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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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AMENDMENT NO. 2 TO
FORM 10
GENERAL FORM FOR
REGISTRATION OF SECURITIES
Pursuant to Section 12(b) or 12(g) of the Securities Exchange Act of 1934
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VALLEY COMMUNITY BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
WASHINGTON 91-1913479
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
1307 EAST MAIN, PUYALLUP, WASHINGTON 98372
(Address of principal executive offices) (Zip Code)
(253) 848-2316
(Registrant's telephone number, including area code)
Securities to be registered pursuant to Section 12(b) of the Act:
NONE
Securities to be registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $1.00 PAR VALUE
(Title of Class)
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TABLE OF CONTENTS PAGE
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ITEM 1. BUSINESS OF VALLEY COMMUNITY BANCSHARES, INC., AND THE BANKS 3
ITEM 2. FINANCIAL INFORMATION 13
ITEM 3. PROPERTIES 40
ITEM 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 40
ITEM 5. DIRECTORS AND EXECUTIVE OFFICERS 41
ITEM 6. EXECUTIVE COMPENSATION 43
ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 45
ITEM 8. LEGAL PROCEEDINGS 45
ITEM 9. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS 46
ITEM 10. RECENT SALES OF UNREGISTERED SECURITIES 46
ITEM 11. DESCRIPTION OF REGISTRANT'S SECURITIES TO BE REGISTERED 47
ITEM 12. INDEMNIFICATION OF DIRECTORS AND OFFICERS 49
ITEM 13. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 50
ITEM 14. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE 79
ITEM 15. FINANCIAL STATEMENTS AND EXHIBITS 79
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VALLEY COMMUNITY BANCSHARES, INC.
AMENDMENT NO. 2 TO FORM 10 REGISTRATION STATEMENT
ITEM 1. BUSINESS OF VALLEY COMMUNITY BANCSHARES, INC., AND THE BANKS
GENERAL
Valley Community Bancshares, Inc. (the "Company") is a bank holding
company registered under the Bank Holding Company Act of 1956, as amended. The
administrative offices of the Company are located at 1307 East Main Avenue,
Puyallup, Washington 98372, and its telephone number is (253) 848-2316.
The Company was organized and incorporated under the laws of the State
of Washington as a holding company for its principal banking subsidiary,
Puyallup Valley Bank, a state chartered, FDIC insured commercial bank, through a
reorganization completed on July 1, 1998. The Company conducts its business
primarily through Puyallup Valley Bank, but has recently completed the
acquisition of Valley Bank, a newly organized state chartered FDIC insured
commercial bank subsidiary located in Auburn, Washington. Puyallup Valley Bank
and Valley Bank are referred to as the "Banks" in this Registration Statement.
The principal source of the Company's revenue are (i) interest and fees
on loans; (ii) deposit service charges; (iii) merchant credit card processing
fees; (iv) federal funds sold (funds loaned on a short-term basis to other
banks); and (v) interest on investments (principally government securities). The
Banks' lending activity consists of short-to-medium-term commercial and consumer
loans, including operating loans and lines of credit, equipment loans,
automobile loans, recreational vehicle and truck loans, personal loans or lines
of credit, home improvement loans and rehabilitation loans. The Banks also offer
cash management services, merchant credit card processing, safe deposit boxes,
wire transfers, direct deposit or payroll and social security checks, automated
teller machine access, and automatic drafts for various accounts.
PUYALLUP VALLEY BANK
Puyallup Valley Bank is a Washington state-charted commercial bank that
provides full-service banking to businesses and residents within the Puyallup
community and its surrounding area. Puyallup Valley Bank places particular
emphasis on serving the small to medium sized business segment of the market by
making available a line of banking products tailored to their needs, with those
services delivered by experienced professionals concerned with building
long-term relationships. Puyallup Valley Bank conducts business out of six
full-service offices and one drive-up facility.
The organizers of Puyallup Valley Bank commenced formation efforts in
1972. Puyallup Valley Bank was formally incorporated on January 9, 1973, under
the laws of the State of Washington after having received approval to organize
from the Division and the FDIC, and commenced operations during October, 1973.
Puyallup Valley Bank was organized with capital of $400,000 through the sale of
20,000 shares of Common Stock at a sales price of $20 per share.
Puyallup Valley Bank had net income of $1,520,000 in 1999, $1,568,000
in 1998, and $1,592,000 in 1997. Total Assets at December 31, 1999 and 1998 were
$124,909,000 and $125,189,000, respectively.
VALLEY BANK
Valley Bank is a newly organized commercial bank that commenced
operations on January 11, 1999. Valley Bank was formally incorporated December
3, 1998, under the laws of the State of Washington after having received
approval to organize from the Division of Banks of the Washington Department of
Financial Institutions (the "Division") and the FDIC. Valley Bank was founded by
a group of business and professional individuals in the King County area as a
commercial bank subsidiary of the Company to serve the needs of the community in
and around the city Auburn. Valley Bank engages in a general commercial banking
business in the Auburn area of King County and offers commercial banking
services to small and medium size businesses, professionals and retail customers
in the Bank's market area.
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Valley Bank is a solely-owned subsidiary of the Company and with
initial capital of $4,025,000, the minimum amount required to capitalize a bank
in the Auburn community under federal and state law.
Valley Bank had net loss of approximately $125,000 in 1999 and total
assets at December 31, 1999 of approximately $8,002,000. It is anticipated that
Valley Bank will continue to incur operating losses in the next year(s) of
operation. It is anticipated that such losses will not have a significant impact
on the Company.
MARKET AREA
The Company's principal market area is located in South King County and
Eastern Pierce County region of Washington State. King County and Pierce County
are the two most populous counties in Washington State with over 2,000,000
residents. The economy of the region is dependent upon aerospace, high
technology, foreign trade and natural resources, including agriculture and
timber. The region has become more diversified over the past decade as a result
of the success of software companies such as Microsoft and the establishment of
numerous research and biotechnology firms. The regional economy generally has
experienced strong growth and stability in recent years.
Eastern Pierce County, where Puyallup Valley Bank has six locations,
is located approximately 30 miles southeast of Seattle and five miles
northeast of Tacoma, the region's two largest cities. The area includes
several residential and agricultural communities including Puyallup, South
Hill, Sumner, Edgewood, Graham, Orting, and Summit/Fredrickson and has a
population in excess of 100,000 residents. This area is characterized as the
Company's principal market area.
South King County, where Valley Bank has one location in Auburn, is
centrally located between Seattle and Tacoma and has a population of over
140,000 residents. The community is supported by light industry, aerospace, and
forest products industries. The Company considers the Auburn and Kent Valley a
natural area of expansion because of its close proximity to Eastern Pierce
County.
BUSINESS STRATEGY
As a locally owned financial institution, the Company emphasizes local
banking needs. The Company seeks to achieve growth and maintain a strong return
on equity. The strategy to accomplish these goals is to focus on small
businesses that traditionally develop an exclusive relationship with a single
bank. The Banks also have the size to give personal attention required by
business people and significant credit expertise to help these businesses meet
their goals.
The Banks offer to its customers a full range of deposit services that
are typically available in most banks and savings and loan associations,
including checking accounts, savings accounts and other time deposits of various
types, ranging from money market accounts to longer term certificates of
deposit. One major goal in developing the Banks' product mix is to keep the
product offerings as simple as possible, both in terms of the number of products
and the features and benefits of the individual services. The transaction
accounts and time certificates are tailored to the principal market areas at
rates competitive in the area. In addition, retirement accounts such as IRAs
(Individual Retirement Accounts) are available. The FDIC up to the maximum
amount insures all deposit accounts. The Banks solicit these accounts from
small-to-medium sized businesses in their respective primary trade areas, and
from individuals who live and/or work within these areas.
The Banks offer loans to their diverse markets and communities. The
market consists of south King County and east Pierce County in general and the
areas in and around Puyallup and Auburn in particular. Loans are provided to
creditworthy borrowers regardless of their race, color, national origin,
religion, sex, age, marital status, sexual orientation, disability, receipt of
public assistance, or any basis prohibited by law. The Banks intend to fulfill
this commitment while maintaining prudent credit practices. In the course of
fulfilling its obligation to meet the credit needs of the communities which they
serve, the Banks give consideration to each credit application regardless of the
fact that the applicant may reside in a low to moderate income neighborhood, and
without regard to the geographic location of the residence, property or business
within their market areas.
The Banks provide innovative, quality, financial products that meet the
banking needs of their customers and communities. The loan programs and
acceptance of certain loans may vary from time-to-time depending upon funds
available and regulations governing the banking industry. The Banks offer all
basic types of credit to their local communities including commercial and
consumer loans. The types of loans within these categories are as follows:
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COMMERCIAL LOANS. Commercial loans are typically made to sole
proprietorships, partnerships, corporations, and other business entities,
municipalities, and individuals, where the loan is to be used primarily for
business purposes. The types of loans the Banks offer include:
- Small Business Administration financing programs
- operating and working capital loans
- loans to finance capital purchases
- commercial real estate loans
- business lines of credit
- term loans
- loans to professionals
- letters of credit
CONSUMER LOANS. Consumer loans are typically available to finance
consumer purchases, such as automobiles, household furnishings, boats, and
education. Loans are available on both a secured and an unsecured basis. The
following types of consumer loans are available:
- automobiles and trucks
- boats and recreational vehicles
- personal loans and lines of credit
- home equity lines of credit
- home improvement and rehabilitation loans
- credit card services
- consumer real estate loans
Other types of credit programs, such as loans to nonprofit
organizations, public entities, for community development, and other
governmental offered programs also are available.
The Banks offer traditional banking services, such as safe deposit
boxes, wire transfers, direct deposit of payroll and social security checks,
automated teller machine access, and automatic drafts for various accounts. The
Banks do not offer trust services.
CREDIT MANAGEMENT
The Company strives to achieve sound credit risk management. In order
to achieve this goal the Company has established stringent, centralized credit
policies and uniform underwriting criteria for all loans. The Company emphasizes
diversification in the types of loans offered, regular credit examinations, and
quarterly reviews of large loans and of loans experiencing deterioration in
credit quality. The Company identifies potential problem loans early, charges
off loans promptly, and maintains a adequate allowance for loan loss. In order
to achieve sound credit risk management the Company has established certain
credit guidelines for its lending portfolio. Guidelines relating to the more
commonly requested loans types are as follows:
1. Short-term Single Payment Loans - These notes are made to
individuals and businesses and generally do not exceed six
months in term. The credit needs are generally seasonal with
the source of repayment being liquidation of the current
assets being financed or other current asset conversion. For
commercial borrowers, cash flow projections are provided to
establish the ability to service the debt within the terms of
the note. Collateral is taken if the commercial borrower
debt-to-worth ratio exceeds 1:1 or the current ratio is less
than 2:1. Loans to closely held corporations are generally
guaranteed by the principal(s).
2. Term Residential First Mortgage Loans - These notes include
any loan whose purpose is to buy residential real estate with
the loan secured by the real estate. The Company currently is
not interested in generating residential real estate loans for
its portfolio, unless the interest rate on those loans can be
periodically adjusted to reflect current market conditions.
Loans in excess of five years have cut-offs for rate review.
The maximum amortization of first residential real estate is
30 years. The loan-to-value ratios normally do not exceed 80
percent.
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3. Consumer Installment Loans - These notes are normally made to
consumers under the following guidelines.
- Automobiles - The dealer cost on new automobiles and
average loan value on used ones.
- Recreational Vehicles and Boats - 80 percent of the cash
selling price.
- Home Improvement - These loans are less than the
borrower's equity in the property and are the borrower's
residence.
- Second Liens Real Estate (Single Family) - Maximum term on
these loans is 180 months. The debt on the property
generally does not exceed a loan-to-value ratio of 80
percent.
- Mobile home - Maximum term on these loans is 180 months.
The debt on the property generally does not exceed a
loan-to-value ratio of 75 percent.
- Unsecured - The term for unsecured loans generally does
not exceed 24 months, 6 months for single payment loans.
4. Consumer Lines of Credit - The Company offers two personal
lines of credit programs: Personal Line of Credit and Home
Equity Line of Credit. The maximum term on these loans is
normally 60 months. The debt on the property generally does
not exceed a loan-to-value ratio of 80 percent.
5. Loans For Business Purposes. - The Company makes term loans to
finance the acquisition of fixed assets or refinance
short-term debt used to purchase fixed assets. The maximum
term is 7 years or the estimated useful life of the asset
being purchased, whichever is less (unless secured by real
estate). These loans include accounts receivable, inventory
and/or equipment. Collateral is the form of a first lien on
commercial real estate and generally has a maximum maturity of
25 years with a loan-to-value ratio not to exceed 80 percent.
Repayment comes from cash flow and therefore borrowers provide
the Company with a forecast of Balance Sheet, Cash Flow and
Profit and Loss Statements as an indication of their capacity
to repay the loan. Debt service coverage generally is at least
1:1.
6. Real Estate Lending - The Company offers loans secured by real
property subject to loan-to-value limits (LTV). However other
credit factors such as capacity of the borrower, income from
the underlying property, the overall credit-worthiness of the
borrower, the level of cash equity invested in the property,
secondary sources of repayment, and additional collateral or
credit enhancements are also considered. The following
loan-to-value limits have been established.
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LOAN TYPE MAXIMUM LTV
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Raw Land 65%
Development 75%
Non-Residential Construction 80%
One-to-Four Family Construction 80%
Improved Property 80%
Home Equity Loans 80%
Residential One-to-Four Family 80%
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EMPLOYEES
At December 31, 1999, the Banks had 49 full and 19 part time employees.
The Company does not have any employees. Management considers its relations with
employees to be satisfactory.
COMPETITION
The geographic market area served by the Banks is highly competitive
with respect to both loans and deposits. The Banks compete principally with
commercial banks, savings and loan associations, credit unions, mortgage
companies, and other financial institutions. The major commercial bank
competitors are the regional banks (Columbia State Bank and Frontier Bank) and
national banks (Key Bank National Association, Bank of America National Trust
and Savings Association, U.S. Bank National Association and Wells Fargo Bank)
that have a branch or branches within the Banks' primary trade areas. Among the
advantages such larger banks have are their ability to finance wide-ranging
advertising campaigns and to allocate
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their investment assets to geographic regions of higher yield and demand.
Such banks offer certain services which are not offered directly by the Bank
(but are offered indirectly through correspondent institutions); and, by
virtue of their greater total capitalization (legal lending limits to an
individual customer are based upon a percentage of a bank's total shareholder
equity accounts), such banks have substantially higher lending limits than
the Banks.
The Banks also compete with the financial markets for funds. For
instance, yields on corporate and government debt securities and other
commercial paper affect the ability of commercial banks to attract and hold
deposits. Further, commercial banks compete for available funds with money
market instruments and similar investment vehicles offered by institutions such
as brokerage firms, credit card companies, and retailers (e.g., Sears, Roebuck &
Co.). In periods of high interest rates, such money market funds have provided
substantial competition to banks for deposits, and it is anticipated that they
may continue to do so in the future.
In order to compete with the other financial institutions in their
primary trade areas, the Banks use, to the fullest extent possible, the
flexibility which is accorded by independent status. This includes an emphasis
on specialized services, local promotional activity, and personal contacts by
the Banks' officers, directors and employees. The Banks also provide special
services and programs for individuals in their primary trade areas who are
employed in the business and professional fields.
The Company anticipates bank competition will continue to change
dramatically over the next several years as the major regional and national
banks continue to consolidate. These larger financial institutions will continue
the trend of consolidating their branch systems and providing incentives to
their customers to use electronic banking instead of visiting branches. It is
anticipated that credit unions, because of their tax benefits, will also
continue to show growth.
SUPERVISION AND REGULATION
The following generally refers to certain statutes and regulations
affecting the banking industry. These references provide brief summaries and
therefore are not complete and are qualified by the statutes and regulations
referenced. In addition, due to the numerous statutes and regulations that apply
to and regulate the operation of the banking industry, many are not referenced
below.
The Company and the Banks are subject to extensive federal and
Washington state legislation, regulation and supervision. These laws and
regulations are primarily intended to protect depositors and the FDIC rather
than shareholders of the Company. The laws and regulations affecting banks and
bank holding companies have changed significantly over recent years, and there
is reason to expect that similar changes will continue in the future. Any change
in applicable laws, regulations or regulatory policies may have a material
effect on the business, operations and prospects of the Company. The Company is
unable to predict the nature or the extent of the effects on its business and
earnings that any fiscal or monetary policies or new federal or state
legislation may have in the future.
THE COMPANY
The Company is a bank holding company by virtue of its ownership of the
Banks, and is registered as such with the Federal Reserve. The Company is
subject to regulation under the Bank Holding Company Act of 1956, as amended
(the "BHCA"), which subjects the Company and the Banks to supervision and
examination by the Federal Reserve. Under the BHCA, the Company files with the
Federal Reserve annual reports of its operations and such additional information
as the Federal Reserve may require. The Federal Reserve Board may examine a bank
holding company and any of its subsidiaries and charge the company for the cost
of such an examination.
SOURCE OF STRENGTH TO THE BANKS. The Federal Reserve Board takes the
position that a bank holding company is required to serve as a source of
financial and managerial strength to its subsidiary banks and may not conduct
its operations in an unsafe or unsound manner. In addition, it is the Board's
position that in serving as a source of strength to its subsidiary banks, bank
holding companies should use available resources to provide adequate capital
funds to its subsidiary banks during periods of financial stress or adversity
and should maintain the financial flexibility and capital raising capacity to
obtain additional resources for assisting its subsidiary banks. A bank holding
company's failure to meet its obligations to serve as a source of strength to
its subsidiary banks will generally be considered by the Board to be an unsafe
and unsound banking practice or a violation of the Board's regulations or both.
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FEDERAL RESERVE APPROVAL. Bank holding companies must obtain the
Federal Reserve's approval before they: (1) acquire direct or indirect ownership
or control of any voting shares of any bank if, after such acquisition, they
would own or control, directly or indirectly, more than 5% of the voting shares
of such bank; (2) merge or consolidate with another bank holding company; and
(3) acquire substantially all of the assets of any additional banks. Until
September 1995, the BHCA also prohibited bank holding companies from acquiring
any such interest in any bank or bank holding company located in a state other
than the state in which the bank holding company was located, unless the laws of
both states expressly authorized the acquisition. Now, subject to certain state
restrictions, such as age and contingency laws, a bank holding company that is
adequately capitalized and adequately managed may acquire the assets of an
out-of-state bank.
CONTROL OF NONBANKS. With certain exceptions, the BHCA also prohibits
bank holding company from acquiring direct or indirect ownership or control of
voting shares in any company other than a bank or a bank holding company unless
the Federal Reserve finds the company's business to be incidental to the
business of banking. When making this determination, the Federal Reserve in part
considers whether allowing a bank holding company to engage in those activies
would offer advantages to the public that would outweigh possible adverse
effects.
The Economic Growth and Regulatory Paperwork Reduction Act of 1996
("Economic Growth Act") amended the BHCA to eliminate the requirement that a
bank holding company seek Federal Reserve approval before engaging de novo in
permissible nonbanking activities, if the holding company is well capitalized
and meets certain other criteria specified in the same statute. A bank holding
company meeting the specifications is now required only to notify the Federal
Reserve within 10 business days after the activity has begun.
CONTROL TRANSACTIONS. The Change in Bank Control Act of 1978, as
amended, requires a person or group of persons acquiring "control" of a bank
holding company to provide the FRB with at least 60 days' prior written notice
of the proposed acquisition. Following receipt of this notice, the Federal
Reserve has 60 days to issue a notice disapproving the proposed acquisition, but
the Federal Reserve may extend this time period for up to another 30 days. An
acquisition may be completed before the disapproval period expires if the
Federal Reserve issues written notice of its intent not to disapprove the
action. Under a rebuttable presumption established by the Federal Reserve, the
acquisition of 10% or more of a class of voting stock of a bank holding company
with a class of securities registered under Section 12 of the Securities
Exchange Act of 1934, as amended ("Exchange Act") would, under the circumstances
set forth in the presumption, constitute the acquisition of control. In
addition, any "company" would be required to obtain the approval of the Federal
Reserve under the BHCA before acquiring 25% (5% if the "company" is a bank
holding company) or more of the outstanding shares of the Company, or otherwise
obtain control over the Company.
AFFILIATE TRANSACTIONS. The Company and the Banks are deemed affiliates
within the meaning of the Federal Reserve Act, and transactions between
affiliates are subject to certain restrictions. Generally, Sections 23A and 23B
of the Federal Reserve Act: (1) limit the extent to which the financial
institution or its subsidiaires may engage in "covered transactions" with an
affiliate, as defined, to an amount equal to 10% of such institution's capital
and surplus and an aggregate limit on all such transactions with all affiliates
to an amount equal to 20% of such capital and surplus, and (2) require all
transactions with an affiliate, whether or not "covered transactions," to be on
terms substantially the same, or at least as favorable to the institution or
subsidiary, as those provided to non-affiliate. The term "covered transaction"
includes the making of loans, purchase of assets, issuance of a guarantee and
other similar type of transactions.
MANAGEMENT REGULATION. Federal law: (1) sets forth the circumstances
under which officers or directors of a financial institution may be removed by
the institution's federal supervisory agency; (2) places restraints on lending
by an institution to its executive oficers, directors, principal stockholders,
and their related insterests; and (3) prohibits management personnel from
serving as a director or in other management positions of another financial
institution whose assets exceed a specified amount or which has an office within
a specified geographic area.
TIE-IN LIMITATIONS. The Company and the Banks are prohibited from
engaging in certain tie-in arrangements in connection with any extension of
credit, sale or lease of property or furnishing of services. For example, with
certain exceptions, neither the Company nor the Banks may condition an extension
of credit on either (1) a requirement that the customer obtain additional
services provided by it or (2) an agreement by the customer to refrain from
obtaining other services from a competitor. Effective April 1997, the Federal
Reserve has adopted significant amendments to its anti-tying rules that: (1)
remove Federal Reserve-imposed anti-tying restrictions on bank holding companies
and their non-bank subsidiaries;
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(2) create exemptions from the statutory restriction on bank tying
arrangements to allow banks greater flexibility to package products with
their affiliates; and (3) establish a safe harbor from the tying restrictions
for certain foreign transactions.
BANKING SUBSIDIARIES
Applicable federal and state statutes and regulations governing a
bank's operations relate, among other matters, to capital requirements, required
reserves against deposits, investments, loans, legal lending limits, certain
interest rates payable, mergers and consolidations, borrowings, issuance of
securities, payment of dividends (see below), establishment of branches, and
dealings with affiliated persons. The FDIC has authority to prohibit banks under
their supervision from engaging in what they consider to be an unsafe and
unsound practice in conducting their business.
The Banks are state-chartered commercial banks subject to extensive
regulation and supervision by the Washington Department of Financial
Institutions Division of Banks ("DFI"). The Banks are also subject to regulation
and examination by the FDIC, which insures their respective deposits to the
maximum extent permitted by law. The federal laws that apply to the Banks
regulate, among other things, the scope of their business, their investments,
their reserves against deposits, the timing of the availability of deposited
funds and the nature and amount of and collateral for loans. The laws and
regulations governing the Banks generally have been promulgated to protect
depositors and not to protect stockholders of such institutions or their holding
companies.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") requires federal banking regulators to adopt regulations or
guidelines in a number of areas to ensure bank safety and soundness, including:
internal controls; credit underwriting; asset growth; management compensation;
ratios of classified assets to capital; and earnings. FDICIA also contains
provisions which are intended to change independent auditing requirements;
restrict the activities of state-chartered insured banks; amend various consumer
banking laws; limit the ability of "undercapitalized banks" to borrow from the
Federal Reserve's discount window; and require regulators to perform periodic
on-site bank examinations and set standards for real estate lending.
