% $332,446 100.00% $302,691 100.00%
======== ====== ======== ====== ======== ====== ======== ====== ======= ======
</TABLE>
6
<PAGE>
Loan Maturity. The following table sets forth certain information at
December 31, 1999, regarding the dollar amount of loans maturing based on
their contractual terms to maturity or repricing. Demand loans, loans having
no stated schedule of repayments and no stated maturity, are reported as due
in one year or less. Loan balances exclude unearned discounts, deferred loan
origination fees, and allowance for loan losses.
Due 2 Years 3 Years
Within Through Through
One Year 3 Years 5 Years After 5
From After After Years
December December December Through Beyond
31, 1999 31, 1999 31, 1999 10 Years 10 Years Total
-------- -------- -------- -------- -------- -----
(In Thousands)
Conventional Real
Estate Loans:
Interim construc-
tion loans.......$ 42,947 $ -- $ -- $ -- $ -- $ 42,947
Loans on existing
property......... 107,856 28,705 21,539 7,058 21,474 186,632
Loans refinanced.. 118,257 31,473 23,616 7,739 23,545 204,630
Insured or
guaranteed real
estate loans..... 191 10 -- -- 74 275
Consumer loans.... 12,351 647 3,377 7,955 105 24,435
Business loans.... 3,261 -- 86 -- -- 3,347
-------- ------- ------- ------- ------- --------
Total Loans .. $284,863 $60,835 $48,618 $22,752 $45,198 $462,266
======== ======= ======= ======= ======= ========
The following table sets forth the dollar amount of all loans,
categorized by fixed interest rates and floating or adjustable interest rates.
Loan balances exclude unearned discounts, deferred loan origination fees, and
allowance for loan losses.
Due Within
One Year
From December 31, 1999 Due After December 31, 2000
------------------------ ---------------------------
Fixed Adjustable Fixed Adjustable
Rates Rates Total Rates Rates Total
----- ----- ----- ----- ----- -----
(In Thousands)
Mortgage loans... $ 7,611 $261,640 $269,251 $51,534 $113,699 $165,233
Consumer loans... 1,213 11,138 12,351 12,084 -- 12,084
Business loans... 1 3,260 3,261 86 -- 86
------- -------- -------- ------- -------- --------
Total....... $ 8,825 $276,038 $284,863 $63,704 $113,699 $177,403
======= ======== ======== ======= ======== ========
Residential Loans. A key lending activity is the granting of conventional
or government-insured loans to enable borrowers to purchase, refinance or
build homes. At December 31, 1999, approximately 21% of the Bank's total loan
portfolio, including loans held for sale, consisted of loans secured by
one-to-four unit family dwellings located within the States of Washington,
Oregon and Idaho.
The Bank's lending policies generally limit the maximum loan-to-value
ratio on residential mortgage loans to 97% of the appraised value as
determined by an independent appraiser, with the condition that private
mortgage insurance is required on home loans with loan-to-value ratios in
excess of 80%.
The loan-to-value ratio, maturity and other provisions of the loans made
by the Bank generally have reflected the policy of making less than the
maximum loan permissible in accordance with sound lending practices, market
conditions, and underwriting standards established by the Bank. Mortgage loans
made by the Bank are generally long-term loans, amortized on a monthly basis,
with principal and interest due each month. The initial contractual loan
payment period for residential loans typically ranges from five to 30 years.
The Bank's experience indicates that real
7
<PAGE>
estate loans remain outstanding for significantly shorter periods than their
contractual terms. Borrowers may refinance or prepay loans at their option,
subject to prepayment penalty provisions when included in the note.
The Bank offers six-month, one-year, three-year, five-year, seven-year
and ten-year loans with limitations on adjustments of two percent in any one
year with a maximum lifetime interest rate adjustment of between four and six
percent. The Bank also offers fixed-rate loans, which it originates for sale
in the secondary market. Since 1982, the Bank has generally followed a policy
of not originating fixed-rate mortgages for its own portfolio.
All improved real estate which serves as security for a loan to the Bank
must be insured by such companies as may be approved by the Bank against fire,
extended coverage, vandalism, malicious mischief and other hazards. Such
insurance must be maintained throughout the term of the loan and in an amount
not less than that amount necessary to meet the replacement cost of the
property structures, subject to insurance carrier limits.
Construction and Commercial Real Estate Loans. First Mutual's real estate
loan portfolio also includes loans on multifamily housing (over four units),
construction loans (residential, commercial and multifamily) and commercial
loans.
Multifamily loans are generally made in amounts between $500,000 and $2.0
million and at December 31, 1999, the largest multifamily loan was for $4.0
million. As of December 31, 1999, multifamily loans were $148.4 million, or
33%, of the loan portfolio as compared to $118.0 million, or 30%, in 1998.
The Bank provides interim (construction) financing for residential and
commercial property development. At December 31, 1999, the Bank had $72.9
million in construction loans of which $30.0 million was disbursed. These
loans constituted 9% of the loan portfolio.
Single-family construction loans are further designated by the Bank into
two categories -- speculative and custom. Speculative (spec) construction
loans are approved for builder-developers who generally first build the
residence and then sell the property to the end buyer. Those loans typically
are made for a twelve-month period, which may be extended subject to
negotiation and the payment of an extension fee. Interest rates on spec loans
are tied to the prime rate and are adjusted when the prime rate changes. At
the present time, rates quoted range from 1.0% to 2.0% above the prevailing
prime rate and are dependent upon the type of loan and its terms.
Custom construction loans are originated directly to the borrower. The
borrower's builder must be approved by the Bank, and the Bank oversees the
disbursement of construction funds to the borrower and builder. Those loans
are generally made for periods ranging from six to 12 months. Interest rates
charged for custom construction loans are typically the same as those offered
for fixed-rate and adjustable-rate one-to-four family loans. The loan fee
structure for custom construction loans is 1% or more higher than that
assessed other single-family loans with similar terms and conditions. The
additional loan fee compensates the Bank for the extra costs associated with
this type of lending.
At December 31, 1999, commercial real estate loans (excluding multifamily
and construction loans) constituted $146.8 million, or approximately 32% of
First Mutual's loan portfolio, including loans held for sale. These loans are
typically secured by office buildings, warehouse, commercial and retail
centers located in First Mutual's primary lending area in the Greater Puget
Sound area and Western Oregon. Permanent commercial real estate loans are
normally made up to 75% of the appraised value of the property and generally
have interest rates which are adjusted annually based on the constant maturity
index of the one-year United States Treasury Bills plus a spread ranging from
3.00% to 4.00%.
Income property loans, consisting of multifamily, construction and
commercial real estate loans, totaled $326.8 million at December 31, 1999.
That figure compares to $261.3 million at year-end 1998 and $216.9 million at
year-end 1997. The increase in income property loans of $109.9 million, or
51%, over a two-year period is a result of both an increase in the asset size
of the Bank and an emphasis on income property lending.
8
<PAGE>
The assets of the Bank totaled $489 million at year-end 1998, which
compares to $581 million at December 31, 1999. An increase in asset size will
typically result in an increase in all types of portfolio loans.
Income property real estate financing is generally considered to involve
a somewhat higher degree of credit risk than financing of residential
properties. The risk of loss on an income property construction loan is
dependent largely upon the accuracy of the initial estimate of the property's
value at completion of construction or development and the estimated cost
(including interest) of construction. If the estimate of the construction cost
of the property upon completion of the project proves to be inaccurate, the
Bank may be required to advance funds beyond the amount originally committed
to permit completion of the development. If the estimate of value proves to
be inaccurate, the Bank may be confronted, at or prior to the maturity of the
loan, with collateral which is insufficient to assure full repayment. On
permanent income property real estate loans, the risk to the Bank is primarily
attributable to the cash flow from the property being financed. If the cash
flow from the property is reduced (e.g., if leases are not obtained or
renewed), the borrower's ability to repay the Bank's loan may be impaired.
The Bank's underwriting criteria are designed to evaluate and minimize
the risk of income property real estate lending. Among other things, the Bank
considers the credit history and reputation of the borrower, the borrower's
net worth and liquidity, the amount of the borrower's equity in the project,
independent appraisal and review of cost estimates, preconstruction sale and
leasing information, and cash flow projections of the borrower. To manage and
control the risk inherent in this type of lending, the Bank has adopted a
concentration of credit policy which, among other things, generally limits the
amount the Bank can lend to any one borrower to $5.0 million unless this
requirement is waived by the Investment Committee of the Board of Directors.
Business Banking. The Business Banking Department makes loans for
"owner-occupied" commercial real estate properties and construction loans, in
addition to non-real-estate-based business loans. At year-end 1999, total
business banking loans grew to $28.2 million compared to $16.2 million the
previous year. Non real-estate business loans included in those totals were
$3.3 million and $2.6 million at December 31, 1999 and 1998, respectively.
Business banking commercial real estate loans are typically made on
"owner-occupied" properties. The Business Banking Department analyzes the
owner's business that occupies the property, and looks at the business' cash
flow as the primary source of repayment. The real estate collateral provides
secondary security to the loan. Non-real-estate business loans are typically
extended to medium-sized businesses for the purpose of financing inventory,
accounts receivable, equipment, facilities, etc.
Interest rates on business loans are generally tied to the prime rate,
plus a spread ranging from 0% to 3% or to the constant maturity index of the
one-year U.S. Treasury Bills, plus a spread ranging from 3% to 4%. The rates
are adjusted when the index rate changes. Prime based loans reprice
immediately while the rest reprice based on set schedules, generally annually
and after a fixed period of time. Annual fees are also usually assessed to
line-of-credit business loans.
Commercial business lending generally involves greater risk than
residential mortgage lending and involves risks that are different from those
associated with residential, commercial and multifamily real estate lending.
Real estate lending is generally considered to be collateral-based lending
with loan amounts based on predetermined loan to collateral values, and
liquidation of the underlying real estate collateral is viewed as the primary
source of repayment in the event of borrower default. Although commercial
business loans are often collateralized by equipment, inventory, accounts
receivable or other business assets, the liquidation of collateral in the
event of a borrower default is often not a sufficient source of repayment
because accounts receivable may be uncollectible and inventories and equipment
may be obsolete or of limited use, among other things. Accordingly, the
repayment of a commercial business loan depends primarily on the
creditworthiness and cash flow of the borrower (and any guarantors), while
liquidation of collateral is a secondary source of repayment.
9
<PAGE>
Consumer Loans. The Bank originates consumer loans through four
departments: sales finance lending, home equity lending, direct consumer
lending, and small business lending. Consumer loans totalled $24.4 million at
December 31, 1999 compared to $17.5 million the previous year. The increase
is primarily in sales finance lending. At December 31, 1999, sales finance
loans totaled $11.0 million compared to $6.0 million in 1998.
The Sales Finance Department began operations during the third quarter of
fiscal 1997. This department purchases non-recourse consumer financing
contracts from approved dealers in Washington, Oregon and Idaho. Typical
collateral for these contracts include retrofitted windows, siding, roofs,
spas, and motorcycles. Dealers must be approved with the Bank prior to the
purchase of contracts. Before a contract is purchased, Bank personnel make
independent credit decisions of the borrowers by checking the creditworthiness
of the borrower, calculating debt-to-income ratios, and evaluating the value
of the collateral purchased. The financing contracts are secured and the
Bank's lien is perfected by the use of a Financing Statement on home
improvement loans over $5,000 and by the vehicle titles on vehicles. The
terms of the contracts are fixed rate and vary in term from two to 10 years.
As an incentive for a selection of dealers, the Bank maintains a quality
assurance account where funds are held on behalf of the dealer of which a
portion of those funds are rebated back to them on an annual basis. The
rebate is based on the performance of the loans delivered by the dealer to the
Bank throughout the year. At December 31, 1999, the dealer quality assurance
account had a total balance of $15,700.
The Bank originates home equity loans and lines-of-credit for its
portfolio and for sale to others in the secondary market. These loans are
secured by a second mortgage deed-of-trust on residential real estate occupied
by the borrower or owned by the borrower as an investment. Home equity loans
totaled $11.1 million at December 31, 1999 compared to $9.2 million in 1998.
The Bank's strategy regarding home equity loans is to sell fixed-rate
installment second mortgages and higher loan-to-value revolving
lines-of-credit. Revolving lines-of-credit retained in the Bank's portfolio
generally have a combined loan-to-value of less than 80%. All revolving
lines-of-credit are tied to the prime rate plus a margin. The margin is
determined based on the loan-to-value ratio, the creditworthiness of the
borrower, and the borrower's debt-to-income ratio. The interest rates charged
to the borrower are adjustable and change based on the prime rate. The
underwriting and insurance requirements for the Bank's home equity products
fall under the same underwriting guidelines and standards as the Bank's
residential loans. See "Residential Loans."
The Direct Consumer Lending Department began operations in the second
quarter of fiscal 1998. The Department processes and closes consumer loan
requests generated within the Bank's deposit branches and from lending
officers. The lending products offered fall into two categories: collateral
based loans (automobiles, boats, recreational vehicles, home improvement,
etc.), and unsecured lines-of-credit. The underwriting criteria for
collateral-based loans are similar to that of the sales finance loans noted
above. Primary consideration is given to the borrower's capacity to repay the
obligation. A secondary consideration on secured consumer loans is the value
of the loan collateral as a source of repayment. The underwriting criteria on
the unsecured lines-of-credit call for a higher level of borrower
creditworthiness because of the unsecured nature of these loans. The terms on
the collateral based loans are fixed rates with terms of up to 10 years. The
unsecured lines-of-credit are variable and tied to the prime rate plus a
margin. Direct consumer loans totaled $953,000 at December 31, 1999.
The Small Business Banking Department began operations in the fourth
quarter of fiscal 1999. The department processes and closes small business
loan requests originating in the branch system, through referral from other
lines of business or from lending officers. The credit products available are
small unsecured lines-of-credit, larger secured lines-of-credit and secured
loans. The primary factors for approval are the borrower's ability to repay
and guarantor creditworthiness. Collateral is taken as an abundance of
caution for small business loans and lines, and is not a factor when
evaluating credit applications. The unsecured lines-of-credit are open-ended
and have a variable rate tied to the prime rate. Secured lines-of-credit
carry a 12 month term and also have a variable rate tied to prime. Terms on
loans can be as long as seven years, and have a fixed rate with an adjustment
every three years. Small business loans totaled $50,000 at December 31, 1999.
10
<PAGE>
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans which are unsecured or secured by
rapidly depreciating assets such as automobiles. In such cases, any
repossessed collateral for a defaulted consumer loan may not provide an
adequate source of repayment of the outstanding loan balance as a result of
the greater likelihood of damage, loss or depreciation. The remaining
deficiency often does not warrant further substantial collection efforts
against the borrower beyond obtaining a deficiency judgment. In addition,
consumer loan collections are dependent on the borrower's continuing financial
stability and thus are more likely to be adversely affected by job loss,
divorce, illness or personal bankruptcy. Furthermore, the application of
various federal and state laws, including federal and state bankruptcy and
insolvency laws, may limit the amount which can be recovered on such loans.
Such loans may also give rise to claims and defenses by a consumer loan
borrower against an assignee of such loans such as the Bank, and a borrower
may be able to assert against such assignee claims and defenses that it has
against the seller of the underlying collateral. At December 31, 1999,
consumer loans past due 90 days or more totaled $27,000.
Loan Solicitation and Processing. The Bank relies upon its employees to
solicit and/or originate business, consumer income property and residential
loans. The Bank also utilizes the services of mortgage brokers. Residential
mortgage brokers take applications from borrowers, process the credit
information, obtain property appraisals, and then submit the loan to First
Mutual for approval. If approved, the loan is funded by and closed in the
name of First Mutual. Income property brokers are generally limited to taking
the initial application from borrowers. Mortgage brokers provide the Bank
with a cost effective method of originating loans in a broader geographic area
than the Bank's customer base. Approximately 59% of all residential loans
closed during the year ended December 31, 1999, were obtained through mortgage
brokers.
The Bank's lending policy is reviewed annually and approved by the Board
of Directors. Residential loans up to specified limits may be approved by a
member of the Loan Committee or designated underwriters. Income property
loans up to $1,000,000, and business loans up to $400,000 are approved by the
Loan Committee, which consists of officers Valaas, Mandery, Boudreau, Young,
Walkky, Werth and Chermak. All residential income property and business
loans with cumulative extensions of credit over $1,000,000 are further
reviewed and subject to approval by the Investment Committee, which is
comprised of Directors Valaas, Freeman, Parker, Wallace (Robert), Florence,
Doud and Rowley.
Loan Originations and Sales. Loan originations decreased in 1999 to $310
million from $380 million in 1998 and the comparable figure for 1997 was $213
million. The decrease in originations came from residential and consumer loan
closings, which decreased from $245 million in 1998 to $139 million in 1999.
Income property and business loan originations increased from $134 million in
1998 to $170 million in 1999.
Selling loans in the secondary mortgage market reduces the Bank's risk
that interest rates will escalate while holding long-term, fixed-rate loans in
its portfolio. The sale of loans into the secondary market also allows the
Bank to continue to make loans during periods when savings flows decline or
funds are not otherwise available for lending purposes. In connection with
such sales, the Bank generally sells the servicing rights (i.e., collection of
principal and interest payments).
The Bank currently sells loan servicing rights for which it typically
receives a fee of 1.5% to 2.25% of the loan principal balance. The Bank sold
$32 million of its servicing rights in the first quarter of 1999, $40 million
in the second quarter, declining to $27 million and $10 million in the third
and fourth quarters, respectively. The net gain on the sale of servicing
rights totaled $1.5 million in fiscal 1999 compared to $2.0 million in fiscal
1998. There were no sales of servicing rights in 1997. The Bank's intent is
to continue to sell servicing rights as they are originated through our
Residential Lending Department. (See further discussions on this subject in
the Management's Discussion and Analysis of Financial Condition and Results of
Operations in the Annual Report, under the caption Gain on Sales of Loans).
11
<PAGE>
As of December 31, 1999, the Bank was servicing loans for others
aggregating approximately $194 million as compared to $268 million in 1998.
Loan servicing fees, net, totaled $469,000 for the year ended December 31,
1999 and $474,000 for the year ended December 31, 1998.
Currently, long-term mortgage loans are being originated for sale in the
secondary mortgage market to FNMA, which is a publicly owned
quasi-governmental agency that purchases residential mortgage loans from
federally insured financial institutions and certain other lenders. During
the year ended December 31, 1999, the Bank securitized and sold $110 million
in loans as compared to $198 million during 1998.
Set forth below is a table showing the Bank's loan origination and sales
activity for the periods indicated.
Years Ended December 31,
---------------------------------
1999 1998 1997
---- ---- ----
(In Thousands)
Total loans at beginning of period
(net of undisbursed loan proceeds).... $394,050 $366,589 $ 337,911
Loans originated:
Real estate loans:
Construction loans.................. 61,045 52,917 39,952
Loans on existing property.......... 165,220 187,802 90,805
Loans refinanced.................... 67,885 124,639 72,779
Insured and guaranteed loans........ -- -- 769
Consumer and other loans.............. 16,249 14,826 8,902
-------- -------- --------
Total loans originated............. 310,399 380,184 213,207
Principal reductions.................... (132,194) (144,764) (86,952)
Loans sold:
Whole loans........................... (104,463) (197,404) (90,412)
Participation loans................... (5,526) (10,555) (7,165)
-------- -------- --------
Total loans sold................... (109,989) (207,959) (97,577)
-------- -------- --------
Total gross loans at end of period (net
of undisbursed loan proceeds)......... $462,266 $394,050 $366,589
======== ======== ========
Loan Commitments. First Mutual's commitments to make conventional
mortgage loans on existing residential dwellings are generally made for
periods of 30 to 60 days. The borrower may reserve ("lock-in") an interest
rate and loan fee for a period of 10 to 60 days from the date of application.
This reservation is conditioned upon loan approval and closing within this
time frame. Interest rates and loan fees committed at the time of the lock-in
are based upon the prevailing market rate at the time of approval.
Outstanding commitments to borrowers for loans, including commitments for
income property loans, totalled $74.3 million at December 31, 1999.
Loan Origination Fees and Other Fees. In addition to interest earned on
loans and servicing fees on loans sold and securitized, the Bank receives loan
origination fees for originating mortgage loans. See Note 1 of Notes to
Consolidated Financial Statements in the Annual Report for information as to
the recognition of loan fee income.
Loan origination fees vary with the volume and type of loans made and
with competitive conditions in mortgage markets. Loan demand and availability
of money affect these market conditions. Recent trends have kept loan
origination fees in the 1% to 2% range for permanent real estate loans.
Construction loan fees at the present time range from 2% to 3% of the loan
amount.
The Bank also receives other fees and charges relating to existing loans,
which include late charges and fees collected in connection with a change in
borrower or other loan modifications, including construction loan extensions.
12
<PAGE>
In connection with its loan origination activities, the Bank also realizes
closing fees. These fees are paid by borrowers to the Bank.
Real Estate Held for Sale and Nonperforming Loans. Loans are defined as
nonperforming when any payment of principal and/or interest is 90 days past
due, unless the loan is well-secured and is in process of collection. While
generally the Bank is able to work out a satisfactory repayment schedule with
a delinquent borrower, the Bank will undertake foreclosure proceedings if the
delinquency is not otherwise resolved. Property acquired by the Bank as a
result of foreclosure or by deed in lieu of foreclosure is classified as "real
estate held for sale" until such time as it is sold or otherwise disposed. At
December 31, 1999, the total of nonperforming loans, repossessed assets, and
real estate acquired through foreclosure was $352,192.
The following table sets forth information regarding nonperforming assets
at the dates indicated.
At December 31,
------------------------
1999 1998 1997
---- ---- ----
(Dollars in Thousands)
Loans greater than 90 days delinquent
and still accruing........................... $ -- $ -- $ --
Restructured troubled loans.................... -- -- --
Nonaccrual loans............................... 343 298 674
Other assets and real estate acquired
through foreclosure.......................... 9 38 --
---- -- - ----
Total........................................ $352 $336 $674
==== ==== ====
As a percentage of net loans................... 0.1% 0.1% 0.2%
As a percentage of total assets................ 0.1% 0.1% 0.2%
Gross interest income that would have
been recorded in the period if loans
had been current with original terms......... $ 60 $ 21 $ 58
Interest income on loans included
in net income for the period................ $ 33 $ 16 $ 44
Nonperforming assets for 1999 were composed of loans collateralized by
single-family residences, consumer loans, and one commercial property.
Reserve for Loan Losses
- -----------------------
The reserve for loan losses is maintained at a level sufficient to
provide for estimated losses based on known and inherent risks in the loan
portfolio. This reserve is based upon management's continuing analysis of the
factors underlying the quality of the loan portfolio. These factors include
changes in the size and composition of the loan portfolio; actual loan loss
experience; current and anticipated economic conditions; detailed analysis of
individual loans for which full collectibility may not be assured and for
which impairment may be present; and determination of the existence and fair
value of the collateral and guarantees securing the loans. The reserve is
based upon factors and trends identified by management at the time the
financial statements are prepared. The ultimate recovery of loans is
susceptible to future market factors beyond the Bank's control, which may
result in losses or recoveries differing significantly from those provided in
the financial statements. At December 31, 1999, the reserve for loan losses
totaled $6.3 million compared to $5.6 million at December 31, 1998.
13
<PAGE>
An $805,000 provision for loan losses was charged to operations in fiscal
1999, which was prompted by several factors. First, the mixture of
residential loans to income property loans has changed materially over the
last few years. In 1996 residential loans amounted to $130.1 million, or
39.1% of the total loan portfolio of $332 million. At the end of fiscal 1999,
residential loans equaled $94.7 million, or 20.8% of the total loan portfolio
of $452 million. The national norm for savings institutions is 71.4%
residential loans and 28.6% commercial and consumer loans (derived from the
third quarter 1999 FDIC Quarterly Banking Profile). For the average
commercial bank, the comparable ratio is 23.4% of residential loans and 76.6%
of commercial and consumer loans, which is almost identical to First Mutual's
ratio at December 31, 1999. The Bank considered the higher risk level in a
portfolio that was shifting to a greater emphasis on commercial and income
property lending.
Secondly, the Puget Sound area, in which most of the Bank's loans are
concentrated, has experienced an exceedingly long period of economic
prosperity and, although the Bank is sanguine about the immediate future for
the local economy, it is becoming concerned that a significant amount of
portfolio loans are being originated at a time when the local economy may be
at or near the peak in the cycle. The inherent risk in that position was also
considered within the provision for loan losses.
At year-end 1999 the ratio of First Mutual's reserves to total loans was
1.37%. That ratio compares to the national average for commercial banks of
1.73%, and for savings institutions of 0.92%. First Mutual believes that its
reserve for loan loss is consistent with its peers. A further discussion of
the Bank's reserve for loan losses is included in the Management's Discussion
and Analysis of Financial Condition and Results of Operations section of the
Annual Report.
While the Bank believes it has established its existing reserve for loan
losses in accordance with generally accepted accounting principles as of
December 31, 1999, there can be no assurance that regulators, when reviewing
the Bank's loan portfolio in the future, will not request the Bank to increase
its reserve for loan losses, thereby adversely affecting the Bank's financial
condition and earnings. See the Consolidated Financial Statements contained
in the Annual Report.
The following table sets forth an analysis of the Bank's allowance for
loan losses for the periods indicated.
Years Ended December 31,
------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(In Thousands)
Balance at beginning of period... $5,569 $4,858 $3,882 $2,223 $1,973
Charge-offs.................... (68) (39) -- (41) --
Residential real estate and
other loans.................. (45) (39) -- (41) --
Commercial real estate........ (23) -- -- -- --
Construction.................. -- -- -- -- --
Recoveries..................... 3 -- -- -- --
Residential real estate and
other loans.................. 3 -- -- -- --
Commercial real estate........ -- -- -- -- --
Construction.................. -- -- -- -- --
Provision...................... 805 750 976 1,700 250
------ ------ ------ ------ ------
Balance at end of period......... $6,309 $5,569 $4,858 $3,882 $2,223
====== ====== ====== ====== ======
Ratio of net charge-offs during
the period to average loans
outstanding during the period... 0% 0% 0% 0% 0%
14
<PAGE>
Interest Rate Risk Management
- -----------------------------
The Bank manages its balance sheet to maximize net interest income while
minimizing the impact on income of changes in the level of market interest
rates. As a framework for evaluating the effects of changes in interest
rates, the balance sheet is allocated according to repricing and maturity
characteristics of products. A static gap analysis compares the sensitivities
of existing assets and liabilities by grouping balances over various time
horizons. A traditional time horizon is a one year period. The Bank had a
negative (more liabilities repricing than assets) 15.3% one-year interest rate
sensitivity ratio at December 31, 1999, as compared to a negative .84% at
December 31, 1998.