LOANS-TO-ONE BORROWER. Each of the Banks is subject to limitations on
the aggregate amount of loans that it can make to any one borrower, including
related entities. Applicable regulations generally limit loans-to-one borrower
to 20% of unimpaired capital. Each of the Banks is in compliance with applicable
loans-to-one borrower requirements.
FDIC INSURANCE. Generally, customer deposit accounts in banks are
insured by the FDIC for up to a maximum amount of $100,000. The FDIC has adopted
a risk-based insurance assessment system under which depository institutions
contribute funds to the BIF and/or the SAIF, as applicable, based on their risk
classification.
In September of 1996, the Deposit Insurance Funds Act of 1996 ("Funds
Act") was enacted. The Funds Act provided, among other things, for the
recapitalization of the SAIF through a special assessment on all depository
institutions that hold SAIF insured deposits. The one-time assessment was
designed to place the SAIF at its 1.25 reserve ratio goal.
The FDIC may terminate the deposit insurance of any insured depository
institution if it determines after a hearing that the institution has engaged or
is engaging in unsafe or unsound practices, is in an unsafe or unsound condition
to continue operations, or has violated any applicable law. The insurance may be
terminated permanently, if the institution has no tangible capital. If deposit
insurance is terminated, the accounts at the institution at the time of the
termination, less subsequent withdrawals, will continue to be insured for a
period of six months to two years, as determined by the FDIC.
CAPITAL ADEQUACY REQUIREMENTS. The Federal Reserve and the FDIC
(collectively, the "Agencies") have adopted risk-based capital guidelines for
banks and bank holding companies that are designed to make regulatory capital
requirements more sensitive to differences in risk profiles among banks and bank
holding companies and account for off-balance sheet items. The guidelines are
minimums, and the federal regulators have noted that banks and bank holding
companies contemplating significant expansion programs should not allow
expansion to diminish their capital ratios and should maintain ratios in excess
of the minimums. Failure to achieve and maintain adequate capital levels may
give rise to supervisory action through the issuance of a capital directive to
ensure the maintenance of required capital levels.
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The current guidelines require all federally-regulated banks to
maintain a minimum risk-based total capital ratio equal to 8%, of which at least
4% must be Tier 1 capital. Tier 1 capital includes common shareholders' equity,
qualifying perpetual preferred stock, and minority interests in equity accounts
of consolidated subsidiaries, but excludes goodwill and most other intangibles
and the allowance for loan and lease losses. Tier 2 capital includes the excess
of any preferred stock not included in Tier 1 capital, mandatory convertible
securities, hybrid capital instruments, subordinated debt and intermediate
term-preferred stock, 20% of unrealized gain of equity securities, and general
reserves for loan and lease losses up to 1.25% of risk-weighted assets. Neither
of the Banks have received any notice indicating that it will be subject to
higher capital requirements.
Under these guidelines, banks' assets are given risk-weights of 0%,
20%, 50% or 100%. Most loans are assigned to the 100% risk category, except for
first mortgage loans fully secured by residential property and, under certain
circumstances, residential construction loans (both carry a 50% rating). Most
investment securities are assigned to the 20% category, except for municipal or
state revenue bonds (which have a 50% rating) and direct obligations of or
obligations guaranteed by the United States Treasury or United States Government
Agencies (which have a 0% rating).
The Agencies have also implemented a leverage ratio, which is equal to
Tier 1 capital as a percentage of average total assets less intangibles, to be
used as a supplement to the risk-based guidelines. The principal objective of
the leverage ratio is to limit the maximum degree to which a bank may leverage
its equity capital base. The minimum required leverage ratio for top-rated
institutions is 3%, but most institutions are required to maintain an additional
cushion of at least 100 to 200 basis points. Any institution operating at or
near the 3% level is expected to be a strong banking organization without any
supervisory, financial or operational weaknesses or deficiencies. Any
institutions experiencing or anticipating significant growth would be expected
to maintain capital ratios, including tangible capital positions, well above the
minimum levels.
PROMPT CORRECTIVE ACTION. Regulations adopted by the Agencies as
required by FDICIA impose even more stringent capital requirements. The FDIC and
other Agencies must take certain "prompt corrective action" when a bank fails to
meet capital requirements. The regulations establish and define five capital
levels: (1) "well-capitalized," (2) "adequately capitalized," (3)
"undercapitalized," (4) "significantly undercapitalized" and (5) "critically
undercapitalized." To qualify as "well-capitalized," an institution must
maintain at least 10% total risk-based capital, 6% Tier 1 risk-based capital,
and a leverage ratio of no less than 5%. Increasingly severe restrictions are
imposed on the payment of dividends and management fees, asset growth and other
aspects of the operations of institutions that fall below the category of being
"adequately capitalized" (which requires at least 8% total risk-based capital,
4% Tier 1 risk-based capital, and a leverage ratio of at least 4%).
Undercapitalized institutions are required to develop and implement capital
plans acceptable to the appropriate federal regulatory agency. Such plans must
require that any company that controls the undercapitalized institution must
provide certain guarantees that the institution will comply with the plan until
it is adequately capitalized. As of the date of this Prospectus/Proxy statement,
neither the Company, Valley, nor their respective subsidiaries were subject to
any regulatory order, agreement, or directive to meet and maintain a specific
capital level for any capital measure.
RESTRICTIONS ON DIVIDENDS. Dividends paid to the Company by Puyallup
Valley Bank is the material source of the Company's cash flow. Various federal
and state statutory provisions limit the amount of dividends banking
subsidiaries are permitted to pay to their holding companies without regulatory
approval. Federal Reserve policy further limits the circumstances under which
bank holding companies may declare dividends. For example, a bank holding
company should not continue its existing rate of cash dividends on its common
stock unless its net income is sufficient to fully fund each dividend and its
prospective rate of earnings retention appears consistent with its capital
needs, asset qualify, and overall financial condition.
If, in the opinion of the applicable federal banking agency, a
depository institution under its jurisdiction is engaged in or is about to
engage in an unsafe or unsound practice (which, depending on the financial
condition of the institution, could include the payment of dividends), the
agency may require, after notice and hearing, that such institution cease and
desist from such practice. In addition, the Federal Reserve and the FDIC have
issued policy statements which provide that insured banks and bank holding
companies should generally pay dividends only out of current operating earnings.
Under Washington law, the Banks may not declare or pay a cash dividend
on their capital stock if it would cause its net worth to be reduced below (1)
the amounts required for liquidation accounts or (2) the net worth requirements,
if any, imposed by the Director of DFI. Dividends on the Banks' capital stock
may not be paid in an aggregate amount greater than the aggregate retained
earnings of the Banks, without the approval of DFI.
10
<PAGE>
FEDERAL RESERVE SYSTEM. The Federal Reserve requires all depository
institutions to maintain reserves against their transaction accounts (primarily
checking accounts) and non-personal time deposits. Currently, reserves of 3%
must be maintained against total transaction accounts of $49.8 million or less
(after a $4.2 million exemption), and an initial reserve of 10% (subject to
adjustment by the Federal Reserve to a level between 8% and 14%) must be
maintained against that portion of total transaction accounts in excess of such
amount. Both of the Banks are in compliance with applicable requirements.
The balances maintained to meet the reserve requirements imposed by the
Federal Reserve may be used to satisfy applicable liquidity requirements.
Because required reserves must be maintained in the form of vault cash or a
noninterest-bearing account at a Federal Reserve Bank, the effect of this
reserve requirement is to reduce the earning assets of the Company and Valley's
banking subsidiaries.
REGULATORY DEVELOPMENTS
Congress has enacted significant federal banking legislation in recent
years. Included in this legislation have been the Financial Institutions Reform,
Recovery and Enforcement Act of 1989 ("FIRREA") and the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA"). FIRREA, among other
things, (i) created two deposit insurance funds administered by the FDIC, the
Bank Insurance Fund ("BIF") and the Savings Association Insurance Fund ("SAIF"),
(ii) permitted commercial banks that meet certain housing-related asset
requirements to secure advances and other financial services from local FHLBs,
(iii) restructured the federal regulatory agencies for savings associations, and
(iv) enhanced the regulators' enforcement powers over financial institutions and
their affiliates.
FDICIA went substantially farther than FIRREA in establishing a more
rigorous regulatory environment. Under FDICIA. regulatory authorities are
required to enact a number of new regulations, substantially all of which are
now effective. These regulations include among other things, (i) a new method
for calculating deposit insurance premiums based on risk, (ii) restrictions on
acceptance of brokered deposits except by well-capitalized institutions, (iii)
additional limitations on loans to executive officers and directors of banks,
(iv) the employment of interest rate risk in the calculation of risk-based
capital, (v) safety and soundness standards that take into consideration, among
other things, management, operations, asset quality, earnings and compensation,
(vi) a five-tiered rating system from well-capitalized to critically
undercapitalized, along with the prompt corrective action the agencies may take
depending on the category, and (vii) new disclosure and advertising requirements
with respect to interest paid on savings accounts.
FDICIA and regulations adopted by the FDIC impose additional
requirements for annual independent audits and reporting when a bank begins a
fiscal year with assets of $500 million or more. Such banks, or their holding
companies, are also required to establish audit committees consisting of
directors who are independent of management.
INTERSTATE BANKING AND BRANCHING: The Riegle-Neal Interstate Banking
and Branching Efficiency Act of 1994 ("Interstate Act") generally permits
nationwide interstate banking and branching by relaxing federal law restrictions
on interstate banking and providing general authorization for interstate
branching. Subject to certain state laws, such as age and contingency laws, the
Interstate Act allows adequately capitalized and adequately managed bank holding
companies to purchase the assets of out-of-state banks). Additionally, since
June 1, 1997, the Interstate Act permits interstate bank mergers, subject to
these state laws, unless the home state of either merging bank has "opted-out"
of these provisions by enacting "opt-out" legislation. The Interstate Act does
allow states to impose certain conditions on interstate bank mergers within
their borders; for example, states may require that the in-state merging bank
exist for up to five years before the interstate merger. Under the Interstate
Act, states may also "opt-in" to de novo branching, allowing out-of-state banks
to establish de novo branches within the state.
In 1996, Washington enacted "opting in" legislation authorizing
interstate mergers pursuant to the Interstate Act. Accordingly, as of June 6,
1996, an out-of-state bank holding company may now acquire more than 5% of the
voting shares of a Washington-based bank, regardless of reciprocity, provided
such bank or its predecessor has been doing business for at least five years
prior to the acquisition. Further, an out-of-state bank may engage in banking in
Washington if the requirements of Washington's interstate banking statute are
met, and the bank either (1) was lawfully engaged in banking in Washington on
June 6, 1996, (2) resulted from an interstate combination pursuant to Washington
law, (3) resulted from a relocation of a head office of a state bank or a main
office of a national bank pursuant to federal law, or (4) resulted from the
establishment of a savings bank branch in compliance with applicable Washington
law. Additionally, the Director of the Division may approve
11
<PAGE>
interstate combinations if the basis for such approval does not discriminate
against out-of-state banks, out-of-state holding companies, or their
subsidiaries.
The Agencies recently adopted regulations, under which banks are
prohibited from using their interstate branches primarily for deposit
production. The Agencies have accordingly implemented a loan-to-deposit ratio
screen to ensure compliance with this prohibition.
Further effects on the Company and the Banks may result from the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "Community
Development Act"). The Community Development Act (i) establishes and funds
institutions that are focused on investing in economically distressed areas and
(ii) streamlines the procedures for certain transactions by financial
institutions with federal banking agencies.
Among other things, the Community Development Act requires the federal
banking agencies to (i) consider the burdens that are imposed on financial
institutions when new regulations are issued or new compliance burdens are
created and (ii) coordinate their examinations of financial institutions when
more than one agency is involved. The Community Development Act also streamlines
the procedures for forming certain one-bank holding companies and engaging in
authorized non-banking activities.
Various regulatory relief provisions were also enacted by recent
legislation. The new legislation includes, among other things, changes to (i)
the Truth in Lending Act and the Real Estate Settlement Procedures Act to
coordinate and simplify the two laws' disclosure requirements, (ii) eliminate
civil liability for violations of the Truth in Savings Act after five years,
(iii) streamline the application process for a number of bank holding company
and bank applications, (iv) establish a privilege from discovery in any civil or
administrative proceeding or bank examination for any fair lending self-trust
results conducted by, or on behalf of, a financial institution in certain
circumstances, (v) repeal the FDICIA requirement that independent public
accountants attest to compliance with designated safety and soundness
regulations, (vi) impose a continuous regulatory review of regulations to
identify and eliminate outdated and unnecessary rules, and (vii) various other
miscellaneous provisions to reduce regulatory burdens.
In 1999, the Financial Services Modernization Act was enacted which:
(1) repealed historical restrictions on preventing banks from affiliating with
securities firms, (2) broadens the activities that may be conducted by national
banks and banking subsidiaries of holding companies, and (3) provides an
enhanced framework for protecting the privacy of consumers' information. In
addition, bank holding companies may be owned, controlled or acquired by any
company engaged in financially related activities, as long as such company meets
regulatory requirements. To the extent that this legislation permits banks to
affiliate with financial services companies, the banking industry may experience
further consolidation, although the impact of this legislation on the Company
and the Banks is unclear at this time.
REGULATORY ENFORCEMENT AUTHORITY
The enforcement powers available to federal banking regulators are
substantial and include, among other things, the ability to assess civil
monetary penalties, to issue cease-and-desist or removal orders and to initiate
injunctive actions against banking organizations and institution-affiliated
parties, as defined. In general, enforcement actions must be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions, or inactions, may provide the basis for enforcement action, including
misleading or untimely reports filed with regulatory authorities. Applicable law
also requires public disclosure of final enforcement actions by the federal
banking agencies.
NATIONAL MONETARY POLICIES
In addition to being affected by general economic conditions, the
earnings and growth of the Banks are affected by the policies of regulatory
authorities, including the Board of Governors of the Federal Reserve System. An
important function of the Federal Reserve System is to regulate the money
supply, credit conditions and interest rates. Among the instruments used to
implement these objectives are open market operations in U.S. Government
securities, changes in reserve requirements against bank deposits and the
Federal Reserve Discount Rate, which is the rate charged member banks to borrow
from the Federal Reserve Bank. These instruments are used in varying
combinations to influence overall growth and distribution of credit, bank loans,
investments and deposits, and their use may also affect interest rates charged
on loans or paid on deposits.
12
<PAGE>
The monetary policies of the Federal Reserve Board have had a
significant effect on the operating results of commercial banks in the past and
are expected to do so in the future. Also important in terms of effect on banks
are controls on interest rates paid by banks on deposits and types of deposits
that may be offered by banks. The Depository Institutions Deregulation
Committee, created by Congress in 1980, phased out ceilings on the rate of
interest that may be paid on deposits by commercial banks and savings and loan
associations, with the result that the differentials between the maximum rates
banks and savings and loans can pay on deposit accounts have been eliminated.
The effect of deregulation of deposit interest rates has been to increase banks'
cost of funds and to make banks more sensitive to fluctuation in market rates.
FORWARD-LOOKING STATEMENTS
Except for historical financial information contained herein, certain
matters discussed in this registration statement of Valley Community Bancshares,
Inc. constitute "forward-looking statements" within the meaning of the
Securities Exchange Act of 1934, as amended. Forward-looking statements are
subject to risks and uncertainties that may cause actual future results to
differ materially. Such risks and uncertainties with respect to Valley Community
Bancshares, Inc., Puyallup Valley Bank and Valley Bank include those related to
the economic environment, particularly in the areas in which the Company and the
Banks operate, competitive products and pricing, fiscal and monetary policies of
the U.S. government, changes in governmental regulations affecting financial
institutions, including regulatory fees and capital requirements, changes in
prevailing interest rates, acquisitions and the integration of acquired
businesses, credit risk management and asset/liability management, the financial
and securities markets, and the availability of and costs associated with
sources of liquidity
ITEM 2. FINANCIAL INFORMATION
SELECTED FINANCIAL DATA
The following financial data of the Company are derived from the
Company's historical audited financial statements and related footnotes.
CHART ON FOLLOWING PAGE.
13
<PAGE>
VALLEY COMMUNITY BANCSHARES, INC.
Selected Financial Data
<TABLE>
<CAPTION>
Year Ended December 31,
(dollars in thousands, except per share amounts)
1999 1998 1997 1996 1995
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA
Interest Income $ 8,958 $ 8,694 $ 8,291 $ 7,516 $ 7,285
Interest expense 2,973 3,139 3,079 2,939 2,666
---------- ---------- ---------- ---------- ----------
Net interest income 5,985 5,555 5,212 4,577 4,619
Provision for loan losses 84 9 66 24 39
---------- ---------- ---------- ---------- ----------
Net interest income after provision for loan losses 5,901 5,546 5,146 4,553 4,580
Noninterest income 589 662 647 696 648
Noninterest expense 4,516 4,111 3,604 3,367 3,323
---------- ---------- ---------- ---------- ----------
Income before provision for income tax 1,974 2,097 2,189 1,882 1,905
Provision for income tax 580 616 597 517 510
---------- ---------- ---------- ---------- ----------
Net Income $ 1,394 $ 1,481 $ 1,592 $ 1,365 $ 1,395
========== ========== ========== ========== ==========
PER SHARE DATA
Cash Dividends $ 135 $ 871 $ 457 $ 429 $ 425
Cash Dividends per weighted average shares outstanding $ 0.12 $ 0.86 $ 0.46 $ 0.43 $ 0.43
Basic earnings per share $ 1.24 $ 1.46 $ 1.59 $ 1.38 $ 1.40
Diluted earnings per share $ 1.21 $ 1.41 $ 1.53 $ 1.34 $ 1.40
Weighted average shares outstanding 1,119,780 1,012,844 1,001,013 987,192 995,401
Weighted average diluted shares outstanding 1,152,576 1,047,745 1,038,599 1,021,198 998,287
BALANCE SHEET DATA
Total Assets $ 133,837 $ 125,329 $ 112,994 $ 106,897 $ 97,316
Net loans 77,675 66,841 63,740 57,582 57,505
Deposits 113,809 110,283 98,150 93,488 85,389
Stockholders' equity 18,724 14,078 13,436 12,240 11,184
Equity to assets ratio 13.99% 11.23% 11.89% 11.45% 11.49%
</TABLE>
VALLEY COMMUNITY BANCSHARES, INC.
Selected Financial Data (continued)
<TABLE>
<CAPTION>
Year Ended December 31,
(dollars in thousands, except per share amounts)
1999 1998 1997 1996 1995
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
FIVE YEAR FINANCIAL PERFORMANCE
Net Income $ 1,394 $ 1,481 $ 1,592 $ 1,365 $ 1,395
Average Assets 132,945 118,960 111,302 102,331 96,259
Average Stockholders' Equity 17,862 13,742 12,632 11,483 10,338
Return on Assets (net income divided by average assets) 1.05% 1.24% 1.43% 1.33% 1.45%
Return on Equity (net income divided by average equity) 7.80% 10.78% 12.60% 11.89% 13.49%
Efficiency Ratio (noninterest expense divided by
noninterest income plus net interest income) 68.69% 66.13% 61.51% 63.85% 63.09%
</TABLE>
14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
The following discussion is provided for the consolidated operations of
the Company, which include its wholly owned subsidiaries, Puyallup Valley Bank
and Valley Bank. The purpose of this discussion is to focus on significant
factors affecting the Company's financial condition and results of operations.
The Company earned net income of $1,394,000 in 1999, compared to net
income of $1,481,000 in 1998 and net income of $1,592,000 in 1997. The decrease
in operating income is the result of the expansion strategy embarked by the
Company in 1998, when the Company organized as a holding company for its
principal banking subsidiary, Puyallup Valley Bank, through reorganization
completed on July 1, 1998. Subsequently, the Company completed a new branch
facility in Graham, Washington, and completed the organization of Valley Bank on
January 11, 1999. This expansion is primarily responsible for the $87,000
decrease in net income reported in 1999 and the $111,000 decrease in net income
reported in 1998.
The Company's net income is derived principally from the operating
results of its banking subsidiaries, namely Puyallup Valley Bank and Valley
Bank. Puyallup Valley Bank is a well-established commercial bank and generates
the Company's operating income. Puyallup Valley Bank had net income of
$1,520.000 in 1999, $1,568,000 in 1998, and $1,592,000 in 1997. The decrease in
Puyallup Valley Bank's net income, during 1998 and 1999, is related to the
opening of a new branch facility in Graham, Washington during the fourth quarter
of 1998. Valley Bank, which incurred losses of $125,000 in 1999, is anticipated
to continue to incur operating losses during the early years of its operation.
It is anticipated that the losses incurred by Valley Bank during its initial
years will not have a significant impact on the company. However, there can be
no assurance that Valley Bank will not incur more significant losses, which
could have an adverse impact on the Company's earnings, dividend payments or
future growth.
NET INTEREST INCOME
The Company's largest component contributing to net income is net
interest income, which is the difference between interest earned on earning
assets (primarily loans and investments) and interest paid on interest-bearing
liabilities (deposits and borrowings). The volume of and yields earned on
earning assets and the volume of and the rates paid on interest-bearing
liabilities determine net interest income. Interest earned and interest paid is
also affected by general economic conditions, particularly changes in market
interest rates, and by government policies and the action of regulatory
authorities. Net interest income divided by average earning assets is referred
to net interest margin. For the years December 31, 1999, 1998, and 1997, the
Company's net interest margin was 4.99 percent, 5.18 percent, and 5.23 percent,
respectively.
Net interest income during 1999, 1998, and 1997 totaled $5,985,000,
$5,555,000 and $5,212,000, respectively, representing a 7.7 percent increases in
1999 over 1998 and a 6.6 percent in 1998 over 1997. The increase resulted from
an increase in average earning assets, partially offset by a decrease in the
Company's net interest margin.
PROVISION FOR LOAN LOSSES
Provisions for loan losses reduce net interest income. The provision
for loan losses reflects management's judgment of the expense to be recognized
in order to maintain an adequate allowance for loan losses. For further
discussion regarding the allowance for loan losses see the discussion on
allowance for loan losses under Risk Elements. The Company provided $84,000 for
loan losses during 1999 compared to $9,000 in 1998 and $66,000 in 1997. The 1999
and 1997 provisions were primarily related to an increase in the Company's loan
portfolio. The reduction in the 1998 provision was the result of a significant
recovery that increased the allowance for loan losses to an acceptable level.
The 1999 provision was also impacted by Valley Bank which had no allowance
established upon the commencement of its lending operations. Management
anticipates that continued growth in the Company's loan portfolio will require
increases in loan loss provisions during the year 2000.
15
<PAGE>
NONINTEREST INCOME AND EXPENSE
Net income is also effected by noninterest income (primarily service
charges, and other operating income) and noninterest expenses (primarily
salaries and employee benefits, occupancy, equipment, and other operating
expenses).