The change in the Bank's negative gap position is in large measure due to
the acquisition of intermediate securities and loans during 1999. Please
refer to the Asset and Liability Management section of the Management
Discussion and Analysis in the Annual Report for further discussion.
Investment Activities
- ---------------------
Under Washington law, savings banks are permitted to own government and
government agency obligations, commercial paper, corporate bonds, mutual fund
shares, debt and equity obligations issued by creditworthy entities, whether
traded on public securities exchanges or placed privately for investment
purposes. The Bank holds a portfolio of mortgage-backed securities, REMICs,
corporate and municipal bonds and common stock. Subject to certain
exceptions, the Bank is prohibited by FDIC regulations from making equity
investments of a type, or in an amount, that is not permissible for national
banks.
The Chief Financial Officer of the Bank determines appropriate
investments in accordance with the Investment Committee of the Board of
Directors' and the approved investment policy. The policy generally limits
investments to US Government and agency securities and mortgage-backed
securities issued and guaranteed by FHLMC, FNMA and GNMA. Investments are
made based on certain considerations, which include the interest rate, yield,
settlement date and maturity of the investment, the Banks' liquidity position
and anticipated cash needs and sources. In addition, the effect on the Banks'
credit and interest rate risk, and risk-based capital is also included in the
evaluation.
At December 31, 1999, the book value of the Banks' investment securities
portfolio totaled $106.4 million, while the estimated fair value amounted to
$102.8 million as compared to $82.1 and $82.8 respectively for 1998.
Securities with stated maturities greater than ten years comprised 27.1% of
the investment portfolio in 1999. Mortgage-backed securities guaranteed by
the FNMA, FHLMC, and the GNMA totaled $60 million including those available
for sale. From time to time, investment levels may be increased or decreased
depending upon a number of factors. These factors include the yields on
investment alternatives and upon management's judgement as to the
attractiveness of the yields then available in relation to other opportunities
and its expectations of the level of yield that will be available in the
future. In addition management's projections as to the short-term demand for
funds to be used in the Banks' loan origination and other activities is also a
consideration. As a result of these factors, during the past year the Banks'
investment portfolio has increased 28%.
US Government and Agency Obligations. At December 31, 1999 the Banks'
portfolio of US Government and agency obligations had a book value of $43
million and a fair value of $41 million. The portfolio includes FHLB bonds
and structured notes and FHLMC and FNMA agency securities. At December 31,
1999 the interest rates on these obligations ranged from 5.50% to 6.8%.
Mortgage-Backed Securities. The Bank purchases mortgage-backed
securities to: (I) generate positive interest rate spreads on large principal
balances with minimal administrative expense, (ii) lower the credit risk of
the Bank as a result of the guarantees provided by the FHLMC, FNMA, and GNMA,
(iii) enable the Bank to use mortgage-backed securities as collateral for
financing, and (iv) invest excess funds during periods of reduced loan demand.
Included in the Banks' mortgage-backed securities portfolio are FNMA, FHLMC,
and GNMA mortgage-backed obligations with a book value totaling $61 million
and a market value of $58 million. In comparison the related figures
15
<PAGE>
for 1998 totaled $39 million and $40 million respectively. Management
perceived this time to be opportune for security purchases because of the
source of the Bank's funding and the then current status of the institution's
various capital components. Also included in the Bank's mortgage-backed
security portfolio are real estate mortgage investment conduits ("REMICS")
with a book value of $624,000 ranging in maturity from 2002 to 2022.
Mortgage-backed securities typically represent a participation interest
in a pool of single-family or multi-family mortgages. The principal and
interest payments on these mortgages are passed from the mortgage originators,
through intermediaries (generally US Government agencies and government-
sponsored enterprises) that pool and resell the participation interests in the
form of securities, to investors such as the Bank. Such US Government
agencies and government sponsored enterprises, which guarantee the payment of
principal and interest to investors, primarily include the FHLMC, FNMA, and
the GNMA. Mortgage-backed securities typically are issued with stated
principal amounts, and the securities are backed by pools of mortgages that
have loans with interest rates that fall within a specified range and have
varying maturities. Mortgage-backed securities generally yield less than
loans that underlie such securities because of the cost of payment guarantees
and credit enhancements. In addition, mortgage-backed securities are usually
more liquid than individual mortgage loans and may be used to collateralize
certain liabilities and obligations of the Bank. These types of securities
also permit the Bank to optimize its regulatory capital because they have a
low risk weighting.
REMICs are generally classified as derivative financial instruments
because they are created by redirecting the cash flows from the pool of
mortgages or mortgage-backed securities underlying these securities to create
two or more classes (tranches) with different maturity or risk characteristics
designed to meet a variety of investors needs.
The actual maturity of a mortgage-backed security may be less than its
stated maturity due to prepayments of the underlying mortgages. Prepayments
that are faster than anticipated may shorten the life of the security and may
result in a loss of any premiums paid and thereby reduce the net yield on such
securities. Although prepayments of underlying mortgages depend on many
factors, including the type of mortgages, the coupon rate, the age of
mortgages, the geographical location of the underlying real estate
collateralizing the mortgages and general levels of market interest rates, the
difference between the interest rates on the underlying mortgages and the
prevailing mortgage interest rates generally is the most significant
determinant of the rate of prepayments. During periods of declining mortgage
interest rates, if the coupon rate of the underlying mortgages exceeds the
prevailing market interest rates offered for mortgage loans, refinancing
generally increases and accelerates the prepayment of the underlying mortgages
and the related security. Under such circumstances, the Bank may be subject
to reinvestment risk because, to the extent that the Bank's mortgage-backed
securities amortize or prepay faster than anticipated, the Bank may not be
able to reinvest the proceeds of such repayments and prepayments at a
comparable rate. In contrast to mortgage-backed securities in which cash flow
is received and prepayment risk is shared pro rata by all security holders,
the cash flow from the mortgages underlying REMICs are segmented and paid in
accordance with a predetermined priority to investors holding various tranches
of such securities. A particular tranche of REMICs may therefore carry
prepayment risk that differs from that of both the underlying collateral and
other tranches.
At December 31, 1999, corporate and municipal bonds included $2.5 million
of Merrill Lynch corporate bonds and four Washington State municipal bonds
that are rated AA or better.
For further information concerning the Banks' investment portfolio,
reference is made to Note 3 and 4 of the Notes to Consolidated Financial
Statements in the Annual Report to Shareholders.
16
<PAGE>
The following table sets forth information regarding the Bank's mortgage-
backed securities (including REMIC's) activity for the periods indicated.
Years Ended December 31,
------------------------
1999 1998 1997
---- ---- ----
(In Thousands)
Beginning balance.............................. $39,286 $23,363 $33,767
Mortgage-backed securities purchased........... 32,768 29,419 --
Amortization of premiums and discounts......... (989) (20) (12)
Principal repayments........................... (11,470) (13,476) (10,392)
------- ------- -------
Ending balance............................ $59,595 $39,286 $23,363
======= ======= =======
The following table sets forth the composition of the Bank's mortgage-
backed securities portfolio at the dates indicated.
Years Ended December 31,
---------------------------------------------------------
1999 1998 1997
------------------ ----------------- -----------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
------ -------- ------ -------- ------ --------
(Dollars in Thousands)
Mortgage-backed
securities:
FHLMC...........$ 2,227 3.74% $ 4,223 10.75% $ 7,312 31.30%
FNMA............ 54,992 92.27 31,916 81,24 11,746 50.27
GNMA............ 1,752 2.94 1,996 5.08 -- --
REMICs.......... 624 1.05 1,151 2.93 4,305 18.43
------- ------ ------- ------ ------- ------
Total.........$59,595 100.00% $39,286 100.00% $23,363 100.00%
======= ====== ======= ====== ======= ======
The following table presents the carrying value of the Bank's investment
securities portfolio. The market value of the Bank's investments in the table
at December 31, 1999, was approximately $102.8 million.
At December 31,
------------------------
1999 1998 1997
---- ---- ----
(In Thousands)
Investment securities:
U.S. Government and agency obligations....... $ 42,653 $39,643 $42,129
Corporate and municipals..................... 3,159 3,172 --
Mortgage-backed certificates................. 59,594 39,286 23,363
-------- ------- -------
Total.......................................... $105,406 $82,101 $65,492
======== ======= =======
17
<PAGE>
<TABLE>
The following table provides the scheduled maturities, carrying values, market values and average
yields for the Bank's investment securities at December 31, 1999.
One One Five Five
to to to to More More
One One Five Five Ten Ten than Ten than Ten
Year Year Years Years Years Years Years Years Total Total
Book Yield Book Yield Book Yield Book Yield Book Market Yield
---- ----- ---- ----- ---- ----- ---- ----- ---- ------ -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Agencies
and Treasuries... $ -- --% $38,656 6.104% $ 3,997 5.625% $ -- --% $ 42,653 $ 41,446 6.060%
Corporate &
Municipals*...... -- -- 2,534 6.000 -- -- 625 5.459 3,159 2,963 5.893
FHLMC
Certificates..... -- -- -- -- -- -- 2,220 6.876 2,220 2,246 6.876
FNMA
Certificates..... -- -- 1,146 5.703 30,774 5.644 23,982 6.711 55,902 53,751 6.103
GNMA
Certificates..... -- -- -- -- -- -- 1,869 6.500 1,869 1,752 6.500
REMICs-FNMA....... -- -- 418 6.000 -- -- 146 6.500 564 571 6.129
REMICs-FHLMC...... -- -- -- -- 60 7.000 -- -- 60 61 7.000
---- ---- ------- ------ ------- ----- ------- ----- -------- -------- -----
Total........ -- -- $42,754 6.087% $34,831 5.644% $28,842 6.681% $106,427 $102,790 6.103%
==== ==== ======= ====== ======= ===== ======= ====== ======== ======== =====
* Municipal bond yields are not shown on a tax equivalent basis.
</TABLE>
18
<PAGE>
Deposit Activities and Other Sources of Funds
- ---------------------------------------------
General. Savings accounts and other deposits have traditionally been an
important source of the Bank's funds for use in lending and for other general
business purposes. Over the course of the past year deposits have declined.
As a result, we increasingly have relied on advances from the FHLB of Seattle.
In addition to deposit accounts, the Bank derives funds from loan repayments,
interest payments, loan sales, FHLB advances and other borrowings and
operations. The availability of funds from loan sales is influenced by
general interest rates and other market conditions. Loan repayments and
interest payments are a relatively stable source of funds, while deposit
inflows and outflows vary widely and are influenced by prevailing interest
rates and money market conditions. Borrowings are used on a short-term basis
to compensate for reductions in deposits or deposit inflows at less than
projected levels and are used on a longer-term basis to support expanded
lending activities.
Deposits. First Mutual offers a number of deposit accounts, including
savings accounts, NOW checking, business checking accounts, money market
accounts and time deposit accounts, ranging in maturity from thirty days to
ten years. Deposit account terms vary with the principal differences being the
minimum balance required, the time period the funds must remain on deposit and
the interest rate.
Jumbo Time Deposits. The Bank offers jumbo, mini-jumbo and public funds
mini-jumbo time deposits. These accounts are offered for minimum terms of 30
days and in minimum amounts of $100,000, $50,000, and $20,000, respectively.
The following table indicates the amount of the Bank's jumbo time
deposits by time remaining until maturity as of December 31, 1999. Jumbo time
deposits require minimum deposits of $100,000, and rates paid on such accounts
are negotiable.
Jumbo
Maturity Period Time Deposits
--------------- -------------
(In Thousands)
Three months or less ........................... $22,058
Four through six months......................... 28,317
Over six through twelve months.................. 27,630
Over twelve months.............................. 18,927
-------
Total.......................................... $96,932
=======
IRA Accounts. The Bank offers tax-deferred individual retirement
accounts (IRA). IRA accounts are offered on the same terms as the time
deposits noted below. In addition, the Bank offers money market deposit
accounts (MMDA) to IRA customers. The MMDA IRA requires a minimum balance of
$100.
19
<PAGE>
<TABLE>
Deposit Flows. The following table sets forth the balance of savings deposits in the various types of
savings accounts offered by the Bank at the dates indicated.
Balance at Balance at Balance at
December December December
31, % of Increase 31, % of Increase 31, % of
1999 Deposits (Decrease) 1998 Deposits (Decrease) 1997 Deposits
---- -------- -------- ---- -------- -------- ---- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
NOW and Business
Checking Accounts.........$ 24,473 6.1% $ (5,057) $ 29,530 7.2% $ 5,311 $ 24,219 6.5%
Jumbo Time Deposits........ 96,932 24.2 (1,724) 98,656 24.0 11,216 87,440 23.5
Mini-Jumbo Time Deposits... -- -- (94) 94 -- (86) 180 0.1
Super NOW Checking
Accounts.................. 1,586 0.4 454 1,132 0.3 679 453 0.1
Savings Accounts........... 11,018 2.8 (1,229) 12,247 3.0 (2,402) 14,649 3.9
Money Market Deposit
Accounts.................. 73,782 18.4 5,524 68,258 16.6 16,397 51,861 13.9
3 Months or less Time
Deposits.................. 1,248 0.3 (695) 1,943 0.5 408 1,535 0.4
4-6 Month Time Deposits.... 6,431 1.6 (10,936) 17,367 4.2 (2,806) 20,173 5.4
7 Month-One Year
Time Deposits............. 74,979 18.7 (27,185) 102,164 24.8 (7,925) 110,089 29.5
13 Month-to Five Year
Time Deposits............. 108,596 27.2 29,986 78,610 19.1 17,532 61,078 16.4
6-10 Year Time Deposits.... 1,129 0.3 (121) 1,250 0.3 98 1,152 0.3
------- ----- -------- -------- ----- ------- -------- -----
Total Deposits...........$400,174 100.0% $(11,077) $411,251 100.0% $38,422 $372,829 100.0%
======== ===== ======== ======== ===== ======= ======== =====
IRA/Keogh Accounts.........$ 21,667 5.4% $ (704) $ 22,371 5.4% $ 2,275 $ 20,096 5.4%
======== ===== ======== ======== ===== ======= ======== =====
</TABLE>
20
<PAGE>
The following table represents an analysis of the Bank's deposit accounts
by interest rate and maturity ranges at December 31, 1999.
1 Year to 2 Years to
Less Than Less Than Less Than 5 Years
One Year 2 Years 5 Years or more Total
-------- ------- ------- ------- -----
(In Thousands)
Less than 4.01%....... $ 42,049 $ 438 $ -- $ -- $ 42,487
4.01 - 5.00%.......... 152,168 1,894 414 6 154,482
5.01 - 6.00%.......... 153,477 26,345 9,364 232 189,418
6.01 - 8.00%.......... 3,223 6,654 3,197 708 13,782
8.01 - 10.00%......... 5 -- -- -- 5
-------- ------ ------ ------ ---------
Total................. $350,922 $35,331 $12,975 $ 946 $400,174
======== ======= ======= ====== =========
The following table provides the savings activity for the periods
indicated.
Years Ended December 31,
-------------------------------
1999 1998 1997
---- ---- ----
(In Thousands)
Deposits.............................. $809,150 $650,908 $575,028
Withdrawals........................... 838,997 632,287 548,392
-------- -------- --------
Net Deposits (Withdrawals)
Before Interest Credited............ (29,847) 18,621 26,636
Interest Credited..................... 18,770 19,802 17,797
-------- --------- ------
Net Increase (Decrease) in Deposits... $(11,077) $ 38,423 $ 44,433
======== ========= ========
For further information concerning the Bank's deposits, reference is made
to Note 9 of the Notes to Consolidated Financial Statements in the Annual
Report.
Borrowings. Deposits are the primary source of funds for First Mutual's
lending and investment activities and for its general business purposes. The
Bank does rely, however, upon advances from the FHLB to supplement its supply
of lendable funds and to meet deposit and withdrawal requirements. The FHLB
has served as the Bank's primary borrowing source. Advances from the FHLB are
typically secured by a portion of the Bank's first mortgage loans, U.S.
Treasury and agency securities, as well as a portion of the mortgage-backed
securities. At December 31, 1999, First Mutual had advances totaling
$134,237,000 from the FHLB, which mature in 2000 through 2006 at interest
rates ranging from 4.83% to 6.45%.
The Company relies on borrowings from other banks. Other advances
totaled $250,000 at the end of 1999. For further information on the Company's
borrowings, see Note 10 of the Notes to Consolidated Financial Statements in
the Annual Report to Shareholders.
21
<PAGE>
Years Ended December 31,
------------------------------
1999 1998 1997
---- ---- ----
(In Thousands)
FHLB advances............................ $134,237 $31,765 $34,230
======== ======= =======
FHLB advances:
Maximum outstanding at any month end.. $134,237 $39,755 $54,180
Average outstanding................... 88,471 33,441 47,184
Weighted average interest rates:
Annual........................... 5.288% 5.798% 5.960%
End of Year...................... 5.513 5.236 6.050
Other advances........................ $250,000 -- --
The FHLB functions as a central reserve bank providing credit for
commercial banks, savings banks, savings and loan associations and certain
other member financial institutions. As a member, First Mutual is required to
own capital stock in the FHLB and is authorized to apply for advances on the
security of its home mortgages and other assets (principally securities which
are obligations of, or guaranteed by, the United States Government) provided
certain standards related to creditworthiness have been met. Advances are made
pursuant to several different programs. Each credit program has its own
interest rate and range of maturities. Limitations on the amount of advances
are based on the FHLB's assessment of the institution's creditworthiness.
Under its current credit policies, the FHLB has limited advances to First
Mutual to 40% of its assets. At December 31, 1999, the percentage of assets
represented by FHLB borrowings was 23%. See "Regulation and Supervision -
Federal Home Loan Bank System" below.
REGULATION AND SUPERVISION
The Bank
General. As a state-chartered, federally-insured financial institution,
the Bank is subject to extensive federal and state regulation. Lending
activities and other investments must comply with various statutory and
regulatory requirements, including prescribed minimum capital standards.
First Mutual is regularly examined by the FDIC (Federal Deposit Insurance
Corporation) and the Department of Financial Institutions of the State of
Washington and files periodic reports concerning the Bank's activities and
financial condition with its federal and state regulators. The Bank's
relationship with depositors and borrowers also is regulated to a great extent
by both federal and state law, especially in such matters as the ownership of
savings accounts and the form and content of mortgage documents.
Federal and state banking laws and regulations govern all areas of the
operation of banks, including reserves, loans, mortgages, capital, issuance of
securities, payment of dividends and establishment of branches. Federal and
state bank regulatory agencies also have the general authority to limit the
dividends paid by insured banks and bank holding companies if such payments
should be deemed to constitute an unsafe and unsound practice. The respective
primary federal regulators of the Company and the Bank have authority to
impose penalties, initiate civil and administrative actions and take other
steps intended to prevent banks from engaging in unsafe or unsound practices.
Deposit Insurance. The FDIC is an independent federal agency that
insures the deposits, up to prescribed statutory limits, of depository
institutions. The FDIC administers two separate deposit insurance funds: the
BIF and the SAIF. The BIF is a deposit insurance fund for commercial banks
and some state-chartered savings banks. The SAIF is a deposit insurance fund
for most savings associations. The Bank is insured under the BIF fund. As an
insurer of the Bank's deposits, the FDIC has examination, supervisory and
enforcement authority over the Bank.
22
<PAGE>
The FDIC has established a risk-based system for setting deposit
insurance assessments. Under the risk-based assessment system, an
institution's insurance assessment varies according to the level of capital
the institution holds and the degree to which it is the subject of supervisory
concern. In addition, regardless of the potential risk to the insurance fund,
federal law requires the ratio of reserves to insured deposits at $1.25 per
$100. Both funds currently meet this reserve ratio. During 1999, the
assessment rate for both SAIF and BIF deposits ranged from zero to 0.27% of
covered deposits. As a well capitalized bank, First Mutual qualified for the
lowest rate on its deposits for 1999.
In addition to deposit insurance assessments, the FDIC is authorized to
collect assessments against insured deposits to be paid to the Finance
Corporation ("FICO") to service FICO debt incurred in the 1980's to help fund
the thrift industry cleanup. The FICO assessment rate is adjusted quarterly.
Prior to 2000, the FICO assessment rate for BIF-insured deposits was
one-fifth the rate applicable to deposits insured by the SAIF. Beginning in
2000, SAIF- and BIF-insured deposits will be assessed at the same rate by
FICO. As a result, BIF FICO assessments will be higher than in previous
periods while SAIF FICO assessments will be lower. For the first quarter of
2000, the annualized rate will be 2.1 cents per $100 of insured deposits. Due
to the fact that the Bank is insured under the BIF fund, the FICO assessment
will increase for 2000 as compared to prior years.
Any insured bank which does not operate in accordance with or conform to
FDIC regulations, policies and directives may be sanctioned for
non-compliance. For example, proceedings may be instituted against any
insured bank or any director, officer, or employee of such bank who engages in
unsafe and unsound practices, including the violation of applicable laws and
regulations. The FDIC has the authority to terminate deposit insurance
pursuant to procedures established for that purpose. Management is not aware
of any existing circumstances that could result in termination of the deposit
insurance for the Bank.
Capital Requirements. FDIC regulations recognize two types or tiers of
capital: core ("Tier 1") capital and supplementary ("Tier 2") capital. Tier 1
capital generally includes common stockholders' equity and noncumulative
perpetual preferred stock, less most intangible assets. Tier 2 capital, which
is limited to 100 percent of Tier 1 capital, includes such items as qualifying
general loan loss reserves, cumulative perpetual preferred stock, mandatory
convertible debt, term subordinated debt and limited life preferred stock;
however, the amount of term subordinated debt and intermediate term preferred
stock (original maturity of at least five years but less than 20 years) that
may be included in Tier 2 capital is limited to 50 percent of Tier 1 capital.
The FDIC currently measures an institution's capital using a leverage
limit together with certain risk-based ratios. The FDIC's minimum leverage
capital requirement specifies a minimum ratio of Tier 1 capital to average
total assets. Most banks are required to maintain a minimum leverage ratio of
at least 4% to 5% of total assets. The FDIC retains the right to require a
particular institution to maintain a higher capital level based on an
institution's particular risk profile. Although the Bank is only required to
maintain the minimum capital level, it has set a higher target range of 6.00%
to 6.50% for asset and liability management purposes. First Mutual Bank
calculated its leverage ratio to be 7.0% as of December 31, 1999.
FDIC regulations also establish a measure of capital adequacy based on
ratios of qualifying capital to risk-weighted assets. Assets are placed in
one of four categories and given a percentage weight -- 0%, 20%, 50% or 100%
- -- based on the relative risk of that category. In addition, certain
off-balance-sheet items are converted to balance-sheet credit equivalent
amounts, and each amount is then assigned to one of the four categories.
Under the guidelines, the ratio of total capital (Tier 1 capital plus Tier 2
capital) to risk-weighted assets must be at least 8%, and the ratio of Tier 1
capital to risk-weighted assets must be at least 4%. First Mutual Bank has
calculated its total risk-based ratio to be 11.1% as of December 31, 1999, and
its Tier 1 risk-based capital ratio to be 7.0%. In evaluating the adequacy of
a bank's capital, the FDIC may also consider other factors that may affect a
bank's financial condition. Such factors may include interest rate risk
exposure, liquidity, funding and market risks, the quality and level of
earnings, concentration of credit risk, risks arising from nontraditional
activities, loan and investment quality, the effectiveness of loan and
investment policies, and management's ability to monitor and control financial
operating risks.
23
<PAGE>
Federal statutes establish a supervisory framework based on five capital
categories: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized. An
institution's category depends upon where its capital levels are in relation
to relevant capital measure, which include a risk-based capital measure, a
leverage ratio capital measure, and certain other factors. The federal
banking agencies have adopted regulations that implement this statutory
framework. Under these regulations, an institution is treated as well
capitalized if its ratio of total capital to risk-weighted assets is 10% or
more, its ratio of core capital to risk-weighted assets is 6% or more, its
ratio of core capital to adjusted total assets is 5% or more, and it is not
subject to any federal supervisory order or directive to meet a specific
capital level. In order to be adequately capitalized, an institution must
have a total risk-based capital ratio of not less than 8%, a Tier 1 risk-based
capital ratio of not less than 4%, and a leverage ratio of not less than 4%.
Any institution which is neither well capitalized nor adequately capitalized
will be considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective
action requirements, regulatory controls and restrictions which become more
extensive as an institution becomes more severely undercapitalized. Failure
by the Bank to comply with applicable capital requirements would, if
unremedied, result in restrictions on its activities and lead to enforcement
actions including, but not limited to, the issuance of a capital directive to
ensure the maintenance of required capital levels. Banking regulators will
take prompt corrective action with respect to depository institutions that do
not meet minimum capital requirements. Additionally, approval of any
regulatory application filed for their review may be dependent on compliance
with capital requirements.
First Mutual's management believes that, under the current regulations,
the Bank will continue to meet its minimum capital requirements in the
foreseeable future. However, events beyond the control of the Bank, such as a
downturn in the economy in areas where the Bank has most of its loans, could
adversely affect future earnings and, consequently, the ability of the Bank to
meet its capital requirements.
Federal Deposit Insurance Improvement Act ("FDICIA"). First Mutual has
surpassed the $500 million asset threshold, and as such, is required to be
compliant with the FDICIA originally enacted in 1991 and with enhanced
provisions adopted in 1993. In general, the Act required the Bank to conduct
an annual independent audit of their financial statements, appoint an
independent audit committee of outside directors, report on and assess
management's responsibilities for preparing financial statements, and
establish an internal control structure.
An independent accountant must attest to and report on the assertions in
management's reports concerning these internal controls with the desired
outcome of efficient and effective operations; the safeguarding of assets;
reliable financial reporting and compliance with applicable laws and
regulations.