Noninterest income during 1999, 1998, and 1997 totaled $589,000,
$662,000 and $647,000, respectively, representing a 11.0 percent decrease in
1999 over 1998 and a 2.3 percent increase in 1998 over 1997. The decrease in
1999 was primarily related to lower origination fees on mortgage loans brokered
which decreased as a result of higher mortgage interest rates in 1999 and a
lower volume of loan applications processed. Noninterest income during 1998 was
favorably impacted by a significant increase in origination fees on mortgage
loans brokered which increased as a result of lower mortgage interest rates in
1998 and a higher volume of loan applications processed. Noninterest income
during 1997 was favorably impacted by a significant gain on sale of
available-for-sale investments.
Noninterest expense during 1999, 1998, and 1997 totaled $4,516,000,
$4,111,000 and $3,604,000, respectively, representing a 9.9 percent increase in
1999 over 1998 and a 14.1 percent increase in 1998 over 1997. The increase in
1999 was primarily related to higher salary and employee benefits, occupancy and
equipment, and other operating expenses associated with the operation of the new
Graham branch facility and Valley Bank. The increase in 1998 was related
primarily related to Organizational costs associated with the formation of the
holding company and Valley Bank. The increase in salary and employee benefits,
occupancy and equipment during 1998 was related to the opening of a loan
production office in Auburn, Washington during the year and the opening of the
Graham branch in November 1998. The percentage of noninterest expense to average
assets was 3.37 percent in 1999, compared to 3.28 percent and 3.24 percent
during 1998 and 1997, respectively.
PROVISION FOR INCOME TAXES
The Company's provision for income taxes is a significant reduction of
operating income. The provision for 1999, 1998, and 1997 was $580,000, $616,000,
and $597,000, respectively. This amount represents an effective taxing rate of
29 percent during 1999 and 1998, compared to 27 percent during 1997. The
Company's marginal tax rate is currently 34 percent. The difference between the
Company's effective and marginal tax rate is primarily related to investments
made in tax exempt securities.
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY; INTEREST RATES;
AND INTEREST DIFFERENTIAL
AVERAGE BALANCES AND AN ANALYSIS OF AVERAGE RATES EARNED AND PAID. The
following tables show average balances and interest income or interest expense,
with the resulting average yield of rate by category of average earning asset or
interest-bearing liability.
CHART ON FOLLOWING PAGE.
16
<PAGE>
VALLEY COMMUNITY BANCSHARES, INC.
Distribution of Assets, Liabilities and Stockholders' Equity
<TABLE>
<CAPTION>
INTEREST RATES AND INTEREST DIFFERENTIAL
(dollars in thousands)
1999 1998 1997
-------------------------- --------------------------- ---------------------------
Average Revenue/ Yield/ Average Revenue/ Yield/ Average Revenue/ Yield/
balance expense rate balance expense rate balance expense rate
------- ------- ---- ------- ------- ---- ------- ------- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets
Loans
Commercial $ 17,607 $ 1,559 8.85% $ 16,678 $ 1,550 9.29% $ 17,586 $ 1,666 9.47%
Real Estate 47,601 4,044 8.50% 41,439 3,687 8.90% 38,887 3,501 9.00%
Installment 5,642 477 8.45% 5,800 503 8.67% 6,030 526 8.72%
Other 1,285 116 9.03% 1,414 131 9.26% 1,307 128 9.79%
Fees on loans - 54 - 250 - 186
-------- ------- ------ -------- ------- ------ -------- ------- ------
Total loans (including fees) $ 72,135 $ 6,250 8.66% $ 65,331 $ 6,121 9.37% $ 63,810 $ 6,007 9.41%
Investment securities
Taxable $ 29,255 $ 1,608 5.50% $ 21,149 $ 1,238 5.85% $ 18,395 $ 1,103 6.00%
Tax-exempt 6,350 439 6.92% 7,265 550 7.57% 8,027 605 7.53%
-------- ------- ------ -------- ------- ------ -------- ------- ------
Total investment securities $ 35,605 $ 2,047 5.75% $ 28,414 $ 1,788 6.29% $ 26,422 $ 1,708 6.46%
Interest bearing deposits with banks $ 13,669 $ 722 5.28% $ 13,347 $ 765 5.73% $ 10,456 $ 619 5.92%
Federal funds sold 1,229 59 4.80% 3,665 197 5.38% 2,943 163 5.54%
Federal Home Loan Bank Stock 392 29 7.40% 135 10 7.41% - - 0.00%
-------- ------- ------ -------- ------- ------ -------- ------- ------
Total Interest-earning assets $123,030 $ 9,107 7.40% $110,892 $ 8,881 8.01% $103,631 $ 8,497 8.20%
Noninterest-earning assets
Cash and due from banks $ 5,187 $ 4,158 $ 3,844
Premises and equipment, net 4,478 3,496 3,431
Other, less allowance for loan losses 250 414 396
-------- -------- --------
Total noninterest-earning assets $ 9,915 $ 8,068 $ 7,671
-------- -------- --------
TOTAL ASSETS $132,945 $118,960 $111,302
======== ======== ========
</TABLE>
(1) Average loan balance include nonaccrual loans, if any. Interest income
on nonaccrual loans has been included.
(2) Tax-exempt income has been adjusted to a tax-equivalent basis using an
incremental rate of 34%.
17
<PAGE>
VALLEY COMMUNITY BANCSHARES, INC.
Distribution of Assets, Liabilities and Stockholders' Equity
<TABLE>
<CAPTION>
INTEREST RATES AND INTEREST DIFFERENTIAL
(dollars in thousands)
1999 1998 1997
--------------------------- -------------------------- ---------------------------
Average Revenue/ Yield/ Average Revenue/ Yield/ Average Revenue/ Yield/
balance expense rate balance expense rate balance expense rate
------- ------- ---- ------- ------- ---- ------- ------- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
LIABILITIES AND STOCKHOLDERS'
EQUITY
Interest-bearing liabilities
Deposits
Savings, NOW accounts, and
money markets $ 57,634 $ 1,396 2.42% $ 52,797 $ 1,466 2.78% $ 48,705 $ 1,420 2.92%
Time deposits < $100,000 21,019 981 4.67% 21,284 1,122 5.27% 22,141 1,145 5.17%
Time deposits > $100,000 12,582 578 4.59% 10,212 517 5.06% 9,727 483 4.97%
-------- ------- ------ -------- ------- ------ -------- ------- ------
Total deposits $ 91,235 $ 2,955 3.24% $ 84,293 $ 3,105 3.68% $ 80,573 $ 3,048 3.78%
Other borrowed funds 414 18 4.35% 691 34 4.92% 648 31 4.78%
-------- ------- ------ -------- ------- ------ -------- ------- ------
Total Interest-bearing $ 91,649 $ 2,973 3.24% $ 84,984 $ 3,139 3.69% $ 81,221 $ 3,079 3.79%
liabilities
------- ------- -------
Noninterest-bearing liabilities
Demand deposits $ 22,737 $ 19,492 $ 16,832
Other liabilities 697 742 617
-------- -------- --------
$ 23,434 $ 20,234 $ 17,449
Stockholders' equity 17,862 13,742 12,632
-------- -------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $132,945 $118,960 $111,302
======== ======== ========
Net interest income $ 6,134 4.99% $ 5,742 5.18% $ 5,418 5.23%
======= ======= =======
Margin Analysis
Interest income/ earning assets $ 9,107 7.40% $ 8,881 8.01% $ 8,497 8.20%
Interest expense/earning assets 2,973 2.42% 3,139 2.83% 3,079 2.97%
Net interest income/earning assets 6,134 4.99% 5,742 5.18% 5,418 5.23%
</TABLE>
18
<PAGE>
ANALYSIS OF CHANGES IN INTEREST DIFFERENTIAL. The following table sets forth, on
a tax-equivalent basis, a summary of the changes in net interest income
resulting from changes in volume and rates.
VALLEY COMMUNITY BANCSHARES, INC.
Distribution of Assets, Liabilities and Stockholders' Equity
<TABLE>
<CAPTION>
VOLUME AND YIELD/RATE VARIANCE
(in thousands and in tax equivalent basis)
1999 Compared to 1998 1998 Compared to 1997
---------------------------- ---------------------------
Volume Rate Net Volume Rate Net
------ ---- --- ------ ---- ---
<S> <C> <C> <C> <C> <C> <C>
Interest income
Loans
Commercial $ 84 $ (75) $ 9 $ (85) $ (31) $(116)
Real Estate 529 (172) 357 227 (41) 186
Installment (14) (12) (26) (20) (3) (23)
Other (12) (3) (15) 10 (7) 3
Fees on loans - (196) (196) - 64 64
------ ------ ------ ------ ------ ------
Total loans (including fees) $ 587 $(458) $ 129 $ 132 $ (18) $ 114
Investment securities
Taxable $ 450 $ (80) $ 370 $ 162 $ (27) $ 135
Tax-exempt (66) (45) (111) (58) 3 (55)
------ ------ ------ ------ ------ ------
Total investment securities $ 384 $(125) $ 259 $ 104 $ (24) $ 80
Interest bearing deposits with banks $ 18 $ (61) $ (43) $ 166 $ (20) $ 146
Federal funds sold (119) (19) (138) 39 (5) 34
Federal Home Loan Bank Stock 19 - 19 10 - 10
------ ------ ------ ------ ------ ------
Total Interest-earning assets $ 889 $(663) $ 226 $ 451 $ (67) $ 384
Interest-bearing liabilities
Deposits
Savings, NOW accounts, and
money markets $ 127 $(197) (70) $ 116 $ (70) 46
Time deposits < $100,000 (14) (127) (141) (45) 22 (23)
Time deposits > $100,000 112 (51) 61 24 10 34
------ ------ ------ ------ ------ ------
Total deposits $ 225 $(375) $(150) $ 95 $ (38) $ 57
Other borrowed funds (12) (4) (16) 2 1 3
------ ------ ------ ------ ------ ------
Total Interest-bearing liabilities $ 213 $(379) $(166) $ 97 $ (37) $ 60
------ ------ ------ ------ ------ ------
Net interest income/earning assets $ 676 $(284) $ 392 $ 354 $ (30) $ 324
====== ====== ====== ====== ====== ======
</TABLE>
(1) The change in interest due to both volume and yield/rate has been
allocated to change due to volume and change due to yield/rate in
proportion to the absolute value of the change in each.
(2) Balances of nonaccrual loans, if any, and related income recognized
have been included for computational purposes.
(3) Tax-exempt income has been converted to a tax-equivalent basis using
an incremental rate of 34%.
19
<PAGE>
INVESTMENT PORTFOLIO
The following table sets forth the carrying values, by type, of the
securities in the Company's portfolio:
VALLEY COMMUNITY BANCSHARES, INC.
Investment Portfolio (Dollars in thousands)
<TABLE>
<CAPTION>
Outstanding Balance at December 31,
---------- ---------- ----------
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
U.S. Treasury and U.S. Government
corporations and agencies $ 27,901 $ 26,449 $ 18,198
States of the United States and political 5,121 6,640 7,576
subdivisions
Other securities 1,481 528 -
--------- --------- ---------
Total $ 34,503 $ 33,617 $ 25,774
========= ========= =========
</TABLE>
Investments in States of the United States and political subdivisions represent
purchases of municipal bonds located in Washington State.
Investment in other securities includes corporate debt obligations made in
companies located and doing business throughout the United States. The debt
obligations were all within the credit ratings acceptable under the Company's
investment policy.
The investments below are reported by contractual maturity. Expected
maturities may differ from contractual maturities because borrows may have the
right to call or prepay obligations with or without prepayment penalties.
VALLEY COMMUNITY BANCSHARES, INC.
Investments as of December 31, 1999 (in thousands)
<TABLE>
<CAPTION>
After one After five
year but years but
Within within within After
One Year five years ten years ten years Total
--------- ----------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C>
U.S. Treasury and U.S. Government
corporations and agencies $ 6,342 $ 17,392 $ 880 $ 3,287 $ 27,901
States of the United States and political
subdivisions 1,597 3,524 5,121
Other securities 1,481 1,481
-------- --------- -------- -------- ---------
Total $ 7,939 $ 22,397 $ 880 $ 3,287 $ 34,503
======== ========= ======== ======== =========
Weighted average yield *
U.S. Treasury and U.S. Government
corporations and agencies 5.49% 5.92% 5.87% 6.06% 5.84%
States of the United States and political 4.90% 4.43% 4.57%
subdivisions
Other securities 5.73% 5.73%
-------- --------- -------- --------- ----------
Total 5.37% 5.67% 5.87% 6.06% 5.64%
======== ========= ======== ========= ==========
</TABLE>
Yields on tax-exempt obligations have not been computed on a tax-equivalent
basis.
LOAN PORTFOLIO
Managing risk is an essential part of successfully operating a
financial institution. The most prominent risk exposures regarding the loan
portfolio are credit quality and interest rate risk. Credit quality risk is the
risk of not collecting interest and/or principal balance of a loan when it is
due. Interest rate risk is the potential reduction of net interest income and
changes in the value of financial instruments as the result of rate movements.
The Company's loan portfolio is originated and managed with these risks in mind.
20
<PAGE>
The Company follows loan and interest rate risk policies, which have
been approved by the Banks' Board of Directors and are overseen by the Executive
Loan Committee, the Asset Liability Committee, and management. These policies
establish lending limits, review and grading criteria and other guidelines such
as loan administration, the allowance for loan losses, and maturity and interest
rate repricing criteria. Loan applications are approved by the Banks' Board of
Directors and/or designated officers in accordance with respective guidelines
and underwriting policies of the Company. Loans to one borrower are limited by
applicable state and federal banking laws and are further limited by internal
limits. Credit limits generally vary according to the type of loan and the
individual loan officer's experience.
TYPES OF LOANS
The following table sets forth the composition of the Company's loan
portfolio for the past five years ending at December 31, 1999 (dollars in
thousands).
VALLEY COMMUNITY BANCSHARES, INC.
Loan Portfolio
<TABLE>
<CAPTION>
Outstanding Balance at December 31,
-----------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Real Estate
Construction $ 7,384 $ 4,890 $ 1,282 $ 5,796 $ 4,837
Mortgage 15,867 13,788 15,087 12,602 12,586
Commercial 40,254 34,696 33,132 26,999 28,528
Commercial 12,892 12,496 11,694 10,858 9,004
Consumer and other 1,864 1,854 2,274 2,103 3,303
Lease financing 377 - - - -
------------- ------------- ------------- ------------- -------------
Total loans 78,638 67,724 63,469 58,358 58,258
Deferred loan fees, net (4) - - - -
------------- ------------- ------------- ------------- -------------
Net loans $ 78,634 $ 67,724 $ 63,469 $ 58,358 $ 58,258
============= ============= ============= ============= =============
</TABLE>
The Company's loan portfolio primarily consists of commercial loans,
residential real estate loans, and commercial real estate loans. At December 31,
1999, loans totaled approximately $78.634 million, which equals approximately 69
percent of total deposits and 59 percent of total assets. At December 31, 1999,
the majority of loans were originated directly by the Company to borrowers
within the Company's principal market area. As a result, the Company has
significant risk because of a lack of geographical diversification. The Company
mitigates this risk primarily by diversifying the loan portfolio by industry and
customer and by strong credit underwriting criteria. At December 31, 1999
approximately 36 percent of the Company's loan portfolio had adjustable rate
features and approximately 64 percent were fixed. Approximately 76 percent of
adjustable rate loans adjust within a twelve-month period and 96 percent of the
Company's fixed rate loan portfolio is scheduled to mature within a five-year
period.
Commercial loans consist primarily of loans to business for various
purposes, including, revolving lines of credit, equipment loans, and letters of
credit. These loans generally have short maturities, have either adjustable or
fixed rates and are unsecured or secured by inventory, accounts receivable,
equipment and/or real estate. The Company monitors portfolio diversification by
industry and by customer. At December 31, 1999, approximately 72 percent had
adjustable rates and 23 percent had fixed rates.
Real estate loans include various types of loans for which the
Company holds real property as collateral and consist of loans primarily on
single-family residences and commercial properties. These loans generally are
secured by a first priority lien but may also be secured by a second priority
lien. Real estate loans typically have maturities extending to five years and
have fixed or adjustable rate features. Construction loans are typically made
to contractors to construct single-family residences and commercial buildings
and generally have maturities to 18 months. Currently, the Company does not
originate real estate for sale to the secondary market, however, the Company
brokers real estate loans to other financial institutions for a fee. At
December 31, 1999, approximately 72 percent of the Company's real estate
loans were fixed rate and approximately 28 percent
21
<PAGE>
had adjustable rate features. However, 98 percent of the Company's real
estate loans are scheduled to mature and have adjustable rates within a
five-year period.
Consumer loans include various types of loans such as automobiles,
boats and recreational vehicles, personal and home equity lines of credit, and
other consumer orientated loans. At December 31, 1999, approximately 55 percent
of the consumer loan portfolio were fixed rate and approximately 45 percent had
adjustable rate features
There are no foreign loans outstanding during the years presented.
The interest rates charged on loans vary with the degree of risk, the
amount of the loan, and the maturity of the loan. Competitive pressures, market
interest rates, the availability of funds, and government regulation further
influence them.
MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES
The contractual maturities of the Company's loan portfolio are as shown
below. Actual maturities may differ from contractual maturities because
individual borrowers may have the right to prepay loans with or without
prepayment penalties.
<TABLE>
<CAPTION>
VALLEY COMMUNITY BANCSHARES, INC. After one
Loans as of December 31, 1999 (in thousands) year but
Within within After
One Year five years five years Total
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Real Estate
Construction $ 6,863 $ 521 $ - $ 7,384
Mortgage 2,665 12,096 1,106 15,867
Commercial 6,575 33,538 141 40,254
Commercial 8,859 3,219 814 12,892
Consumer and other 728 933 203 1,864
Lease financing 69 308 - 377
------------- ------------- ------------- -------------
Total loans $ 25,759 $ 50,615 $ 2,264 $ 78,638
============= ============= ============= =============
Loan maturities after one year with:
Fixed rates $ 44,169 $ 864
Variable rates 6,446 1,400
------------- -------------
$ 50,615 $ 2,264
============= =============
</TABLE>
RISK ELEMENTS
The following table sets forth information concerning the Company's
non-performing assets for the year ended December 31, 1999 (dollars in
thousands).
VALLEY COMMUNITY BANCSHARES, INC.
on-performing Assets
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
on-performing assets:
Nonaccrual loans $ - $ - $ - $ 509 $ -
Loans 90 days or more past due - 507 - -
Restructured loans
------------- ------------- ------------- ------------- -------------
- - 507 509 -
Other real estate owned - - - - -
------------- ------------- ------------- ------------- -------------
Total non-performing assets $ - 0 - $ - 0 - $ 507 $ 509 $ - 0 -
============= ============= ============= ============= =============
</TABLE>
22
<PAGE>
The accrual of interest on nonaccrual and other impaired loans is
discontinued at 90 days or when, in the opinion of management, the borrower may
be unable to meet payments as they become due. When interest accrual is
discontinued, all unpaid accrued interest is reversed. Interest income is
subsequently recognized only to the extent cash payments are received. Interest
income on restructured loans is recognized pursuant to the terms of the new loan
agreement. Interest income on other impaired loans is monitored and based upon
the terms of the underlying loan agreement. However, the recorded net investment
in impaired loans, including accrued interest, is limited to the present value
of the expected cash flows of the impaired loan or the observable fair market
value of the loans collateral.
During 1999 and 1998 there were no loans placed on nonaccrual status
and, therefore, there was no impact to interest income during those periods
presented.
SUMMARY OF LOAN LOSS EXPERIENCE
CHANGES IN THE ALLOWANCE FOR LOAN LOSSES
The following table sets forth information regarding changes in the
Company's allowance for loan losses for the most recent five years (dollars in
thousands):
CHART ON FOLLOWING PAGE.
23
<PAGE>
VALLEY COMMUNITY BANCSHARES, INC.
Loan Loss Experience
<TABLE>
<CAPTION>
Analysis of the Allowance for Loan Losses
Year ended December 31,
-----------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Balance at beginning of period $ 883 $ 840 $ 776 $ 752 $ 731
Charge-offs:
Real Estate
Construction
Mortgage
Commercial
Commercial
Consumer and other 8 11 3 1 19
Lease financing
------------- ------------- ------------- ------------- -------------
8 11 3 1 19
Recoveries:
Real Estate
Construction
Mortgage
Commercial 42
Commercial 3
Consumer and other 1 1 1
Lease financing
------------- ------------- ------------- ------------- -------------
- 45 1 1 1
Net charge-offs 8 (34) 2 18
Additions charged to operations 84 9 66 24 39
------------- ------------- ------------- ------------- -------------
Balance at end of period $ 959 $ 883 $ 840 $ 776 $ 752
============= ============= ============= ============= =============
Average Loans Outstanding $ 72,135 $ 65,331 $ 63,810 $ 58,586 $ 56,988
Ratio of net charge-offs during the
period to average loans outstanding 0.01% -0.05% 0.00% 0.00% 0.03%
Ratio of allowance for loan losses
to average loans outstanding 1.33% 1.35% 1.32% 1.32% 1.32%
</TABLE>
The allowance for loan losses is increased by charges to income and
decreased by charge-offs (net of recoveries), and established through a
provision for credit losses charged to expense. Loans are charged against the
allowance for credit losses when management believes that the collectability of
the principal is unlikely. The allowance is an amount that management believes
will be adequate to absorb losses inherent in existing loans, commitments to
extend credit and standby letters of credit based on evaluations of
collectability and prior loss experience of loans, commitments to extend credit
and standby letters of credit. The evaluations take into consideration such
factors as changes in the nature and volume of the portfolio, overall portfolio
quality, loan concentrations, specific problem loans, commitments, standby
letters of credit and current economic conditions that may affect the borrowers'
ability to pay.
A material estimate that is particularly susceptible to significant
change relates to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In
24
<PAGE>
connection with the determination of the estimated losses on loans and
foreclosed assets held for sale, management obtains independent appraisals
for significant properties.
The majority of the Company's loan portfolio consists of commercial
loans and single-family residential loans secured by real estate in the Puyallup
and Pierce County areas and also in the Auburn and King County area. Real estate
prices in this market are stable at this time. However, the ultimate
collectability of a substantial portion of the Company's loan portfolio may be
susceptible to change in local market conditions in the future.
While management uses available information to recognize losses on
loans, further reductions in the carrying amounts of loans may be necessary
based on changes in local economic conditions. In addition, regulatory agencies,
as an integral part of their examination process, periodically review the
estimated losses on loans. Such agencies may require the Company to recognize
additional losses based on their judgment about information available to them at
the time of their examination.
BREAKDOWN OF ALLOWANCE FOR LOAN LOSSES BY CATEGORY
The following table sets forth information concerning the Company's
allocation of the allowance for loan losses (dollars in thousands).
<TABLE>
<CAPTION>
Allocation of the Allowance for Loan Losses
Year ended December 31,
-----------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------- ------------- ------------- ------------- -------------
Amount % * Amount % * Amount % * Amount % * Amount % *
<S> <C> <C> <C> <C> <C>
Balance at end of period applicable to:
Real Estate
Construction $ 55 9% $ 37 7% $ 10 2% $ 43 10% $ 36 8%
Mortgage 16 20% 14 20% 15 24% 13 22% 13 22%
Commercial 141 51% 121 51% 116 52% 94 46% 100 49%
Commercial 129 16% 125 18% 117 18% 109 19% 90 15%
Consumer and other 37 2% 37 3% 45 4% 42 4% 66 6%
Lease financing 4 0% - 0% - 0% - 0% - 0%
Unallocated 577 NA 549 NA 537 NA 475 NA 447 NA
------------- ------------- ------------- ------------- -------------
$ 959 100% $ 883 100% $ 840 100% $ 776 100% $ 752 100%
============= ============= ============= ============= =============
</TABLE>
* Percent of loans in each category to total loans
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses reflects management's best estimate of
probable losses that have been incurred as of the balance sheet date. The
allowance for loan losses is maintained at a level considered adequate by
management to provide for loan losses inherent in the loan portfolio based on
management's assessment of various factors affecting the loan portfolio,
including, local economic conditions and growth of the loan portfolio and its
composition. Non-performing loans and net charge offs during these periods have
been minimal, demonstrating strong credit quality. Increases in the allowance
for loan losses made though provisions were primarily a result of loan growth.
Management determines the amount of the allowance for loan losses by
utilizing a loan grading system to determine risk in the loan portfolio and by
considering the results of credit reviews. The loan portfolio is separated by
quality and then by loan type. Loans of acceptable quality are evaluated as a
group, by loan type, with a specific loss rate assigned to the total loans in
each type, but unallocated to any individual loan. Conversely, each adversely
classified loan is individually analyzed, to determine an estimated loss amount.
A valuation allowance is also assigned to these adversely classified loans, but
at a higher loss rate due to the greater risk of loss. For those loans where the
estimated loss is greater than the background percentage, the estimated loss
amount is considered specifically allocated to the allowance.
Although management has allocated a portion of the allowance to the
loan categories using the method described above, the adequacy of the allowance
must be considered as a whole. To mitigate the imprecision in most estimates of
expected
25
<PAGE>
loan losses, the allocated component of the allowance is supplemented by an
unallocated component. The unallocated portion includes management's
judgmental determination of the amounts necessary for qualitative factors
such as the consideration of new products and policies, economic conditions,
concentrations of credit risk, and the experience and abilities of lending
personnel. Loan concentrations, quality, terms and basic underlying
assumptions remained substantially unchanged during the period.
The Company uses the historical loss experience method in conjunction
with the specific identification method for calculation of the adequacy of
allowance for loan losses. A six-year average historical loan loss rate is
calculated. This experience loss rate is applied to graded loans that are not
adversely classified for a subtotal of needed allowance. Loans adversely
classified are analyzed for potential loss on an individual basis. This subtotal
is added to the experience subtotal and the total is compared to the allowance
for loan losses.
The Company also evaluates current conditions and may adjust the
historical loss estimate by qualitative factors that effect loan repayment.
These factors may include levels of, and trends in, delinquencies and
non-accruals; trends in volume and terms of loans; effects of any changes in
lending policies; experience, ability and depth of management and lending staff;
national and local economic trends; concentrations of credit; and any legal and
regulatory requirements.
DEPOSITS
TYPES OF DEPOSITS
The Company's primary source of funds is customer deposits. The Company
attempts to maintain a high percentage of noninterest-bearing deposits, which
are a low cost funding source. In addition, the Company offers a variety of
interest-bearing accounts designed to attract both short-term and longer-term
deposits from customers. Interest-bearing accounts earn interest at rates
established by bank management based on competitive market factors and the
Company's need for funds. The Company traditionally has not purchased brokered
deposits and does not intend to do so in the future.
The following table sets forth the average balances for each major
category of deposit and the weighted average interest rate paid for deposits
during the year ended December 31 (dollars in thousands).
VALLEY COMMUNITY BANCSHARES, INC.
Deposits
<TABLE>
<CAPTION>
Average Deposits by Type
---------------- ---------------- --------------- ---------------- ---------------
1999 1998 1997 1996 1995
---------------- ---------------- --------------- ---------------- ---------------
Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate
---------------- ---------------- --------------- ---------------- ---------------
<S> <C> <C> <C> <C> <C>
Noninterest bearing demand deposits $ 22,737 $ 19,492 $ 16,832 $ 15,157 $ 15,321
Interest bearing demand deposits 16,279 1.19% 14,143 1.51% 13,395 1.61% 11,697 1.60% 11,851 1.60%
Money market deposit 28,963 3.26% 27,806 3.58% 24,979 3.81% 18,822 3.77% 15,244 3.89%
Savings deposits 12,392 2.08% 10,848 2.36% 10,331 2.45% 10,425 2.45% 11,895 2.51%
Time certificates < $100,000 21,019 4.67% 21,284 5.27% 22,141 5.17% 23,569 5.28% 20,843 5.16%
Time certificates > $100,000 12,582 4.59% 10,212 5.06% 9,727 4.97% 10,021 5.15% 9,834 4.97%
--------- --------- --------- --------- ---------
$113,972 $ 103,785 $ 97,405 $ 89,691 $ 84,988
========= ========= ========= ========= =========
</TABLE>
CERTIFICATES OF DEPOSIT AND TIME DEPOSITS
The following table shows the amounts and remaining maturities of time
certificates of deposit that had balances of more than $100,000 at December 31
(in thousands).
CHART ON FOLLOWING PAGE.
26
<PAGE>
VALLEY COMMUNITY BANCSHARES, INC.
Deposit Maturity
<TABLE>
<CAPTION>
Outstanding Balance at December 31,
-----------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
3 months or less $ 7,235 $ 5,997 $ 4,668 $ 6,024 $ 6,669
Over 3 through 12 months 6,820 4,368 4,076 3,644 3,367
Over 12 through 36 months 500 327 606 427 157
Over 36 months 182 172 - -
------------- ------------- ------------- ------------- -------------
Total $ 14,555 $ 10,874 $ 9,522 $ 10,095 $ 10,193
============= ============= ============= ============= =============
</TABLE>
RETURN ON EQUITY AND ASSETS
The following table shows the various performance ratios for the
Company for the past five years:
VALLEY COMMUNITY BANCSHARES, INC.
Return on Equity and Assets
<TABLE>
<CAPTION>
For the Year Ended December 31,
1999 1998 1997 1996 1995
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Return on average assets (net income divided by average assets) 1.05% 1.24% 1.43% 1.33% 1.45%
Return on equity (net income divided by average equity) 7.80% 10.78% 12.60% 11.89% 13.49%
Dividend payout ratio (dividends per share divided by net 9.64% 60.18% 31.71% 36.16% 35.68%
income per share)
Equity to assets ratio (Average equity divided by average assets) 13.44% 11.55% 11.35% 11.22% 10.74%
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
Management actively analyzes and manages the Company's liquidity
position. The objective of liquidity management is to ensure the availability of
sufficient cash flows to meet all financial commitments and to capitalize on
opportunities for profitable business expansion. Management believes that the
Company's cash flow will be sufficient to support its existing operations for
the foreseeable future.
Cash flows from operations contribute significantly to liquidity as
well as proceeds from maturities of securities and increasing customer deposits.
As indicated on the Company's Consolidated Statement of Cash Flows, net cash
from operating activities contributed $2.0 million to liquidity in 1999, $1.9
million in 1998, and $2.1 million in 1997. The majority of the Company's funding
comes from customer deposits within its operating region. Customer deposits
provided $3.5 million in 1999, $12.1 million in 1988 and $4.7 million in 1997.
In 1999, certificates of deposit over $100,000 provided the majority of the
deposit growth while in 1998 the deposit grown was primarily in core deposits
(demand, money market, and savings accounts). The majority of the $14.6 million
of certificates of deposit over $100,000 is from local bank customers and are
not solicited from brokers or municipalities. The Company considers these
deposits a stable source of funds.
Another important source of liquidity is investments in federal funds
and interest-bearing deposits with banks and the Company's security portfolio.
The Company maintains a ladder of securities that provides prepayments and
payments at maturity and a portfolio of available-for-sale securities that could
be converted to cash quickly. Proceeds from maturities of securities provided
$15.4 million in 1999, $16.2 million in 1998, and $7.2 million in 1997.
27
<PAGE>
Borrowing represents an important long term and manageable source of
liquidity based on the Company's ability to raise new funds and renew maturing
liabilities in a variety of markets. The Banks are members of the Federal Home
Loan Bank of Seattle and have committed lines of credit up to ten percent of
assets. In addition, the Banks have committed line of credit agreements totaling
approximately $6.75 million from unaffiliated banks with maturities that range
from April 2000 to June 2000.
The Company's total stockholder's equity increased to $18.7 million at
December 31, 1999, from $14.1 million at December 31, 1998. At December 31,
1999, stockholders' equity was 13.99 percent of total assets, compared to 11.23
percent at December 31, 1998. At December 31, 1999, the bank held cash and due
from banks, interest-bearing deposits with banks, and federal funds sold of
approximately $14.8 million. In addition, at such date $33.3 million of the
Company's investments were classified as available-for-sale.
The market value of available-for-sale securities was less than book
value at year-end, primarily as a result of increasing interest rates, which
resulted in an unrealized loss in the investment portfolio. Management does not
believe the sale of the Company's securities would materially affect the overall
condition of the Company.
The capital levels of the Company currently exceed applicable
regulatory guidelines at December 31, 1999. Management believes the Company's
capital will be adequate to fund the start up and related costs associated
with any new branches and Valley bank until it can achieve the deposit and
loan levels necessary to be profitable. The Company has commitments to
construct a $2 million permanent facility at 10th and D Street in Auburn,
Washington. It is anticipated the building will be completed in June 2000.
The primary impact of inflation on the Company's operations is
increased asset yields, deposit costs and operating overhead. Unlike most
industries, virtually all of the assets and liabilities of a financial
institution are monetary in nature. As a result, interest rates generally have a
more significant impact on a financial institution's performance than they would
on non-financial companies. Although interest rates do not necessarily move in
the same direction or to the same extent as the prices of goods and services,
increases in inflation generally have resulted in increased interest rates. The
effects of inflation can magnify the growth of assets and if significant,
require that equity capital increase at a faster rate than would be otherwise
necessary.
INTEREST RATE RISK
Interest rate risk refers to the exposure of earnings and capital
arising from changes in interest rates. Management's objectives are to control
interest rate risk and to ensure predictable and consistent growth of earnings
and capital. Interest rate risk management focuses on fluctuations in net
interest income identified through computer simulations to evaluate volatility
varying interest rate, spread and volume assumptions. The risk is quantified and
compared against tolerance levels.
The simulation model used by the Company combines the significant
factors that affect interest rate sensitivity into a comprehensive earnings
simulation. Earning assets and interest-bearing liabilities with longer lives
may be subject to more volatility than those with shorter lives. The model
accounts for these differences in its simulations. At December 31, 1999, the
simulation modeled the impact of assumptions that interest rates would increase
or decrease 200 basis points. Results indicated the Company was positioned so
equity would not drop below that point where the Company, for regulatory
purposes, would continue to be classified "well capitalized". It should be
emphasized that the model is static in nature and does not take into
consideration possible management actions to minimize the impact on equity.
Management also matches assets and liabilities on a maturity gap analysis and
repricing gap analysis to assist in interest rate sensitivity measurement.
Interest rate sensitivity is closely related to liquidity because each
is directly affected by the maturity of assets and liabilities. Management
considers any asset or liability, which matures, or is subject to repricing over
one year, to be interest sensitive, although continual monitoring is also
performed for other time intervals. The difference between interest-sensitive
assets and liabilities for a defined period of time is known as the
interest-sensitive "gap" and may be either positive or negative. If positive,
more assets reprice before liabilities; if negative, the reverse is true. In
theory, if the gap is positive, a decrease in general interest rates might have
an adverse impact on earnings as interest income decreases faster than interest
expense. This assumes that management adjusts rates equally as general interest
rates fall. Conversely, an increase in interest rates would increase net
interest income as interest income increases faster than interest expense.
However, the exact impact of the gap on
28
<PAGE>
future income is uncertain both in timing and amount because interest rates
for the Company`s assets and liabilities can change rapidly as a result of
market conditions and customer patterns.
The simulation model process provides a dynamic assessment of interest
rate sensitivity, whereas a static interest rate gap table is compiled as of a
point in time. The model simulations differ from a traditional gap analysis
because a traditional gap analysis does not reflect the multiple effects of
interest rate movement on the entire range of assets, liabilities and ignores
the future impact of new business strategies.
IMPACT OF THE YEAR 2000 ISSUE
The Company did not experience any difficulties as a result of the
rollover into the Year 2000 nor does it anticipate any problems during 2000.
However, the Company continues to be vigilant monitoring its systems, loan
portfolio and customer base for potential problems.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's results of operations are largely dependent upon its
ability to manage market risks. Changes in interest rates can have a significant
effect on the Company's financial condition and results of operation. Other
types of market risk such as foreign currency exchange rate risk and commodity
price risk do not arise in the normal course of the Banks' business activities.
The Company does not use interest rate risk management products such as interest
rate swaps, hedges or derivatives, nor does management intend to use such
products in the future. All of the Company's transactions are denominated in
U.S. Dollars. Approximately 35% of the Company's loan portfolio has interest
rates which are variable. Fixed rate loans are generally made with a term of
five years or less.
The following table sets forth the estimated maturity or repricing and
the resulting interest sensitivity gap, of the Company's interest-earning assets
and interest-bearing liabilities and the cumulative interest sensitivity gap at
December 31, 1999. The expected maturities are presented on a contractual basis.
Actual maturities may differ from contractual maturities because of prepayment
assumptions, early withdrawal of deposits and competition.
<TABLE>
<CAPTION>
VALLEY COMMUNITY BANCSHARES, INC.
Contractual Maturity or Repricing Outstanding Balance at December 31, 1999
Less than Three One to Over
three months to five five Cumulative
months one year years years Total
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Interest - earning assets
Interest-bearing deposits with banks $ 9,293 $ 199 $ 200 $ - $ 9,692
Investments 4,251 8,638 21,157 457 34,503
Loans 21,404 8,808 47,642 780 78,634
Other 420 - - - 420
------------- ------------- ------------- ------------- -------------
Total interest - earning assets $ 35,368 $ 17,645 $ 68,999 $ 1,237 $ 123,249
============= ============= ============= ============= =============
Interest-bearing liabilities
Interest bearing demand deposits $ 15,926 $ - $ - $ - $ 15,926
Money market deposit and Savings 40,605 - - - 40,605
Time certificates < $100,000 7,000 13,234 1,140 - 21,374
Time certificates > $100,000 7,232 6,823 500 - 14,555
Other borrowed funds 539 539
------------- ------------- ------------- ------------- -------------
Total interest-bearing liabilities $ 71,302 $ 20,057 $ 1,640 $ - $ 92,999
Interest sensitivity gap $ (35,934) $ (2,412) $ 67,359 $ 1,237 $ 30,250
============= ============= ============= ============= =============
Cumulative interest sensitivity gap $ (35,934) $ (38,346) $ 29,013 $ 30,250
============= ============= ============= =============
Cumulative interest sensitivity gap
as a percent of total assets -26.85% -28.65% 21.68% 22.60%
============= ============= ============= =============
</TABLE>
29
<PAGE>
Certain shortcomings are inherent in the method of analysis presented
in the foregoing table. For example although certain assets and liabilities may
have similar maturities and periods to repricing, they may react differently to
changes in market interest rates. Also, interest rates on assets and liabilities
may fluctuate in advance of changes in market interest rates, while interest
rates on other assets and liabilities may follow changes in market interest
rates. Additionally, certain assets have features that restrict changes in the
interest rates of such assets, both on a short-term basis and over the lives of
such assets.
According to the traditional banking industry static gap table set
forth above, the Company was liability sensitive with a negative cumulative
one-year gap of $38.3 million or -28.6 percent of total assets at December 31,
1999. In general, based upon the Company's mix of deposits, loans and
investments, increases in interest rates would be expected to result in a
decrease in the Company's net interest margin, and a decrease in interest rates
would be expected to result in an increase in the Company's net interest margin.
As noted above, the static gap report is subject to inherent
limitations. To more accurately predict the Company's interest rate exposure, a
financial analysis (dynamic gap) to analyze the change in the net interest
margin from a changing rate environment is provided below. This estimate of
interest rate sensitivity takes into account the differing time intervals and
rate change increments of each type of interest-sensitive asset and liability.
It then measures the projected impact of changes in market interest rates on the
Company's net interest income, net interest income and return on equity.
Based on a financial analysis performed as of December 31, 1999, which
takes into account how the specific interest rate scenario would be expected to
affect each interest-earning asset and each interest-bearing liability, the
company estimates that changes in the federal fund interest rate would affect
the Company's performance as follows.
VALLEY COMMUNITY BANCSHARES, INC.
Financial Analysis
<TABLE>
<CAPTION>
Increase (Decrease) In
Net Interest Net Interest Return on
Income Margin Equity
------------- ------------- -------------
(dollars in thousands)
<S> <C> <C> <C>
(Current federal fund rate is 5.50%)
Federal fund rate increase of:
100 basis points to 6.50% $ (403) -0.32% -1.31%
200 basis points to 7.50% $ (726) -0.58% -2.42%
Federal fund rate decrease of:
100 basis points to 4.50% $ 332 0.23% 1.15%
200 basis points to 3.50% $ 507 0.33% 1.73%
</TABLE>
No assurances can be given that the actual net interest margin
(percentage) or net interest income would increase or decrease by such amounts
in a 100 or 200 basis point increase or decrease in the federal fund rate.
FOR THE THREE MONTHS ENDED MARCH 31, 2000 AND 1999
RESULTS OF OPERATION
The Company earned net income of $377,000, or $0.33 per diluted share
for the three months ended March 31, 2000, compared to net income of $284,000,
or $0.25 per diluted share, for the three months ended March 31, 1999, an
increase of 33 percent. The Company's return on average assets was 1.13 percent
for the three months ended March 31, 2000, compared to .90 percent for the three
months ended March 31, 1999.
The increase in net income for the three month period ended March 31,
2000 was primarily the result of an increase in net interest income that
reflects an improvement in the Company's net interest margin and from a growth
in earning assets, primarily loans. Earnings were negatively impacted by higher
operating costs associated with the holding company and Valley Bank, and lower
origination fees on mortgage loans brokered.
30
<PAGE>
The Company's net income is derived principally from the operating
results of its banking subsidiaries, namely Puyallup Valley Bank and Valley
Bank. Puyallup Valley Bank is a well-established commercial bank and generates
the Company's operating income. Puyallup Valley Bank earned net income of
$405,000 for the three months ended March 31, 2000, compared to $339,000 for
the three months ended March 31, 1999. Valley Bank incurred losses of $19,000
for the three months ended March 31, 2000, compared to losses of $57,000 for
the three months ended March 31, 1999. It is anticipated that Valley Bank will
continue to incur operating losses during its early years of operation but that
the losses will continue to not have a significant impact on the Company. There
can be no assurance, however, that Valley Bank will not incur more significant
losses, which could have an adverse impact on the Company's earnings, dividend
payments or future growth.
The following table shows the various performance ratios for the Company
for the three month periods ended March 31, 2000 and March 31, 1999.
<TABLE>
<CAPTION>
VALLEY COMMUNITY BANCSHARES, INC.
Selected Financial Data
(dollars in thousands, except per sahre amounts) THREE MONTHS ENDED MARCH 31,
2000 1999
--------------- --------------
<S> <C> <C>
FINANCIAL PERFORMANCE
Net Income $377 $284
Average Assets 134,133 128,273
Average Stockholders' Equity 18,417 17,786
Return on Assets (net income divided by average assets) 1.13% 0.90%
Return on Equity (net income divided by average equity) 8.21% 6.48%
Efficiency Ratio (noninterest expense divided by
noninterest income plus net interst income) 67.90% 73.30%
Ratio of noninterest income to average assets 3.58% 3.61%
</TABLE>
31
<PAGE>
NET INTEREST INCOME
The Company's largest component contributing to net income is net
interest income, which is the difference between interest earned on earning
assets (primarily loans and investments) and interest paid on interest-bearing
liabilities (deposits and borrowings). The volume of, and yields earned on,
earning assets and the volume of, and rates paid on, interest-bearing
liabilities determine net interest income. Interest earned and interest paid are
also affected by general economic conditions, particularly changes in market
interest rates, and by government policies and the action of regulatory
authorities. Net interest income divided by average earning assets is referred
to "net interest margin." For the three months ended March 31, 2000, the
Company's net interest margin was 5.36 percent compared to 4.93 percent for the
three months ended March 31, 1999.
Net interest income for the three months ended March 31, 2000 totaled
$1,627,000 compared to $1,404,000 for the three months ended March 31, 1999, a
16 percent increase. The increase resulted from an increase in the volume of
interest-earning assets (primarily loans) and an increase in the Company's net
interest margin.
Interest income was $2,400,000 for the three months ended March 31,
2000 compared to $2,134,000 for the three months ended March 31, 1999. The
increase was due to an increase in the yield earned and growth in
interest-earning assets. The yield on interest-earning assets increased to 7.86
percent for the three months ended March 31, 2000, compared to 7.42 percent
during the same period a year ago. The yield increase was primarily a result of
a greater percentage of the Company's earning assets concentrated in loans and
from an overall increase in interest rates and the resulting impact on
adjustable rate loans and securities.
Interest expense was $773,000 for the three months ended March 31,
2000, compared to $726,000 for the three months ended March 31, 1999. The
increase was due to a slight increase in the cost of funds and growth in
interest-bearing liabilities. The cost of funds increased to 3.38 percent for
the three months ended March 31, 2000, compared to 3.33 percent during the same
period a year ago. The costof-funds increase was primarily related to a higher
concentration in certificate of deposits greater the $100,000 and an overall
increase in market interest rates.
During the three months ended March 31, 2000, market interest rates
increased and it is anticipated they will increase further. In periods of rising
interest rates, the Company's net interest income and margin may decrease
because the Company has a greater amount of interest-bearing liabilities subject
to more rapid repricing than interest-earning assets. The Company's strategy to
offset rising rates is to increase commercial and commercial real estate lending
as a percentage of interest-earning assets while continuing its emphasis on
noninterest-bearing deposits and other deposits with administered interest rates
such as NOW, savings and money market accounts to fund such assets.
32
<PAGE>
The following table sets forth information concerning the
Company's average balance and average interest rates earned or paid,
interest rate spread and net interest margin for the three month
periods ended March 31:
VALLEY COMMUNITY BANCSHARES, INC.
AVERAGE BALANCES AND INTEREST RATES EARNED/PAID
(dollars in thousands)
<TABLE>
<CAPTION>
2000 1999
------------------------------- --------------------------------
Average Revenue/ Yield/ Average Revenue/ Yield/
ASSETS balance expense rate balance expense rate
--------- --------- -------- --------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets
Loans (including fees) $ 82,040 $1,812 8.86% $ 68,533 $1,474 8.72%
Investment securities 34,553 509 5.91% 33,203 476 5.82%
Interest bearing deposits with banks 6,976 103 5.92% 14,049 184 5.31%
Federal funds sold - - 0.00% 2,595 31 4.84%
Federal Home Loan Bank Stock 420 7 6.68% 360 7 7.89%
---------- --------- -------- ----------- ---------- --------
Total Interest-earning assets 123,989 $2,431 7.86% 118,740 $2,172 7.42%
Total noninterest-earning assets 10,143 9,533
----------- ------------
TOTAL ASSETS $134,132 $128,273
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities
Deposits $ 91,240 $ 768 3.38% $ 88,545 $ 726 3.33%
Other borrowed funds 419 5 4.79% 384 4 4.22%
---------- --------- -------- ----------- --------- --------
Total Interest-bearing liabilities 91,659 $ 773 3.38% 88,929 $ 730 3.33%
Noninterest-bearing liabilities 24,056 21,558
Stockholders' equity 18,417 17,786
TOTAL LIABILITIES AND ---------- -----------
STOCKHOLDERS' EQUITY $134,132 $128,273
========== ===========
--------- -------- -------------------
Net interest spread $1,658 4.48% $1,442 4.09%
Margin Analysis
Interest income/ earning assets $2,431 7.86% $2,172 7.42%
Interest expense/earning assets 773 2.50% 730 2.49%
--------- -------- -------------------
Net interest margin 1,658 5.36% 1,442 4.93%
</TABLE>
1 Average loan balance include nonaccrual loans, if any. Interest income
on nonaccrual loans has been included.