The FDIC as the primary regulator of the Bank has outlined, in general,
the requirements for compliance with FDICIA, but does not provide specific
guidance on the internal control structure, documentation, or procedures to
test the Bank's effectiveness. It is up to each bank to establish document
and design procedures to evaluate and test the internal control structure over
financial reporting and compliance with designated laws and regulations that
minimally include loans to insiders and dividend restrictions.
In brief, to ensure compliance, the Bank has established and coordinated
a management team that identifies and documents existing controls with
consideration given to the Bank's control environment, risk assessment,
control activities, information and communication systems, and monitoring
activities. In addition, management establishes internal control procedures,
develops and selects criteria for evaluation, tests the effectiveness of
controls, and ensures that proper written documentation is in place.
Under FDICIA, the Audit Committee has several responsibilities that
include but are not limited to overseeing the internal audit function;
conducting periodic meetings with management, the independent public
accountant, and the internal auditors; review of significant accounting
policies, and audit conclusions regarding significant accounting
24
<PAGE>
estimates; review of the assessments prepared by management and independent
auditor on the adequacy of internal controls and the resolution of identified
material weaknesses and reportable conditions in internal controls; and the
review of compliance with laws and regulations.
Federal Home Loan Bank System. The FHLB of Seattle serves as a reserve
or central bank for the member institutions within its assigned region. It is
funded primarily from proceeds derived from the sale of consolidated
obligations of the FHLBs. It makes loans (i.e., advances) to members in
accordance with policies and procedures established by the Federal Housing
Finance Board and the Board of Directors of the FHLB of Seattle. As a member,
the Bank is required to purchase and hold stock in the FHLB of Seattle in an
amount equal to the greater of 1% of their aggregate unpaid home loan balances
at the beginning of the year or an amount equal to 5% of FHLB advances
outstanding. As of December 31, 1999, First Mutual held stock in the FHLB of
Seattle in the amount of $7.0 million. See "Business -- Deposit Activities
and Other Sources of Funds -- Borrowings."
Federal Reserve System. The Federal Reserve Board requires (under
"Regulation D") that all depository institutions, including savings banks,
maintain reserves on transaction accounts or non-personal time deposits.
These reserves may be in the form of cash or non-interest bearing deposits
with the regional Federal Reserve Bank. NOW accounts and other types of
accounts that permit payments or transfers to third parties fall within the
definition of transaction accounts and are subject to Regulation D reserve
requirements, as are any non-personal time deposits at a savings bank. Under
Regulation D, First Mutual must maintain reserves against net transaction
accounts in the amount of 3% on amounts of $44.3 million or less, plus 10% on
amounts in excess of $44.3 million. The Bank may designate and exempt $5.0
million of certain reservable liabilities from these reserve requirements.
These amounts and percentages are subject to adjustment by the Federal Reserve
Board. The reserve requirement on non-personal time deposits with original
maturities of less than 1.5 years is 0%. As of December 31, 1999, the Bank's
deposit with the Federal Reserve Bank and vault cash exceeded the Bank's
reserve requirements.
The Company
General. The Company, as the sole shareholder of the Bank is a bank
holding company and is registered as such with the Federal Reserve. Bank
holding companies are subject to comprehensive regulation by the Federal
Reserve under the Bank Holding Company Act of 1956, as amended ("BHCA"), and
the regulations of the Federal Reserve. As a bank holding company, the
Company is required to file with the Federal Reserve annual reports and such
additional information as the Federal Reserve may require and will be subject
to regular examinations by the Federal Reserve. The Federal Reserve also has
extensive enforcement authority over bank holding companies, including, among
other things, the ability to assess civil money penalties, to issue cease and
desist or removal orders and to require that a holding company divest
subsidiaries (including its bank subsidiaries). In general, enforcement
actions may be initiated for violations of law and regulations and unsafe or
unsound practices.
New Legislation. On November 12, 1999, President Clinton signed into law
the Gramm-Leach-Bliley Financial Services Modernization Act of 1999, federal
legislation intended to modernize the financial services industry by
establishing a comprehensive framework to permit affiliations among commercial
banks, insurance companies, securities firms and other financial service
providers. Generally, the Act:
. repeals the historical restrictions and eliminates many federal and
state law barriers to affiliations among banks, securities firms,
insurance companies and other financial service providers;
. provides a uniform framework for the functional regulation of the
activities of banks, savings institutions and their holding
companies;
. broadens the activities that may be conducted by national banks,
banking subsidiaries of bank holding companies and their financial
subsidiaries;
25
<PAGE>
. provides an enhanced framework for protecting the privacy of
consumer information;
. adopts a number of provisions related to the capitalization,
membership, corporate governance and other measures designed to
modernize the FHLB system;
. modifies the laws governing the implementation of the Community
Reinvestment Act; and
. addresses a variety of other legal and regulatory issues affecting
day-to-day operations and long-term activities of financial
institutions.
Acquisitions. Under the BHCA, a bank holding company must obtain Federal
Reserve approval before: (1) acquiring, directly or indirectly, ownership or
control of any voting shares of another bank or bank holding company if, after
such acquisition, it would own or control more than 5% of such shares (unless
it already owns or controls the majority of such shares); (2) acquiring all or
substantially all of the assets of another bank or bank holding company; or
(3) merging or consolidating with another bank holding company.
The BHCA also prohibits a bank holding company, with certain exceptions,
from acquiring direct or indirect ownership or control of more than 5% of the
voting shares of any company that is not a bank or bank holding company and
from engaging directly or indirectly in activities other than those of
banking, managing or controlling banks, or providing services for its
subsidiaries. Under the BHCA, the Federal Reserve is authorized to approve
the ownership of shares by a bank holding company in any company, the
activities of which the Federal Reserve has determined to be so closely
related to the business of banking or managing or controlling banks as to be a
proper incident thereto. The list of activities determined by regulation to
be closely related to banking within the meaning of the BHCA includes, among
other things: operating a savings institution, mortgage company, finance
company, credit card company or factoring company; performing certain data
processing operations; providing certain investment and financial advice;
underwriting and acting as an insurance agent for certain types of
credit-related insurance; leasing property on a full-payout, non-operating
basis; selling money orders, travelers checks and U.S. Savings Bonds; real
estate and personal property appraising; providing tax planning and
preparation services; and, subject to certain limitations, providing
securities brokerage services for customers.
Interstate Banking. The Federal Reserve must approve an application of
an adequately capitalized and adequately managed bank holding company to
acquire control of, or acquire all or substantially all of the assets of, a
bank located in a state other than such holding company's home state, without
regard to whether the transaction is prohibited by the laws of any state. The
Federal Reserve may not approve the acquisition of a bank that has not been in
existence for the minimum time period, not exceeding five years, specified by
the statutory law of the host state. Nor may the Federal Reserve approve an
application if the applicant, and its depository institution affiliates,
controls or would control more than 10% of the insured deposits in the United
States or 30% or more of the deposits in the target bank's home state or in
any state in which the target bank maintains a branch. Federal law does not
affect the authority of states to limit the percentage of total insured
deposits in the state which may be held or controlled by a bank holding
company to the extent such limitation does not discriminate against
out-of-state banks or bank holding companies. Individual states may also
waive the 30% state-wide concentration limit contained in the federal law.
The Federal banking agencies are authorized to approve interstate merger
transactions without regard to whether such transaction is prohibited by the
law of any state, unless the home state of one of the banks adopted a law
prior to June 1, 1997 which applies equally to all out-of-state banks and
expressly prohibits merger transactions involving out-of-state banks.
Interstate acquisitions of branches will be permitted only if the law of the
state in which the branch is located permits such acquisitions. Interstate
mergers and branch acquisitions will also be subject to the nationwide and
statewide insured deposit concentration amounts described above.
Dividends. The Federal Reserve has issued a policy statement on the
payment of cash dividends by bank holding companies, which expresses the
Federal Reserve's view that a bank holding company should pay cash
26
<PAGE>
dividends only to the extent that the company's net income for the past year
is sufficient to cover both the cash dividends and a rate of earnings
retention that is consistent with the company's capital needs, asset quality
and overall financial condition. The Federal Reserve also indicated that it
would be inappropriate for a company experience serious financial problems to
borrow funds to pay dividends. Furthermore, under the prompt corrective
action regulations adopted by the Federal Reserve, the Federal Reserve may
prohibit a bank holding company from paying any dividends if the holding
company's bank subsidiary is classified as "undercapitalized" under the prompt
corrective action regulations.
Stock Repurchases. Bank holding companies, except for certain
"well-capitalized" and highly rated bank holding companies, are required to
give the Federal Reserve prior written notice of any purchase or redemption of
its outstanding equity securities if the gross consideration for the purchase
or redemption, when combined with the net consideration paid for all such
purchases or redemptions during the preceding 12 months, is equal to 10% or
more of their consolidated net worth. The Federal Reserve may disapprove such
a purchase or redemption if it determines that the proposal would constitute
an unsafe or unsound practice or would violate any law, regulation, Federal
Reserve order, or any condition imposed by, or written agreement with, the
Federal Reserve.
In October 1999, the Company approved a stock repurchase program
authorizing the repurchase of up to 225,000 shares or approximately 5% of the
Company's outstanding common stock. Shares may be purchased from time to time
depending upon market conditions, price and other management considerations.
In 1999, the Company had repurchased 8,500 shares. As of March 29, 2000, the
Company has repurchased a total of 18,500 shares.
Capital Requirements. The Federal Reserve has established capital
adequacy guidelines for bank holding companies that generally parallel the
capital requirements of the FDIC for the Bank. The Federal Reserve
regulations provide that capital standards will be applied on a consolidated
basis in the case of a bank holding company with $150 million or more in total
consolidated assets.
The Company's total risk-based capital must equal 8% of risk-weighted
assets and one half of the 8%, or 4%, must consist of Tier 1 (core) capital.
As of December 31, 1999, the Company's total risk-based capital was 11.08% of
risk-weighted assets and its risk-based capital of Tier 1 (core) capital was
9.83% of risk-weighted assets.
FEDERAL AND STATE TAXATION
Federal Taxation
General. The Company and its subsidiaries report their income on a
fiscal year basis using the accrual method of accounting and are subject to
federal income taxation in the same manner as other corporations with some
exceptions, including particularly the Bank's reserve for bad debts discussed
below. The following discussion of tax matters is intended only as a summary
and does not purport to be a comprehensive description of the tax rules
applicable to the Company or the Bank.
Bad Debt Reserves. Historically, savings institutions such as the Bank,
which met certain definitional tests primarily related to their assets and the
nature of their businesses, were permitted to establish a reserve for bad
debts and to make annual additions to the reserve. These additions may,
within specified formula limits, have been deducted in arriving at the Bank's
taxable income. For purposes of computing the deductible addition to its bad
debt reserve, the Bank's loans are separated into "qualifying real property
loans" (i.e., generally those loans secured by interests in residential real
property) and all other loans ("non-qualifying loans"). The following
formulas were used to compute the bad debt deduction with respect to
qualifying real property loans: (i) actual loss experience or (ii) a
percentage equal to 8% of taxable income. The deduction with respect to
non-qualifying loans was computed under the experience method. Reasonable
additions to the reserve for losses on non-qualifying loans were based upon
actual loss experience and would reduce the current year's addition to the
reserve for losses on qualifying real property loans, unless that
27
<PAGE>
addition was also determined under the experience method. The sum of the
additions to each reserve for each year was the Bank's annual bad debt
deduction.
The provisions repealing the current thrift bad debt rules were passed by
Congress as part of "The Small Business Job Protection Act of 1996." The
rules eliminate the 8% of taxable income method for deducting additions to the
tax bad debt reserves for all financial institutions for tax years beginning
after December 31, 1995. These rules also require that all institutions
recapture all or a portion of their bad debt reserves added since the base
year (last taxable year beginning before January 1, 1988). The Bank has
previously recorded a deferred tax liability equal to the bad debt recapture
and as such the rules will have no effect on the net income or federal income
tax expense. For taxable years beginning after December 31, 1995, the Bank's
bad debt deduction will be determined under the experience method using a
formula based on actual bad debt experience over a period of years or, if the
Bank is a "large" association (assets in excess of $500 million), on the basis
of net charge-offs during the taxable year. The rules allow an institution to
suspend bad debt reserve recapture for the 1996 and 1997 tax years if the
institution's lending activity for those years is equal to or greater than the
institution's average mortgage lending activity for the six taxable years
preceding 1996 adjusted for inflation. For this purpose, only home purchase
or home improvement loans are included and the institution can elect to have
the tax years with the highest and lowest lending activity removed from the
average calculation. If an institution is permitted to postpone the reserve
recapture, it must begin its six year recapture no later than the 1998 tax
year. The unrecaptured base year reserves will not be subject to recapture as
long as the institution continues to carry on the business of banking. In
addition, the balance of the pre-1988 bad debt reserves continue to be subject
to provisions of present law referred to below that require recapture in the
case of certain excess distributions to shareholders. First Mutual did not
meet the residential loan requirement for the taxable years ending December
31, 1997, 1998 and 1999.
Distributions. If a stock institution distributes amounts to
stockholders and the distribution is treated as being from its accumulated bad
debt reserves, the distribution will cause the institution to have additional
taxable income. A distribution to stockholder is deemed to have been made
from accumulated bad debt reserves to the extent that (i) the reserves exceed
the amount that would have been accumulated on the basis of actual loss
experience, and (ii) the distribution is a "non-dividend distribution." A
distribution in respect of stock is a non-dividend distribution to the extent
that, for federal income tax purposes, (i) it is redemption of shares, (ii) it
is pursuant to a liquidation or partial liquidation of the institution, or
(iii) in the case of current distribution, together with all other such
distributions during the taxable year, it exceeds the institution's current
and post-1951 accumulated earnings and profits. The amount of additional
taxable income created by a non-dividend distribution is an amount that, when
reduced by tax attributable to it, is equal to the amount of the distribution.
Minimum Tax. In addition to regular corporate income tax, corporations
are subject to an alternative minimum tax which generally is equal to 20% of
alternative minimum taxable income (taxable income, increased by tax
preference items and adjusted for certain regular tax items). The preference
items which are generally applicable include an amount equal to 75% of the
amount by which a financial institution's adjusted current earnings (generally
alternative minimum taxable income computed without regard to this preference
and prior to reduction for net operating losses) exceed its alternative
minimum taxable income without regard to this preference and the excess of the
institution's bad debt deduction over the amount deductible under the
experience method, as discussed below. Alternative minimum tax paid can be
credited against regular tax due in later years.
First Mutual's federal income tax returns have been audited through 1991,
and no additional taxes have been assessed.
State Taxation
The Bank is subject to a business and occupation tax which is imposed
under Washington law at the rate of 1.5% of gross receipts. However, interest
received on loans secured by first lien mortgages or deeds of trust on
residential properties is not subject to such tax.
28
<PAGE>
Reference is made to Note 11 of the Notes to Consolidated Financial
Statements in the Annual Report to Shareholders for additional information
regarding income taxes payable by the Bank.
Competition
The Bank's competition for savings deposits comes from securities
brokerage firms and other financial institutions, many of which have greater
resources than the Bank. In addition, during times of low interest rates the
Bank experiences significant competition for investors' funds from stock and
bond mutual funds that yield total returns higher than those paid by the Bank
on savings deposits.
The Bank competes for deposits principally by offering depositors a wide
variety of savings programs, convenient branch locations, preauthorized
payment and withdrawal systems, on-line banking services tax deferred
retirement programs, and miscellaneous services such as money orders and
travelers checks.
The Bank's competition for real estate and other loans comes principally
from mortgage banking companies, savings banks, savings and loan associations,
commercial banks, insurance companies and other institutional lenders. The
Bank competes for loan originations primarily through the interest rates and
loan fees it charges and the efficiency and quality of services it provides
borrowers, real estate brokers and builders. The competition for loans
encountered by the Bank, as well as the types of institutions with which the
Bank competes, varies from time to time depending upon certain factors.
Conditions which affect competition include, among others, the general
availability of lendable funds and credit, general and local economic
conditions, current interest rate levels, volatility in the mortgage markets
and other factors which are not readily predictable.
Employees
At December 31, 1999, First Mutual employed 121 full-time and 20
part-time employees. First Mutual employees are not represented by any
collective bargaining agreement. Management considers its relations with its
employees to be good.
Item 2. Properties
- ------------------
The following table provides the location of the Bank's offices, as well
as certain information relating to these offices.
<TABLE>
Lease
Book Value --------------------------
Total As of Date of
Cost of December Square Owned/ Initial Termi- Renewal
Year Opened Assets 31, 1999 Feet Leased Lease nation Terms
----------- ------ -------- ---- ------ ----- ------ -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Branch Locations:
- -----------------
Bellevue Office &
Administrative Offices October 1985 $ 1,741 $605 14,903 Leased June 15, May 31, One five-
400 1085h Avenue NE 1985 2007 year option
Bellevue, WA 98004
(Originally opened 1952)
Issaquah Office December 1977 701 314 2,860 Owned -- -- --
855 Rainier Blvd. N.
Issaquah, WA 98027
(Originally opened
November 1965)
(table continued on following page)
</TABLE>
29
<PAGE>
<TABLE> Lease
Book Value --------------------------
Total As of Date of
Cost of December Square Owned/ Initial Termi- Renewal
Year Opened Assets 31, 1999 Feet Leased Lease nation Terms
----------- ------ -------- ---- ------ ----- ------ -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Monroe Office April 1993 1,534 1,133 5,415 Owned -- -- --
19265 State Route 2
Monroe, WA 98272
(Originally opened
April 1968)
Crossroads Office September 1969 412 150 2,972 Owned -- -- --
15635 N.E. 8th Street
Bellevue, WA 98008
Redmond Office December 1977 1,226 581 6,474 Owned -- -- --
16900 Redmond Way
Redmond, WA 98052
Ballard Office June 1994 183 28 1,700 Leased March 25, June 1, One three-
2038 N.W. Market St. 1994 2001 year option
Seattle, WA 98107
West Seattle Office July 1996 306 102 2,200 Leased March 1, February Two five-
4520 California 1996 28, 2001 year
Ave., S.W. options
Seattle, WA 98116
Bellevue West Office July 1997 2,699 2,499 9,190 Owned -- -- --
10001 NE 8th Street
Bellevue, WA 98004
Bellingham Branch and March 1998 164 100 1,700 Leased February February Three
Loan Office 14, 1998 14, 2003 five-year
1100 Harris Street options
Bellingham, WA 98225
Loan Production Offices:
- ------------------------
Tacoma Loan Office January 1999 11 4 300 Leased January 1, December Month to
2323 N 31st St., Suite 200 1999 2001 month
Tacoma, WA 98043 after
(Originally opened initial
October 1996) term
Salem Office October 1999 24 11 820 Leased October 4, October 31, --
401 Ratcliff Drive, SE, 1994 2001
Suite 170
Salem, OR 97301
(Originally
opened November 1999)
</TABLE>
The Bank reviews the utilization of its properties on a regular basis and
believes that it has adequate facilities for current operations.
The Bank regularly analyzes demographic and geographic data as well as
information regarding the Bank's competitors and its current loan and deposit
customers in order to locate potential future bank sites. Specific criteria
is gathered for each potential geographic area identified. The criteria is
then weighted as to importance to the Bank, its customers and its target
market and a ranking is made of the various locations under analysis.
The Bank may open new branches from time-to-time, and on a selective
basis, depending on the availability of capital resources, the locations
potential for growth and profitability, and if the business model for the
branch is favorable. The Bank intends to open an office in Kirkland,
Washington in mid-year 2000.
30
<PAGE>
Item 3. Legal Proceedings
- --------------------------
At December 31, 1999, First Mutual was not engaged in any litigation
which in the opinion of management, after consultation with its counsel, would
exceed 10% of the equity capital accounts of the Bank.
Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1999.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
- ------------------------------------------------------------------------------
The information contained under the caption "Stock Information" in the
Annual Report is incorporated herein by reference.
The following table provides the cash dividends declared by the Company
(and the Bank as its predecessor) during the last three fiscal years. All
amounts have been adjusted for stock dividends and the dilutive effect of
stock options.
Fiscal Fiscal Fiscal Fiscal Fiscal
Quarter Ending 1999 1998 1997 1996 1995
- -------------- ---- ---- ---- ---- ----
Fiscal year $.200 $.600 $.501 $.105 $.198
March 31 .050 .450 .029 .027 .021
June 30 .050 .050 .034 .026 .021
September 30 .050 .050 .034 .026 .021
December 31 .050 .050 .404 .026 .135
Item 6. Selected Financial Data
- --------------------------------
The information contained in the section captioned "Selected Financial
Data" in the Annual Report is incorporated herein by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- -----------------------------------------------------------------------------
The information contained under the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in
the Annual Report is incorporated herein by reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
- --------------------------------------------------------------------
The information contained in the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Market Risk Sensitive Instruments" in the Annual Report is incorporated herein
by reference.
Item 8. Financial Statements and Supplementary Data
- ---------------------------------------------------
The financial statements contained in the Annual Report, which are listed
under Item 14 herein, are incorporated herein by reference.
31
<PAGE>
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
- -----------------------------------------------------------------------------
Not applicable.
Part III
Item 10. Directors and Executive Officers of the Registrant
- -----------------------------------------------------------
The information contained under the section captioned "Proposal 1.
Election of Directors" in the Company's Proxy Statement is incorporated herein
by reference. Reference is made to the cover page of this report for
information regarding compliance with Section 16(a) of the Exchange Act.
The following table sets forth certain information with respect to the
executive officers of the Company and the Bank.
Age at
December Position
-------------------------------------------
Name 31, 1999 Company Bank
- ---- -------- ------- ----
John R. Valaas 55 President and Chief President and
Executive Officer Chief Executive
Officer
Roger A. Mandery 57 Executive Vice President Executive Vice
and Treasurer President - Chief
Financial Officer,
Treasurer and
Assistant Secretary
James R. Boudreau 52 Senior Vice
President -
Chief Credit
Officer
Kenneth J. Walkky 51 Vice President -
Income Property
Production Manager
Kari Stenslie 35 Vice President - Vice President -
Controller Controller
Robin R. Carey 42 Vice President -
Operations and
Administration
Scott Harlan 38 Vice President -
Residential and Con-
sumer Lending
Ronald P. Werth 52 Vice President -
Business Banking
Manager
The following is a description of the principal occupation and employment
of the executive officers of the Bank during at least the past five years:
JOHN R. VALAAS is the President and Chief Executive Officer for First
Mutual Bank and First Mutual Bancshares, Inc. Prior to his appointment as
President of the Bank, Mr. Valaas was Senior Vice President and manager of the
Commercial Financial Services Division at Seafirst Bank where he was employed
from 1983 to 1992. Mr. Valaas has over 28 years of experience in commercial
banking.
ROGER A. MANDERY, CPA, is Executive Vice President for First Mutual Bank
and First Mutual Bancshares, Inc. Prior to serving in that capacity, from
March 1984 to 1989, he was Senior Vice President of Finance.
32
<PAGE>
Mr. Mandery serves as the Bank's Chief Financial Officer and in this capacity
is responsible for the Bank's treasury, accounting, internal audit, asset/
liability, and consumer and retail banking functions.
JAMES R. BOUDREAU is First Mutual's Senior Vice President and Chief
Credit Officer; he has been employed by the Bank since 1975. He is
responsible for overseeing lending policies for all lending areas of the Bank.
He chairs the Bank's Loan Committee and supervises the asset management and
residential underwriting departments.
KENNETH J. WALKKY, CPA, joined First Mutual in September 1990 as Vice
President and Manager of Income Property Lending. He is responsible for
income property and construction lending production. Prior to joining the
Bank, he served as Vice President and Northern Regional Manager of Commercial
Real Estate Lending, Puget Sound National Bank, where he was employed from
1983 to 1990. He was a Vice President at Seafirst Bank from 1980 to 1983. Mr
Walkky is also a Washington State certified general appraiser.
KARI STENSLIE, CPA, CMA, is the Vice President and Controller for First
Mutual Bank and First Mutual Bancshares, Inc. and has been employed by the
Bank since 1988. She is responsible for the Bank's accounting systems
financial reporting, tax accounting, and operational analysis functions.
ROBIN R. CAREY is First Mutual's Vice President of Operations and
Administration and has been employed by the Bank since 1979. She is
responsible for overseeing central banking operations, facilities, loan
servicing, income property operations, and human resources.
SCOTT HARLAN is the Bank's Vice President of Residential and Consumer
Lending and has been employed by the Bank since 1985. He is responsible for
the home equity, consumer, wholesale residential lending, secondary marketing,
and the information systems departments.
RONALD P. WERTH joined First Mutual in February 1996 as Vice President
and Manager of Business Banking. He is responsible for all aspects of
Business Banking including business development and administration. From 1988
to 1995 he served as Vice President - Finance for two privately owned
companies. Prior to that, he served as Vice President for the Corporate
Banking Division at Seafirst Bank where he was employed from 1973 to 1988.
Item 11. Executive Compensation
- --------------------------------
The information required by this item is incorporated by reference to the
section captioned - "Proposal I -Executive Compensation" in the Proxy
Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management
- ------------------------------------------------------------------------
The information required by this item is incorporated herein by reference
to the sections captioned "Proposal 1. Election of Directors" and "Principal
Shareholders" in the Company's definitive proxy statement for the Company's
2000 Annual Meeting of Shareholders.
Item 13. Certain Relationships and Related Transactions
- --------------------------------------------------------
The information required by this item is incorporated by reference to the
section captioned - "Proposal I -Meetings, Compensation, Relationships and
Certain Committees of the Board of Directors" in the Proxy Statement.
33
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
- --------------------------------------------------------------------------
(a)(1) Consolidated Financial Statements (*)
-------------------------------------
Independent Auditors' Report
Consolidated Statements of Financial Condition at December 31, 1999 and
1998
Consolidated Statements of Income for the three years ended December
31, 1999
Consolidated Statements of Stockholders' Equity for the three years
ended December 31, 1999
Consolidated Statements of Cash Flows for the three years ended
December 31, 1999
Notes to Consolidated Financial Statements
(2) All required financial statement schedules are included in the Notes to
Consolidated Financial Statements.
(b) A Form 8-K was filed on November 10, 1999 in connection with the holding
company reorganization.
(c) Exhibits
--------
(3) a. Articles of Incorporation (a)
b. Bylaws (a)
(11) Statement regarding computation of per share earnings.
Reference is made to the Company's Consolidated Statements of
Income attached hereto as part of Exhibit 13, which are
incorporated herein by reference.
(13) 1999 Annual Report to Shareholders.
(21) Subsidiaries
- -------------------
(*) Incorporated by reference from 1999 Annual Report to Shareholders
attached hereto as Exhibit 13.
(a) Incorporated by reference to the Current Report on Form 8-K filed with
the SEC on November 10, 1999.
34
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 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.
FIRST MUTUAL BANCSHARES, INC.
DATE: March 29, 2000 BY: /s/John R. Valaas
-----------------------------------
John R. Valaas, President and Chief
Executive
Officer and Duly Authorized
Representative
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 and on the dates indicated.
By: /s/Roger A. Mandery By:/s/Victor E. Parker
------------------------------ ----------------------------
Roger A. Mandery Victor E. Parker
Principal Financial Officer Director
Date: March 29, 2000 Date: March 28, 2000
By: /s/Kari A. Stenslie By:/s/George W. Rowley, Jr.
------------------------------ ----------------------------
Kari A. Stenslie George W. Rowley, Jr.
Principal Accounting Officer Director
Date: March 29, 2000 Date: March 28, 2000
By: /s/F. Kemper Freeman, Jr. By:/s/Richard S. Sprague
------------------------------ ----------------------------
F. Kemper Freeman, Jr. Richard S. Sprague
Chairman of the Board Director
Date: March 27, 2000 Date: March 27, 2000
By: /s/James J. Doud, Jr. By: /s/John R. Valaas
------------------------------ ---------------------------
James J. Doud, Jr. John R. Valaas
Director Director
Date: March 27, 2000 Date: March 29, 2000
By: By:
---------------------------- ---------------------------
Mary Case Dunnam H. Scott Wallace
Director Director
Date: March , 2000 Date: March , 2000
-- --
By: By: /s/Robert C. Wallace
------------------------------ --------------------------
Janine Florence Robert C. Wallace
Director Director
Date: March , 2000 Date: March , 2000
-- --
<PAGE>
EXHIBIT 13
1999 Annual Report to Shareholders
<PAGE>
FIRST MUTUAL
BANCSHARES
INCORPORATED
1999
ANNUAL
REPORT
<PAGE>
Corporate Profile
First Mutual Bancshares, Inc. (the "Company") is based on the Eastside,
the area immediately east of Seattle and Lake Washington that includes parts
of King and Snohomish counties. It is the holding company for First Mutual
Bank, its principal subsidiary. First Mutual Bank's primary lending market
serves citizens of the Eastside and the I-5 corridor, which stretches from
Bellingham, Washington, on the north to Salem, Oregon, on the south. The nine
branches of this state-chartered, FDIC-insured bank are located in Bellevue
(three), Ballard, Bellingham, Redmond, Issaquah, Monroe and West Seattle. In
addition, commercial real estate loan production offices are located in
Tacoma, Washington, and Salem, Oregon.
Operating income is derived primarily from real estate lending
activities. First Mutual Bank also makes consumer and small business loans and
sells a range of depository and other financial services.
First Mutual Bank converted to an FDIC-insured mutual savings bank in
1968. It originally was chartered as a savings and loan association when it
opened in 1953. In December 1985 the Bank converted to a stock FDIC savings
bank and completed its initial public offering of common stock. The holding
company, First Mutual Bancshares, Inc., was formed in October 1999.
In 1999 the Company's net income increased 15.2 percent to $6.0 million,
or $1.26 diluted earnings per share, up from $5.2 million, or $1.09 diluted
earnings per share, in 1998. Net interest income for 1999 was $19.0 million,
while deposits totaled $400 million, and total assets were $581 million at
year-end 1999.
The Company's common stock trades on The Nasdaq Stock Market under the
symbol FMSB.
<TABLE>
Financial Highlights
1999 1998 1997 1996
-------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total assets $581,116,306 $489,230,139 $445,762,440 $416,832,072
Net income $6,000,348 $5,207,696 $4,518,680 $3,914,648
Net interest income* $18,219,694 $16,646,362 $14,829,996 $11,850,706
Diluted earnings per share** $1.26 $1.09 $0.97 $0.85
Book value per share** $8.42 $7.42 $6.75 $6.15
Return on average assets 1.12% 1.11% 1.05% 1.01%
Return on average equity 16.22% 15.95% 15.57% 15.33%
Shares outstanding** 4,672,636 4,672,003 4,537,750 4,452,971
* After provision for loan losses.
** Adjusted for a 20% stock dividend paid April 3, 1996, a 10% stock dividend paid July 2, 1997, a
three-for-two stock split paid November 5, 1997, and a 10% stock dividend paid May 5, 1999.
</TABLE>
page 1
<PAGE>
Letter to Shareholders
Dear Fellow Shareholder:
First Mutual Bancshares, Inc. includes the results of First Mutual Bank,
which ended 1999 with record earnings and notably high performance ratios. The
final quarter of the year marked our 29th consecutive quarter of record year-
over-year earnings gains. Net income for 1999 increased 15 percent to $6.0
million, and diluted earnings per share rose 16 percent to $1.26, compared
with $1.09 for 1998.
Total assets also reached record levels, rising to $581 million from $489
million at the end of 1998. We are less interested in the absolute level of
assets, however, than we are in their earning power and their quality. With
regard to the latter, we once again are pleased to report that non-performing
assets were only $352,000 at the end of 1999, or .06 percent of total assets.
One of the primary measures of earning power by which we judge ourselves
is return on equity, a measure of how efficiently shareholder funds are used.
For 1999 our return on equity was a record 16.22 percent.
A full discussion of First Mutual's financial performance may be found in
the Management's Discussion and Analysis section, beginning on page 5.
Strategies for Change
Over the past several years we have discussed the strategic evolution of
First Mutual's balance sheet. It may be useful to review that evolution in
this communication.
Several years ago the Board made a strategic commitment to fundamentally
alter First Mutual's balance sheet by reducing the portfolio's reliance on
single-family home loans. In 1990 single-family home loans were 73 percent of
the loan portfolio. At the end of 1999 they were approximately 21 percent of
the portfolio.
The goal was to develop strong, multiple lines of business that would
provide superior levels of earnings and portfolio diversification. This
process had already begun in the mid-1980s when a department was formed to
underwrite small commercial real estate loans. Substantial resources have been
devoted to our Income Property Department and, today, small commercial real
estate loans represent 64 percent of our loan portfolio.
In 1996 we established our Business Banking Department, which targets
companies with credit needs in excess of $100,000. Business loans now are 6.2
percent of our portfolio. To complement the customer set targeted by Business
Banking, we formed the Small Business Department this year. It will provide
credit solutions to those smaller enterprises whose needs are less than
$100,000. We are confident that the extensive relationships established
page 2
<PAGE>
between our branch teams and the businesses in their communities provide a
strong foundation on which to grow our Small Business product line.
As noted in last year's letter, our Consumer Lending Department has added
basic product lines aimed at the individual with borrowing needs, beginning
with home equity loans. We also provide direct consumer loans as well as
indirect consumer financing. Indirect consumer loans are granted through a
select set of home improvement dealers located in Washington and Oregon.
Finally, in 1999 we established our Private Banking Department, which
focuses on higher-income, higher-net-worth individuals who are seeking
extraordinary levels of personalized service from their financial institution.
We have piloted this program successfully in our primary market region east of
Lake Washington and have been gratified by its early success.
To provide better access to our financial services, we began offering
on-line banking to our customers in 1999. Interest in this product has been
high, as it adds another level of convenience for many customers to do their
banking with us. In that capacity it serves as an adjunct to the high levels
of service we provide in person in our branches.
In recent years First Mutual has evolved from being primarily a
transactional provider of home mortgage loans to being a relationship-oriented
institution that can provide any individual or company with all the financial
products they need. As we have discussed consistently, over the years, we
believe strong, responsive relationships with our customers are the key to
profitable expansion of First Mutual. It is what differentiates us. Over time
very large financial institutions will provide a range of products that, in
effect, will be offered in a mass production fashion. The success of community
financial institutions like First Mutual will be based on competitively priced
products provided with a very high level of personal service.
First Mutual Bancshares, Inc.
During 1999 we took the important step of establishing a holding company.
At the same time we changed the name of the bank subsidiary from First Mutual
Savings Bank to First Mutual Bank. First Mutual Bancshares owns all of First
Mutual Bank. The holding company structure provides us with more flexibility
to take advantage of growth opportunities that continue to become available to
us in our robust Pacific Northwest marketplace.
page 3
<PAGE>
Dynamic Regional Economy
First Mutual Bank, with its headquarters in Bellevue, Washington, is
situated in a market that has experienced some of the most dynamic growth of
any area in the United States. While growth may slow somewhat in 2000, we
continue to expect significant job creation and growth in income levels. Our
market is home to the world's largest and most successful software company,
the world's largest on-line retailer, and the world's largest airplane
manufacturer. These entities, their spin-offs, and all the associated wealth
created by them are exceptionally strong engines for economic growth. We
believe First Mutual Bank is well situated to take advantage of the
opportunities that lie ahead.
/s/F. Kemper Freeman, Jr.
F. Kemper Freeman, Jr.
Chairman of the Board
/s/John R. Valaas
John R. Valaas
President/CEO
February 1, 2000
In this Annual Report to Shareholders, First Mutual Bancshares, Inc. (the
"Company") has included certain forward-looking statements concerning its
future operations. It is the Company's desire to take advantage of the "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995.
This statement is for the express purpose of availing the Company of the
protections of such safe harbor with respect to all forward-looking statements
contained in this Annual Report to Shareholders. Sentences containing words
such as "may," "will," "expect," "anticipate," "believe," "estimate,"
"optimistic," "hopeful," "should," "projected," or similar words may
constitute forward-looking statements. Although the Company believes that the
expectations expressed in these forward-looking statements are based on
reasonable assumptions within the bounds of its knowledge of its business and
operations, risks and uncertainties may cause actual results to differ
materially from these expectations. Factors which could affect actual results
include interest rate trends, the general state of the economy in the
Company's market area and the country as a whole, the impact of competitive
products, services and pricing, the ability of the Company to control costs
and expenses, loan delinquency rates, and legislative, regulatory and
accounting changes affecting the banking and financial services industry.
These risks and uncertainties should be considered in evaluating the
forward-looking statements and undue reliance should not be placed on such
statements. Also, there are other risks and uncertainties discussed from time
to time in the Company's SEC securities filings. The Company and the Bank
disclaim any obligation publicly to announce future events or developments
which affect the forward-looking statements herein.
page 4
<PAGE>
Management's Discussion and Analysis of Financial
Condition and Results of Operations
The information contained in this section should be read in conjunction
with the Consolidated Financial Statements and accompanying Notes to
Consolidated Financial Statements.
Formation of the Bank Holding Company
First Mutual Bancshares, Inc. (the "Company"), a Washington corporation,
is a holding company primarily engaged in the business of planning, directing,
and coordinating the activities of its wholly-owned subsidiary, First Mutual
Bank (formerly First Mutual Savings Bank). On October 26, 1999, First Mutual
Savings Bank converted into the holding company form of ownership in a
tax-free reorganization. In the reorganization, First Mutual Savings Bank
changed its name to First Mutual Bank and became the wholly-owned subsidiary
of the Company. First Mutual Bank is also referred to as the "Bank" in this
report.
Financial Highlights
First Mutual Bank's performance in 1999 reflects another year of record
earnings, solid asset growth, and excellent credit quality.
Net income was up 15.2%, totaling $6,000,000, or $1.26 per diluted share,
which compares to $5,208,000, $1.09 per diluted share, in 1998, and
$4,519,000, $0.97 per diluted share, in 1997. Net income in 1999 was
influenced by a favorable increase in net interest income, which was partially
offset by a decline in other operating income. Net interest income in 1999
improved to $19.0 million from $17.4 million in 1998, an increase of 9.4%,
compared to an increase of $1.6 million, or 10.1%, from 1997 to 1998. Net
interest income in 1997 totaled $15.8 million, up 16.6% from the previous
year. Other operating income fell 8.7%, from $3,230,000 in 1998 to $2,949,000
in 1999. In prior years other operating income has experienced gains, jumping
89.3% in 1998 and a more modest 3.9% increase in 1997.
Contributing to record earnings for 1999 was the successful growth in
assets, which increased $92 million, or 18.8%. By comparison, the growth in
assets in 1998 was $43 million, or 9.8%. Those figures compare to the national
average for asset growth for FDIC-insured savings institutions of 6.1% for
1998 and an increase of 8.8% for the 12 months ending September 1999. The
growth in assets occurred in both the investment securities and loan
portfolios. Investment securities increased 28.4%, from $82,101,000 in 1998 to
$105,406,000 in 1999. The growth in securities from
[Bar graph]:
1997 $4,519
1998 $5,208
1999 $6,000
Net Income/Dollars in Thousands
page 5
<PAGE>
1997 to 1998 was also significant, rising $17 million, or 25.4%. Portfolio
loans (loans receivable) increased dramatically in 1999 to $457,981,000, a
growth of 25.4% from 1998's balance of $365,104,000. The comparative increase
the prior year was 2.3%, or $8.3 million. Partially offsetting the rise in
portfolio loans was a decrease in loans held for sale, which are loans pending
delivery into the mortgage-backed secondary market. Loans held for sale fell
90.1%, from $27,371,000 in 1998 to $2,710,000 in 1999. In contrast to 1999,
loans held for sale in 1998 rose dramatically, from $8,422,000 in 1997 to
$27,371,000 in 1998. The rapid growth and contraction in loans held for sale
reflects the "refinance boom" experienced in the mortgage market.
The Bank's non-performing assets continued to remain at exceptionally low
levels. Non-performing assets increased slightly to $352,000, from $336,000 in
1998. As a percent of assets, non-performing assets totaled .06% in 1999
versus .07% the previous year.
page 6
<PAGE>
<TABLE>
Rate Volume Analysis
(Dollars in thousands)
1999 vs. 1998 1998 vs. 1997 1997 vs. 1996
Increase (decrease) due to Increase (decrease) due to Increase (decrease) due to
Total Total Total
Volume Rate Change Volume Rate Change Volume Rate Change
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest Income
Investments:
Mortgage-backed and
related securities $ 2,474 $ (448) $ 2,026 $ (376) $ (42) $ (418) $ (455) $ 33 $ (422)
Interest-earning
deposits with banks (21) (4) (25) (408) 1 (407) 473 (44) 429
Other equity invest-
ments 45 (17) 28 26 (1) 25 24 (5) 19
U.S. Treasury and
government agencies 281 (169) 112 319 (17) 302 1,018 139 1,157
------- ------- ------ ------- ------- -------- -------- ------- --------
Total investments 2,779 (638) 2,141 (439) (59) (498) 1,060 123 1,183
Loans:
Residential (1,975) (78) (2,053) (523) (376) (899) (1,052) 126 (926)
Residential
construction 200 (207) (7) 761 (82) 679 382 153 535
Multifamily 1,805 (659) 1,146 1,942 (348) 1,594 1,138 (40) 1,098
Multifamily
construction 307 (119) 188 (115) 22 (93) 320 23 343
Commercial and
commercial real
estate 1,985 (722) 1,263 1,398 (264) 1,134 1,967 51 2,018
Commercial real
estate construction 91 (44) 47 353 (30) 323 (40) (97) (137)
Other 372 6 378 526 53 579 370 60 430
------- ------- ------ ------- ------- -------- -------- ------- --------
Total loans 2,785 (1,823) 962 4,342 (1,025) 3,317 3,085 276 3,361
------- ------- ------ ------- ------- -------- -------- ------- --------
Total interest
income 5,564 (2,461) 3,103 3,903 (1,084) 2,819 4,145 399 4,544
Interest Expense
Deposits:
Money market deposit
and checking 586 (57) 529 573 43 616 266 38 304
Regular savings (53) (37) (90) (97) (25) (122) (100) (2) (102)
Time deposits (639) (1,078) (1,717) 1,670 (63) 1,607 2,939 (235) 2,704
------- ------- ------ ------- ------- -------- -------- ------- --------
Total deposits (106) (1,172) (1,278) 2,146 (45) 2,101 3,105 (199) 2,906
FHLB advances and other 3,150 (397) 2,753 (834) (38) (872) (672) 55 (617)
------- ------- ------ ------- ------- -------- -------- ------- --------
Total interest
expense 3,044 (1,569) 1,475 1,312 (83) 1,229 2,433 (144) 2,289
------- ------- ------ ------- ------- -------- -------- ------- --------
Net interest
income $ 2,520 $ (892) $1,628 $ 2,591 $(1,001) $ 1,590 $ 1,712 $ 543 $ 2,255
======= ======= ====== ======= ======= ======== ======== ======= ========
</TABLE>
RESULTS OF OPERATIONS
Net Interest Income
Net interest income, which increased 9.4% from the prior year, is
influenced by changes in the volume and mix of earning assets and funding
sources and the market rate of interest.
Earning assets rose $93 million, or 19.6%, in 1999, following increases
of 10.1% and 6.3% in 1998 and 1997, respectively. The contribution to net
interest income from the growth in assets totaled $2,520,000 in 1999.
Offsetting that contribution was a decrease of $892,000, resulting from an
unfavorable change in interest rates. In 1998 the growth in earning assets
increased net interest income by $2,591,000, which also was in part offset by
an adverse change in rates amounting to $1,001,000. Net interest income in
1997 was increased by both a growth in earning assets, which added $1,712,000,
and a positive trend in interest rates, which contributed $543,000.
The net interest margin declined in 1999 to 3.66%, from 3.85% the
previous year, and 3.78% in 1997. The drop in the net interest margin in 1999
is attributable to a greater decline in the interest income ratio than the
corresponding figure for the interest expense ratio. The interest income ratio
(interest income/average-earning assets) fell from 8.67% in 1998 to 8.13% in
1999, a decrease of .54%. During the same period the interest expense ratio
(interest expense/average deposits and borrowings) only declined .37%. One of
the factors that contributed to the decrease in the net interest margin was
the Bank's 28.4% increase in investment securities. The yield from the
investment securities portfolio is significantly less than that received from
the loan portfolio; for example, investment securities at year-end 1999 had an
average return of 6.15% as compared to 8.29% for the loan portfolio.
Also contributing to the decline in the net interest margin in 1999 was
the rise in short-term interest rates. The one-year Treasury rate, for
example, increased from 4.59% on December 31, 1998, to 6.11% at year-end 1999.
Because the Bank was negatively gapped (which is more liabilities repricing
within a one-year period than assets) at year-end 1998 by .84%, and further
negatively gapped by 15.3% at December 1999, the
page 7
<PAGE>
rise in short-term interest rates worked to the Bank's disadvantage.
In 1998 the net interest margin increased to 3.85% from 3.78% the
previous year. The net interest margin rose that year even though the Bank was
negatively gapped and the impact from the change in interest rates was
adverse. The cause of that anomaly was a change in the mix between the loan
and securities portfolios. The securities portfolio's average quarterly
balance declined 2.4%, while the same measure for loans rose 12.5%. The
combination of these changes created a condition in which the net interest
margin increased on a year-to-year comparison, while the overall effect from
interest rates was negative.
The outlook for 2000 is influenced by the effect of trends in interest
rates and the Bank's ability to successfully increase earning assets. Although
84% of the Bank's loan portfolio is comprised of adjustable-rate loans, the
balance of the portfolio is invested in fixed-rate instruments. In addition,
most of the securities portfolio is comprised of fixed-rate instruments.
During periods of rising rates, as we experienced in 1999, the net interest
margin is compressed as funding costs rise faster than yields on assets.
If interest rates continue to rise, it is likely that the net interest
margin will further decline. Management, however, is cautiously optimistic
that some or all of that decline could be offset through the growth in assets.
Although future results cannot be predicted based upon past performance, the
Bank has increased its assets by 13.7%, compounded per year, for the past five
years. The comparative national average for FDIC-insured institutions is
6.76%, compound growth, for the five years ended in 1998.
Other Operating Income
Other operating income fell in 1999 to $2,949,000, from $3,230,000 the
previous year. The comparable figure for 1997 was $1,706,000. The
disappointment in 1999 was primarily due to a decline in mortgage banking
activities and the resulting decrease in gain on sales of loans. Adversely
affecting all three years was the decline in net service fee income, which has
decreased from $805,000 in 1997 to $469,000 in 1999.
Gain on Sales of Loans. Gain on sales of loans fell 17.2% to $1,452,000
in 1999, after rising sharply in 1998 to $1,753,000, from $140,000 in 1997.
Gain on sales of loans is heavily influenced by residential loan volume, which
in turn benefited from the "refinance boom" experienced in 1998 and the first
half of 1999. Gain on sales of loans is composed of three elements: sale of
mortgage servicing rights, secondary market fees, and capitalization of
mortgage servicing rights.
page 8
<PAGE>
The net gain on sale of servicing rights amounted to $1,530,000 in 1999,
down $452,000, or 22.8%, from $1,982,000 the previous year. There were no
sales of a similar nature in 1997. The sale of servicing rights totaled $110
million in 1999, as compared to $178 million the previous year. In addition,
the sale of servicing rights in 1999 declined substantially on a quarterly
sequential basis. In the first quarter of 1999 the sale of servicing rights
totaled $32 million, with the sale in the second quarter rising to $40
million, falling to $28 million in the third quarter, and further dropping to
$10 million in the fourth quarter. The projected sale for the first quarter of
2000 is $7 million.
The amount and profit of sales executed in 2000 will depend on
residential loans originated, both in terms of amount and mix of loans. The
total number of loans closed and type of loans originated is heavily
influenced by the nature of the interest rate yield curve and whether or not
long-term rates are generally rising or falling. Rising rates, as we
experienced in 1999, usually have an adverse affect upon the amount of
residential loans originated.
Although it is the Bank's intent to sell servicing rights in 2000, sales
in subsequent years could be materially reduced or eliminated if the Bank
believes that it is in the best interest of the institution to retain the
servicing rights and the annuity-like fee income attendant with those rights.
Secondary market fees are the cash gains or losses from the sale of loans
into the secondary market. Cash losses in 1999 totaled $351,000 on loan sales
of $110 million. In 1998 the cash losses amounted to $426,000 on sales of $198
million. The comparable figure for 1997 was a loss of $5,000 on sales of $98
million. The more favorable results achieved in 1999 and 1997 are attributable
to fewer loan sales than in 1998. Nineteen-ninety-seven also benefited from
the sale of $4 million in income property loans. The margin for income
property loans is significantly greater than that for residential loans.
Beginning in 1996 the Bank adopted a new accounting procedure that
requires the capitalization of mortgage servicing rights. The amount
recognized as income in 1999 totaled $273,000, which compares to $197,000 in
1998, and $145,000 in 1997. The rise in 1999 is largely the result of an
increase in valuations of servicing rights as compared to previous years.
Servicing Fees, Net of Amortization. Servicing fee revenue is sensitive
to amortization expense, the
[Bar graph]
1997 $213
1998 $380
1999 $310
Loan Production/Dollars in Millions
page 9
<PAGE>
spread realized on the servicing portfolio and, of course, the size of the
portfolio.
In 1999 gross fee income (net of guarantor fees) received from the
mortgage servicing portfolio totaled $622,000. Deducted from those gross fees
was amortization expense of $153,000. In 1998 gross fees totaled $742,000, and
amortization expense amounted to $268,000. The comparable figures for 1997
were $1,055,000 and $250,000, respectively.
Amortization expense is largely impacted by the early prepayment of
loans. In 1999 principal prepayments totaled $51 million, or 17% of the
year-end 1998 servicing portfolio balance. The prepayment rate was greater in
1998, with $78 million in loan principal repaid, an amount equal to 21% of the
1997 year-end servicing balance. The results for 1997 were better than either
of the two subsequent years principal prepayments totaled $50 million and
represented 13% of the 1996 year-end servicing portfolio.
Also impacting servicing fee income is the spread realized from the
servicing portfolio. The spread is the difference between the total loan
interest received from the borrower and the amount remitted to the investor.
The Bank retains the spread as compensation for servicing the loan on behalf
of the investor. In 1999 the spread on the $231 million average servicing
portfolio equaled .27%. In contrast, the servicing portfolio averaged $324
million in 1998 and carried a spread of .23%. The comparable figures for 1997
were $375 million for the servicing portfolio and .28% for the servicing
spread.
The drop in the servicing portfolio in 1999 contributed to the decline in
service fee income. As was noted earlier, it is the Bank's current position to
sell mortgage servicing rights as they are originated. This practice will most
likely lead to a continued decline in the mortgage servicing portfolio, and a
further decrease in service fee income.
Whether or not the Bank will change its position in the future regarding
the retention of servicing rights will be dependent on interest rate trends,
the borrowers' propensity to prepay loans, management's expectations for
future interest rate directions, and the estimated lives of loans in the
servicing portfolio.
Fees on Deposit Services and Other Income. Deposit fee income has risen
88.62% in the last three years, from $167,000 in 1997, to $208,000 in 1998,
and $315,000 this year. The increase in all three years is largely
attributable to fee income from checking accounts. Revenue from checking
accounts amounted to $85,000 in 1997, increasing to $95,000 last year, and
further rising to $155,000 in 1999.
Other income is composed of a variety of fee sources of which loan fees,
late payment assessments
page 10
<PAGE>
(late charges), rental income and limited partnership fee income constitute
the most significant items. Loan fees, those that were not deferred,
increased from $240,000 in 1997 to $385,000 last year. There was a slight
decrease to $383,000 in 1999. The jump in fee income in 1998 was principally
the result of increased sales to investors where the Bank functioned as a
broker. In 1999, with the decline in mortgage banking lending from $217
million in 1998 to $85 million this year, brokered loan revenues dropped
$50,000, or 19.8%. That loss of fee income was partially offset by loan fees
from other sources.
Late charges have declined for the past three years, from $118,000 in
1997 to $77,000 this year. This trend is a reflection of both a fall in total
loans serviced and the emphasis that the Bank places on asset management.