2 Tax-exempt income has been adjusted to a tax-equivalent basis using an
incremental rate of 34%.
33
<PAGE>
The following table sets forth information concerning the Company's
change in net interest income for the periods that are attributable to changes
in interest rate and changes in volume for the three month period ended March
31, 2000, compared to the three months ended March 31, 1999.
VALLEY COMMUNITY BANCSHARES, INC.
Volume/Rate Analysis
(dollars in thousands)
<TABLE>
<CAPTION>
2000 Compared to 1999
-----------------------------------------
VOLUME RATE NET
------ ---- ---
<S> <C> <C> <C>
Interest income
Loans (including fees) $320 $18 $338
Investment securities 34 (2) 32
Interest bearing deposits with banks (82) 1 (81)
Federal funds sold (27) (4) (31)
Federal Home Loan Bank Stock 2 (2) -
----------- ----------- -----------
Total Interest-earning assets 247 11 258
Interest-bearing liabilities
Total deposits 53 (11) 42
Other borrowed funds - 1 1
----------- ----------- -----------
Total Interest-bearing liabilities 53 (10) 43
=========== ============= ===========
Net interest income $194 $21 $215
=========== ============= ===========
</TABLE>
1 The change in interest due to both volume and yield/rate has been
allocated to change due to volume and change due to yield/rate in
proportion to the absolute value of the change in each.
2 Balances of nonaccrual loans, if any, and related income recognized have
been included for computational purposes.
3 Tax-exempt income has been converted to a tax-equivalent basis using an
incremental rate of 34%
PROVISION FOR LOAN LOSSES
Provisions for loan losses reduce net interest income. The Company
provided $27,000 for loan losses for the three months ended March 31, 2000
compared to $15,000 during the same period last year. The provision was made as
a result of increasing loans.
As a result of the increase in provision for loan losses, management
believes the allowance for loan losses to be adequate to absorb losses in the
current portfolio. This statement is based upon management's continuing
evaluation of inherent risks in the current loan portfolio, current levels of
classified assets, and economic factors. The Company will continue to monitor
the allowance and make future adjustments to the allowance as conditions
dictate. For further discussion regarding the allowance for loan losses, see the
discussion on allowance for loan losses under Risk Elements.
NONINTEREST INCOME AND EXPENSE
Net income is also affected by noninterest income (primarily service
charges and other operating income) and noninterest expenses (primarily salaries
and employee benefits, occupancy, equipment, and other operating expenses).
Noninterest income was $142,000 for the three months ended March 31,
2000, a decrease from $154,000 for the three months ended March 31, 1999. The
decrease in noninterest income was primarily related to lower origination fees
on mortgage
34
<PAGE>
loans brokered, which decreased as a result of higher mortgage interest rates
in 2000 and a lower volume of loan applications processed. Based on the current
interest rate environment, the Company anticipates that mortgage loans brokered
will remain at low level during the remainder of the year 2000 compared to the
levels realized in 1999.
Noninterest expense was $1,203,000 for the three months ended March 31,
2000, compared to $1,142,000 for the three months ended March 31, 1999.
Noninterest expense continues to be impacted by higher salary and employee
benefits, occupancy and equipment, and other operating expenses associated with
the operation of the new Graham Branch facility (November 1998) and Valley Bank
(January 1999). The percentage of noninterest expense to average assets was 3.58
percent for the three months ended March 31, 2000, compared to 3.61 percent
during the same period last year.
The Company's efficiency ratio (the ratio of noninterest expense to net
interest income plus noninterest income) was 67.9 percent for the three months
ended March 31, 2000, compared to 73.3 percent for the three months ended March
31, 1999. The improvement in the ratio was primarily due to a greater increase
in net interest income, resulting from the increase in loans, when compared to
the increase in noninterest expense.
PROVISION FOR INCOME TAXES
The Company's provision for income taxes is a significant reduction of
operating income. The provision for the three months ended March 31, 2000 was
$162,000, compared to $117,000 for the three months ended March 31, 1999. This
amount represents an effective taxing rate of 30 percent and 29 percent during
2000 and 1999, respectively. The Company's marginal tax rate is currently 34
percent. The difference between the Company's effective and marginal tax rate is
primarily related to investments made in tax-exempt securities.
FINANCIAL CONDITION
The Company's total consolidated assets were $135.5 million as of March
31, 2000, compared to $133.8 million as of December 31, 1999. The increase in
assets was primarily in loans, funded by increasing deposits and maturing
securities. The new Graham Branch and Valley Bank impacted the growth in
deposits.
INVESTMENT PORTFOLIO
As of March 31, 2000, the Company had $31.9 million of securities
available for sale, compared to $33.3 million as of December 31, 1999. The
decrease resulted from maturities and principal repayments on amortizing
securities. As of March 31, 2000, approximately 96 percent of the Company's
securities were classified as available for sale. Management believes that a
high percentage of securities classified as available for sale provides greater
flexibility to respond to interest rate changes and liquidity needs to fund loan
growth.
LOAN PORTFOLIO
Loans were $83.9 million as of March 31, 2000, compared to $78.6
million as of December 31, 1999. This increase was primarily in construction and
commercial real estate loans. The percentage of loans to total assets increased
to 61.9 percent at March 31, 2000, compared to 58.8 percent at December 31,
1999. It is management's intent to grow the loan portfolio and to increase the
percent of loans to assets, which potentially could improve the Company's net
interest margin.
35
<PAGE>
The following table sets forth the composition of the Company's loan
portfolio as of the dates indicated.
<TABLE>
<CAPTION>
VALLEY COMMUNITY BANCSHARES, INC.
Loan Portfolio
(dollars in thousands) March 31, December 31,
--------------------------- ---------------------------
2000 1999
--------------------------- ---------------------------
Amount Percent Amount Percent
------------ ------------- ------------- ------------
<S> <C> <C> <C> <C>
Real Estate
Construction $ 8,288 9.9% $ 7,384 9.4%
Mortgage 16,314 19.4% 15,867 20.2%
Commercial 43,731 52.1% 40,254 51.2%
Commercial 12,938 15.4% 12,892 16.4%
Consumer and other 2,168 2.6% 1,864 2.4%
Lease financing 529 0.6% 377 0.5%
------------ ------------- ------------- ------------
Total loans 83,968 100.0% 78,638 100.0%
============= ============
Unearned income (36) (4)
------------ -------------
Net loans $83,932 $78,634
============ =============
</TABLE>
36
<PAGE>
RISK ELEMENTS
As of March 31, 2000 and December 31, 1999, the Company had no
nonperforming assets, which includes nonaccrual loans, loans 90 days or more
past due and still accruing interest, and restructured loans.
During the three-month periods ended March 31, 2000 and March 31, 1999,
there were no loans placed on nonaccrual status and, therefore, there was no
impact to interest income during those periods presented.
SUMMARY OF LOAN LOSS EXPERIENCE
The following table sets forth information regarding changes in the
Company's allowance for loan losses for the dates indicated (dollars in
thousands):
VALLEY COMMUNITY BANCSHARES, INC.
Loan Loss Experience
<TABLE>
<CAPTION>
Thre months ended March 31,
---------------------------
2000 1999
------------ -------------
<S> <C> <C>
Balance at beginning of period $ 959 $ 883
Charge-offs - -
Recoveries: - -
Net charge-offs - -
Additions charged to operations 27 15
------------ -------------
Balance at end of period $ 986 $ 898
============ =============
Average Loans Outstanding $82,040 $68,533
Ratio of net charge-off during the
period to average loans outstanding 0.00% 0.00%
Ratio of allowance for loan losses
to average loans outstanding 1.20% 1.31%
</TABLE>
There were no charge-offs or recoveries of loans during the three
months ended March 31, 2000 and March 31, 1999. However, the ratio of the
allowance for loan losses to average loans outstanding decreased from 1.31
percent at March 31, 1999 to 1.20% at March 31, 2000. The decrease was the
result of loan growth exceeding the growth in the allowance for loan losses. The
ratio is anticipated to increase during the balance of the year 2000, as a
result of increased provisions to the allowance for loan losses.
The allowance for loan losses is maintained at an amount considered
adequate by management to provide for loan losses inherent in the loan portfolio
based on management's assessment of various factors affecting the loan
portfolio, including local economic conditions and growth of the loan portfolio
and its composition. Non-performing loans and net charge offs during the periods
presented have been minimal, demonstrating strong credit quality. Increases in
the allowance for loan losses made though provisions were primarily a result of
loan growth.
DEPOSITS
The Company's primary source of funds is customer deposits. The Company
attempts to maintain a high percentage of noninterest-bearing deposits, which
are a low cost funding source. In addition, the Company offers a variety of
interest-bearing accounts designed to attract both short-term and longer-term
deposits from customers. Interest-bearing accounts earn
37
<PAGE>
interest at rates established by bank management based on competitive market
factors and the Company's need for funds. The Company traditionally has not
purchased brokered deposits and does not intend to do so in the future.
Deposits increased to $115.6 million as of March 31, 2000, compared to
$113.8 million as of December 31, 1999. Time certificates in excess of $100,000
increased to $15.9 million as of March 31, 2000, compared to $14.6 million as of
December 31, 1999.
The following table sets forth the balances for each major category of
deposit by amount and percent during the periods indicated.
<TABLE>
<CAPTION>
VALLEY COMMUNITY BANCSHARES, INC.
Deposits
(dollars in thousands) Period ended,
------------------------- -------------------------
March 31, 2000 December 31, 1999
------------------------- -------------------------
Amount Percent Amount Rate
------------------------- -------------------------
<S> <C> <C> <C> <C>
Noninterest bearing demand deposits $ 22,831 19.76% $ 21,349 18.76%
Interest bearing demand deposits 16,261 14.07% 15,926 13.99%
Money market deposits 27,075 23.43% 28,603 25.13%
Savings deposits 12,177 10.54% 12,002 10.55%
Time certificates < $100,000 21,309 18.44% 21,374 18.78%
Time certificates > $100,000 15,903 13.76% 14,555 12.79%
========================= =========================
$115,556 100.00% $113,809 100.00%
========================= =========================
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
Management actively analyzes and manages the Company's liquidity
position. The objective of liquidity management is to ensure the availability of
sufficient cash flows to meet all financial commitments and to capitalize on
opportunities for profitable business expansion. Management believes that the
Company's cash flow will be sufficient to support its existing operations for
the foreseeable future.
Cash flows from operations, as well as proceeds from maturities of
securities and increasing customer deposits, contribute significantly to
liquidity. Net cash from operating activities for the three months ended March
31, 2000 contributed $.7 million to liquidity compared to $.4 million for the
three months ended March 31, 1999. The majority of the Company's funding comes
from customer deposits within its operating region. Customer deposits provided
$1.7 million for the three months ended March 31, 2000, compared to ($1.6)
million for the three months ended March 31, 1999. For the first three months
ended March 31, 2000, noninterest-bearing demand deposits and certificates of
deposit over $100,000 provided the majority of the deposit growth. The majority
of the $15.9 million of certificates of deposit over $100,000 is from local bank
customers and are not solicited from brokers or municipalities. The Company
considers these deposits a stable source of funds.
Another important source of liquidity is investments in federal funds
and interest-bearing deposits with banks and the Company's security portfolio.
The Company maintains a ladder of securities that provides prepayments and
payments at maturity and a portfolio of available-for-sale securities that could
be converted to cash quickly. Proceeds from maturities of securities provided
$2.6 million for the three months ended March 31, 2000, compared to $5.7 million
for the three months ended March 31, 1999.
At March 31, 2000, the Banks held cash and due from banks and
interest-bearing deposits with banks of approximately $12.4 million. In
addition, at such date $31.9 million of the Company's investments were
classified as available-for-sale.
The Banks have capacity to borrow funds, up to ten percent of assets
from the Federal Home Loan Bank of Seattle ("FHLB") through pre-approved credit
lines as a secondary source of liquidity. However, these credit lines have
pledge requirements whereby the Banks must maintain unencumbered collateral with
a value at least equal to the outstanding balance.
38
<PAGE>
At March 31, 2000, the Banks had no advances outstanding to the FHLB. The Banks
also have committed line-of-credit agreements totaling approximately $6.75
million from unaffiliated banks.
The Company's total stockholders' equity decreased to $18.5 million at
March 31, 2000, from $18.7 million at December 31, 1999. The decrease resulted
from an increase in unrealized losses recorded on securities available for sale,
net of income tax and from a $.50 dividend paid to stockholders of record on
December 31, 1999. The decrease was partially offset by net income earned during
the three months ended March 31, 2000. At March 31, 2000, stockholders' equity
was 13.62 percent of total assets, compared to 13.99 percent at December 31,
1999.
The market value of available-for-sale securities was less than book
value at both March 31, 2000 and December 31, 1999, primarily as a result of
increasing interest rates, which resulted in an unrealized loss in the
investment portfolio. Management currently does not anticipate selling the
Company's securities, but if required for liquidity or any other purpose,
management does not believe the resulting sale would materially affect the
overall condition of the Company.
CAPITAL ADEQUACY REQUIREMENTS.
The capital levels of the Company currently exceed applicable
regulatory guidelines, and the Banks are qualified as "well-capitalized" at
March 31, 2000. Management believes the Company's capital will be adequate to
fund the startup and related costs associated with any new branches and Valley
Bank until it can achieve the deposit and loan levels necessary to be
profitable. The Company has commitments to construct a $2 million permanent
facility at 10th and D Street in Auburn, Washington. It is anticipated the
building will be completed in June, 2000.
The capital amounts and ratios for the Company and the Banks as of
March 31, 2000, are presented in the following table (dollars in thousands):
<TABLE>
<CAPTION>
VALLEY COMMUNITY BANCSHARES, INC.
Capital
For Capital
Actual Adequacy Purposes
---------------------- --------------------------------------------
AS OF MARCH 31, 2000 Amount Ratio Amount Ratio
----------- -------- ------------ -------
<S> <C> <C> <C> <C>
Total Capital
(to Risk-Weighted Assets)
Consolidated $19,781 20.3% GREATER THAN OR EQUAL TO $7,791 GREATER THAN OR EQUAL TO 8.0%
Puyallup Valley Bank $13,908 15.5% GREATER THAN OR EQUAL TO $7,170 GREATER THAN OR EQUAL TO 8.0%
Valley Bank $3,959 60.6% GREATER THAN OR EQUAL TO $523 GREATER THAN OR EQUAL TO 8.0%
Tier I Capital
(to Risk-Weighted Assets)
Consolidated $18,795 19.3% GREATER THAN OR EQUAL TO $3,895 GREATER THAN OR EQUAL TO 4.0%
Puyallup Valley Bank $13,000 14.5% GREATER THAN OR EQUAL TO $3,585 GREATER THAN OR EQUAL TO 4.0%
Valley Bank $3,881 59.4% GREATER THAN OR EQUAL TO $261 GREATER THAN OR EQUAL TO 4.0%
Tier I Capital
(to Average Assets)
Consolidated $18,795 14.0% GREATER THAN OR EQUAL TO $5,368 GREATER THAN OR EQUAL TO 4.0%
Puyallup Valley Bank $13,000 10.4% GREATER THAN OR EQUAL TO $5,008 GREATER THAN OR EQUAL TO 4.0%
Valley Bank $3,900 49.1% GREATER THAN OR EQUAL TO $316 GREATER THAN OR EQUAL TO 4.0%
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
--------------------------------------------
AS OF MARCH 31, 2000 Amount Ratio
------------ -------
<S> <C> <C>
Total Capital
(to Risk-Weighted Assets)
Consolidated GREATER THAN OR EQUAL TO $9,738 GREATER THAN OR EQUAL TO 10.0%
Puyallup Valley Bank GREATER THAN OR EQUAL TO $8,962 GREATER THAN OR EQUAL TO 10.0%
Valley Bank GREATER THAN OR EQUAL TO $653 GREATER THAN OR EQUAL TO 10.0%
Tier I Capital
(to Risk-Weighted Assets)
Consolidated GREATER THAN OR EQUAL TO $5,843 GREATER THAN OR EQUAL TO 6.0%
Puyallup Valley Bank GREATER THAN OR EQUAL TO $5,377 GREATER THAN OR EQUAL TO 6.0%
Valley Bank GREATER THAN OR EQUAL TO $392 GREATER THAN OR EQUAL TO 6.0%
Tier I Capital
(to Average Assets)
Consolidated GREATER THAN OR EQUAL TO $6,710 GREATER THAN OR EQUAL TO 5.0%
Puyallup Valley Bank GREATER THAN OR EQUAL TO $6,261 GREATER THAN OR EQUAL TO 5.0%
Valley Bank GREATER THAN OR EQUAL TO $395 GREATER THAN OR EQUAL TO 5.0%
</TABLE>
39
<PAGE>
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
A number of measures are used to monitor and manage interest rate risk,
including income simulations and interest sensitivity (gap) analyses. An income
simulation model is the primary tool used to assess the direction and magnitude
of changes in net interest income resulting from changes in interest rates. Key
assumptions in the model include repayment speeds on certain assets, cash flows
and maturities of other investment securities, loan and deposit volumes and
pricing. These assumptions are inherently uncertain and, as a result, the model
cannot precisely estimate net interest income or precisely predict the impact of
higher or lower interest rates on net interest income.
Actual results will differ from simulated results due to timing,
magnitude and frequency of interest rate changes and changes in market
conditions and management strategies, among other factors. At March 31, 2000,
based on the measures used to monitor and manage interest rate risk, there
has not been a material change in the Company's interest rate risk since
December 31, 1999.
ITEM 3. PROPERTIES
The Company's main office is located in Puyallup, Washington and also
serves as the main office for Puyallup Valley Bank. Puyallup Valley Bank
conducts its business through six full-service offices and one drive-up
facility. All but three of Puyallup Valley Bank's premises are owned by Puyallup
Valley Bank with options to extend existing leases on the leased facilities. The
facilities are: Main office, 1307 East Main, Puyallup, Washington; Downtown
Branch, 209 South Meridian Avenue, Puyallup, Washington; Downtown Drive-Up, 112
E. Main Avenue, Puyallup, Washington; Summit Branch, 10413 Canyon Road East,
Puyallup, Washington; South Hill Branch, 15815 Meridian Avenue East, Puyallup,
Washington; Canyon Road Branch, 12803 Canyon Road, Puyallup, Washington; and
Graham Branch, 9921 224th St. SE, Graham, Washington.
Valley Bank has entered into a lease for its initial facility located
at 1525 A Street, Suites 106 and 107, in Auburn. The lease term is for three
years with an optional two-year extension. Valley Bank makes lease payments of
$2,812 per month. Valley Bank plans to ultimately build a permanent facility on
a site, owned by the Company, that is located at 10th and D Street in Auburn,
Washington.
ITEM 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the shares of Valley Community
Bancshares Common Stock beneficially owned as of March 15, 2000 by each Director
and each named Executive Officer, and the Directors and Officers as a group. As
of that date, the Company is not aware of anyone who owns more than five percent
of its shares either beneficially or of record, except as listed below.
DIRECTORS AND EXECUTIVE OFFICERS
<TABLE>
<CAPTION>
Shares Beneficially % of Total Shares
Name Owned(1) Outstanding(2)
---- -------- --------------
<S> <C> <C>
Thomas R. Absher 56,703 5.04%
David H. Brown(3) 62,830 5.48%
William E. Fitchitt 1,427 *
David K. Hamry 3,303 *
A. Eugene Hammermaster 26,490 2.35%
Steven M. Harris 5,030 *
Warren D. Hunt 17,506 1.56%
Roger L. Knutson 47,455 4.22%
Directors and Executive Officers 260,654 22.51%*
(12) as a group(4)
</TABLE>
* Less than 1%
40
<PAGE>
OTHER BENEFICIAL OWNERS
<TABLE>
<CAPTION>
Shares Beneficially % of Total Shares
Name and Address Owned(1) Outstanding(2)
---------------- -------- --------------
<S> <C> <C>
Charles R. Wadsworth
P. O. Box 578
Puyallup, WA 98371 57,220 5.08%
----------
</TABLE>
(1) The shares "beneficially owned" include shares owned by or for, among
others, the spouse and/or minor children of the individual and any other
relative who has the same home as such individual, as well as other shares
with respect to which the individual has or shares voting or investment
power, or has the right to acquire within 60 days under outstanding stock
options. Beneficial ownership may be disclaimed as to certain of the
shares.
(2) Any securities not outstanding but which are subject to options and
presently exercisable by the named person within 60 days, are deemed to be
outstanding for computing the percentage of outstanding securities owned by
such person, but are not deemed to be outstanding for the purposes of
computing the percentage of the class owned by any other person.
(3) Includes 21,428 shares subject to stock options granted pursuant to the
Puyallup Valley Bank Employee Stock Option Plan and presently exercisable.
(4) Includes 10,721 shares subject to stock options granted pursuant to the
Puyallup Valley Bank Employee Stock Option Plan and presently exercisable.
ITEM 5. DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth summary information about the Directors
and Executive Officers of Valley Community Bancshares. All of the persons named
hold the same position with Puyallup Valley Bank as they do with the Company,
with the exception of William E. Fitchitt and Steven M. Harris, who are not
members of the Board of Directors of Puyallup Valley Bank.
<TABLE>
<CAPTION>
Year Elected
Name Age Position with the Company or Appointed
---- --- ------------------------- ------------
<S> <C> <C> <C>
Thomas R. Absher 68 Chairman 1973
David H. Brown 54 Director, President and CEO 1989
Warren D. Hunt 67 Vice-Chairman 1975
A. Eugene Hammermaster 65 Director, Secretary 1973
William E. Fitchitt 57 Director 1998
David K. Hamry 59 Director 1991
Steven M. Harris 53 Director 1998
Roger L. Knutson 55 Director 1977
Joseph E. Riordan 46 Senior Vice President and CFO 1997
Roy W. Thompson 57 Senior Vice President and Credit 1989
Administrator
Richard D. Pickett 50 President and CEO of Valley Bank 1999
</TABLE>
The Board of Directors of the Company consists of eight members. The
Board of Directors is divided into three groups for the purpose of defining
terms of office. All Directors serve three-year terms; one-third of the
Directors are elected annually. The Company's Articles of Incorporation provide
that a director may only be removed for cause, and vacancies will be filled by
the Board of Directors.
The principal occupation or business and experience of the Directors
and Executive Officers of the Company for the past five years is set forth
below.
41
<PAGE>
THOMAS R. ABSHER is the Chairman of the Board of Directors of the
Company and a Partner of Morningview Development, Morningside Development,
Northwest Care Development, TJC Partnership, Terrace Ventures, Poulsbo
Development, and Madison Hotel. Mr. Absher was the former President of Absher
Construction Company. Mr. Absher is also a director of Valley Bank.