Total loans serviced in 1997 included $365 million of portfolio loans and $379
million in loans serviced for others for a total of $744 million. At year-end
1999 total loans serviced had decreased 12% from 1997 levels to $655 million,
of which loans serviced for others had fallen to $194 million.
Fee income from rental income and limited part-nership dropped from
$130,000 in 1998 to $85,000 this year. While rental income rose modestly, fee
income from the Bank's limited partnership fell $47,000, or 73%. The Bank's
percentage of ownership in the partnership is de minimus; thus, its influence
on dividends declared is not significant. The Bank is hopeful that fee income
in the year 2000 will be comparable to the dividends received in 1998.
Revenues from rental fees and limited-partnership dividends totaled $96,000 in
1997.
Other Operating Expenses
Salaries and Employee Benefits. Salaries and employee benefits expense
essentially leveled off in 1999, after having grown rapidly in the previous
two years. Employee costs in 1999 fell a modest $199,000, or 2.7%, as compared
to increases of $1,541,000, or 25.9%, from 1997 to 1998, and $1,356,000, or
29.4%, from 1996 to 1997. Salaries and employee benefits expense was affected
by a change in loan officer commission expense, a decline in discretionary
bonuses paid to directors and senior management, and a drop in the benefit of
deferred loan origination expense. Salaries and benefits costs were not
materially affected by an increase in staff. The full-time equivalent (FTE)
count was 135 at December 31, 1999, up just a fraction from 133 in 1998. The
FTE staff in 1997 was 125.
Loan officer commission expense fell $307,000, or 33%, from $929,000 in
1998, to $622,000 this year. Commission expense amounted to $339,000 in 1997.
Loans originated in 1999 totaled $310 million as compared to $380 million the
year before. Loan volume
page 11
<PAGE>
in 1997 amounted to $213 million.
Employee compensation expense also benefited from a substantial reduction
of discretionary bonuses to directors and senior management. Certain
discretionary bonuses awarded to directors and senior management in 1997 and
1998 were not awarded in 1999. These discontinued bonuses totaled $465,000 in
1997 and $808,000 in 1998.
Offsetting compensation costs is the deferral of loan origination
expense. In accordance with the current accounting literature, standard loan
origination costs are deferred and amortized over the life of the loan. The
standard loan costs, which are determined for common loan types, are then
deducted from operating expense, with the net figures reported in the
financial statements. As was noted earlier, loan originations have ranged from
$213 million in 1997 to $310 million this year. The accounting benefit (see
Note 14 to the financial statements) has also varied, from $1,093,000 in 1997,
to $1,622,000 last year, to $1,495,000 in 1999.
Occupancy Expense. Occupancy expense of $1,480,000 in 1999 was up 7.3%,
from $1,379,000 the previous year. The comparative figure for 1997 was
$1,165,000. The increases in all three years are principally due to opening
new offices and corporate expan-sion at the Bellevue headquarters. In 1999 the
Bank opened a loan production office in Salem, Oregon, and incurred a full
year's operating expense from the Bellingham Branch. The previous year the
Bank had opened its ninth full-service branch. In 1997 occupancy expense
increased as a result of the opening of a second branch in Bellevue and
additional leased space at the Corporate Headquarters to accommodate the
residential lending department.
Other Expenses. Other expenses rose 6.4%, from $3,108,000 in 1998, to
$3,307,000 in 1999. The in-crease from 1997 to 1998 was $542,000, or 21.1%. A
number of items contributed to the change in other operating expenses,
including legal expenses, outside services, and audit and accounting services.
The Bank's legal fees were up sharply in the last two years, jumping
101.3% in 1999, to $298,000, from $148,000 the previous year. Legal costs in
1998 had risen 82.7%, from 1997's figure of $81,000. The in-crease in 1999 was
due primarily to the formation of the Bank's holding company; thus, legal
expenses for year 2000 should drop accordingly. In 1998 the Bank encountered
several issues related to residential construction lending that were difficult
to litigate. Those
[Bar graph]
1997 .15%
1998 .07%
1999 .06%
Non-performing Assets/Percentage of Total Assets
page 12
<PAGE>
issues have since been settled and the Bank does not anticipate any further
legal expenses regarding those particular matters.
Outside services expense dropped from $379,000 in 1998 to $180,000 in
1999. In July of 1998 the Bank engaged independent consultants to review the
operating procedures of the Bank and to implement improvements as needed. The
project was concluded by late spring 1999. The comparable level of costs for
outside services expense in 1997 was $80,000.
Audit and accounting services and bank examination costs increased from
$90,000 in 1997 to $147,000 this year. The 63.3% rise in expenses reflects
both a growth in assets and the increased complexity of the Bank over the past
three years. Assets have grown $164 million, or 39.4%, since December 1996,
and the Bank has added two full-service offices, a loan production facility in
Salem, Oregon, and three new consumer lending departments.
Reserve and Provision for Loan Losses
The provision for loan losses reflects the amount deemed appropriate to
produce an adequate reserve for estimated losses that exist based on the
inherent risk characteristics of the Bank's loan portfolio. In determining the
appropriate reserve balance, the Bank takes into consideration the profile of
the loan portfolio, the local and national economic outlook, and the current
and historical performance of the loan portfolio.
The determination of the level of reserves, and thus any additional
provision, is arrived at through a process that begins with the Asset
Management Department. That department analyzes the loan portfolio from a
historical credit perspective and a composition and geographic concentration
viewpoint. The Asset Management Department then prepares an economic analysis
of the Puget Sound region to include employment forecasts, housing sales,
vacancy rates, commercial real estate analysis, and comments on the area's
major employers. That information is then reviewed by the Bank's Senior Loan
Committee, which further evaluates national and international trends and
establishes the appropriate level of reserve.
An $805,000 provision for loan losses was charged to operations in 1999.
The Bank's reserve balance was $6,309,000 at December 31, 1999. At year-end
1998 the reserve balance was $5,569,000, which in turn was an increase of
$711,000 over 1997's balance of $4,858,000.
A key factor in determining the appropriate level of loan loss reserves
is the mix of the Bank's loan portfolio. Currently 20.8% of the portfolio is
residential loans, while the remaining 79.2% is composed of commercial,
construction, and consumer loans. The residen-
Page 13
<PAGE>
tial figure of 20.8% compares, per third-quarter 1999 FDIC Quarterly Banking
Profile (latest available data), to 71.4% for FDIC-insured thrift institutions
and 23.4% for FDIC-insured commercial banks. Management's view is that its
loan portfolio is closely related to that of a commercial bank.
The Bank's loan loss reserves to total loans ratio was 1.37% at December
31, 1999. The comparable ratios for FDIC-insured savings institutions and
commercial banks, as of September 30, 1999, were .92% and 1.73%, respectively.
Although the Bank's loan mix is similar to that of a commercial bank, and
therefore arguably its ratio of loan loss reserves to total loans should
correspond to the national average, management believes that the Bank's
current ratio of non-performing loans to assets warrants favorable
consideration. As of year-end 1999 the Bank's non-performing assets to total
assets ratio was .06%. That number compares to the national ratios of .66% for
savings institutions and .61% for commercial banks as of September 30, 1999.
Although the Bank uses neither local nor national ratios to determine its
appropriate provision or level of reserves, its ratio of 1.37% reserves to
total loans would appear to be reasonable in light of those national norms and
the nature of the Bank's loan portfolio, and its favorable non-performing
asset status.
REVIEW OF FINANCIAL CONDITION
Investment Securities
Investment securities increased from $82 million at year-end 1998 to $105
million as of December 31, 1999, a growth of 28.4% in year-end balances.
In the fourth quarter of 1998, and again in the first quarter of 1999,
the Bank substantially increased its investment in securities. Management
perceived this period to be opportune for security purchases because of the
source of the Bank's funding and the then current status of the institution's
various capital components.
Loans
The loan portfolio is segregated into two components, loans held for sale
and loans receivable. Loans held for sale is that portion of the loan
portfolio which is pending sale and delivery into the secondary market. Loans
receivable are loans held in the Bank's portfolio of which the largest
component is commercial real estate.
Loans held for sale totaled $3 million at December 31, 1999, a decline of
$24 million from the previous year-end. At December 31, 1998, loans held for
sale had risen to $27 million, reflecting the sudden increase in mortgage
banking activity in 1998. It is not unusual for the balance in loans held for
sale to change dramatically from year to year. At year-end 1993, another year
of vigorous mortgage-banking activity, the year-end
page 14
<PAGE>
balance for loans held for sale totaled $24 million; the following year, 1994,
the loan totals fell to $4 million. The normal balance for loans held for sale
is in the range of $4 to $12 million, but will vary with refinancing activity.
Portfolio loans increased substantially, 25.4%, in 1999, from $365
million at December 31, 1998, to $458 million at year-end 1999. The growth in
the loan portfolio is the result of record loan portfolio originations and a
drop in the prepayment of loans. Loans closed for the Bank's portfolio totaled
$225 million in 1999, up 38.2% from $163 million in 1998. Loan prepayments,
which were a strong $138 million in 1998, declined to $124 million this year.
Contributing to 1999's success was the "slope" of the interest rate yield
curve. A "steepening" of the yield curve in 1999 made the Bank's
adjustable-rate commercial loans more attractive as compared to fixed-rate
commercial instruments. At the same time as the yield curve was adjusting to a
more favorable position, rising interest rates discouraged current borrowers
from prepaying their loans.
The future shape of the yield curve is difficult to predict, and,
consequently, so is the prospect of whether loans will continue to prepay.
Nevertheless, management is guardedly optimistic that it can continue to grow
assets under the current conditions. Nineteen-ninety-nine was a year of record
portfolio lending, and the Bank is reasonably hopeful that 2000 will be a
successful year.
Deposits
Deposits declined $11,077,000, or 2.7%, in 1999. That figure compares to
a growth of 10.3% in 1998, and an average increase of 4.8% in the first nine
months of 1999 for all FDIC-insured institutions. Management is concerned
about the erosion of the Bank's deposit base, which could eventually degrade
its ability to fund the growth of earning assets. Actions taken in 1999 to
address this problem include new leadership and branch incentive programs.
Management is guardedly hopeful that the steps taken in 1999 will bear
positive results in year 2000.
Market Risk Sensitive Instruments
Market risk is the risk of loss from adverse changes in market prices and
rates. A significant market risk for the Bank arises from interest rate risk
inherent in its lending, deposit, and mortgage banking activities. To that
end, management actively monitors and man-ages its interest rate risk
exposure.
[Bar graph]
1997 $373
1998 $411
1999 $400
Deposits/Dollars in Millions
page 15
<PAGE>
1999 Percentage Change 1998 Percentage Change
Immediate Change --------------------------- ---------------------------
in Interest Rates Net Interest Net Portfolio Net Interest Net Portfolio
(in basis points) Income Value Income Value
- ------------------------------------------------------------------------------
+400......... -15% -49% 7% -11%
+300......... -11 -38 7 -6
+200......... -8 -26 6 -1
+100......... -4 -14 4 0
-100......... 1 5 -5 -2
-200......... 0 8 -10 -8
-300......... -2 6 -15 -13
-400......... -4 2 -20 -18
The Bank's profitability is affected by fluctuations in interest rates.
An immediate and substantial increase in interest rates may adversely impact
the Bank's earnings to the extent that the interest rates borne by assets and
liabilities do not change at the same speed, to the same extent, or on the
same basis. Increases in the level of interest also may adversely affect the
fair value of the Bank's securities and other earning assets. Generally, the
fair value of fixed-rate instruments fluctuates inversely with changes in
interest rates. As a result, increases in interest rates could result in
decreases in the fair value of the Bank's interest-earning assets, which could
adversely affect the Bank's results of operations if such assets were sold. In
the case of interest-earning securities classified as available for sale, the
Bank's stockholders' equity could sustain significant unrealized losses if
such assets were retained.
The Bank uses a number of measures to monitor and manage interest rate
risks, including income simulation and interest "gap" analysis (further
discussed under the subhead Asset and Liability Management). An income
simulation model is primarily used to assess the possible direction and
magnitude of changes in interest rates. Key assumptions in the model include
prepayment speeds on mortgage-related assets, cash flows and maturities of
financial instruments held for purposes other than trading, changes in market
conditions, loan volumes and pricing, deposit sensitivity, customer
preferences, and management's financial capital plans. These assumptions are
inherently uncertain; therefore, the model cannot precisely estimate net
interest in-come or precisely predict the impact of higher or lower interest
rates on net interest income. Actual results may significantly differ from
simulated results due to the timing, magnitude, and frequency of interest rate
changes, and changes in market conditions and management strategies, among
other factors.
Based solely on the results of simulated calculations as of December 31,
1999 and 1998, the estimated impact of immediate changes in interest rates is
as
[Bar graph]
1997 $446
1998 $489
1999 $581
Assets/Dollars in Millions
page 16
<PAGE>
shown in the table to the left. The percentages shown represent changes over a
12-month period in the Bank's net interest income and net portfolio value
under a stable interest rate environment compared to the various rate
scenarios. Net portfolio value is defined as the net market value of the
Bank's assets and liabilities, which has been estimated by calculating the
present value of their cash flows. The cash flows have been adjusted to
account for projected amortization, pre-payments, core deposit decay rates,
and other factors.
The percentage changes in net interest income and in net portfolio value
moved adversely in 1999, as compared to the prior year. Interest rates
increased significantly in 1999, from 4.59% at year-end 1998 for the one-year
Treasury bill to 6.11% in 1999, and from 4.66% to 6.68% for the 10-year
Treasury security. The addition of $31 million of securities and $22 million
of loans with intermediate-term repricing characteristics is reflected in the
simulation as an increase in the Bank's sensitivity to interest rate
fluctuations.
The Bank's primary objective in managing in-terest rate risk is to
minimize the adverse impact of changes in interest rates on the Bank's net
interest income and capital, while structuring the Bank's asset and liability
components to obtain the maximum net interest margin. The Bank relies
primarily on its asset and liability structure to control interest rate risk.
Asset and Liability Management
Asset and liability management is the responsibility of the
Asset/Liability Committee, which acts within policy directives established by
the Board of Directors. The Asset/Liability Committee meets regularly to
monitor the composition of the balance sheet, to assess projected earnings
trends, and to formulate strategies consistent with the objectives for
liquidity, interest rate risk, and capital adequacy. The objective of
asset/liability management is to maximize long-term shareholder returns by
optimizing net interest income within the constraints of credit quality,
interest rate risk policies, levels of capital leverage, and adequate
liquidity.
The Bank manages assets and liabilities by matching maturities and
repricing in a systematic manner. In addition to the simulation model, an
interest "gap" analysis is issued to measure the effect interest rate changes
have on net interest income. The interest gap is the difference between the
amount of interest-earning assets maturing or repricing within a specific time
period and the amount of interest-bearing liabilities maturing or repricing in
that same time period. A gap is considered positive when the amount of
interest-rate-sensitive assets exceed the amount of interest-rate-sensitive
liabilities. A gap is considered negative in the reverse situation.
page 17
<PAGE>
The following table shows the Bank's one-year interest-rate-sensitive gap
at December 31:
1999 1998
- ------------------------------------------------------------------------------
One-year repricing assets $ 333,124,176 $ 311,261,831
One-year repricing
liabilities 422,095,639 315,375,840
------------- -------------
One-year gap $ (88,971,463) $ (4,114,009)
============= =============
Total assets $ 581,116,306 $ 489,230,139
============= =============
Interest rate sensitivity
gap as a percent of assets (15.3)% (.84)%
During a period of rising interest rates, the net earnings of an
institution with a negative gap may be adversely affected due to its
interest-bearing liabilities repricing to a greater extent than its
interest-earning assets. Conversely, during a period of falling interest
rates, net earnings may increase. At December 31, 1999 and 1998, the Bank had
a matched one-year gap posi-tion of minus 15.3% and minus .84%, respectively.
The change in the Bank's negative gap from ..84% to 15.3% is in large
measure due to the Bank's acquisition of intermediate securities and loans. At
year-end 1998, assets in the one-to-five-year range totaled $106 million. The
amount of assets in the same time range at December 31, 1999, was $158
million. Securities increased $32 million and loans rose by $20 million. The
majority of those loans were commercial real estate projects.
Although interest rates have risen substantially in the last 12 months,
and a number of economists predict further increases in interest rates, the
Bank remains optimistic that its strategy of investing in intermediate-term
instruments will be successful. Interest rates have, in general, declined from
their highs in 1982, with periodic reversals such as occurred in 1987 and
1994. Management believes that the long-term trend for interest rates is still
downward.
The Bank's focus in managing its interest rate risk is through the
marketing and funding of adjustable-rate loans. As of December 31, 1999, 84%
of the Bank's loan portfolio had adjustable rates. The Bank also originates
and sells long-term, fixed-rate mortgage loans, which have been underwritten
to specifications of the Federal Home Loan Mortgage Corporation and the
Federal National Mortgage Association.
The Bank's management reviews, on a monthly basis, interest rate trends.
Where appropriate, hedging techniques are employed. These techniques may
include financial futures, options on financial futures, and extended
commitments on future lending activities and interest rate exchange
agreements. During 1999, 1998, and 1997, the Bank did not choose to enter into
any off-balance-sheet derivative agreements, nor were any agreements held at
December 31, 1999, 1998, and 1997.
page 18
<PAGE>
Liquidity
The Bank's primary sources of funds are: (1) deposits, (2) principal
repayments of both loans and investment securities, (3) loan sales, and (4)
borrowings from the Federal Home Loan Bank (FHLB) of Seattle. The principal
use of funds is to invest in securities and loans. Security purchases amounted
to $41 million in 1999, down 39.7% from $68 million in purchases in 1998. The
comparative figure for 1997 was $29 million. Loan originations, including
loans held for sale, totaled $310 million, $380 million, and $213 million
during 1999, 1998, and 1997, respectively. Principal repayments on portfolio
loans totaled $124 million, $138 million, and $84 million, for the same
periods. Funds obtained from loan sales amounted to $110 million in 1999, $198
million in 1998, and $98 million in 1997.
The Bank's line of credit with the FHLB, for the year 2000, has been
established at 40% of assets. Borrowings totaled $134 million, $32 million,
and $34 million, at December 31, 1999, 1998, and 1997, respectively. These
borrowings represented 23.1% of the year-end assets in 1999, 6.5% in 1998, and
7.7% in 1997.
FHLB borrowings increased dramatically in 1999 due to a decline of 2.7%
in deposits at the same time that assets grew 18.8%. It is the Bank's intent
to continue to fund asset growth with FHLB borrowings until such time as
deposits are able to contribute as the main element of the Bank's funding
sources.
Capital Requirements
The Company is regulated by the Federal Reserve Board. Bank holding
companies are subject to capital adequacy requirements of the Federal Reserve
under the Bank Holding Company Act of 1956, as amended, and the regulations of
the Federal Reserve. The Bank, as a state-chartered, federally insured
institution, is subject to the capital requirements established by the FDIC.
The Federal Reserve requires the Company to maintain capital adequacy that
generally parallels the FDIC requirements.
At December 31, 1999, the Company, and its bank subsidiary, exceeded all
current regulatory capital requirements as presented in the following table:
The Well-Capitalized
Capital Ratios Company FMB Minimum
- ------------------------------------------------------------------------------
Total capital to
risk-weighted assets 11.08% 11.10% 10.00%
Tier 1 capital to
risk-weighted assets 9.83% 9.85% 6.00%
Tier 1 leverage capital to
average assets 7.02% 7.03% 5.00%
page 19
<PAGE>
BUSINESS SEGMENTS
The Bank has identified three distinct segments of business for the
purposes of management reporting (see Note 21 to the financial statements).
Segment results are determined based on the Bank's management accounting
process, which assigns balance sheet and income statement items to each
responsible business unit. This process is dynamic and somewhat subjective.
Unlike financial accounting, there is no body of guidance for management
accounting equivalent to generally accepted accounting principles.
The management accounting process measures the performance of the
business segments based on the management structure of the Bank and is not
necessarily comparable with similar information for any other financial
institution. Changes in management structure and/or the allocation process may
result in changes in allocations, transfers, and assignments.
Consumer Banking
This segment provides depositor banking services, and offers consumer
loans on automobiles, boats, individual lines of credit, loans for home
improvements, etc.
Income before tax has fallen sharply for the last few years, from
$2,114,000 in 1997, to $1,566,000 last year, to $877,000 in 1999. Although net
interest income has risen modestly, from $6,235,000 in 1997 to$6,418,000 in
1999, the operating expenses have more than offset the benefits of increased
interest revenues.
Operating expenses rose $843,000, or 18.3%, from $4,605,000 in 1997 to
$5,448,000 last year, and a further $617,000, or 11.3%, in 1999. Expenses for
this segment have increased as a result of adding new offices and consumer
lending departments. In the last three years the Bank has opened two
full-service branch offices, a Private Banking Department, and three consumer
loan departments Sales Finance Department, Direct Consumer Loan Department,
and the Small Business Banking Department. The addition of these support
departments now provides the branch offices with a full line of consumer
lending products. Management is hopeful that the increase in operating costs
will be less aggressive in 2000. There is no planned expansion of
branch-support departments and only the addition of one full-service office in
Kirkland.
Residential Lending
Residential lending is a segment encompassing the mortgage banking
operations, permanent single-family loans, and construction residential
lending.
Income before taxes dropped, from $2,017,000 in 1998 to $1,537,000 in
1999. Income before taxes was $1,094,000 in 1997. The favorable results in
1998 were largely the effect from a rise in mortgage banking
page 20
<PAGE>
activity. Loan originations related to the mortgage banking operation more
than doubled, from $94 million in 1997 to $217 million in 1998, an increase of
132.3%. Mortgage banking originations then declined in 1999 to $85 million, a
decrease of 60.7% from the 1998 level. Loan sales, which are highly correlated
with loan originations, also fell in 1999, to $110 million from $198 million
the previous year. Loan sales in 1997 totaled $98 million.
Although mortgage banking loan originations and sales declined in 1999,
operating costs rose $59,000, or 2.8%, from $2,098,000 in 1998 to $2,157,000
this year. Most of the increase in operating costs is related to non-direct
overhead, such as accounting, human resources, etc. Operating expenses for
this business segment were $1,642,000 in 1997.
The Bank anticipates that loan originations and sales for year 2000 will
either equal or decline from the 1999 levels.
Commercial Lending
Commercial lending activities include multi-family housing, commercial
real estate properties, and business banking loans.
Commercial lending is the most profitable segment, contributing 74.8% of
the Bank's income before federal income taxes. Earnings before income taxes in
1999 were $7,174,000, an increase of $1,149,000, or 19.1%, from 1998. Pretax
income was also up sharply in 1998, by $988,000, or 19.6%, compared to
$5,038,000 in 1997.
The improvement in both years is principally the result of increased
assets, which rose from $235 million in 1997, to $274 million in 1998, to $338
million this year.
Particularly encouraging was the increase in business banking assets,
which rose from less than $4 million in 1997, to over $16 million in 1998,
with a further increase to $25 million in 1999.
Year 2000 Issues
As was true for the country as a whole, the Bank went through the date
change into 2000 without any disruptions to its systems or services to
customers. The Bank relies on third-party vendors for almost all of its data
processing and telecommunications systems. These vendors made all the
necessary changes to their systems to ensure a smooth changeover.
While the Bank has not experienced any problems related to year 2000 to
date, there are still some impor-
[Bar graph]
1997 15.6%
1998 16.0%
1999 16.2%
Return on Average Equity/Percentages
page 21
<PAGE>
tant dates ahead as defined by the Federal Financial Institutions Examination
Council. These dates include the end of the first quarter and the end of the
year. The Bank will continue to monitor its systems to ensure they properly
handle these dates.
While the Bank currently believes that these dates will not pose
significant operational problems, there can be no assurance that any
significant failures will not have a material impact on the operations of the
Bank.
Inflation and Changing Prices
Generally accepted accounting principles require the measurement of
financial position and operating results in terms of historical dollars,
without consideration for change in relative purchasing power, over time, due
to inflation. Virtually all assets and liabilities of a financial institution
are monetary in nature; therefore, interest rates generally have a more
significant impact on a bank's performance than does the effect of inflation.
Over short periods of time, interest rates may not necessarily move in the
same direction or in the same magnitude as inflation.
page 22
<PAGE>
<TABLE>
Selected Financial Data
December 31,
---------------------------------------------------------------
1999 1998 1997 1996 1995
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total assets $581,116,306 $489,230,139 $445,762,440 $416,832,072 $361,525,779
Loans outstanding, net,
including loans held for sale 454,381,131 386,905,629 360,330,609 332,446,147 302,690,822
Cash and investments 109,271,367 87,630,187 71,400,689 73,471,099 49,009,383
Savings deposits 300,333,966 312,331,832 296,296,151 267,117,248 220,550,828
Other deposits 99,840,124 98,919,316 76,532,403 61,278,247 53,956,008
Advances 134,486,925 31,765,000 34,230,000 54,180,000 55,325,000
Stockholders' equity 39,336,659 34,661,953 30,651,828 27,396,063 23,673,567
</TABLE>
<TABLE>
Years ended December 31,
---------------------------------------------------------------
1999 1998 1997 1996 1995
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Interest income $ 42,318,058 $ 39,215,036 $ 36,395,958 $ 31,851,577 $ 26,919,219
Interest expense (23,293,364) (21,818,674) (20,589,962) (18,300,871) (16,231,748)
Net interest income 19,024,694 17,396,362 15,805,996 13,550,706 10,687,471
Other income 2,948,612 3,230,006 1,706,382 1,641,898 1,645,405
Noninterest expense (12,087,151) (11,987,138) (9,689,756) (7,532,531) (6,942,353)
Provision for loan losses (805,000) (750,000) (976,000) (1,700,000) (250,000)
Income before taxes 9,081,155 7,889,230 6,846,622 5,960,073 5,140,523
Federal income tax (3,080,807) (2,681,534) (2,327,942) (2,045,425) (1,712,778)
Net income 6,000,348 5,207,696 4,518,680 3,914,648 3,427,745
Return on average assets 1.12% 1.11% 1.05% 1.01% 1.03%
Return on average equity 16.22% 15.95% 15.57% 15.33% 15.40%
</TABLE>
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries Consolidated Statements of
Financial Condition
December 31,
-------------------------
Assets 1999 1998
- ------------------------------------------------------------------------------
Cash and cash equivalents:
Interest-earning deposits with banks $ 14,993 $ 216,953
Noninterest-earning demand deposits and cash
on hand 3,850,002 5,312,192
------------ ------------
3,864,995 5,529,145
Mortgage-backed and other securities available
for sale 17,350,034 20,336,611
Loans receivable held for sale, fair value of
$2,709,750 and $27,578,835 2,709,750 27,370,815
Mortgage-backed and other securities held to
maturity, fair value of $85,439,652 and
$62,467,023 88,056,338 61,764,431
Loans receivable, net:
Loans receivable 457,980,649 365,104,245
Reserve for loan losses (6,309,268) (5,569,431)
------------ ------------
451,671,381 359,534,814
Accrued interest receivable 3,840,911 3,311,122
Mortgage servicing rights 110,341 356,585
Land, buildings, and equipment, net 5,527,024 5,536,748
Federal Home Loan Bank (FHLB) stock, at cost 7,020,400 4,876,500
Other assets 965,132 613,368
------------ ------------
TOTAL $581,116,306 $489,230,139
============ ============
Liabilities and Stockholders' Equity
- ------------------------------------------------------------------------------
Liabilities:
Deposits:
Investor custodial checking $ 3,216,280 $ 8,146,226
Money market deposit and checking accounts 96,623,844 90,773,090
Regular savings 11,018,069 12,247,457
Time deposits 289,315,897 300,084,375
------------ ------------
Total deposits 400,174,090 411,251,148
Drafts payable 1,381,374 4,382,611
Accounts payable and other liabilities 4,147,946 5,465,700
Advance payments by borrowers for taxes and
insurance 1,589,312 1,517,253
FHLB advances 134,236,925 31,765,000
Other advances 250,000
Federal income taxes 186,474
------------ ------------
Total liabilities 541,779,647 454,568,186
Stockholders' equity:
Common stock, $1 par value Authorized,
10,000,000 shares; issued and outstanding,
4,672,636 and 4,247,275 shares 4,672,636 4,247,275
Additional paid-in capital 31,116,359 25,848,681
Employee Stock Ownership Plan debt (310,739) (603,738)
Retained earnings 4,527,356 5,181,720
Accumulated other comprehensive loss:
Unrealized loss on securities available for sale,
net of federal income tax (668,953) (11,985)
------------ ------------
Total stockholders' equity 39,336,659 34,661,953
------------ ------------
TOTAL $581,116,306 $489,230,139
============ ============
See notes to consolidated financial statements.
page 24
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries Consolidated Statements of
Income
Years ended December 31,
-----------------------------------------
1999 1998 1997
- ------------------------------------------------------------------------------
INTEREST INCOME:
Loans receivable $35,480,694 $34,518,508 $31,201,837
Mortgage-backed and related
securities 3,677,457 1,651,771 2,069,627
U.S. Treasury, government agency,
and other securities 2,737,325 2,624,756 2,322,780
Interest-earning deposits with banks 37,245 62,476 470,254
FHLB stock dividends 385,337 357,525 331,460
----------- ----------- -----------
42,318,058 39,215,036 36,395,958
INTEREST EXPENSE:
Deposits 18,601,358 19,879,653 17,779,162
FHLB advances and other 4,692,006 1,939,021 2,810,800
----------- ----------- -----------
23,293,364 21,818,674 20,589,962
----------- ----------- -----------
Net interest income 19,024,694 17,396,362 15,805,996
PROVISION FOR LOAN LOSSES 805,000 750,000 976,000
----------- ----------- -----------
Net interest income after
provision for loan losses 18,219,694 16,646,362 14,829,996
OTHER OPERATING INCOME:
Servicing fees, net of amortization 469,040 473,678 805,049
Gain on sales of loans 1,452,267 1,753,397 140,161
Fees on deposit services 314,539 207,948 167,107
Other 712,766 794,983 594,065
----------- ----------- -----------
Total other operating income 2,948,612 3,230,006 1,706,382
OTHER OPERATING EXPENSES:
Salaries and employee benefits 7,300,890 7,500,148 5,958,712
Occupancy 1,479,618 1,378,519 1,164,847
Other 3,306,643 3,108,471 2,566,197
----------- ----------- -----------
Total other operating expenses 12,087,151 11,987,138 9,689,756
----------- ----------- -----------
Income before federal income taxes 9,081,155 7,889,230 6,846,622
FEDERAL INCOME TAXES:
Current 3,730,157 3,206,350 2,602,726
Deferred (649,350) (524,816) (274,784)
----------- ----------- -----------
3,080,807 2,681,534 2,327,942
----------- ----------- -----------
NET INCOME $ 6,000,348 $ 5,207,696 $ 4,518,680
=========== =========== ===========
PER SHARE DATA
Basic earnings per common share $1.28 $1.12 $1.01
===== ===== =====
Earnings per common share assuming
dilution $1.26 $1.09 $0.97
===== ===== =====
WEIGHTED AVERAGE SHARES OUTSTANDING 4,675,654 4,637,340 4,469,106
========= ========= =========
WEIGHTED AVERAGE SHARES OUTSTANDING
INCLUDING DILUTIVE STOCK OPTIONS 4,759,276 4,760,115 4,658,144
========= ========= =========
See notes to consolidated financial statements.
page 25
<PAGE>
<TABLE>
First Mutual Bancshares, Inc. and Subsidiaries Consolidated Statements of
Stockholders' Equity
Years ended December 31, 1999, 1998, and 1997
Employee Accumulated
Stock compre-
Common Stock (1) Additional Ownership hensive
----------------- paid-in Retained Plan income
Shares Amount capital(1) earnings (ESOP) debt (loss)(3) Total
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1,
1997 3,680,141 $3,680,141 $19,941,490 $ 4,805,295 $(1,024,111) $ (6,752) $ 27,396,063
Options exercised 76,890 76,890 552,607 629,497
10% stock dividend 368,196 368,196 4,388,676 (4,756,872)
Repayment of ESOP debt 152,541 152,541
Cash dividends declared
($0.50 per share(2)) (2,046,925) (2,046,925)
Comprehensive income:
Net income 4,518,680 4,518,680
Other comprehensive
income (loss)-Change
in unrealized loss
on securities
available for sale,
net of federal
income tax(4) 1,972 1,972
----------- --------- ------------
Total comprehensive
income 4,518,680 1,972 4,520,652
--------- ---------- ----------- ----------- ----------- --------- ------------
Balance, December 31,
1997 4,125,227 4,125,227 24,882,773 2,520,178 (871,570) (4,780) 30,651,828
Options exercised,
including tax
benefit of $545,675 122,048 122,048 965,908 1,087,956
Repayment of ESOP debt 267,832 267,832
Cash dividends declared
($0.60 per share(2)) (2,546,154) (2,546,154)
Comprehensive income:
Net income 5,207,696 5,207,696
Other comprehensive
income (loss)-Change in
unrealized loss on
securities available
for sale, net of
federal income tax(4) (7,205) (7,205)
----------- --------- ------------
Total comprehensive
income 5,207,696 (7,205) 5,200,491
--------- ---------- ----------- ----------- ----------- --------- ------------
Balance, December 31,
1998 4,247,275 4,247,275 25,848,681 5,181,720 (603,738) (11,985) 34,661,953
Options exercised,
including tax benefit
of $13,038 9,378 9,378 48,701 58,079
10% stock dividend 424,483 424,483 5,252,977 (5,677,460)
Retirement of shares
repurchased (8,500) (8,500) (34,000) (60,031) (102,531)
Repayment of ESOP debt 292,999 292,999
Cash dividends declared
($0.20 per share(2)) (917,221) (917,221)
Comprehensive income:
Net income 6,000,348 6,000,348
Other comprehensive
income (loss)-Change
in unrealized loss on
securities available
for sale, net of
federal income tax(4) (656,968) (656,968)
----------- --------- ------------
Total comprehensive
income 6,000,348 (656,968) 5,343,380
--------- ---------- ----------- ----------- ----------- --------- ------------
Balance, December 31,
1999 4,672,636 $4,672,636 $31,116,359 $ 4,527,356 $ (310,739) $(668,953) $ 39,336,659
========= ========== =========== =========== =========== ========= ============
</TABLE>
See notes to consolidated financial statements.
page 26
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries Consolidated Statements of
Cash Flows
Years ended December 31,
---------------------------------------------
Operating Activities: 1999 1998 1997
- ------------------------------------------------------------------------------
Net income $ 6,000,348 $ 5,207,696 $ 4,518,680
Adjustments to reconcile net
income to net cash provided
(used) by operating activities:
Provision for loan losses 805,000 750,000 976,000
Depreciation and amortization 691,064 545,020 428,075
Deferred loan origination
fees, net of accretion 1,144 171,310 (173,756)
Amortization of mortgage
servicing rights 152,996 268,257 250,270
Gain on sales of loans (1,527,473) (1,938,900) (140,161)
Gain on securities available
for sale (753)
Gain on sale of repossessed
real estate (17,029) (46,332)
FHLB stock dividends (385,337) (357,300) (331,300)
Deferred federal income tax
benefit (649,350) (524,816) (274,784)
Cash provided (used) by changes in
operating assets and liabilities:
Loans receivable held for sale 24,661,065 (18,949,102) 4,023,464
Accrued interest receivable (529,789) (162,709) (315,268)
Other assets 177,848 (302,839) 24,512
Drafts payable (3,001,237) 2,518,867 (397,925)
Accounts payable and other
liabilities 359,462 659,679 170,088
Advance payments by borrowers for
taxes and insurance 72,059 (70,025) 71,858
Federal income taxes (186,474) 547,954 (26,634)
------------- ------------- -------------
Net cash provided (used) by
operating activities 26,624,297 (11,683,240) 8,802,366
Investing Activities:
- ------------------------------------------------------------------------------
Loan originations (225,070,857) (162,849,964) (119,652,687)
Loan principal repayments 123,909,771 137,747,107 84,331,634
Increase in undisbursed loan
proceeds 8,193,950 6,830,982 2,650,908
Principal repayments on mortgage-
backed and other securities 16,471,568 61,066,514 22,491,981
Purchase of mortgage-backed and
other securities held to
maturity (40,764,092) (50,178,401) (28,644,099)
Purchase of mortgage-backed
securities available for sale (17,881,548)
Purchase of premises and equipment (647,999) (675,318) (3,031,631)
Purchase of FHLB stock (1,758,563)
Proceeds from sale of loans 1,972,098 2,341,219
Proceeds from sale of securities
available for sale 6,090
Proceeds from sale of real estate
held for sale 119,738 418,743 59,130
------------- ------------- -------------
BALANCE, net cash used by
investing activities, (117,574,386) (23,180,666) (41,788,674)
carried forward
Footnotes for Stockholders' Equity (see page 26):
(1)The amount of common stock issued and outstanding for 1997 has been
adjusted to show the effect of the three-for-two stock split paid November
5, 1997.
(2)Cash dividends declared divided by weighted average shares outstanding of
4,675,654 in 1999, 4,215,764 in 1998, and 4,062,824 in 1997.
(3)Income tax benefit netted against accumulated comprehensive losses were
$344,612, $6,174, and $2,462 for the years ended December 31, 1999, 1998,
and 1997, respectively.
(4)There were no reclassification adjustments to other comprehensive income
(loss).
See notes to consolidated financial statements.
page 27
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries Consolidated Statements of
Cash Flows (continued)
Years ended December 31,
---------------------------------------------
1999 1998 1997
Net cash used by investing
activities, brought forward $(117,574,386) $ (23,180,666) $ (41,788,674)
Financing Activities:
- ------------------------------------------------------------------------------
Net increase (decrease) in
deposit accounts (29,847,370) 18,620,774 26,635,899
Interest credited to deposit
accounts 18,770,312 19,801,820 17,797,160
Proceeds from advances 456,003,925 212,647,000 40,693,000
Repayment of advances (353,282,000) (215,112,000) (60,643,000)
Dividends paid (2,594,437) (2,283,821) (520,655)
Proceeds from exercise of stock
options 45,041 542,281 629,497
Repurchase of common stock (102,531)
Repayment of Employee Stock
Ownership Plan debt 292,999 267,832 152,541
------------- ------------- -------------
Net cash provided by financing
activities 89,285,939 34,483,886 24,744,442
NET DECREASE IN CASH
AND CASH EQUIVALENTS (1,664,150) (380,020) (8,241,866)
CASH AND CASH EQUIVALENTS:
Beginning of year 5,529,145 5,909,165 14,151,031
------------- ------------- -------------
End of year $ 3,864,995 $ 5,529,145 $ 5,909,165
============= ============= =============
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Loans originated for mortgage
banking activities $ 85,327,840 $ 217,334,219 $ 93,553,864
Loans originated for investment
activities 225,070,857 162,849,964 119,652,687
------------- ------------- -------------
Total loans originated for
mortgage banking activities and
investment activities $ 310,398,697 $ 380,184,183 $ 213,206,551
============= ============= =============
Proceeds from sales of loans
held for sale $ 109,988,905 $ 198,385,117 $ 97,577,328
Cash paid during the year for:
Interest $ 22,962,500 $ 21,712,686 $ 20,673,000
Income taxes $ 3,565,155 $ 2,110,000 $ 2,305,030
SUPPLEMENTAL DISCLOSURES OF NONCASH
INVESTING ACTIVITIES:
Loans transferred to (from) real
estate held for sale, net $ (21,827) $ 21,922
Loans securitized into
securities held to maturity
and available for sale $ 9,574,060
See notes to consolidated financial statements.
page 28
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Years ended December 31, 1999, 1998, and 1997
Note 1: Summary of Significant Accounting Policies
Formation of the bank holding company: First Mutual Bancshares, Inc. and
subsidiaries (the Company), a Washington corporation, is a holding company
primarily engaged in the business of planning, directing, and coordinating the
activities of its wholly-owned subsidiary, First Mutual Bank (formerly First
Mutual Savings Bank). On October 26, 1999, First Mutual Savings Bank converted
into the holding company form of ownership in a tax-free reorganization. In
the reorganization, First Mutual Savings Bank changed its name to First Mutual
Bank and became the wholly-owned subsidiary of the Company. First Mutual Bank
is also referred to as the Bank in this report.
Principles of consolidation and basis of presentation: The consolidated
financial statements include the accounts of First Mutual Bancshares, Inc. and
its wholly owned subsidiaries, First Mutual Bank and First Mutual Services,
Inc. (collectively, the Bank). All significant intercompany transactions have
been eliminated. Certain reclassifications have been made to the 1998 and 1997
financial statements to conform to the 1999 presentation.
Use of estimates: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make 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 revenues and expenses during the
reporting period. Changes in these estimates and assumptions are considered
reasonably possible and may have a material impact on the financial
statements.
Nature of business: The Bank is a community-oriented savings bank offering a
variety of savings products to retail customers while concentrating its
lending activities on housing and commercial real estate loans. The Bank
conducts business from its main office in Bellevue, Washington and its nine
branches in the greater Puget Sound area. The Bank accepts deposits from the
general public and provides lending services to citizens of the Eastside and
the I-5 corridor stretching from Bellingham, Washington to Salem, Oregon. In
addition to portfolio lending, the Bank operates a mortgage banking operation.
Cash and cash equivalents: For purposes of the consolidated statements of cash
flows, all deposits and investment securities with an original term to
maturity of three months or less are considered to be cash equivalents.
Securities: Securities are classified at acquisition into three categories:
held to maturity, available for sale, and held for trading. Securities are
classified as held to maturity when the Company has the ability and positive
intent to hold them to maturity. Securities classified as available for sale
are maintained for future liquidity requirements and may be sold prior to
maturity. There were no securities classified as held for trading during 1999,
1998, and 1997.
Securities held to maturity are carried at cost, adjusted for amortization of
premiums and accretion of discounts to maturity. Unrealized losses on
securities held to maturity caused by fluctuations in fair value are
recognized when it is determined that an other-than-temporary decline in value
has occurred. Unrealized gains and losses on securities available for sale are
excluded from earnings and are reported net of tax as a separate component of
comprehensive income until realized. Realized gains and losses on sale are
computed on the specific identification method and are included in operations
on the date sold.
Loans receivable, loans receivable held for sale, and reserve for loan losses:
Loans receivable are stated at unpaid principal balances less the reserve for
loan losses and deferred loan origination fees. Mortgage loans securitized and
transferred into the security portfolio are transferred at amortized cost.
Nonaccrual loans are those for which management has discontinued accrual of
interest because there exists significant uncertainty as to the full and
timely collection of either principal or interest or such loans have become
contractually past due 90 days with respect to principal or interest.
The reserve for loan losses is maintained at a level that is sufficient to
provide for estimated losses based on evaluating known and inherent risks in
the loan portfolio. This reserve is provided for based upon management's
continuing analysis of the factors underlying the quality of the loan
portfolio.
For income property and business loans, loan quality is evaluated on an
individual basis and an appropriate grade is assigned. The grades range from
three-or-better, for the better quality loans, to grades four, five, and six
for loans with potential problems. Loss reserves are then computed on the loan
balance for each grade using ratios developed from historical loss experience.
For the residential and consumer loans, management computes loss reserves on a
portfolio-wide basis, but provides higher reserves for specific loans that are
delinquent or are known to have problems.
Management then considers other factors in evaluating the adequacy of the
reserve for loan losses. These factors include changes in the size and
composition of the loan portfolio, actual loan loss experience, current and
anticipated economic conditions, detailed analysis of individual loans for
which full collectibility may not be assured, and determination of the
existence and realizable value of the collateral and guarantees securing the
loans. The reserve is based upon factors and trends identified by management
at the time financial statements are prepared. The ultimate recovery of loans
is susceptible to future market factors beyond management's control, which may
result in losses or recoveries differing significantly from those provided in
the financial statements.
Management also evaluates income property and business loans for impairment on
an individual basis. A loan is considered impaired when it is probable that a
creditor will not collect all amounts due (principal and interest) under the
terms of a loan agreement. The valuation of impaired loans is based on the
present value of expected future cash flows using the loan's effective
interest rate or the loan's observable market price or fair value of the
collateral, if the loan is collateral dependent. The amount by which the
recorded investment in the loan exceeds market price or the fair value of the
collateral is included in the allocated reserve for loan losses. Any portion
of an impaired loan classified as loss under regulatory guidelines is charged
off. The remaining groups of smaller-balance homogeneous loans are evaluated
collectively for impairment.
Mortgage loans originated and held for sale are carried at the lower of
aggregate cost or estimated fair value. Net unrealized losses on loans
receivable held for sale are recognized in a valuation allowance by charges to
operations.
Note 1 continued on next page.
page 29
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 1: Summary of Significant Accounting Policies (continued)
Real estate held for sale (included in other assets): Real estate held for
sale includes properties acquired through foreclosure. These properties are
initially recorded at the lower of cost or fair value and are subsequently
evaluated to determine that the carrying value does not exceed the then
current fair value of the property. Losses that result from ongoing periodic
valuation of these properties are charged to operations in the period in which
they are identified. The amounts that will ultimately be recovered from real
estate held for sale may differ substantially from the carrying value of the
assets because of future market factors beyond management's control.
Land, buildings, and equipment: Premises and equipment are stated at cost,
less accumulated depreciation. Depreciation is computed on the straight-line
method over the estimated useful lives as follows:
Buildings and improvements 15 to 40 years
Leasehold improvements 5 to 20 years
Furniture, fixtures, and equipment 1 to 20 years
The Company follows the policy of capitalizing expenditures for betterments
and major renewals, and expenses ordinary maintenance and repairs as incurred.
Mortgage servicing rights: Originated servicing rights are recorded when
mortgage loans are originated and subsequently sold or securitized (and held
as available-for-sale securities) with the servicing rights retained. The
total cost of the mortgage loans is allocated between servicing rights and the
loans (without the servicing rights) based on their relative fair values. The
cost relating to the mortgage servicing rights is capitalized and amortized in
proportion to, and over the period of, estimated future net servicing income.
Amounts capitalized are recorded at cost, net of accumulated amortization and
valuation allowance.
In order to determine the fair value of servicing rights, management uses a
valuation model that calculates the present value of future cash flows.
Assumptions used in the valuation model include market discount rates and
anticipated prepayment speeds. The prepayment speeds are based on loan
prepayment forecasts derived from the consensus of investment banking firms as
reported by on-line, fixed-income quotation systems. In addition, estimates of
the cost of servicing per loan, an inflation rate, ancillary income per loan,
and default rates are used.
Management assesses impairment of the capitalized mortgage servicing rights
based on recalculations of the present value of remaining future cash flows
using updated market discount rates and prepayment speeds. Subsequent loan
prepayments and changes in prepayment assumptions in excess of those
forecasted can adversely impact the carrying value of the servicing rights.
Impairment is assessed on a stratum-by-stratum basis with any impairment
recognized through a valuation allowance for each impaired stratum. The
servicing rights are stratified based on the predominant risk characteristics
of the underlying loans: fixed-rate loans and adjustable-rate loans.
Employee Stock Ownership Plan: The Company sponsors a leveraged Employee Stock
Ownership Plan (ESOP). Statement of Position (SOP) No. 93-6, Employers'
Accounting for Employee Stock Ownership Plans, was effective as of January
1994. As is allowed under SOP No. 93-6, the Company continues to account for
ESOP transactions for shares purchased by the ESOP prior to 1994 under SOP No.
76-3. Accordingly, the Company records compensation expense based on the
amounts contributed by the Company to the ESOP and includes unallocated ESOP
shares as outstanding for purposes of its earnings-per-share calculation.
ESOP stock purchases have been insignificant since January 1994. At such time
that the ESOP purchases material amounts of stock in future periods, such
transactions will be accounted for in accordance with the provisions of SOP
No. 93-6 as described below.
Under SOP No. 93-6, as shares are released from collateral, compensation
expense is recorded equal to the then current market price of the shares, and
the shares become outstanding for purposes of earnings-per-share calculations.
Stock and cash dividends on allocated shares are recorded as a reduction of
retained earnings and paid directly to plan participants or distributed
directly to participants' accounts. Cash dividends on unallocated shares are
recorded as a reduction of debt and accrued interest. Stock dividends on
unallocated shares are recorded as an increase to the unearned shares issued
to the employee stock ownership trust contra-equity account and distributed to
participants over the remaining debt service period.
Income taxes: The Company files a consolidated tax return which includes
income earned by its subsidiaries. The Company accounts for income taxes on
the liability method. The liability method recognizes the amount of tax
currently payable and deferred at the date of the financial statements as a
result of all events that have been recognized in the financial statements, as
measured by the provisions of current enacted tax laws and rates.
Loan fee income and interest income on loans receivable: Loan origination fees
and certain direct loan origination costs related to loan origination
activities are deferred. Net deferred fees are amortized into income over the
contractual or actual life of the loan as an adjustment to the loan yield. Net
deferred fees related to loans sold are recognized in income at the time the
loans are sold.
Interest income is accrued on loans receivable until management doubts the
collectibility of the loan or the unpaid interest, at which time a reserve for
any accrued interest is established.
Interest rate risk management: Management may hedge certain mortgage banking
transactions with purchased option contracts and forward sales commitments.
Net gains or losses on these options are considered in the calculation of the
lower of cost or fair value for loan receivables held for sale.
Earnings per share (EPS) data: The Company displays basic and diluted EPS in
the income statement. Basic EPS is computed by dividing net income by the
weighted average number of shares outstanding during the year. Diluted EPS
reflects the potential dilutive effect of stock options and is computed by
dividing net income by the weighted-average number of shares outstanding
during the year, plus the dilutive common shares that would have been
outstanding had the stock options been exercised. A reconciliation of the
numerator and denominator used for the basic EPS to the numerator and
denominator used for the diluted EPS is provided in Note 13.
Note 1 continued on next page.
page 30
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 1: Summary of Significant Accounting Policies (continued)
New accounting standards:
Recently issued and adopted:
Accounting for mortgage-backed securities: Statement of Financial
Accounting Standards (SFAS) No. 65, Accounting for Certain Mortgage
Banking Activities, as amended by SFAS No. 115 and 125, required that
after the securitization of a mortgage loan held for sale, an entity
engaged in mortgage banking activities classify the resulting
mortgage-backed security as a trading security. In October 1998, the
Financial Accounting Standards Board (FASB) issued SFAS No. 134,
Accounting for Mortgage-Backed Securities Retained after the
Securitization of Mortgage Loans Held for Sale by a Mortgage Banking
Enterprise. SFAS No. 134 further amends SFAS No. 65 to require that after
the securitization of a mortgage loan held for sale, an entity engaged in
mortgage banking activities should classify the resulting retained
mortgage-backed securities using the classification criteria in SFAS No.
115 (i.e., held-to-maturity, available-for-sale, or trading). However, a
mortgage banking entity must classify as trading any retained
mortgage-backed securities described above that it has committed to sell
before or during the securitization process. The adoption of this
standard did not have a material impact on the results of operations or
financial condition of the Company.
Recently issued and not yet adopted:
Accounting for derivative instruments and hedging activities: In June
1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities. SFAS No. 133 establishes accounting and reporting
standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities. It requires that an entity
should recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair
value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a
hedge of the exposure to variable cash flows of a forecasted transaction,
or (c) a hedge of the foreign currency exposure of a net investment in a
foreign operation, an unrecognized firm commitment, an available-for-sale
security, or a foreign-currency-denominated forecasted transaction. The
accounting for changes in the fair value of a derivative (gains and
losses) depends on the intended use of the derivative and the resulting
designation.
As allowed by SFAS No. 137, which defers the effective date of SFAS No.
133 by one year, the Company will implement this statement on January 1,
2001. The impact of the adoption of the provision of this statement on
the results of operations or financial condition of the Company has not
been determined.
Note 2: Reserve Balances
The Bank is required to maintain an average reserve balance of $25,000 in its
account with the Federal Reserve. For the years ended December 31, 1999, 1998,
and 1997, the Bank complied with this requirement.