DAVID H. BROWN has been the President and Chief Executive Officer of
the Company since its formation and the President and Chief Executive Officer of
Puyallup Valley Bank since 1989. Prior to joining Puyallup Valley Bank, Mr.
Brown was an executive officer with Seafirst Bank for twenty years, beginning as
a Management Trainee and concluding his tenure at Seafirst as Manager of
Southwest Corporate Banking. Mr. Brown is a graduate of Pacific Coast Banking
School and holds a BA from Washington State University.
WARREN D. HUNT is the Vice Chairman of the Board of Directors of the
Company and co-owner of Newell Hunt Furniture, Inc.
EUGENE HAMMERMASTER is Secretary to the Board of Directors of the
Company, and attorney and senior member in the Hammermaster Law Firm, and a
Municipal Court Judge in Pierce County.
WILLIAM E. FITCHITT is the Vice-Chairman of Valley Bank, a Certified
Public Accountant and President of Fitchitt & Benedict, P.S., Inc.
DAVID K. HAMRY is the CEO and Director of Good Samaritan Hospital, and
Good Samaritan Community Health Care. He is a Director of WA Casualty Company
and Northwest Healthcare.
STEVEN M. HARRIS is the Chairman of the Board of Directors of Valley
Bank and is President and Designated Broker of Northwest Corporate Real Estate,
Inc., a commercial real estate sales and leasing company.
ROGER L. KNUTSON is the President of Knutson Farms, Inc., Knutson
Equipment & Supply, Puyallup Valley Rhubarb Company, Puyallup Valley Flower
Exchange and Puget Sound Bulb Exchange.
JOSEPH E. RIORDAN has been Senior Vice President and Chief Financial
Officer of the Company since its formation and Senior Vice President and Chief
Financial Officer of Puyallup Valley Bank since 1997. Prior to joining the
Company and Puyallup Valley Bank, Mr. Riordan was Vice President of Finance
InterWest Bancorp, Inc. From 1985 through 1996, Mr. Riordan was Vice President
and Secretary-Treasurer of Central Bancorporation. Mr. Riordan's career in the
banking industry spans over twenty years. Mr. Riordan is a Certified Public
Accountant, a Certified Management Accountant, and holds a BA in Business
Administration from Central Washington University. Mr. Riordan is the Senior
Vice President and Chief Financial Officer of Valley Bank.
ROY W. THOMPSON has been Senior Vice President of the Company since its
formation and Senior Vice President and Credit Administrator of Puyallup Valley
Bank since 1989. Prior to joining Puyallup Valley Bank, Mr. Thompson was Vice
President and Account Officer of U.S. Bank of Washington in Private Banking.
From 1983 through 1988, Mr. Thompson was Vice President and Credit Administrator
of Seattle-First National Bank. Mr. Thompson's career in the banking industry
spans over twenty years. Mr. Thompson is a graduate of Pacific Coast Banking
School, holds an MBA in Finance from the United States International University
and a BS in Business from the University of Southern California. Mr. Thompson is
the Senior Vice President and Credit Administrator of Valley Bank.
RICHARD D. PICKETT is President and CEO of Valley Bank. Prior to
joining Valley Bank, Mr. Pickett was an officer with Seafirst Bank for over
twenty five years, beginning as a Management Trainee and concluding his tenure
at Seafirst as Commercial Banking Team Leader. Mr. Pickett is a graduate of
Pacific Coast Banking School, University of Southern California Executive
Leadership School and holds a BA from Washington State University.
42
<PAGE>
ITEM 6. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth all compensation paid by the Company for
services rendered in all capacities paid or accrued for the fiscal years ended
December 31, 1999, 1998 and 1997, to the Chief Executive Officer. No other
Executive officer of the Company received annual compensation in excess of
$100,000 for such years.
<TABLE>
<CAPTION>
Name and Position Year Salary Bonus Other (1)(2)(3) Total
----------------- ---- ------ ----- --------------- -----
<S> <C> <C> <C> <C> <C>
David H. Brown 1997 $123,520 $12,250 $53,674 $189,444
President and CEO 1998 $128,000 $30,000 $53,798 $211,798
1999 $133,000 $22,770 $53,198 $208,968
</TABLE>
(1) Includes $9,000 paid to Mr. Brown by Puyallup Valley Bank for director's
fees in 1997, 1998, and 1999.
(2) Includes profit sharing pursuant to The Company's 401(k) Plan and Profit
Sharing Plan.
(3) Includes $35,000 accrued by Puyallup Valley Bank each year for Mr. Brown's
Deferred Compensation Plan.
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The Board of Directors of the Company, acting as a committee of the
whole, serves as the Compensation Committee. The Committee is responsible for
establishing and implementing all compensation policies of the Company and its
subsidiaries, as well as setting the compensation for the executive officers of
the Company and its subsidiaries. The Committee evaluates the performance of the
Chief Executive Officer and approves an appropriate compensation level. The
Chief Executive Officer evaluates the performance of all other executive
officers and recommends to the Committee individual compensation levels for
approval by the Committee.
The Committee believes that a compensation plan for executive officers
should take into account management skills, long-term performance results and
shareholder returns. The principles underlying compensation policies are: (i) to
attract and retain highly talented and productive executives; (ii) to provide
levels of compensation competitive with those offered throughout the banking
industry; (iii) to motivate executive officers to enhance long-term shareholder
value by helping them build their own ownership in the Company; and (iv) to
integrate the compensation program with the Company's long-term strategic
planning and measurement processes.
The current compensation plan involves a combination of salary,
bonuses, profit sharing and grants of stock options to encourage long-term
performance. The salary levels of executive officers are designed to be
competitive within the banking and financial services industries. The Committee
annually reviews industry peer group and the Washington Financial Industry
Survey and America's Community Bankers Survey of Salaries to determine
competitive salary levels. Individual annual performance is reviewed to
determined appropriate salary adjustments.
The Company's bonus plan is based on a review of the salary surveys,
the performance of the Company and the subjective evaluation of the performance
of each executive officer.
The Committee awards stock options to employees as a long-range
compensation program designed to reward performance and benefit shareholders.
Awards of stock options are intended to provide employees with increased
motivation and incentive to exert their best efforts on behalf of the Company by
enlarging their personal stake in its success through the opportunity to
increase the value of their stock ownership. Options are issued at the fair
market price on the date of the grant, in order to insure that any value derived
from the grant is realized by shareholders generally. The number of options
granted to any employee is based on the employee's performance and relative
responsibility within the Company. Options may have a deferred vesting and are
not exercisable prior to vesting. During the fiscal year ended December 31,
1999, the Committee granted stock options totaling 14,500 shares to employees of
the Company and its subsidiaries.
During the fiscal year ended December 31, 1999, the base salary of
David H. Brown, President and Chief Executive Officer of the Company, was
$133,000. In addition, Mr. Brown received a performance bonus of $22,770, a
profit sharing allocation of $9,198, and was credited with $35,000 in a Deferred
Compensation Plan adopted effective January 1, 1997, which
43
<PAGE>
provides for the accrual of $245,000 plus interest over a ten-year period to
be paid to Mr. Brown upon his retirement (see Deferred Compensation Plan
below) and $9,000 in Director's fees. This resulted in total compensation of
$208,968, which represents a 1.34 percent decrease from the previous year. In
determining his compensation, special consideration was given to the efforts
Mr. Brown had put forth to integrate Valley Bank as a wholly-owned subsidiary
of the Company. The Committee believes the increase in compensation is
appropriate based on competitive salary surveys and the performance of the
Company. Mr. Brown did not participate in deliberations of the Committee
relating to his compensation.
Submitted by Members of the Committee:
Thomas R. Absher
David H. Brown
Eugene Hammermaster
Warren D. Hunt
Roger L. Knutson
William E. Fitchitt
Steven M. Harris
David K. Hamry
SEVERANCE AND CHANGE IN CONTROL AGREEMENTS
In addition to regular compensation, the Company has agreed to pay
Messrs. Brown, Thompson, Riordan, and Pickett additional compensation should
their employment terminate with the Company under certain conditions. The
severance Agreements are effective only if Messrs. Brown, Thompson, Riordan, and
Pickett employment is terminated within three years after a change in control;
or employment is terminated on or after the date that any party announces (or
should announce) any prospective change in control transaction, if a change in
control occurs with twelve months of termination. Change in control means a
change in the ownership or effective control, or in the ownership of a
substantial portion of, the assets of the Company as used in section 280G of the
Internal Revenue Code of 1986, as amended. Changes in control as includes any
change within a twelve-month period in the composition of the Board of Directors
whereby the individuals serving as directors at the beginning of such period
cease to constitute at least a majority of the Board at any time during such
period. The amount of the severance payment equals the highest compensation (as
reportable on the executive's IRS W-2 form) during one of the most recent three
calendar years ending before, or simultaneous with, the date on which the change
in control occurs.
DEFERRED COMPENSATION PLAN
In addition to regular compensation, the Company, on April 21, 1999 to
be effective January 1, 1997, agreed to provide Mr. Brown with deferred
compensation under the terms of an Supplemental Retirement Benefits Agreement.
The Agreement provides for the accrual of $245,000 plus interest to an account
over a ten-year period. The account is to be distributed to Mr. Brown on the
last day of the contract period, to Mr. Brown or his Beneficiary upon total
disability or death, to Mr. Brown upon the termination of service within a
period of twelve months following a change of control. Change in control means
(a) the purchase or other acquisition by any person, entity, or group of persons
as defined under the provisions of Section 13(d) or 14(d) of the Securities
Exchange Act of 1934 of more than fifty percent of either the outstanding shares
of common stock or the combined voting power of the Company's then outstanding
voting securities; (b) the approval by the stockholders of the Company of a
reorganization, merger of consolidation with respect to which persons who were
stockholders of the Company immediately prior to such reorganization, merger or
consolidation do not, immediately thereafter, own more than fifty percent of the
combined voting power of the Company's then outstanding securities entitled to
vote generally; (c) a liquidation or dissolution of the Company; (d) a change in
the membership of the Board of Directors such that those individuals who at the
beginning of any twelve consecutive month period cease to constitute at a
majority thereof for any reason within that twelve month period.
EMPLOYEE BENEFIT PLANS
The Company has a 401(k) Profit Sharing plan for all eligible
employees. Contributions to the plan adopted in December 1998 are at the
discretion of the Board of Directors. Participants may contribute up to 12
percent of compensation. The Company made no contributions to the plan in 1999,
1998, or 1997. The Company also has a noncontributory profit sharing plan
covering substantially all employees. Contributions to the plan are at the
discretion of the Board of Directors and totaled $83,500, $94,000, and $95,500
in 1999, 1998, and 1997, respectively.
44
<PAGE>
STOCK OPTION PLANS
The Company has two stock option plans that were approved by the
shareholders. One stock option plan was approved by the shareholders on April
22, 1986, and extended until March 20, 2006, at a meeting of shareholders held
in April 1996 (the "1996 Plan"). There are presently 159,070 shares authorized
for issuance under the 1996 Plan, of which 156,518 have been issued, 109,227
have been exercised, 47,241 are outstanding. No additional options will be
granted under the 1996 Plan. On April 23, 1998, the shareholders adopted the
1998 Employee Stock Option Plan (the "1998 Plan). There are presently 100,000
shares authorized for issuance under the 1998 Plan, of which 17,500 have been
issued and none exercised.
The purpose of the 1996 Plan and 1998 Plan is to provide additional
incentives to key employees of Bancshares and to help attract and retain quality
personnel and to enhance shareholder value aligning employee interest with those
of the shareholders. The grant of options is at the discretion of the Company's
Board of Directors or such other committee as it may designate. The 1998 Plan is
very similar to the 1986 Plan, except that it: (i) is updated to correct
references to the Internal Revenue Code which have been changed, (ii) permits an
employee to exercise options by surrendering already-owned shares, and (iii)
permits the grant of nonqualified stock options.
OPTION EXERCISES AND YEAR-END OPTION VALUES
The following table summarizes option exercises during the 1999 fiscal
year by each of the Named Executives and the 1999 fiscal year-end value of
unexercised options granted to the Named Executives:
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Shares Underlying Unexercised Options In-the-Money Options at
Acquired on Value at 12/31/99 12/31/99 (1)
Name Exercise Realized (Exercisable/unexercisable) (Exercisable/unexercisable)
---- -------- -------- --------------------------- ---------------------------
<S> <C> <C> <C> <C>
David H. Brown 2,031 $49,930 21,428 / -0- $469,374 / --0-
Roy W. Thompson -0- -0- 10,721 / -0- $217,630 / --0-
Joseph E. Riordan -0- -0- -0 - / 5,250 --0 - / $32,500
Richard D. Pickett -0- -0- -0 - / 10,000 --0 - / --0-
</TABLE>
(1) Values are calculated by subtracting the exercise price from the fair
market value of the underlying stock. For purposes of this table, fair
market value is deemed to be $30.00, the last known sale price of
Bancshares common stock on December 31, 1999.
ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Some of the Directors and Officers of the Company, Puyallup Valley
Bank, and Valley Bank and the firms and corporations with which they are
associated, have transactions with the Puyallup Valley Bank and Valley Bank,
including borrowings and investments in time deposits. All such loans and
investments in time deposits have been made in the ordinary course of business,
have been made on substantially the same terms (including interest rates paid or
charged and collateral required) as those prevailing at the time for comparable
transactions with unaffiliated persons, and did not involve more than the normal
risk of collectability or present other unfavorable features. As of December 31,
1999, the aggregate outstanding amount of all loans to Directors and Officers
was approximately $2,139,000.
ITEM 8. LEGAL PROCEEDINGS
The Banks are from time to time parties to various legal actions
arising in the normal course of business. The Company believes that there is no
threatened or pending proceeding against the Company or the Banks, which, if
determined adversely, would have a material effect on the business or financial
position of the Company or the Banks.
45
<PAGE>
ITEM 9. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
NATURE OF TRADING MARKET
At March 15, 2000, the Company had approximately 688 shareholders of
record. The stock is not traded on any exchange or automated quotation system,
and there is no firm which makes a market in the stock. The stock has been held
by shareholders who typically have held the stock for investment. Therefore,
there is no active trading market for the stock and no assurance can be given
that an active trading market for the stock will develop. During 1999, there
were 141 transfers known to the Company. These transfers involved a total of
60,731 shares. Sales prices have ranged from $30 to $35, to the Company's best
knowledge. The last trade occurred on February 29, 2000, and was for 1,000
shares of Common Stock at a price of $30 per share. These prices are not
necessarily indicative of the fair market value of the stock, nor is the Company
necessarily aware of all transfers or the price of those transfers.
DIVIDEND HISTORY
The Company (Puyallup Valley Bank prior to July 1, 1998) has paid,
since Puyallup Valley Bank's inception in 1973, a combination of stock and cash
dividends to its shareholders. Since 1993, Puyallup Valley Bank has paid a stock
dividend of 5 percent per year and a cash dividend of 50 CENTS per share per
year. Since July 1, 1998, the Company paid a cash dividend of 38 CENTS during
1998 and a 12 CENTS dividend during 1999. On January 26, 2000, the Board of
Directors of the Company declared a cash dividend of $.50 per share, which was
paid during February 2000 to those shareholders of record on December 31, 1999.
Although the Company intends to continue its policy of paying cash
dividends on its Common Stock in amounts not less than those paid in recent
periods, the ability of the Company to continue to pay such dividends will
depend primarily upon the earnings of Puyallup Valley Bank and Valley Bank and
their ability to pay dividends to the Company, as to which there can be no
assurance. For the foreseeable future, none of the earnings of Valley Bank will
be dividends to the Company as the capital will be retained at Valley Bank to
promote its growth.
The ability of the banks to pay dividends is governed by various
statutes. These statutes provide that no bank shall declare or pay any dividend
in an amount greater than its retained earnings, without approval from the
Director. The Director shall, in his or her discretion, have the power to
require any bank to suspend the payment of any and all dividends until all
requirements that may have been made by the Director shall have been complied
with, and upon such notice to suspend dividends, no bank shall thereafter
declare or pay any dividends until such notice has been rescinded in writing.
ITEM 10. RECENT SALES OF UNREGISTERED SECURITIES
The following sets forth information as to all securities of registrant
sold by the registrant within the past three years, which were not registered
under the Securities Act of 1933.
<TABLE>
(a) SECURITIES SOLD
<S> <C> <C> <C> <C>
(i) Exchange
DATE OF EXCHANGE TITLE OF SECURITIES AMOUNT
EXCHANGED
July 1, 1998 Common Stock 1,012,729 shares
$1 par value
(ii) Public Offering
DATE OF SALE TITLE OF SECURITIES AMOUNT SOLD
January 31, 1999 Common Stock 102,619 shares
$1 par value
(iii) Private Placement
DATE OF SALE TITLE OF SECURITIES AMOUNT SOLD
46
<PAGE>
March 15, 1999 Common Stock 3,570 shares
$1 par value
(iv) Exercise of Stock Options
DATE OF SALE TITLE OF SECURITIES AMOUNT SOLD
Between January 1,1997 Common Stock 6,643 shares
and December 31, 1999 $1 par value
</TABLE>
(b) UNDERWRITERS AND OTHER PURCHASERS. The shares sold in the
offering listed under Item 10(a)(i) were sold in a public
offering without the use of underwriters. The shares sold in
the private placement listed under Item 10(a)(ii) were sold in
an isolated private placement. The shares sold in the
transactions listed under Item 10(a)(iii) above were sold to
employees of the registrant upon the exercise of stock options
within the past three years.
(c) CONSIDERATION. The consideration received for the 102,619
share offering completed on January 31, 1999 was $3,591,000.
The Company received land valued at $125,000 for the 3,570
shares issued on March 15, 1999. The land is being used for
Valley Bank's permanent facility being constructed at 10th and
D Street in Auburn, Washington. The total consideration for
the sale of the 6,643 shares sold upon the exercise of stock
options granted by the registrant under the 1996 Plan was
approximately $52,000.
(d) EXEMPTIONS FROM REGISTRATION CLAIMED. The sales of common
stock by the registrant described herein have not been
registered with the SEC in reliance on exemptions from such
registration. Because the securities have not been registered,
they are deemed "restricted securities" and can only be resold
in compliance with certain exemptions from registration. The
shares listed under Item 10(a)(i) were exchanged for an
identical number of shares then outstanding in Puyallup Valley
Bank, as part of a tax-free reorganization in which each
outstanding share of common stock of Puyallup Valley Bank was
exchanged into one outstanding share of common stock of Valley
Community Bancshares, Inc., a newly-formed holding company.
The transaction was exempt from registration with the SEC
under Section 3(a)(12) of the Securities Act of 1933, as
amended, and were exempt from registration in the state of
Washington pursuant to Section 21.20.320(14) of the Revised
Code of Washington. The shares listed under Item 10(a)(ii)
were sold to Washington residents in an intra-state
offering, exempt from registration with the SEC under
Section 3(a)(11) of the Securities Act of 1933, as amended,
and registered by qualification with the Securities Division
of the State of Washington Department of Financial
Institutions pursuant to Section 21.20.210 of the Revised
Code of Washington. The shares listed under Item 10(a)(iii)
were sold in an isolated private placement that did not
involve a public offering, and were exempt from registration
with the SEC under Section 4(2) of the Securities Act of
1933, as amended, and were exempt from registration with the
Securities Division of the State of Washington Department of
Financial Institutions pursuant to Section 21.20.320(1) of
the Revised Code of Washington. The shares listed under Item
10(a)(iv) were sold pursuant to option issuances from a
compensatory benefit plan, and were exempt from registration
with the SEC under 17 CFR 230.701 promulgated under Section
3(b) of the Securities Act of 1933, as amended, and were
exempt from registration with the Securities Division of the
State of Washington Department of Financial Institutions
pursuant to Section 21.20.310(10) of the Revised Code of
Washington.
(e) STOCK DIVIDENDS. Between January 1, 1997 and April 1, 2000,
the registrant issued 93,175 shares of registrants Common
Stock, $1 par value, as stock dividends. The value of the
securities issued at the time of issuance was $2,194,000 and
have not been registered under the Securities Act of 1933.
ITEM 11. DESCRIPTION OF REGISTRANT'S SECURITIES TO BE REGISTERED
GENERAL
The Company's Common Stock consists of 5,000,000 shares of Common
Stock, par value $1.00 per share, of which 1,125,561 are presently issued and
outstanding. Each share of Common Stock has the same relative rights as, and is
identical in all respects with, each other share of Common Stock. No shares of
preferred stock are authorized for issuance. In addition, up to
47
<PAGE>
100,000 shares of the Company's Common Stock are available for grant to
employees of the Company and the banks pursuant to the Valley Community
Bancshares 1998 Stock Option Plan.
NO CUMULATIVE VOTING
Holders of Common Stock will be entitled to one vote per share on all
matters submitted to a vote of the shareholders, including election of
Directors. Article VII of the Articles of Incorporation of the Company provides
that shareholders may not cumulate their votes in the election of Directors.
Cumulative voting means the ability to vote, in person or by proxy, the number
of shares owned by the shareholder for as many persons as there are Directors to
be elected and for whose election the shareholder has a right to vote, or to
cumulate votes by giving one candidate as many votes as are determined by the
number of such Directors to be elected multiplied by the total number of shares
the shareholder has the right to vote, or distributing such votes on the same
principle among any number of candidates.
DIVIDEND RIGHTS
The Company may pay dividends as declared from time to time by the
Board of Directors out of funds legally available for the payment of dividends.
The ability of the Company to pay dividends will initially and for the
foreseeable future depend on the amount of dividends paid to it by the banks.
The dividend restrictions imposed on subsidiaries by statue and regulation may
effectively limit the amount of dividends the Company can pay. See "SUPERVISION
AND REGULATION--Banking Subsidiaries" and "DIVIDEND HISTORY." Under Washington
corporate law, the Board of Directors is barred from making any dividend payment
if, after giving effect to such payment, the Company is either unable to pay its
debts as they become due in the normal course of business, or the Company's
total assets would be less than the sum of its total liabilities. The holders of
Common Stock will be entitled to receive and share equally in such dividends as
may be declared by the Board of Directors. See "DIVIDEND HISTORY."
LIQUIDATION/DISSOLUTION
In the event of any liquidation, dissolution or winding up of the
Company, the holders of the Common Stock would be entitled to receive, on a
pro-rata basis, after payment of all debts and liabilities of the Company
(including all deposit accounts and accrued interest thereon), all assets of the
Company available for distribution.
MERGER, ACQUISITION AND "ANTI-TAKEOVER" PROVISION
Article X of the Company's Articles of Incorporation provides that in
the event of a merger or consolidation of the Company or a sale of substantially
all of its assets, the Board of Directors must consider all relevant factors in
addition to the amount of consideration, including, without limitation, the
social and economic effects on its community and its depositors, borrowers,
employees, suppliers and other constituents. This provision might discourage a
tender offer for the Company's stock, which might be at a price above the
prevailing market rate.
The Company's Articles of Incorporation also require the approval of
the holders of: (i) at least 66-2/3 percent of the Company's outstanding shares
of voting stock, and (ii) at least a majority of the Company's outstanding
shares of voting stock, not including shares held by an "interested
shareholder," to approve certain "transactions." However, the preceding shall
not apply in cases where the proposed transaction has been: (i) approved by a
majority of the Board of Directors, excluding Directors who have a material
financial interest in the transaction or who were nominated and elected as a
result of an arrangement with the "interested shareholder" within 24 months of
the proposed transaction, or (ii) a majority of the Board of Directors, whose
votes are entitled to be counted under clause: (i) determines that the fair
market value of the consideration to be received by non-interested shareholders
for shares of any class of which shares are owned by any interested shareholder
is not less than the highest fair market value of the consideration paid by any
interested shareholder in acquiring shares of the same class within 24 months of
the proposed transaction. The term "interested shareholder" is defined to
include any person or group of affiliated persons who beneficially owns 20
percent or more of the outstanding voting shares of a corporation. An affiliated
person is any person who either acts jointly or in concert with, or directly or
indirectly controls, is controlled by, or is under common control with another
person. The provisions of Article XI apply to any transaction between a
corporation, or any subsidiary thereof, and an interested shareholder of such
corporation or an affiliated person to an interested shareholder, that must be
authorized pursuant to applicable law by a vote of the shareholders.
48
<PAGE>
The increased stockholder vote required to approve a transaction with
an interested shareholder has the effect of foreclosing mergers and other
business combinations that a majority of stockholders deem desirable and places
the power to prevent such a merger or combination in the hands of a minority of
stockholders.
NO PREEMPTIVE RIGHTS
Article III of the Articles of Incorporation of the Company provides
that holders of Common Stock will not have any preemptive rights with respect to
any shares issued by the Company in the future; the Company may therefore sell
shares without first offering them to the then shareholders of the Company.
CERTAIN REQUIRED VOTES; AMENDMENT TO ARTICLES OF INCORPORATION
Article VIII of the Articles of Incorporation of the Company provides
that the Company reserves the right to amend the Articles of Incorporation in
any manner now or hereafter permitted by law. Under present Washington law, the
Articles of Incorporation may be amended by a vote of a majority of the members
of the Board of Directors without the requirement of shareholder approval, if
such amendment applies only to: (i) deletion of the name and address of the
initial Directors; (ii) a change of the name of the Company, and if the Company
has only one class of shares outstanding; (iii) to change or eliminate any
provision with respect to the par value of any class of shares; and (iv) to
change the number of authorized shares to effectuate a split of, or stock
dividend in, the Company's own shares. Other amendments to the Articles of
Incorporation of the Company require the affirmative vote of the shareholders
representing two-thirds of the outstanding shares of stock.
LIMITATION OF LIABILITY
Article VI of the Company's Articles of Incorporation limits the
liability of Directors, in their capacity as Directors, to the full extent
permitted by Washington law. Accordingly, Directors shall not be liable to the
Company and its shareholders for monetary damage except for acts or omissions
that: (i) involve intentional misconduct or a knowing violation of law by the
director; (ii) involve conduct which violates RCW 23B.08.310 of the Washington
Business Corporation Act, pertaining to unpermitted distributions to
shareholders or loans to directors, or (iii) involve any transaction from which
the director will personally receive a benefit in money, property or services to
which the director is not legally entitled. This provision does not affect the
availability of equitable remedies such as an action to enjoin or rescind a
transaction involving a breach of fiduciary duty. The above limitation of
liability also may not limit Director liability for violations of, or relieve
them from the necessity of complying with, federal securities laws.
ITEM 12. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Article IX of the Company's Articles of Incorporation permits the
Company to indemnify and hold each Director and Officer ("Indemnitee") harmless
against all liability, provided that: (i) the Indemnitee acted in good faith;
(ii) in the case of official conduct, he reasonably believed that he was acting
in the Company's best interests, or in all other cases, that his action was not
opposed to the Company's best interests; (iii) in the case of a criminal
proceeding, he had no reasonable cause to believe his conduct was unlawful; and
provided further, that (iv) the Indemnitee did not engage in the conduct
described in RCW 30.12.240.
Notwithstanding the preceding, no Indemnitee shall be indemnified in
connection with: (i) a proceeding by or in the right of the Company or another
enterprise in which he was adjudged liable to the Company or other enterprise;
or (ii) any other proceeding charging improper personal benefit to himself,
whether or not involving action in his official capacity, in which he was
adjudged liable on the basis that personal benefit was improperly received by
him. Additionally, no Indemnitee shall be indemnified for any civil money
penalty or judgment resulting from any administrative or civil action instituted
by a federal banking agency, or any other liability or legal expense with regard
to any administrative proceeding or civil action instituted by any federal
banking agency which results in a final order or settlement pursuant to which
such person is: (i) assessed a civil money penalty; (ii) removed from office or
prohibited from participating in the conduct of the affairs of the Company or
other enterprise; or (iii) is required to cease and desist from or to take any
affirmative action described in Section 8(b) of the Federal Deposit Insurance
Act, as amended (12 U.S.C. 1811, ET SEQ.). However, permissible indemnification
payments may be made as permitted by 12 C.F.R. Section 359, ET SEQ., as amended
from time to time.
49
<PAGE>
ITEM 13. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
MOSS ADAMS LLP
INDEPENDENT AUDITOR'S REPORT
----------------------------
To the Board of Directors and Stockholders
Valley Community Bancshares, Inc.
We have audited the accompanying consolidated balance sheet of Valley Community
Bancshares, Inc. and subsidiaries (the Company) as of December 31, 1999 and
1998, and the related consolidated statements of income, changes in
stockholders' equity, and cash flows for the years then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits. The financial statements of Puyallup Valley Bank
as of December 31, 1997 were audited by other auditors whose report dated
January 9, 1998, except for Note 15 as to which the date is August 24, 1998,
expressed an unqualified opinion on those statements.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits 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 provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Valley Community
Bancshares, Inc. and subsidiaries as of December 31, 1999 and 1998, and the
results of their operations and their cash flows for the years then ended, in
conformity with generally accepted accounting principles.
/s/...................................................Everett, Washington
Moss Adams LLP.............................................February 1, 2000
DAVID CHRISTENSEN
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
--------------------------------------------------
Board of Directors and Stockholders
Puyallup Valley Bank
We have audited the accompanying balance sheet of Puyallup Valley Bank as of
December 31, 1997 and December 31, 1996, and the related statements of income,
changes in stockholders' equity, and cash flows for the years then ended. These
financial statements are the responsibility of the Bank's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the 1997 and 1996 financial statements referred to above present
fairly, in all material respects, the financial position of Puyallup Valley Bank
as of December 31, 1997 and December 31, 1996, and the results of its operations
and its cash flows for the years then ended in conformity with generally
accepted accounting principles.
/s/.....................................................Portland, Oregon
David Christensen............................................January 09, 1998
Except Note 15 dated
August 24, 1998
50
<PAGE>
VALLEY COMMUNITY BANCSHARES, INC.
CONSOLIDATED BALANCE SHEET
(Dollars in thousands)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1999 1998
---------- -----------
<S> <C> <C>
ASSETS
Cash and due from banks $ 5,127 $ 5,630
Interest-bearing deposits with banks 9,692 11,270
Federal funds sold 2,530
Securities available-for-sale 33,262 31,282
Securities held-to-maturity 1,241 2,335
Federal Home Loan Bank stock 420 355
---------- -----------
49,742 53,402
Loans 78,634 67,724
Less allowance for loan losses 959 883
---------- -----------
Loans, net 77,675 66,841
Accrued interest receivable 851 772
Premises and equipment, net 4,717 3,543
Real estate held for investment 224 256
Other assets 628 515
---------- -----------
Total assets $ 133,837 $ 125,329
========== ===========
LIABILITIES
Deposits
Noninterest-bearing $ 21,349 $ 20,806
Interest-bearing 92,460 89,477
---------- -----------
Total deposits 113,809 110,283
Other borrowed funds 539 234
Accrued interest payable 347 340
Other liabilities 418 394
---------- -----------
Total liabilities 115,113 111,251
---------- -----------
STOCKHOLDERS' EQUITY
Common stock, par value $1 per share; 5,000,000 shares authorized;
1,125,561 and 1,014,982 shares issued and outstanding in 1999
and 1998, respectively 1,126 1,015
Additional paid-in capital 16,286 12,642
Retained earnings 1,569 310
Accumulated other comprehensive income (loss), net of tax (257) 111
---------- -----------
Total stockholders' equity 18,724 14,078
---------- -----------
Total liabilities and stockholders' equity $ 133,837 $ 125,329
========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
51
<PAGE>
VALLEY COMMUNITY BANCSHARES, INC.
CONSOLIDATED STATEMENT OF INCOME
(In thousands except for per share amounts)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1999 1998 1997
------------- ----------- -----------
<S> <C> <C> <C>
INTEREST INCOME
Interest and fees on loans $ 6,247 $ 6,121 $ 6,007
Interest on federal funds sold and deposits in banks 784 972 782
Securities available-for-sale 1,837 1,437 1,188
Securities held-to-maturity 90 164 314
------------- ----------- -----------
Total interest income 8,958 8,694 8,291
------------- ----------- -----------
INTEREST EXPENSE
Interest on deposits 2,955 3,105 3,048
Interest on federal funds and other short-term borrowings 18 34 31
------------- ----------- -----------
Total interest expense 2,973 3,139 3,079
------------- ----------- -----------
Net interest income 5,985 5,555 5,212
PROVISION FOR LOAN LOSSES 84 9 66
------------- ----------- -----------
Net interest income after provision for loan losses 5,901 5,546 5,146
------------- ----------- -----------
NONINTEREST INCOME
Service charges 329 318 315
Gain on sale of investment securities, net 1 2 85
Origination fees on mortgage loans brokered 47 139 61
Other operating income 212 203 186
------------- ----------- -----------
Total noninterest income 589 662 647
------------- ----------- -----------
NONINTEREST EXPENSE
Salaries 1,849 1,741 1,552
Employee benefits 385 340 327
Occupancy 449 341 334
Equipment 471 389 358
Organizational costs 131
Other operating expenses 1,362 1,169 1,033
------------- ----------- -----------
Total noninterest expense 4,516 4,111 3,604
------------- ----------- -----------
INCOME BEFORE INCOME TAX 1,974 2,097 2,189
PROVISION FOR INCOME TAX 580 616 597
------------- ----------- -----------
NET INCOME $ 1,394 $ 1,481 $ 1,592
============= =========== ===========
EARNINGS PER SHARE
Basic $ 1.24 $ 1.46 $ 1.59
Diluted $ 1.21 $ 1.41 $ 1.53
Weighted average shares outstanding 1,119,780 1,012,844 1,001,013
Weighted average diluted shares outstanding 1,152,576 1,047,745 1,038,599
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
52
<PAGE>
VALLEY COMMUNITY BANCSHARES, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands)
<TABLE>
<CAPTION>
Accumulated
Common Stock Additional Other Total
------------------ Paid-In Comprehensive Retained Comprehensive Stockholders'
Shares Amount Capital Income Earnings Income (Loss), net Equity
------ ------ ---------- ------------- -------- ------------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE,
December 31, 1996 906,054 $ 906 $ 9,561 $ 1,652 $ 123 $ 12,242
Net income $ 1,592 1,592 1,592
Other comprehensive
income, net of $16 tax
Unrealized loss
on securities (31) (31) (31)
-----------
Comprehensive income $ 1,561
===========
Cash dividend (457) (457)
Stock dividend 45,132 45 948 (993)
Common stock exercised
under stock option plan 13,500 14 76 90
------------ ----------- ----------- -------- ------------------ -------------
BALANCE,
December 31, 1997 964,686 965 10,585 1,794 92 13,436
Net income $ 1,481 1,481 1,481
Other comprehensive
income, net of $10 tax
Unrealized gains
on securities 19 19 19
-----------
Comprehensive income $ 1,500
===========
Holding company reorganization 893 (893)
Cash dividend (871) (871)
Stock dividend 48,043 48 1,153 (1,201)
Common stock exercised
under stock option plan 2,253 2 11 13
------------ ----------- ----------- ----------- ------------ -----------
BALANCE,
December 31, 1998 1,014,982 1,015 12,642 310 111 14,078
Net income $ 1,394 1,394 1,394
Other comprehensive
income, net of $190 tax
Unrealized loss
on securities (368) (368) (368)
-----------
Comprehensive income $ 1,026
===========
Common stock issued 106,189 106 3,610 3,716
Cash dividend (135) (135)
Common stock exercised
under stock option plan 4,390 5 34 39
------------ ----------- ----------- ----------- ------------ -----------
BALANCE,
December 31, 1999 1,125,561 $ 1,126 $ 16,286 $ 1,569 $ (257) $ 18,724
============ =========== =========== =========== ============ ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
53
<PAGE>
VALLEY COMMUNITY BANCSHARES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,394 $ 1,481 $ 1,592
Adjustments to reconcile net income to net cash
from operating activities
Provisions for loan losses 84 9 66
Depreciation 415 307 303
Deferred income tax (8) (33) (49)
Net amortization on securities 70 62 97
FHLB stock dividends (29) (10)
Gain on sale of securities available-for-sale (1) (2) (85)
Loss on sale of premises and equipment 4
Increase in accrued interest receivable (79) (103) (38)
Increase (decrease) in other assets 85 (74) 108
Increase (decrease) in accrued interest payable 7 21 (1)
Increase in other liabilities 24 188 72
----------- ----------- -----------
Net cash from operating activities 1,962 1,846 2,069
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Net (increase) decrease in federal funds sold 2,530 (530) 200
Net (increase) decrease in interest-bearing deposits with banks 1,578 1,600 (6,411)
Purchase of securities available-for-sale (17,919) (26,432) (12,715)
Proceeds from sales of securities available-for-sale 1,001 2,377 11,329
Proceeds from maturities of securities available-for-sale 14,311 13,619 5,060
Proceeds from maturities of securities held-to-maturity 1,094 2,562 2,155
Purchase stock in FHLB (36) (345)
Net increase in loans (10,918) (3,110) (6,223)
Additions to premises and equipment (1,464) (796) (128)
Additions to real estate held for investment (1) (24)
Reduction to real estate held for investment 32
----------- ----------- -----------
Net cash from investing activities (9,791) (11,056) (6,757)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 3,526 12,133 4,662
Net increase (decrease) in other borrowed funds 305 (649) 168
Cash dividends paid (135) (871) (457)
Common stock issued 3,591
Stock options exercised 39 13 90
----------- ----------- -----------
Net cash from financing activities 7,326 10,626 4,463
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS (503) 1,416 (225)
CASH AND DUE FROM BANKS, beginning of year 5,630 4,214 4,439
----------- ----------- -----------
CASH AND DUE FROM BANKS, end of year $ 5,127 $ 5,630 $ 4,214
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for
Interest $ 2,966 $ 3,118 $ 3,080
=========== =========== ===========
Income taxes $ 563 $ 655 $ 642
=========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITIES
Unrealized gains (losses) on securities available-for-sale $ (558) $ 29 $ (46)
=========== =========== ===========
Common stock issued for land $ 125
=========== =========== ===========
Deferred tax on unrealized gains (losses) on securities
available-for-sale $ 189 $ 10 $ (15)
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
54
<PAGE>
NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION - The consolidated financial statements include
the accounts of Valley Community Bancshares, Inc. (the Company) and its
wholly-owned subsidiaries Puyallup Valley Bank and Valley Bank (collectively,
the "Bank"). All significant intercompany transactions and balances have been
eliminated in consolidation.
DESCRIPTION OF BUSINESS - The Company is a Washington State bank
holding company headquartered in Puyallup, Washington. The Company was organized
as a holding company for its principal bank subsidiary, Puyallup Valley Bank,
through a reorganization completed on July 1, 1998. The Company conducts its
business primarily through the Bank. The Company recently became a multi-bank
holding company by assisting in the formation of Valley Bank, a wholly-owned
subsidiary of the Company, beginning January 11, 1999.
The Company's main office is located in Puyallup, Washington, which
also serves as the main office of Puyallup Valley Bank. Valley Bank is located
in Auburn, Washington. The Company provides a full range of commercial banking
services to small and medium-sized businesses, professionals and other
individuals through banking offices located in Puyallup and Auburn, Washington,
and their environs.
USE OF ESTIMATES - The preparation of the consolidated financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions. These assumptions and estimates
affect the reported amounts of assets and liabilities, and disclosures of
contingent assets and liabilities at the date of the consolidated financial
statements. They also affect the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
CASH EQUIVALENTS - For purposes of reporting cash flows, cash and cash
equivalents include cash on hand, and amounts due from banks. Cash and cash
equivalents have an original maturity of three months or less.
INTEREST-BEARING DEPOSITS WITH BANKS - Interest-bearing deposits with
banks include interest-bearing deposits at the Federal Home Loan Bank and
certificates of deposit in financial institutions located throughout the United
States. All certificates of deposit are under the FDIC insurance limit.
INVESTMENT SECURITIES - Investment securities are classified into one
of three categories: (1) held-to-maturity, (2) available-for-sale, or (3)
trading. Investment securities are categorized as held-to-maturity when the
Company has the positive intent and ability to hold those securities to
maturity. Securities which are held-to-maturity are stated at cost and adjusted
for amortization of premiums and accretion of discounts, which are recognized as
adjustments to interest income.
Investment securities categorized as available-for-sale are generally
held for investment purposes (to maturity), although unanticipated future events
may result in the sale of some securities. Available-for-sale securities are
recorded at estimated fair value, with the net unrealized gain or loss included
in comprehensive income, net of the related tax effect. Realized gains or losses
on dispositions are based on the net proceeds and the adjusted carrying amount
of securities sold, using the specific identification method.
Declines in the fair value of individual held-to-maturity and
available-for-sale securities below their cost that are other than temporary are
recognized by write-downs of the individual securities to their fair value. Such
write-downs would be included in earnings as realized losses.
Premiums and discounts are recognized in interest income using the
interest method over the period to maturity. The Company had no trading
securities at December 31, 1999 and 1998.
55
<PAGE>
NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
FEDERAL HOME LOAN BANK STOCK - The Company's investment in Federal Home
Loan Bank (the FHLB) stock is carried at par value ($100 per share), which
reasonably approximates its fair value. As a member of the FHLB system, the
Company is required to maintain a minimum level of investment in FHLB stock
based on specified percentages of its outstanding FHLB advances. The Company may
request redemption at par value of any stock in excess of the amount the Company
is required to hold. Stock redemptions are at the discretion of the FHLB.
LOANS - Loans that management has the intent and ability to hold for
the foreseeable future, or until maturity or pay-off are reported at their
outstanding principal, are adjusted for any charge-offs, the allowance for loan
losses, and any deferred fees or costs on originated loans and unamortized
premiums or discounts on purchased loans. Loan origination fees and certain
direct origination costs are capitalized and recognized as an adjustment of the
yield of the related loan.
The accrual of interest on impaired loans is discontinued when, in
management's opinion, the borrower may be unable to meet payments as they become
due. When interest accrual is discontinued, all unpaid accrued interest is
reversed. Interest income is subsequently recognized only to the extent cash
payments are received. Interest income on restructured loans is recognized
pursuant to the terms of the new loan agreement. Interest income on other
impaired loans is monitored and based upon the terms of the underlying loan
agreement. However, the recorded net investment in impaired loans, including
accrued interest, is limited to the present value of the expected cash flows of
the impaired loan or the observable fair market value of the loan, or the fair
market value of the loan's collateral.
ALLOWANCE FOR LOAN LOSS - The allowance for loan loss is management's
best estimate of loan losses incurred at the balance sheet date. The allowance
for loan losses is increased by charges to income and decreased by charge-offs
(net of recoveries), and established through a provision for credit losses
charged to expense. Loans are charged against the allowance for credit losses
when management believes that the collectability of the principal is unlikely.
The allowance is an amount that management believes will be adequate to absorb
losses inherent in existing loans, commitments to extend credit and standby
letters of credit based on evaluations of collectability and prior loss
experience of loans, commitments to extend credit and standby letters of credit.
The evaluations take into consideration such factors as changes in the nature
and volume of the portfolio, overall portfolio quality, loan concentrations,
specific problem loans, commitments, standby letters of credit and current
economic conditions that may affect the borrowers' ability to pay.
A material estimate that is particularly susceptible to significant
change relates to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with the determination of the estimated
losses on loans and foreclosed assets held for sale, management obtains
independent appraisals for significant properties.
The majority of the Company's loan portfolio consists of commercial
loans and single-family residential loans secured by real estate in the Puyallup
and Pierce County areas and also in the Auburn and King County area. Real estate
prices in this market are stable at this time. However, the ultimate
collectability of a substantial portion of the Company's loan portfolio may be
susceptible to change in local market conditions in the future.
While management uses available information to recognize losses on
loans, further reductions in the carrying amounts of loans may be necessary
based on changes in local economic conditions. In addition, regulatory agencies,
as an integral part of their examination process, periodically review the
estimated losses on loans. Such agencies may require the Company to recognize
additional losses based on their judgment about information available to them at
the time of their examination.
Management determines the amount of the allowance for loan losses by
utilizing a loan grading system to determine risk in the loan portfolio and by
considering the results of credit reviews. The loan portfolio is separated by
quality and then by loan type. Loans of acceptable quality are evaluated as a
group, by loan type, with a specific loss rate assigned to the total loans in
each type, but unallocated to any individual loan. Conversely, each adversely
classified loan is individually analyzed, to determine an estimated loss amount.
A valuation allowance is
56
<PAGE>
also assigned to these adversely classified loans, but at a higher loss rate
due to the greater risk of loss. For those loans where the loss is greater
than the background percentage, the estimated loss amount is considered
specifically allocated to the allowance.
Although management has allocated a portion of the allowance to the
loan categories using the method described above, the adequacy of the allowance
must be considered as a whole. To mitigate the imprecision in most estimates of
expected loan losses, the allocated component of the allowance is supplemented
by an unallocated component. The unallocated portion includes management's
judgmental determination of the amounts necessary for qualitative factors such
as the consideration of new products and policies, economic conditions,
concentrations of credit risk, and the experience and abilities of lending
personnel. Loan concentrations, quality, terms and basic underlying assumptions
remained substantially unchanged during the period.
57
<PAGE>
NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
PREMISES AND EQUIPMENT - Premises and equipment are stated at cost,
less accumulated amortization and depreciation. Leasehold improvements are
amortized on a straight-line basis over the lives of the respective leases.
Depreciation is computed on the straight-line method over the following
estimated useful lives:
<TABLE>
<S> <C>
Building and improvements 10 - 40 years
Furniture, fixtures and equipment 3 - 10 years
</TABLE>
REAL ESTATE HELD FOR INVESTMENT - Real estate held for investment is
property that was acquired for resale. The property is recorded at the lower of
cost or fair value and is periodically evaluated to determine that the carrying
value does not exceed the fair value of the property. The amount the Company
will ultimately recover may differ from the carrying value of the asset because
of future market factors beyond the Company's control.
INCOME TAX - The Company records its provision for income taxes using
the liability method. Deferred tax assets and liabilities are reflected at
currently enacted income tax rates applicable to the period in which the
deferred tax assets or liabilities are expected to be realized or settled. As
changes in tax laws or rates are enacted, deferred tax assets and liabilities
are adjusted through the provision for income taxes.
RESTRICTED ASSETS - Federal Reserve Board Regulations require
maintenance of certain minimum reserve balances on deposit with the Federal
Reserve Bank. The amounts of such balances on deposit were approximately
$868,000 and $874,000 at December 31, 1999 and 1998, respectively.