Note 3: Mortgage-Backed and Other Securities Available for Sale
The amortized cost and estimated fair value of securities available for sale
at December 31, 1999 and 1998, are summarized as follows:
Gross Gross
Amortized unrealized unrealized Estimated
cost gains losses fair value
- ------------------------------------------------------------------------------
1999: FHLMC securities $ 427,499 $ 7,216 $ $ 434,715
FNMA securities 16,073,769 22,354 933,028 15,163,095
GNMA securities 1,869,018 116,794 1,752,224
----------- ----------- ----------- -----------
$18,370,286 $ 29,570 $ 1,049,822 $17,350,034
=========== =========== =========== ===========
1998: FHLMC securities $ 648,646 $ 17,941 $ $ 666,587
FNMA securities 17,679,888 35,825 41,675 17,674,038
GNMA securities 1,996,385 399 1,995,986
----------- ----------- ----------- -----------
$20,324,919 $ 53,766 $ 42,074 $20,336,611
=========== =========== =========== ===========
Proceeds from the sale of securities available for sale during 1999, 1998, and
1997, were $-0-, $-0-, and $6,090, respectively. Gross gains on those sales
were $-0-, $-0-, and $753, respectively. No gross losses were realized on
sales during 1999, 1998, and 1997.
The securities available for sale at December 31, 1999, have contractual
maturities of over 10 years. Expected maturity may differ from contractual
maturity because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
page 31
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 4: Mortgage-Backed and Other Securities Held to Maturity
The amortized cost and estimated fair value of mortgage-backed and other
securities are summarized as follows:
Gross Gross
Amortized unrealized unrealized Estimated
cost gains losses fair value
- ------------------------------------------------------------------------------
December 31, 1999:
FNMA certificates $39,827,759 $ 149,563 $ 1,389,648 $38,587,674
FHLMC certificates 1,792,23 18,780 1,811,017
U.S. government agency
securities 42,652,659 44,178 1,250,503 41,446,334
Merrill Lynch corporate
bond 2,534,010 111,285 2,422,725
Municipal bonds 625,395 84,965 540,430
REMICs 624,278 7,194 631,472
----------- ----------- ----------- -----------
$88,056,338 $ 219,715 $ 2,836,401 $85,439,652
=========== =========== =========== ===========
December 31, 1998:
FNMA certificates $14,241,885 $ 238,948 $ 14,235 $14,466,598
FHLMC certificates 3,555,875 14,470 4,180 3,566,165
U.S. government agency
securities 38,643,616 656,784 151,235 39,149,165
Merrill Lynch corporate
bond 2,544,950 33,450 2,511,500
Municipal bonds 627,083 36,313 590,770
REMICs 1,151,194 31,631 1,182,825
U.S. Treasury securities 999,828 172 1,000,000
----------- ----------- ----------- -----------
$61,764,431 $ 942,005 $ 239,413 $62,467,023
=========== =========== =========== ===========
The amortized cost and estimated fair value of mortgage-backed and other
securities held to maturity at December 31, 1999, by contractual maturity, are
shown below. Expected maturity may differ from contractual maturity because
borrowers may have the right to call or prepay obligations with or without
call or prepayment penalties:
Amortized Estimated
cost fair value
- ------------------------------------------------------------------------------
Due after one year through five years $42,753,848 $41,612,287
Due after five years through ten years 34,831,242 33,283,523
Due after ten years 10,471,248 10,543,842
----------- -----------
$88,056,338 $85,439,652
=========== ===========
There were no sales out of the held-to-maturity portfolio during 1999 or 1998.
page 32
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 5: Loans Receivable, Net and Loans Receivable Held for Sale
Loans receivable consisted of the following as of December 31:
1999 1998
- ------------------------------------------------------------------------------
Real estate:
Single-family residential $ 96,417,980 $ 95,807,396
Single-family construction 41,261,540 38,640,163
Income property:
Commercial construction 10,920,400 12,740,000
Commercial real estate 146,764,503 121,257,209
Multifamily construction 20,723,753 9,260,369
Multifamily residential 148,354,325 118,014,727
Consumer and other loans 24,435,217 17,464,747
Business loans 3,347,265 2,629,590
------------ ------------
492,224,983 415,814,201
Less:
Deferred loan origination fees (1,575,966) (1,574,473)
Undisbursed loan proceeds (29,958,618) (21,764,668)
Reserve for loan losses (6,309,268) (5,569,431)
------------ ------------
454,381,131 386,905,629
Loans receivable held for sale (2,709,750) (27,370,815)
------------ ------------
Loans receivable, net $451,671,381 $359,534,814
============ ============
A substantial portion of the Company's revenues is derived from the
origination of loans in the Puget Sound region of Washington State. The
customers' ability to honor their commitments to repay such loans is dependent
upon the region's economy and, to a certain extent, the dominant industries in
that region such as aerospace, international trade, and high technology.
Single-family residential, permanent, and construction loans are primarily
secured by collateral located in Western Washington. Income property loans, by
county or state in which the property resides, are as follows at December 31,
1999:
<TABLE>
King Snohomish Pierce Whatcom
County County County County Oregon Other Total
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Income property:
Commercial construc-
tion $ 7,337,000 $ 400,000 $ 3,183,400 $ $ $ $ 10,920,400
Commercial real
estate 71,352,628 24,923,086 14,962,126 4,873,538 12,863,793 17,789,332 146,764,503
Multifamily construc-
tion 16,446,897 1,491,856 300,000 2,485,000 20,723,753
Multifamily residen-
tial 73,052,416 6,788,388 26,628,374 5,650,286 13,724,023 22,510,838 148,354,325
------------ ----------- ----------- ----------- ----------- ----------- ------------
$168,188,941 $32,111,474 $46,265,756 $10,823,824 $29,072,816 $40,300,170 $326,762,981
============ =========== =========== =========== =========== =========== ============
</TABLE>
The Bank originates both adjustable and fixed interest rate loans. At December
31, 1999, the composition of those loans was as follows:
Term to maturity Adjustable
or rate adjustment Fixed rate rate Total
- ------------------------------------------------------------------------------
Due within one year $ 8,712,231 $271,090,893 $279,803,124
After one but within three years 1,818,639 57,935,795 59,754,434
After three but within five years 3,633,037 44,134,840 47,767,877
After five but within ten years 13,025,800 9,390,926 22,416,726
After ten years 44,439,609 199,361 44,638,970
------------ ------------ ------------
$ 71,629,316 $382,751,815 $454,381,131
============ ============ ============
Single-family adjustable-rate loans have both period and lifetime adjustment
limitations. Income property adjustable-rate loans typically only have
lifetime adjustment limitations. Both types of adjustable-rate loans are
generally indexed to either the one-, three-, or five-year Treasury constant
maturity or the Federal Home Loan Bank's 11th District cost of funds. Future
market factors may affect the correlation of the interest rate adjustment with
the rates the Bank pays on the short-term deposits that have been primarily
utilized to fund these loans.
Note 5 continued on next page.
page 33
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 5: Loans Receivable, Net and Loans Receivable Held for Sale (continued)
An analysis of the changes in the reserve for loan losses is as follows for
the years ended December 31:
1999 1998 1997
- ------------------------------------------------------------------------------
Balance, beginning of year $5,569,431 $4,858,376 $3,882,376
Provision for loan losses 805,000 750,000 976,000
Writeoffs (68,123) (38,945)
Recoveries 2,960
---------- ---------- ----------
Balance, end of year $6,309,268 $5,569,431 $4,858,376
========== ========== ==========
The Bank had the following non-performing loans (loans over 90 days
delinquent) as of December 31:
1999 1998
- ------------------------------------------------------------------------------
Non-performing loans $ 342,579 $ 298,503
Percentage of total loans 0.07% 0.08%
The Bank had no impaired loans during the years and at year-end 1999, 1998,
and 1997.
The Bank serviced loans owned by other investors with aggregate principal
balances of $193,923,146 and $268,246,425 as of December 31, 1999 and 1998,
respectively.
Outstanding commitments to borrowers for loans totalled $74,307,000 and
$65,071,000 at December 31, 1999 and 1998, respectively. Outstanding
commitments to sell loans to investors, which totalled $2,000,000 and
$34,811,000 at December 31, 1999 and 1998, respectively, hedge against
interest rate fluctuations from the time of loan commitment until the date at
which loans are sold, which is generally within 60 days.
Commitments to extend credit generally have fixed expiration dates. Since
portions of the commitments are expected to expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash
requirements. Prior to extending commitments, the Bank evaluates each
customer's creditworthiness on a case-by-case basis. The amount of collateral
obtained upon extension of credit is based on management's credit evaluation
of the borrower. Collateral held includes residential and income-producing
properties.
Note 6: Accrued Interest Receivable
Accrued interest receivable at December 31 is summarized as follows:
1999 1998
- ------------------------------------------------------------------------------
Loans receivable $2,726,936 $2,359,489
Mortgage-backed securities
available for sale 100,322 113,668
Mortgage-backed and other
securities held to maturity 1,013,653 837,965
---------- ----------
$3,840,911 $3,311,122
========== ==========
Note 7: Mortgage Servicing Rights and Servicing Fees
Changes in the mortgage servicing rights balance for the years ended December
31 are as follows:
1999 1998
- ------------------------------------------------------------------------------
Balance, beginning of year $ 356,585 $ 601,435
Additions 273,391 197,054
Sales (366,639) (173,647)
Amortization (152,996) (185,759)
Provision for impairment (82,498)
---------- ----------
Balance, end of year $ 110,341 $ 356,585
========== ==========
Changes in the valuation for impairment of mortgage servicing rights for the
years ended December 31:
1999 1998 1997
- ------------------------------------------------------------------------------
Balance, beginning of year $ 120,226 $ 37,728 $
Additions 82,498 37,728
--------- --------- ---------
Balance, end of year $ 120,226 $ 120,226 $ 37,728
========= ========= =========
Note 7 continued on next page.
page 34
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 7: Mortgage Servicing Rights and Servicing Fees (continued)
Servicing fee income, net of amortization, consisted of the following for the
years ended December 31:
1999 1998 1997
- ------------------------------------------------------------------------------
Servicing fees $ 622,036 $ 741,935 $ 1,055,319
Amortization and provision for
impairment of mortgage
servicing rights (152,996) (268,257) (250,270)
----------- ----------- -----------
Loan servicing fees, net $ 469,040 $ 473,678 $ 805,049
=========== =========== ===========
Note 8: Land, Buildings, and Equipment
The following is a summary of land, buildings, and equipment at December 31:
1999 1998
- ------------------------------------------------------------------------------
Land $ 1,930,130 $ 1,921,349
Buildings 3,645,059 3,580,105
Furniture, fixtures, and equipment 2,849,775 2,390,291
Leasehold improvements 576,329 527,449
9,001,293 8,419,194
Less accumulated depreciation and amortization 3,474,269 2,882,446
----------- -----------
$ 5,527,024 $ 5,536,748
=========== ===========
The Bank leases six of its office locations under operating leases. Total
lease obligations are as follows:
2000 $ 436,003
2001 472,631
2002 440,424
2003 445,865
2004 446,598
-----------
$ 2,241,521
===========
Total lease expenses were $367,216, $338,871, and $307,349, for the years
ended December 31, 1999, 1998, and 1997, respectively.
Note 9: Deposits
Deposits consisted of the following at December 31:
<TABLE>
Weighted
average rate at 1999 1998
December 31, ---------------- ----------------
Terms 1999 Amount % Amount %
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Money market deposit and checking accounts,
including noninterest-bearing deposits of
$10,665,061 (1999) and $13,775,959 (1998) 3.3% $ 99,840,124 24.9% $ 98,919,316 24.0%
Regular savings 2.7 11,018,069 2.8 12,247,457 3.0
Time deposits:
1 to 6 months 4.5 13,566,826 3.4 30,246,949 7.4
7 to 12 months 5.2 108,269,959 27.1 145,937,279 35.5
13 to 18 months 5.2 128,550,883 32.1 75,458,401 18.3
2 to 10 years 5.8 38,928,229 9.7 48,441,746 11.8
------------ ----- ------------ -----
Total time deposits 5.2 289,315,897 72.3 300,084,375 73.0
------------ ----- ------------ -----
Total deposits 4.7% $400,174,090 100.0% $411,251,148 100.0%
============ ===== ============ =====
</TABLE>
Note 9 continued on next page.
page 35
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 9: Deposits (continued)
Deposits at December 31, 1999 and 1998, included public funds of $5,509,152
and $7,134,255, respectively. Mortgage-backed securities with a book value of
$913,032 and $1,255,260 were pledged as collateral on these deposits at
December 31, 1999 and 1998, respectively, which exceeds the minimum collateral
requirements established by the Washington Public Deposit Protection
Commission.
As of December 31, 1999, scheduled maturities of time deposits were as
follows:
Year ending December 31,
------------------------
2000 $240,063,226
2001 35,331,191
2002 5,930,735
2003 4,773,943
2004 2,270,526
Thereafter 946,276
------------
$289,315,897
============
Included in deposits are time deposits greater than or equal to $100,000 of
$96,931,913 and $98,656,486 at December 31, 1999 and 1998, respectively.
Interest on time deposits greater than or equal to $100,000 totalled
$5,300,446, $5,229,314, and $4,506,761 for the years ended December 31, 1999,
1998, and 1997, respectively.
Deposit interest expense by type for the years ended December 31 was as
follows:
1999 1998 1997
- ------------------------------------------------------------------------------
Time deposits $14,955,529 $16,672,427 $15,065,475
Money market deposit and checking 3,331,616 2,802,074 2,187,329
Regular savings 314,213 405,152 526,358
----------- ----------- -----------
$18,601,358 $19,879,653 $17,779,162
=========== =========== ===========
Note 10: FHLB and Other Advances
The Company's borrowings consisted of the following at December 31:
1999 1998
- ------------------------------------------------------------------------------
FHLB advances $134,236,925 $31,765,000
============ ===========
FHLB advances:
Maximum outstanding at any
month end $134,236,925 $39,755,000
Average outstanding 88,470,615 33,441,310
Weighted average interest rates:
Annual 5.288% 5.798%
End of year 5.513 5.236
Other advances $ 250,000
============
Under the terms of the FHLB advances, in addition to FHLB stock held, the Bank
must maintain unencumbered collateral of at least 120% of outstanding advances
if the collateral is one to four family permanent mortgages, 125% if the
collateral is rated first-lien residential privately issued mortgage-backed
securities and collateralized mortgage obligations, and 105% if the collateral
is U.S. Treasury and agency securities. At December 31, 1999, the minimum book
value of eligible collateral pledged for these borrowings was $161,411,131.
The Bank has an available line of credit with the FHLB in the amount equal to
35% of total assets.
FHLB advances at December 31, 1999, mature as follows:
Interest rates Amount
- ------------------------------------------------------------------------------
2000 4.94 - 6.45% $113,586,925
2002 5.3% 4,650,000
2004 4.83 - 4.97% 15,000,000
2006 6.25% 1,000,000
------------
$134,236,925
============
The other advances mature on November 30, 2000, with an interest rate of
7.84%.
page 36
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 11: Federal Taxes on Income
For tax years beginning prior to January 1, 1996, a qualified thrift
institution was allowed a bad debt deduction based on a percentage of taxable
income or on actual experience. Accordingly, the Bank used the percentage of
taxable income method prior to 1996.
The Small Business Job Protection Act of 1996 (the Act) required qualified
thrift institutions, such as the Bank, to recapture their post-1987 additions
to their bad debt reserves. Such recaptured amounts are to be taken into
taxable income ratably over a six-year period, which began with the year ended
December 31, 1998.
As of December 31, 1997, these additions were $1,973,380, of which $328,897
was recaptured in taxable income for both 1999 and 1998. The Act also repealed
the reserve method of accounting for tax bad debt deductions and required
thrifts to calculate the tax bad debt deduction based on actual current loan
losses. The recapture of the post-1987 additions to tax basis bad debt
reserves does not result in a charge to earnings as these amounts have been
provided for in the deferred tax liability.
If bad debt deductions taken for federal income tax purposes before 1987 are
later used for purposes other than bad debt losses, they will be subject to
federal income taxes at the prevailing corporate rates. Retained earnings at
December 31, 1999, 1998, and 1997, includes $640,000, for which no federal
taxes had been provided in the financial statements. The Bank does not
anticipate that retained earnings will be used in any way which would result
in payment of taxes.
Deferred federal income taxes constitute the differences in the reporting of
income and expense for financial statement and income tax purposes.
The components of deferred income tax benefit are as follows for the years
ended December 31:
1999 1998
- ------------------------------------------------------------------------------
Mortgage servicing rights $ (218,140) $ (120,856)
Loan origination fees and costs (75,332) (14,115)
FHLB stock dividends 131,015 121,558
Reserve for loan losses (385,735) (375,948)
Other, net (101,158) (135,455)
----------- -----------
$ (649,350) $ (524,816)
=========== ===========
At December 31, the significant components of the Company's net deferred tax
asset were as follows:
1999 1998
- ------------------------------------------------------------------------------
Deferred tax assets:
Reserve for loan losses $ 1,742,582 $ 1,356,847
Other, net 202,253 101,095
Mortgage servicing rights 196,367
----------- -----------
2,141,202 1,457,942
Deferred tax liabilities:
Mortgage servicing rights 21,773
Loan origination fees and costs 385,509 460,841
FHLB stock dividends 956,668 825,653
----------- -----------
1,342,177 1,308,267
Unrealized loss on available-for-
sale securities 346,885
----------- -----------
Net deferred tax asset $ 1,145,910 $ 149,675
=========== ===========
Note 12: Stockholders' Equity and Regulatory Capital Requirements
Stock dividends and stock splits: The Company's Board of Directors declared a
10% stock dividend in March 1999, a 10% stock dividend in May 1997, and a
three-for-two stock split in September 1997.
Restricted retained earnings: Under Washington State law, preconversion
retained earnings are restricted for the protection of preconversion
depositors. Restricted retained earnings at December 31, 1999, totalled
$161,411.
Regulatory capital requirements: The Company and the Bank are subject to
various regulatory capital requirements administered by the Federal Deposit
Insurance Corporation (FDIC), Washington State Department of Financial
Institutions, and the Federal Reserve Board. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary action by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and the Bank must meet specific capital guidelines that involve
quantitative measures of their assets, liabilities, and certain
off-balance-sheet items as calculated under regulatory accounting practices.
The Company's and the Bank's capital amounts and classifications are also
subject to qualitative judgments by the regulators about components,
risk-weightings, and other factors.
Note 12 continued on next page.
page 37
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 12: Stockholders' Equity and Regulatory Capital Requirements (continued)
Quantitative measures established by regulators to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital to risk-weighted assets,
and of Tier I capital to average assets. Management believes, as of December
31, 1999, that the Company and the Bank met all capital adequacy requirements
to which they are subject.
As of December 31, 1999 and 1998, the FDIC categorized the Bank as well
capitalized under the regulatory framework for prompt corrective action. To be
categorized as well capitalized, the Bank must maintain minimum total
risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the
table. There are no conditions or events since that notification that
management believes have changed the Bank's category.
Actual capital amounts and ratios for the Company and the Bank are presented
in the table below:
<TABLE>
To be categorized
as well
capitalized under
For capital prompt corrective
Actual adequacy purposes action provisions
---------------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1999:
Total capital (to risk-
weighted assets): Greater
First Mutual Bancshares, than or
Inc. $45,102,020 11.08% 32,560,672 equal to 8.00% n/a n/a
Greater Greater
than or than or
First Mutual Bank 45,161,792 11.10 32,555,563 equal to 8.00% $40,694,453 equal to 10.00%
Tier I capital (to risk-
weighted assets): Greater
First Mutual Bancshares, than or
Inc. 40,014,415 9.83 16,280,336 equal to 4.00 n/a n/a
Greater Greater
than or than or
First Mutual Bank 40,074,985 9.85 16,277,781 equal to 4.00 24,416,672 equal to 6.00
Tier I capital (to
average assets): Greater
First Mutual Bancshares, than or
Inc. 40,014,415 7.02 22,794,065 equal to 4.00 n/a n/a
Greater Greater
than or than or
First Mutual Bank 40,074,985 7.03 22,787,911 equal to 4.00 28,484,889 equal to 5.00
As of December 31, 1998:
Greater Greater
Total capital (to risk- than or than or
weighted assets) $38,909,518 11.52% $27,031,580 equal to 8.00% $33,789,475 equal to 10.00%
Greater Greater
Tier I capital (to than or than or
risk-weighted assets) 34,685,834 10.27 13,515,790 equal to 4.00 20,273,685 equal to 6.00
Greater Greater
Tier I capital (to than or than or
average assets) 34,685,834 7.16 19,378,224 equal to 4.00 24,222,781 equal to 5.00
The holding company is not subject to any written agreement, order, capital directive, or prompt corrective
action directive issued by the FDIC to meet and maintain a specific capital level.
page 38
</TABLE>
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 13: Earnings Per Share
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations:
Income Shares(1) Per share(1)
(numerator) (denominator) amount
- ------------------------------------------------------------------------------
Year ended December 31, 1999:
Basic EPS:
Income available to common
shareholders $ 6,000,348 4,675,654 $1.28
=====
Effect of dilutive stock options 83,622
----------- ---------
Diluted EPS:
Income available to common
shareholders plus assumed stock
options exercise $ 6,000,348 4,759,276 $1.26
=========== ========= =====
Year ended December 31, 1998:
Basic EPS:
Income available to common
shareholders $ 5,207,696 4,637,340 $1.12
=====
Effect of dilutive stock options 122,775
----------- ---------
Diluted EPS:
Income available to common
shareholders plus assumed stock
options exercise $ 5,207,696 4,760,115 $1.09
=========== ========= =====
Year ended December 31, 1997:
Basic EPS:
Income available to common
shareholders $ 4,518,680 4,469,106 $1.01
=====
Effect of dilutive stock options 189,038
----------- ---------
Diluted EPS:
Income available to common
shareholders plus assumed stock
options exercise $ 4,518,680 4,658,144 $0.97
=========== ========= =====
(1)Shares and EPS have been adjusted for a 10% stock dividend paid May 5,
1999, a 10% stock dividend paid July 2, 1997, and a three-for-two stock split
paid November 5, 1997.
Note 14: Other Operating Expenses
Salaries and employee benefits consisted of the following for the years ended
December 31:
1999 1998 1997
- ------------------------------------------------------------------------------
Salaries and employee benefits
incurred $ 8,795,576 $ 9,122,196 $ 7,051,486
Amounts deferred with loan
origination fees (1,494,686) (1,622,048) (1,092,774)
----------- ----------- -----------
$ 7,300,890 $ 7,500,148 $ 5,958,712
=========== =========== ===========
Direct costs of originating loans are deferred and capitalized with the
related loan origination fees collected. Deferral of costs varies directly
with the volume of loan originations.
page 39
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 15: Retirement Plan and Trust
The Bank has a 401(k) retirement plan and trust for employees. All employees
who have completed one year of service and meet the minimum hours-worked
requirement are eligible for the plan. The Bank funds the annual cost of the
plan as accrued. Employees may contribute up to 12% of their salaries to the
plan. The Bank matches 75% of the employees' contributions up to 6% of the
employees' compensation. At plan year-end, the Bank contributes an additional
3% of the employees' compensation. Participants are fully vested in employer
contributions to the plan upon six years of employment.
The Bank's contributions to the 401(k) retirement plan and trust were
$356,087, $320,971, and $255,658 for the years ended December 31, 1999, 1998,
and 1997, respectively. There were no significant changes in the rate of
contributions to the plan between those years.
Note 16: Employee Stock Ownership Plan
In 1985, the Company established an ESOP to provide benefits to all employees
who have completed one year of service and meet the minimum hours-worked
requirement. The plan is noncontributory on the part of the participants and
provides for full vesting upon completion of five years of service. The plan
provides for the distribution of accumulated benefits to the employees or
their beneficiaries upon death, termination, or retirement. The Company loaned
the ESOP's trustee $200,000 for purchase of the Company's common stock at the
initial offering price in 1985. During 1990, the Company's Board of Directors
authorized the trustee to borrow an additional $1,464,375 from the Company to
purchase 139,600 more shares (unadjusted for subsequent stock dividends and
stock splits) of the Company's common stock in the open market. Shares of
stock are allocated to employees as the loans are repaid. The outstanding
loan balance at December 31, 1999, was $310,739. During 1999, the ESOP sold
15,409 shares in the open market.
Shares held by the ESOP at December 31, 1999, were as follows:
Average
Number Price range price
of shares per share per share
- ------------------------------------------------------------------------------
Allocated:
Vested 288,723
Nonvested 11,075
-------
299,798 $1.20 - $4.63 $ 2.84
Nonallocated 64,866
-------
364,664
=======
Contributions to the ESOP during the years ended December 31, 1999, 1998, and
1997, were $77,312, $65,109, and $-0-, respectively.
page 40
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 17: Stock Option Plan
The Company has a stock option plan for directors and employees. Options have
a term of six or 10 years and are granted at fair market value on the grant
date. The Company's Board of Directors determines vesting of the options.
Options generally become exercisable in one or more installments during their
term, and the right to exercise may be cumulative. At December 31, 1999,
80,682 shares of common stock, adjusted for stock dividends, were available
for grant under the plan. A total of 200,708 shares are currently exercisable
at December 31, 1999. All schedules presented in this footnote are adjusted
for stock dividends and stock splits.
A summary of the Company's stock option plan as of December 31, 1999, 1998,
and 1997, and changes during the years ended on those dates is presented
below:
Weighted Weighted
Range of average average
exercise exercise fair
Shares price* price* value*
- ------------------------------------------------------------------------------
BALANCE, January 1, 1997 401,823 $3.38-$7.16 $ 4.36
Exercisable at year-end:
201,623 shares 3.65
Options granted 47,355 10.98 10.98 $ 3.94
Options exercised (85,087) 3.38-4.44 3.57
Options terminated (7,174) 4.44-10.98 5.30
--------
BALANCE, December 31, 1997 356,917 3.38-10.98 5.42
Exercisable at year-end:
167,906 shares 3.95
Options granted 114,664 15.85-15.91 15.89 4.97
Options exercised (134,252) 3.38-7.16 4.05
Options terminated (1,096) 7.16-15.85 10.06
--------
BALANCE, December 31, 1998 336,233 3.38-15.91 9.52
Exercisable at year-end:
96,259 shares 4.53
Options granted 62,300 12.38 12.38 5.34
Options exercised (9,378) 4.43-10.98 4.80
Options terminated (3,333) 7.16-15.85 12.20
--------
BALANCE, December 31, 1999 385,822 10.07
Exercisable at year-end: ========
200,708 shares 7.13
*per share
The following table summarizes information about stock options outstanding at
December 31, 1999:
Options outstanding Options exercisable
- ----------------------------------------------------- -----------------------
Weighted Weighted Weighted
Number average average Number average
Range of of shares exercise remaining of shares exercise
exercise price outstanding price* life exercisable price*
- ------------------------------------------------------------------------------
$3.00-$6.00 123,503 $ 4.23 5.3 years 123,503 $ 4.23
6.01- 9.00 42,354 7.16 6.5 years 28,620 7.16
9.01-12.00 45,045 10.98 7.5 years 14,135 10.98
12.01-15.00 61,250 12.38 9.5 years
15.01-18.00 113,670 15.89 6.0 years 34,450 15.91
------- -------
385,822 $10.07 6.5 years 200,708 $ 7.13
======= =======
* per share
The Company applies Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for its stock option plan. Accordingly, no
compensation cost has been recognized for its stock option plan for the years
ended December 31, 1999, 1998, and 1997. Had compensation cost for the
Company's stock option plan been determined based on the fair value at the
grant dates for awards under those plans consistent with the method of SFAS
No. 123, the Company's net income and earnings per share for the years ended
December 31, 1999, 1998, and 1997, would have been reduced to the pro forma
amounts indicated below:
1999 1998 1997
- ------------------------------------------------------------------------------
Net income:
As reported $ 6,000,348 $ 5,207,696 $ 4,518,680
Pro forma 5,781,149 5,038,625 4,419,924
Basic earnings per common
share:
As reported $1.28 $1.12 $1.01
Pro forma 1.24 1.09 0.99
Earnings per common share -
assuming dilution:
As reported $1.26 $1.09 $0.97
Pro forma 1.22 1.06 0.95
Note 17 continued on next page.
page 41
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 17: Stock Option Plan (continued)
The compensation expense included in the pro forma net income and net income
per share figures on the previous page are not likely to be representative of
the effect on reported net income for future years because options vest over
several years and additional awards generally are made each year.
The fair value of options granted under the Company's stock option plan was
estimated on the date of grant using the Black-Scholes option-pricing model
with the following weighted-average assumptions used: Annual dividend yield of
1.62% for 1999, 3.14% for 1998, and 1.10% for 1997; expected volatility of 35%
for 1999, 33% for 1998, and 33% for 1997; and expected lives of 8.1 years for
1999, 6.5 years for 1998, and 5.0 years for 1997. The risk-free interest rate
assumptions used were 6.00%, 5.79%, and 6.19%, for 1999, 1998, and 1997,
respectively.
Note 18: Contingencies
In the normal course of business, the Company has various legal claims and
other contingent matters outstanding. Management believes that any ultimate
liability arising from these actions will not have a material adverse effect
on the Company's financial condition or results of operations.
Note 19: Fair Value of Financial Instruments
The following disclosure of the estimated fair value of financial instruments
is made in accordance with the requirements of SFAS No. 107, Disclosures about
Fair Value of Financial Instruments. The estimated fair value amounts have
been determined by the Company using available market information and
appropriate valuation methodologies. However, considerable judgment is
necessary to interpret market data in the development of the estimates of fair
value. Accordingly, the estimates presented herein are not necessarily
indicative of the amounts the Company could realize in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
The estimated fair value of financial instruments is as follows at December
31, 1999 and 1998 (in thousands):
1999 1998
----------------------------- ----------------------------
Esti- Favorable Esti- Favorable
mated (unfavor- mated (unfavor-
Carrying fair able) Carrying fair able)
value value variance value value variance
- ------------------------------------------------------------------------------
Assets:
Cash and cash
equivalents $ 3,865 $ 3,865 $ $ 5,529 $ 5,529 $(4,456)
Securities held
for sale 17,350 17,350 20,337 20,337
Loans held for
sale 2,710 2,710 27,371 27,579 208
Mortgage-backed
and other
securities 88,056 85,440 (2,616) 61,764 62,467 703
Loans receivable 451,671 452,358 687 359,535 361,849 2,314
Accrued interest
receivable 3,841 3,841 3,311 3,311
Mortgage servicing
portfolio 110 393 283 357 2,076 1,719
FHLB stock 7,020 7,020 4,877 4,877
------- -------
Favorable
(unfavorable)
variance (1,646) 4,944
Liabilities:
Demand, savings,
and money market
deposits 110,858 110,858 111,167 111,167
Time deposits 289,316 289,114 202 300,084 301,427 (1,343)
Drafts payable 1,381 1,381 4,383 4,383
Advance payments
by borrowers for
taxes and
insurance 1,589 1,589 1,517 1,517
Short-term FHLB
advances 113,587 112,390 1,197 23,265 23,296 (31)
Long-term FHLB
advances 20,650 20,433 217 8,500 8,550 (50)
Other advances 250 250
------- -------
Favorable
(unfavorable)
variance 1,616 (1,424)
Off-balance-sheet
financial instruments:
Commitments to
sell loans 7 7 (25) (25)
------- -------
Favorable
(unfavorable)
variance 7 (25)
------- -------
Net favorable
(unfavorable)
variance $ (23) $ 3,495
======= =======
Note 19 continued on next page.
page 42
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 19: Fair Value of Financial Instruments (continued)
Fair value estimates, methods, and assumptions are set forth below for the
Company's financial and off-balance-sheet instruments.
Securities, loans held for sale, and commitments to sell loans: The fair
value of securities and loans receivable held for sale, and forward
commitments, are based on quoted market rates and dealer quotes.
Loans receivable: For variable-rate loans that reprice frequently and
with no significant change in credit risk, fair values are based on
carrying values. The fair value of the loans that have fixed interest
rates or a variable rate which do not reprice frequently is estimated
using discounted cash flow analysis, using interest rates currently being
offered for loans with similar terms to borrowers or similar credit
quality. The fair value of non-performing loans is estimated using
discounted cash flow analysis, using applicable risk adjusted spreads to
the contractual interest rates applicable to each category of loan.
No adjustment was made to the market interest rates for changes in credit
of performing loans for which there are no known credit concerns.
Management believes that the risk factor embedded in the market interest
rates along with the general reserves applicable to the loan portfolio
for which there are not known credit concerns results in a fair valuation
of such loans.
Deposit liabilities: Under SFAS No. 107, the fair value of deposits with
no stated maturity, such as noninterest-bearing demand deposits, savings,
NOW accounts, and money market and checking accounts, is equal to the
amount payable on demand. The fair value of time deposits is based on the
discounted value of contractual cash flows. The discount rate is
estimated using market rates for deposits of similar maturity of the top
25 local deposit-ranked institutions.
FHLB and other advances: The fair value of FHLB advances and other
borrowings is estimated based on discounting the estimated future cash
flows using rates currently available to the Company for debt with
similar remaining maturity.
Other: The carrying value of other financial instruments has been
determined to be a reasonable estimate of their fair value.
Mortgage servicing portfolio: The carrying value of the mortgage
servicing portfolio is mortgage servicing rights as defined by SFAS No.
125. The fair value of the mortgage servicing portfolio represents the
fair value of the total servicing portfolio, and is based upon an
independent appraisal and a valuation model that calculates the present
value of future cash flows.
Commitments to originate loans: Based on the short terms of these
instruments, the unrealized gains or losses are expected to be
insignificant.
Limitations: The fair value estimates presented herein are based on
pertinent information available to management as of December 31, 1999 and
1998. Although management is not aware of any factors that would
significantly affect the estimated fair value amounts, such amounts have
not been comprehensively revalued for purposes of these financial
statements since that date, and therefore, current estimates of fair
value may differ significantly from the amounts presented herein.
Note 20: Selected Quarterly Financial Data (unaudited)
<TABLE>
Year ended December 31, 1999
---------------------------------------------------------------------------
First Second Third Fourth
quarter quarter quarter quarter Total
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Interest income $ 10,022,313 $ 10,260,540 $ 10,688,735 $ 11,346,470 $ 42,318,058
Interest expense 5,479,790 5,579,946 5,857,199 6,376,429 23,293,364
------------ ------------ ------------ ------------ ------------
Net interest income $ 4,542,523 $ 4,680,594 $ 4,831,536 $ 4,970,041 $ 19,024,694
============ ============ ============ ============ ============
Provision for loan losses $ 150,000 $ 285,000 $ 250,000 $ 120,000 $ 805,000
Other operating income and ============ ============ ============ ============ ============
expenses, net $ (2,229,862) $ (2,170,652) $ (2,239,491) $ (2,498,534) $ (9,138,539)
============ ============ ============ ============ ============
Net income $ 1,429,056 $ 1,470,159 $ 1,547,445 $ 1,553,688 $ 6,000,348
============ ============ ============ ============ ============
Basic earnings per share $ 0.31 $ 0.31 $ 0.33 $ 0.33 $ 1.28
Earnings per share assuming ============ ============ ============ ============ ============
dilution $ 0.30 $ 0.31 $ 0.32 $ 0.33 $ 1.26
Weighted average shares ============ ============ ============ ============ ============
outstanding 4,671,758 4,672,243 4,679,239 4,679,256 4,675,654
Weighted average shares ============ ============ ============ ============ ============
outstanding including
effect of dilutive stock
options 4,761,876 4,760,023 4,759,307 4,755,777 4,759,276
============ ============ ============ ============ ============
Note 20 continued on next page.
page 43
</TABLE>
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 20: Selected Quarterly Financial Data (unaudited) (continued)
<TABLE>
Year ended December 31, 1999
---------------------------------------------------------------------------
First Second Third Fourth
quarter quarter quarter quarter Total
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Interest income $ 9,551,242 $ 9,807,688 $ 9,948,913 $ 9,907,193 $ 39,215,036
Interest expense 5,344,232 5,505,230 5,488,352 5,480,860 21,818,674
------------ ------------ ------------ ------------ ------------
Net interest income $ 4,207,010 $ 4,302,458 $ 4,460,561 $ 4,426,333 $ 17,396,362
============ ============ ============ ============ ============
Provision for loan losses $ 100,000 $ 100,000 $ 385,000 $ 165,000 $ 750,000
Other operating income and ============ ============ ============ ============ ============
expenses, net $ (2,227,700) $ (2,267,161) $ (2,038,211) $ (2,224,060) $ (8,757,132)
============ ============ ============ ============ ============
Net income $ 1,240,344 $ 1,277,296 $ 1,344,651 $ 1,345,405 $ 5,207,696
============ ============ ============ ============ ============
Basic earnings per share $ 0.27 $ 0.27 $ 0.29 $ 0.29 $ 1.12
Earnings per share assuming ============ ============ ============ ============ ============
dilution $ 0.26 $ 0.26 $ 0.28 $ 0.28 $ 1.09
Weighted average shares ============ ============ ============ ============ ============
outstanding 4,551,128 4,655,635 4,669,710 4,671,214 4,637,340
============ ============ ============ ============ ============
Weighted average shares
outstanding including effect
of dilutive stock options 4,727,940 4,775,679 4,772,181 4,762,989 4,760,115
============ ============ ============ ============ ============
</TABLE>
Note 21: Segments
The Company is organized based on the products and services that it offers.
Under this organizational structure, the Company has three reportable
segments: consumer banking, residential lending, and commercial lending.
- -- Residential lending offers conventional or government-insured loans to
Borrowers to purchase, refinance, or build homes, secured by one-to- four-
unit family dwellings. Embedded within the residential lending segment is
a mortgage banking operation, which sells loans in the secondary mortgage
market. The mortgage banking operation may choose to retain or sell the
right to service the loans sold (i.e., collection of principal and
interest payments) depending upon market conditions.
- -- Commercial lending offers permanent and interim (construction) loans for
multifamily housing (over four units), commercial real estate properties,
and loans to small- and medium-sized businesses for financing inventory,
accounts receivables, and equipment, among other things. The underlying
real estate collateral or business asset being financed typically secures
these loans.
- -- Consumer banking offers depositor banking services, home equity lending,
direct consumer loans, and consumer dealer financing contracts.
These segments are managed separately because each business requires different
processes and different marketing strategies to reach the customer base that
buys those products and services. All three segments derive a majority of
their revenue from interest, and management relies primarily on net interest
revenue in managing these segments. No single customer provides more than 10%
of the Company's revenues.
Basis of accounting for reportable segments: Starting in 1997, the Company
adopted business unit profitability reporting, which measures the
performance of segments as self-standing business entities. As self-
standing entities, the segments have fully income-allocated and cost-
burdened profit and loss statements. Except for the allocations and the
funds transfer-pricing mechanism described below, the accounting policies
for the segments are the same as those described in the Summary of
Significant Accounting Policies.
Allocations and funds transfer-pricing mechanism:
- -- Operating income and expenses are allocated to segments whenever they can
be directly attributed to their activities. Indirect income and overhead
costs are credited or charged to the segments whenever they are
specifically identified as providers or users of the ancillary internal
service, or are allocated based on some common denominator. For certain
services, intersegment user fees are assessed at agreed-upon prices.
- -- A funds transfer-pricing method has been utilized to allocate interest
income for the deposits held in the branch banks. The deposit-gathering
activities contribute to the profitability by reducing borrowing costs.
The deposits are therefore presumed to generate revenues for consumer
banking through reinvestments in low-risk securities (inferred interest-
earning assets). The interest earnings are calculated using an internal,
proxy-market interest rate. The loan-producing units in the residential,
commercial, and consumer segments are also presumed to borrow money to
fund their loans using an internal, proxy-market interest rate.
- -- Equity capital commensurate with the risk weight of segment assets has
been allocated to simulate the operating capital level required by the
Bank's regulators. The allocated capital provides the segments with
interest-free funding.
Note 21 continued on next page.
page 44
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 21: Segments
Financial information for the Company's segments is shown below for the:
Years ended December 31,
------------------------
Consumer Residential Commercial
Banking Lending Lending Totals
- ------------------------------------------------------------------------------
Revenues from
external
customers 1999 $ 9,087,676 $ 8,462,124 $ 26,782,327 $ 44,332,127
1998 6,521,653 10,718,074 24,156,802 41,396,529
1997 6,326,339 10,068,321 20,810,023 37,204,683
Revenues from
other
segments 1999 17,373,355 303,320 1,634,108 19,310,783
1998 21,051,822 428,300 1,482,378 22,962,500
1997 18,505,479 467,586 1,303,662 20,276,727
Total revenues 1999 26,461,031 8,765,444 28,416,435 63,642,910
1998 27,573,475 11,146,374 25,639,180 64,359,029
1997 24,831,818 10,535,907 22,113,685 57,481,410
Net interest
revenue 1999 6,418,249 1,739,501 10,155,577 18,313,327
1998 6,446,931 1,967,849 8,838,699 17,253,479
1997 6,235,391 2,098,386 7,254,032 15,587,809
Income before
federal income
taxes 1999 877,327 1,537,276 7,173,600 9,588,203
1998 1,565,589 2,017,212 6,025,083 9,607,884
1997 2,113,629 1,093,807 5,037,563 8,244,999
Total assets 1999 413,124,784 106,367,487 337,945,234 857,437,505
1998 414,809,598 107,019,912 274,234,989 796,064,499
1997 373,687,398 124,405,900 235,318,964 733,412,262
Revenues from external customers is comprised of interest income and other
operating income. Revenues from other segments include the interest-free
benefit of allocated equity capital, the interest revenue from the inferred
earning assets on branch deposits, and intersegment user fees and charges.
Note 21 continued on next page.
page 45
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 21: Segments (continued)
Reconciliations of segment data to the Company consolidated financial
statements are shown in the table below. The amounts for the segments
differ from the actual consolidated financial statements due to the use of
internal, proxy-market interest rates, and various methods for allocating
costs. The provision for loan losses and the reserve for loan losses have not
been allocated to the segments. Total segment assets include inferred
interest-earning assets on branch deposits, which are essentially the same
assets from the lending segments, but credited with a proportionate
interest yield.
Years ended December 31,
------------------------
1999 1998 1997
- ------------------------------------------------------------------------------
Total revenues for year ended
December 31:
Segment total revenues $ 63,642,910 $ 64,359,029 $ 57,481,410
Back out or add back:
Revenues from other segments (19,310,783) (22,962,500) (20,276,727)
Revenues of administrative
departments netted against
overhead costs and reallocated
as net costs 934,543 1,048,513 897,657
------------ ------------ ------------
Consolidated total revenues $ 45,266,670 $ 42,445,042 $ 38,102,340
============ ============ ============
Net interest revenue for year
ended December 31:
Segment net interest revenue $ 18,313,327 $ 17,253,479 $ 15,587,809
Back out or add back:
Difference between actual interest
expense and intersegment funding
allocation 51,974 (653,030) (291,096)
Interest revenues of administrative
departments netted against
overhead costs and reallocated
as net costs 659,393 795,913 509,283
------------ ------------ ------------
Consolidated net interest income $ 19,024,694 $ 17,396,362 $ 15,805,996
============ ============ ============
Income before federal income taxes
for year ended December 31:
Segment pre-tax income $ 9,588,203 $ 9,607,884 $ 8,244,999
Back out or add back:
Unallocated loan loss provision (762,475) (750,000) (976,000)
Difference between actual total
funding cost and total
intersegment funding allocation 426,795 (81,573) 66,053
Unallocated net expenses of
administrative departments (171,368) (887,081) (488,430)
------------ ------------ ------------
Consolidated pretax income $ 9,081,155 $ 7,889,230 $ 6,846,622
============ ============ ============
Total assets as of December 31:
Segment total assets $857,437,505 $796,064,499 $733,412,262
Back out or add back:
Inferred intersegment interest-
earning assets on branch deposits (274,549,327) (308,525,629) (290,256,005)
Unallocated reserve for loan loss (6,309,268) (5,569,431) (4,858,376)
Unallocated nonearning assets of
administrative departments 4,537,396 7,260,700 7,464,559
------------ ------------ ------------
Consolidated total assets $581,116,306 $489,230,139 $445,762,440
============ ============ ============
page 46
<PAGE>
First Mutual Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 22: Parent Company Only Financial Statements
Summary of condensed parent company financial information for First Mutual
Bancshares, Inc. for December 31, 1999 (in thousands):
Statement of Financial Condition
Assets
- ------------------------------------------------------------------------------
Cash $ 533
Investment in subsidiaries 39,397
Other assets 64
---------
Total $ 39,994
=========
Liabilities and Stockholders' Equity
- ------------------------------------------------------------------------------
Liabilities:
Borrowings $ 250
Other liabilities 408
---------
658
Stockholders' equity 39,336
---------
TOTAL $ 39,994
=========
Statement of Income
INCOME:
Equity in undistributed net income from
subsidiaries $ 6,124
OTHER EXPENSE:
Compensation and employee benefits 3
Other operating expense 185
---------
Total expenses 188
---------
Income before federal income taxes 5,936
FEDERAL INCOME TAX BENEFIT 64
---------
NET INCOME $ 6,000
=========
page 47
<PAGE>
Independent Auditors' Report
Board of Directors
First Mutual Bancshares, Inc.
Bellevue, Washington
We have audited the accompanying consolidated statements of financial
condition of First Mutual Bancshares, Inc. and subsidiaries (the Company) as
of December 31, 1999 and 1998, and the related consolidated statements of
income, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these 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, such consolidated financial statements present fairly, in all
material respects, the financial condition of the Company as of December 31,
1999 and 1998, and the results of its operations and its cash flows for each
of the three years in the period ended December 31, 1999, in conformity with
generally accepted accounting principles.
/s/Deloitte & Touche LLP
January 28, 2000
Deloitte & Touche LLP
Seattle, Washington
Stock Information
The Company sold 966,000 shares of common stock in its initial public offering
on December 23, 1985. As of December 31, 1999, there were 4,672,636 shares
outstanding. The shares are held by approximately 1,200 shareholders of record
and persons or entities who hold their stock in nominee or "street" name
through various brokerage firms or other depositories.
First Mutual Bancshares, Inc.'s common stock trades on The Nasdaq Stock Market
under the symbol FMSB. The following data are based on the reported sale
prices on the Nasdaq National Market System for the quarters indicated, as
reported by the National Association of Securities Dealers.
Quarter Ending High* Low*
---------------------------------------------------------
March 31, 1998 $ 17.73 $ 15.91
June 30, 1998 16.59 15.00
September 30, 1998 16.08 10.80
December 31, 1998 13.75 11.19
March 31, 1999 12.73 11.36
June 30, 1999 13.06 11.25
September 30, 1999 13.00 9.00
December 31, 1999 12.88 10.00
*Adjusted to reflect the 10% stock dividend paid May 5, 1999.
page 48
<PAGE>
General Information
BOARD OF DIRECTORS
F. Kemper Freeman, Jr.
Chairman
H. Scott Wallace
Vice Chairman
John R. Valaas
President, CEO
James J. Doud, Jr.
Mary Case Dunnam
Janine Florence
Victor E. Parker
George W. Rowley, Jr.
Richard S. Sprague
Robert C. Wallace
BANCSHARES OFFICERS
President
John R. Valaas
Chief Executive Officer
Executive Vice President
Roger A. Mandery
Chief Financial Officer
Vice President
Kari A. Stenslie
Controller
Corporate Secretary
Phyllis A. Easterlin
BANK EXECUTIVE OFFICERS
President
John R. Valaas
Chief Executive Officer
Executive Vice President
Roger A. Mandery
Chief Financial Officer
Senior Vice President
James R. Boudreau
Chief Credit Officer
Vice Presidents
Robin R. Carey
Operations and Administration
Scott B. Harlan
Residential and Consumer Lending
Kari A. Stenslie
Controller
Corporate Secretary
Phyllis A. Easterlin
FIRST MUTUAL BANCSHARES, INC.,
AND FIRST MUTUAL BANK
CORPORATE HEADQUARTERS
AND MAIN OFFICE
400 - 108th Avenue NE
Bellevue, Washington 98004
(425) 455-7300
(425) 453-5302 Fax
www.firstmutual.com
ANNUAL MEETING
The annual meeting is scheduled to be held April 27, 2000, 3 p.m., at the
Hyatt Regency Bellevue, 900 Bellevue Way NE, Bellevue, Washington.
TRANSFER AGENT AND REGISTRAR
ChaseMellon Shareholder Services, L.L.C.
Shareholder Relations
P.O. Box 3315
South Hackensack, NJ 07606
(800) 522-6645
www.chasemellon.com
INDEPENDENT CERTIFIED PUBLIC
Accountants
Deloitte & Touche LLP
LEGAL COUNSEL
Preston Gates Ellis LLP
INVESTOR RELATIONS COUNSEL
Len Cereghino & Co.
2605 Western Avenue
Seattle, Washington 98121
(206) 448-1996
FORM 10-K
A copy of the Form 10-K as filed with the Securities and Exchange Commission
will be furnished to shareholders upon written request to the Secretary, First
Mutual Bancshares, Inc., P.O. Box 1647, Bellevue, WA 98009-1647.
You may also contact us through our Web site: www.firstmutual.com.
FIRST MUTUAL BANK OFFICES
Ballard
2038 NW Market Street
Seattle, Washington 98107
(206) 706-0894
Bellevue Financial Center
400 - 108th Avenue NE
Bellevue, Washington 98004
(425) 453-2801
Bellevue West
10001 NE 8th Street
Bellevue, Washington 98004
(425) 453-9434
Bellingham
1100 Harris Street
Bellingham, Washington 98225
(360) 714-0433
Crossroads
15635 NE 8th Street
Bellevue, Washington 98008
(425) 644-4214
Issaquah
855 Rainier Boulevard N
Issaquah, Washington 98027
(425) 392-2673
Monroe
19265 State Route 2
Monroe, Washington 98272
(360) 794-8686
Redmond
16900 Redmond Way
Redmond, Washington 98052
(425) 883-4700
West Seattle
4520 California Avenue SW
Seattle, Washington 98116
(206) 932-6299
LOAN PRODUCTION OFFICES
Salem
401 Ratcliff Drive SE, Suite 170
Salem, Oregon 97302
(503) 363-4726
Tacoma
2323 N 31st Street, Suite 200
Tacoma, Washington 98403
(253) 759-3559
<PAGE>
-----------------------
FIRST MUTUAL BANCSHARES
-----------------------
INCORPORATED
460 -108th Avenue NE
Bellevue, Washington 98004
(425) 455-7300
<PAGE>
Exhibit 21
Subsidiaries of the Registrant
Parent
- ------
First Mutual Bancshares, Inc.
Percentage Jurisdiction or
Subsidiaries of Ownership State of Incorporation
- ------------ ------------ ----------------------
First Mutual Bank 100% Washington
First Mutual Services (1) 100% Washington
- ----------------
(1) This corporation is a wholly owned subsidiary of First Mutual Bank.
First Mutual Services (FMS) engages in the sale of mutual funds and
annuities. PRIMEVEST Financial Services functions as the broker dealer
and is responsible for the sale and delivery of securities. As of December
1999, the company has decided to discontinue directly offering investment
products to its customers. The Bank's investment in First Mutual Services
at December 31, 1999, was $38,555.
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<CASH> 3850
<INT-BEARING-DEPOSITS> 15
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 17350
<INVESTMENTS-CARRYING> 88056
<INVESTMENTS-MARKET> 85440
<LOANS> 454381
<ALLOWANCE> 6309
<TOTAL-ASSETS> 581116
<DEPOSITS> 400174
<SHORT-TERM> 113837
<LIABILITIES-OTHER> 7119
<LONG-TERM> 20650
0
0
<COMMON> 4673
<OTHER-SE> 34664
<TOTAL-LIABILITIES-AND-EQUITY> 581116
<INTEREST-LOAN> 35481
<INTEREST-INVEST> 6415
<INTEREST-OTHER> 423
<INTEREST-TOTAL> 42318
<INTEREST-DEPOSIT> 18601
<INTEREST-EXPENSE> 23293
<INTEREST-INCOME-NET> 19025
<LOAN-LOSSES> 805
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 12087
<INCOME-PRETAX> 9081
<INCOME-PRE-EXTRAORDINARY> 6000
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6000
<EPS-BASIC> 1.28
<EPS-DILUTED> 1.26
<YIELD-ACTUAL> 3.66
<LOANS-NON> 352
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 5569
<CHARGE-OFFS> 68
<RECOVERIES> 3
<ALLOWANCE-CLOSE> 6309
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 6309
</TABLE>