STOCK OPTION PLAN - The Company recognizes the financial effects of
stock options in accordance with Accounting Principles Board (APB) Opinion No.
25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. Stock options are issued at a
price that approximates the fair value of the Bank's stock as of the grant date.
Under APB 25, options issued in this manner do not result in the recognition of
employee compensation in the Company's financial statements.
FINANCIAL INSTRUMENTS - In the ordinary course of business, the Company
has entered into off-balance sheet financial instruments consisting of
commitments to extend credit, commitments under credit card arrangements,
commercial letters of credit and standby letters of credit. Such financial
instruments are recorded in the financial statements when they are funded, or
related fees are incurred or received.
EARNINGS PER SHARE - Basic earnings per share amounts are computed
based on the weighted average number of shares outstanding during the period
after giving retroactive effect to stock dividends and stock splits. Diluted
earnings per share amounts are computed by determining the number of additional
shares that are deemed outstanding due to stock options under the treasury stock
method.
ADVERTISING COSTS - The Company expenses advertising costs as they are
incurred and are not considered to be material.
IMPACT OF NEW ACCOUNTING ISSUES - In June 1999, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
("SFAS") No. 137 entitled ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES - DEFERRAL OF THE EFFECTIVE DATE OF SFAS STATEMENT NO.133. The
statement amends SFAS No. 133 to defer its effective date to all fiscal quarters
of all fiscal years beginning after June 15, 2000. Management does not believe
the adoption of this statement will have a material effect on its financial
condition or results of operation.
58
<PAGE>
NOTE 2 - INVESTMENT SECURITIES
Investment securities have been classified according to management's
intent. The carrying amount of securities and their estimated fair values are as
follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1999
SECURITIES AVAILABLE-FOR-SALE Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
U.S. Treasury and U.S. Government
corporations and agencies $ 18,630 $ 23 $ 224 $ 18,429
State and political subdivisions 4,233 7 39 4,201
Mortgage-backed securities 9,269 14 132 9,151
Other 1,520 39 1,481
----------- ----------- ---------- -----------
33,652 44 434 33,262
----------- ----------- ---------- -----------
SECURITIES HELD-TO-MATURITY
U.S. Treasury and U.S. Government
corporations and agencies 321 2 323
State and political subdivisions 920 4 924
-------------------------------------------------------
1,241 6 1,247
----------- ----------- ---------- -----------
$ 34,893 $ 50 $ 434 $ 34,509
=========== =========== ========== ===========
<CAPTION>
DECEMBER 31, 1998
SECURITIES AVAILABLE-FOR-SALE Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
U.S. Treasury and U.S. Government
corporations and agencies $ 15,867 $ 92 $ 60 $ 15,899
State and political subdivisions 4,658 85 2 4,741
Mortgage-backed securities 10,056 65 7 10,114
Other 533 5 528
----------- ----------- ---------- -----------
31,114 242 74 31,282
----------- ----------- ---------- -----------
SECURITIES HELD-TO-MATURITY
U.S. Treasury and U.S. Government
corporations and agencies 436 2 438
State and political subdivisions 1,899 25 1,924
-------------------------------------------------------
2,335 27 2,362
----------- ----------- ---------- -----------
$ 33,449 $ 269 $ 74 $ 33,644
=========== =========== ========== ===========
</TABLE>
59
<PAGE>
NOTE 2 - INVESTMENT SECURITIES (continued)
The amortized cost and estimated market value of securities
available-for-sale and securities held-to-maturity, at December 31, 1999, by
contractual maturity, are shown below. Expected maturities may differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without prepayment penalties.
<TABLE>
<CAPTION>
Available-For-Sale Held-to-Maturity
-------------------------- -------------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
----------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Due in one year or less $ 7,099 $ 7,054 $ 885 $ 889
Due from one to five years 22,698 22,362 35 35
Due from five to ten years 913 880
Due after ten years 2,942 2,966 321 323
----------- ----------- ---------- -----------
Totals $ 33,652 $ 33,262 $ 1,241 $ 1,247
=========== =========== ========== ===========
</TABLE>
Proceeds from sales of available-for-sale investment securities were
$1,001,000, $2,377,000 and $11,329,000 in 1999, 1998 and 1997, respectively.
Gross gains from the sales of available-for-sale investment securities
were $1,000, $5,000 and $87,000 in 1999, 1998 and 1997, respectively. The
Company incurred gross losses of $0 in 1999, $3,000 in 1998, and $2,000 in 1997.
Investments in State and political subdivisions represent purchases of
municipal bonds located in Washington State. Investments in corporate debt
obligations are made in companies located and doing business throughout the
United States. The debt obligations were all within the credit ratings
acceptable under the Company's investment policy.
Investment securities with a book value of $3,864,000 and $2,370,000 at
1999 and 1998, respectively, have been pledged to secure public deposits, as
required by law, and other purposes. The estimated fair value of these pledged
securities is $3,829,000 and $2,370,000 at December 31, 1999 and 1998,
respectively.
NOTE 3 - LOANS
The major classifications of loans at December 31 are summarized as
follows (dollars in thousands):
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Real Estate
Construction $ 7,384 $ 4,890
Mortgage 15,867 13,788
Commercial 40,257 34,696
Commercial 12,892 12,496
Consumer and other 1,860 1,854
Lease 377
----------- -----------
78,637 67,724
Less deferred loan fees, net (3)
----------- -----------
$ 78,634 $ 67,724
=========== ===========
</TABLE>
60
<PAGE>
NOTE 3 - LOANS (continued)
Contractual maturities of loans as of December 31, 1999 are as shown
below. Actual maturities may differ from contractual maturities because
individual borrowers may have the right to prepay loans with or without
prepayment penalties.
<TABLE>
<CAPTION>
Within 1 Year 1 - 5 Years After 5 Years Total
------------- ------------- ------------- -----------
<S> <C> <C> <C> <C>
Commercial $ 8,859 $ 3,219 $ 814 $ 12,892
Real Estate, commercial 6,575 33,538 141 40,254
Real Estate, construction 6,863 521 7,384
Real Estate, mortgage 2,665 12,096 1,106 15,867
Consumer and other 724 933 203 1,860
Lease 69 308 377
------------- ------------- ------------- -----------
$ 25,755 $ 50,615 $ 2,264 $ 78,634
============= ============= ============= ===========
<CAPTION>
1 - 5 After
Years 5 Years
------------- -------------
<S> <C> <C>
Loans maturing after one year with:
Fixed rates $ 44,169 $ 864
Variable rates 6,446 1,400
------------- -------------
$ 50,615 $ 2,264
============= =============
</TABLE>
At December 31, 1999 and 1998, the Company had no loans that were
specifically classified as impaired and therefore, no allocation of the
allowance for possible credit losses was considered necessary at December 31,
1999 and 1998.
The effects of troubled debt restructurings are not considered material
to the Company's financial position and results of operations.
NOTE 4 - ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses are summarized as follows
(dollars in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Balance, beginning of year $ 883 $ 840 $ 776
Provision for loan losses 84 9 66
Additions from recoveries 45
Loans charged off (8) (11) (2)
----------- ----------- -----------
Balance, end of year $ 959 $ 883 $ 840
=========== =========== ===========
</TABLE>
61
<PAGE>
NOTE 5 - PREMISES AND EQUIPMENT
Premises and equipment at December 31 consisted of the following
(dollars in thousands):
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Equipment, furniture and fixtures $ 3,205 $ 2,644
Land and buildings 3,748 3,695
Construction in progress 950
----------- -----------
7,903 6,339
Less: accumulated depreciation (3,186) (2,796)
----------- -----------
$ 4,717 $ 3,543
=========== ===========
</TABLE>
Depreciation expense on premises and equipment totaled $415,000 in
1999, $307,000 in 1998, and $303,000 in 1997.
The Company began construction on the future headquarters of Valley
Bank. Estimated cost to complete construction in progress at December 31, 1999
is $1,050,000.
NOTE 6 - DEPOSITS
Interest-bearing deposits at December 31 consisted of the following (dollars in
thousands):
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Demand accounts $ 15,926 $ 16,185
Money market accounts 28,603 29,040
Savings accounts 12,002 12,101
Certificates of deposit over $100,000 14,555 10,874
Other certificates of deposit 21,374 21,277
----------- -----------
$ 92,460 $ 89,477
=========== ===========
</TABLE>
At December 31, 1999, the scheduled maturities of certificates of
deposit are as follows (dollars in thousands):
<TABLE>
<S> <C>
2000 $ 34,289
2001 1,339
2002 265
2003 36
-----------
$ 35,929
===========
</TABLE>
62
<PAGE>
NOTE 7 - CREDIT ARRANGEMENTS
The Banks are members of the Federal Home Loan Bank of Seattle. As a
member, Puyallup Valley Bank has a committed line of credit up to 10 percent
of total assets. Valley Bank's credit line is on a case-by-case basis.
Borrowings generally provide for interest at the then current published rates.
There were no borrowings outstanding at December 31, 1999 or 1998.
At December 31, 1999, committed line of credit agreements totaling
approximately $6,750,000 were available to the Company from unaffiliated
banks with maturities that range from April 2000 to June 2000. Such lines
generally provide for interest at the then existing federal funds rate. There
were no borrowings outstanding under these credit arrangements at December
31, 1999 and 1998.
NOTE 8 - INCOME TAXES
The components of the provision for federal income tax expense for
the years ended December 31, are as follows (dollars in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- ----------
<S> <C> <C> <C>
Current $ 588 $ 649 $ 646
Deferred (8) (33) (49)
----------- ----------- ----------
$ 580 $ 616 $ 597
=========== =========== ==========
</TABLE>
A reconciliation of the effective income tax rate with the federal
statutory rate is as follows (dollars in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
-------------------------- -------------------------- -------------------------
Amount Rate Amount Rate Amount Rate
----------- ----------- ----------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Federal income tax at
statutory rates $ 671 34% $ 713 34% $ 744 34%
Effect of tax-exempt
interest income (96) (5)% (108) (5)% (136) (6)%
Other 5 11 (11) (1)%
----------- ----------- ----------- ----------- ----------- ----------
$ 580 29% $ 616 29% $ 597 27%
=========== =========== =========== =========== =========== ==========
</TABLE>
63
<PAGE>
NOTE 8 - INCOME TAXES (continued)
The following are the significant components of deferred tax assets
and liabilities at December 31 (dollars in thousands):
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Deferred tax assets
Allowance for loan losses $ 270 $ 232
Unrealized loss on securities available-for-sale 132
Deferred compensation 36
Other 31 73
----------- -----------
469 305
----------- -----------
Deferred tax liabilities
Accumulated depreciation 32 70
Unrealized gain on securities available-for-sale 57
Other 65 3
----------- -----------
97 130
----------- -----------
Net deferred tax asset $ 372 $ 175
=========== ===========
</TABLE>
The Bank believes, based on available information, all deferred
assets will be realized in the normal course of business, therefore, these
assets have not been reduced by a valuation allowance.
NOTE 9 - STOCKHOLDERS' EQUITY AND REGULATORY CAPITAL
In January 1998 and 1997, the Company distributed, 48,043 shares and
45,132 shares, respectively, of common stock in connection with 5 percent
stock dividends. All references in the accompanying consolidated financial
statements to the average number of shares of common stock and per share
amounts have been restated to reflect these stock dividends.
The Company is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly, additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company must meet specific capital guidelines that involve quantitative
measures of the Company's assets, liabilities, and certain off-balance-sheet
items as calculated under regulatory accounting practices. The Company's
capital amounts and classification are also subject to qualitative judgments
by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Company to maintain minimum amounts and ratios (set
forth in the following table) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined). Management believes, as of December
31, 1999, that the Company meets all capital adequacy requirements to which
it is subject.
As of November 1999, the most recent notification from the Federal
Deposit Insurance Corporation categorized the Banks as well capitalized under
the regulatory framework for prompt corrective action. To be categorized as
well capitalized, the Company must maintain minimum total risk-based, Tier I
risk-based, 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 institution's category.
64
<PAGE>
NOTE 9 - STOCKHOLDERS' EQUITY AND REGULATORY CAPITAL (continued)
The Company's actual capital amounts and ratios are also presented in
the table (dollars in thousands):
<TABLE>
<CAPTION>
Actual
------------------------
AS OF DECEMBER 31, 1999: Amount Ratio
---------- ----------
<S> <C> <C>
Total Capital
(to Risk-Weighted Assets)
Consolidated $ 19,940 21.7% GREATER THAN OR EQUAL TO
Puyallup Valley Bank $ 13,867 16.3% GREATER THAN OR EQUAL TO
Valley Bank $ 3,962 68.0% GREATER THAN OR EQUAL TO
Tier I Capital
(to Risk-Weighted Assets)
Consolidated $ 18,981 20.6% GREATER THAN OR EQUAL TO
Puyallup Valley Bank $ 12,970 15.2% GREATER THAN OR EQUAL TO
Valley Bank $ 3,900 66.9% GREATER THAN OR EQUAL TO
Tier I Capital
(to Average Assets)
Consolidated $ 18,981 13.8% GREATER THAN OR EQUAL TO
Puyallup Valley Bank $ 12,970 10.0% GREATER THAN OR EQUAL TO
Valley Bank $ 3,900 53.4% GREATER THAN OR EQUAL TO
AS OF DECEMBER 31, 1998:
Total Capital
(to Risk-Weighted Assets)
Consolidated $ 14,850 19.2% GREATER THAN OR EQUAL TO
Puyallup Valley Bank $ 13,233 17.1% GREATER THAN OR EQUAL TO
Tier I Capital
(to Risk-Weighted Assets)
Consolidated $ 13,967 18.0% GREATER THAN OR EQUAL TO
Puyallup Valley Bank $ 12,350 16.0% GREATER THAN OR EQUAL TO
Tier I Capital
(to Average Assets)
Consolidated $ 13,967 11.0% GREATER THAN OR EQUAL TO
Puyallup Valley Bank $ 12,350 9.8% GREATER THAN OR EQUAL TO
<CAPTION>
For Capital
Adequacy Purposes
-----------------------------------------------------
AS OF DECEMBER 31, 1999: Amount Ratio
---------- ------------
<C> <C>
Total Capital
(to Risk-Weighted Assets)
Consolidated 7,357 GREATER THAN OR EQUAL TO 8.0% GREATER THAN OR EQUAL TO
Puyallup Valley Bank 6,814 GREATER THAN OR EQUAL TO 8.0% GREATER THAN OR EQUAL TO
Valley Bank 466 GREATER THAN OR EQUAL TO 8.0% GREATER THAN OR EQUAL TO
Tier I Capital
(to Risk-Weighted Assets)
Consolidated 3,678 GREATER THAN OR EQUAL TO 4.0% GREATER THAN OR EQUAL TO
Puyallup Valley Bank 3,407 GREATER THAN OR EQUAL TO 4.0% GREATER THAN OR EQUAL TO
Valley Bank 233 GREATER THAN OR EQUAL TO 4.0% GREATER THAN OR EQUAL TO
Tier I Capital
(to Average Assets)
Consolidated 5,522 GREATER THAN OR EQUAL TO 4.0% GREATER THAN OR EQUAL TO
Puyallup Valley Bank 5,194 GREATER THAN OR EQUAL TO 4.0% GREATER THAN OR EQUAL TO
Valley Bank 292 GREATER THAN OR EQUAL TO 4.0% GREATER THAN OR EQUAL TO
AS OF DECEMBER 31, 1998:
Total Capital
(to Risk-Weighted Assets)
Consolidated 6,198 GREATER THAN OR EQUAL TO 8.0%
Puyallup Valley Bank 6,187 GREATER THAN OR EQUAL TO 8.%
Tier I Capital
(to Risk-Weighted Assets)
Consolidated 3,099 GREATER THAN OR EQUAL TO 4.0% GREATER THAN OR EQUAL TO
Puyallup Valley Bank 3,093 GREATER THAN OR EQUAL TO 4.0% GREATER THAN OR EQUAL TO
Tier I Capital
(to Average Assets)
Consolidated 5,065 GREATER THAN OR EQUAL TO 4.0% GREATER THAN OR EQUAL TO
Puyallup Valley Bank 5,061 GREATER THAN OR EQUAL TO 4.0% GREATER THAN OR EQUAL TO
<CAPTION>
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
-----------------------------------------------
AS OF DECEMBER 31, 1999: Amount Ratio
--------- ----------
<C> <C>
Total Capital
(to Risk-Weighted Assets)
Consolidated 9,196 GREATER THAN OR EQUAL TO 10.0%
Puyallup Valley Bank 8,518 GREATER THAN OR EQUAL TO 10.0%
Valley Bank 583 GREATER THAN OR EQUAL TO 10.0%
Tier I Capital
(to Risk-Weighted Assets)
Consolidated 5,518 GREATER THAN OR EQUAL TO 6.0%
Puyallup Valley Bank 5,111 GREATER THAN OR EQUAL TO 6.0%
Valley Bank 350 GREATER THAN OR EQUAL TO 6.0%
Tier I Capital
(to Average Assets)
Consolidated 6,903 GREATER THAN OR EQUAL TO 5.0%
Puyallup Valley Bank 6,492 GREATER THAN OR EQUAL TO 5.0%
Valley Bank 365 GREATER THAN OR EQUAL TO 5.0%
AS OF DECEMBER 31, 1998:
Total Capital
(to Risk-Weighted Assets)
Consolidated 7,747 GREATER THAN OR EQUAL TO 10.0%
Puyallup Valley Bank 7,733 GREATER THAN OR EQUAL TO 10.0%
Tier I Capital
(to Risk-Weighted Assets)
Consolidated $ 4,648 GREATER THAN OR EQUAL TO 6.0%
Puyallup Valley Bank $ 4,640 GREATER THAN OR EQUAL TO 6.0%
Tier I Capital
(to Average Assets)
Consolidated $ 6,331 GREATER THAN OR EQUAL TO 5.0%
Puyallup Valley Bank $ 6,326 GREATER THAN OR EQUAL TO 5.0%
</TABLE>
65
<PAGE>
NOTE 10 - COMMITMENTS AND CONTINGENT LIABILITIES
(a) FINANCIAL INSTRUMENTS - The Company is party to financial
instruments with off-balance sheet risk in the normal course of business to meet
the financing needs of its customers. These financial instruments include
commitments to extend credit and standby letters of credit. These instruments
involve, to varying degrees, elements of credit risk in excess of the amount
recognized in the balance sheets.
The Company's exposure to credit loss, in the event of
nonperformance by the other party to the financial instruments for
commitments to extend credit and standby letters of credit, is represented by
the contractual amount of those instruments. The Company uses the same credit
policies in making commitments and conditional obligations as it does for
on-balance sheet instruments. A summary of commitments at December 31 is as
follows (dollars in thousands):
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Commitments to extend credit $ 13,910 $ 8,513
Standby letters of credit 343 391
------------ ------------
$ 14,253 $ 8,904
============ ============
</TABLE>
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since some commitments are expected
to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Company's experience has
been that approximately 75% of loan commitments are drawn upon by customers.
While approximately all of commercial letters of credit are utilized, a
significant portion of such utilization is on an immediate payment basis. The
Company evaluates each customer's credit worthiness on a case-by-case basis.
The amount of collateral obtained, if it is deemed necessary by the Company
upon extension of credit, is based on management's credit evaluation of the
counterparty. Collateral held varies but may include accounts receivable,
inventory, property and equipment, and income producing properties.
Standby letters of credit are conditional commitments issued by the
Company to guarantee the performance of a customer to a third party. Those
guarantees are primarily issued to support public and private borrowing
arrangements. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to
customers. Collateral held varies as specified above, and is required in
instances where the Company deemed necessary.
(b) OPERATING LEASE COMMITMENTS - The Company leases its operating
facilities under agreements which expire between 2000 and 2004. The
agreements require the Company to pay certain operating expenses. The
approximate annual commitment for rental space under these operating leases
is summarized as follows (dollars in thousands):
<TABLE>
<CAPTION>
Year Ending
December 31,
------------
<S> <C>
2000 $ 102
2001 93
2002 65
2003 27
------------
$ 287
============
</TABLE>
66
<PAGE>
NOTE 10 - COMMITMENTS AND CONTINGENT LIABILITIES (continued)
Rental expense charged to operations was $109,000, $74,000 and
$75,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
NOTE 11 - RELATED PARTY TRANSACTIONS
Certain directors, executive officers, principal stockholders and
companies in which they have a beneficial interest, are loan customers of the
Company. All loans and loan commitments were made in compliance with
applicable laws and regulations on substantially the same terms (including
interest rates and collateral) as those prevailing at the time for comparable
transactions with other persons and do not involve more than the normal risk
of collectability or present any other unfavorable features.
Such loans had aggregate balances and activity during 1999, 1998 and
1997 as follows (dollars in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
------------ ----------- -----------
<S> <C> <C> <C>
Balance, beginning of year $ 550 $ 500 $ 435
New loans or advances 2,378 50 2,165
Repayments (789) (2,100)
------------ ----------- -----------
Balance, end of year $ 2,139 $ 550 $ 500
============ =========== ===========
</TABLE>
Deposits from related parties totaled approximately $5,175,000 and
$4,677,000 at December 31, 1999 and 1998, respectively.
NOTE 12 - EMPLOYEE BENEFITS
The Company has a 401(k) defined contribution plan for those
employees who meet the eligibility requirements set forth in the plan.
Contributions to the plan, adopted in January 1987, are at the discretion of
the Company's Board of Directors. Eligible employees can contribute up to 12%
of compensation. The Company made no contributions to the plan in 1999, 1998
or 1997.
The Company also has a noncontributory profit sharing plan covering
substantially all employees. Contributions to the plan are at the discretion
of the Company's Board of Directors, and totaled $84,000, $94,000 and $96,000
in 1999, 1998 and 1997, respectively.
NOTE 13 - STOCK OPTION PLAN
The Company has a qualified incentive stock option plan that
provides for the awarding of stock options to certain officers and employees
of the Company. The awarding of stock options is at the discretion of the
Board of Directors. Options granted under the plan vest under a schedule
determined by the Board of Directors and expire ten years from the date of
the grant. The exercise price of all options granted under the plan is equal
to the fair value of the common stock on the date of the grant. Average
exercise price per share, number of shares authorized, available for grant,
granted, exercised, outstanding and currently exercisable reflect the
dilutive effect of stock dividends and stock splits.
67
<PAGE>
NOTE 13 - STOCK OPTION PLAN (continued)
Pro forma information regarding net income and earnings per share is
required by Statement of Financial Accounting Standards No. 123, ACCOUNTING
FOR STOCK-BASED COMPENSATION. The pro forma recognizes, as compensation, the
estimated present value of stock options granted using an option valuation
model known as the Black-Scholes model. Pro forma earnings per share amounts
reflect an adjustment as if the present value of the options were recognized
as compensation for the period.
For the most part, variables and assumptions are used in the model.
For the periods 1999, 1998 and 1997, respectively, the risk-free interest
rate is 5.75%, 5.75% and 5.90%, the dividend yield rate is 1.4%, 1.7% and
1.9%, the price volatility is not meaningful, and the weighted average
expected life of the options has been measured at 7 years.
The fair value of options issued in 1999 and 1998 were estimated at
$24,000 and $21,000, respectively. The remaining unrecognized compensation
for fair value of stock options was approximately $25,000 as of December 31,
1999.
Management believes that the variables and assumptions used in the
options pricing model are subjective and represent only one estimate of
possible value. The fair value of options granted, that are recognized in pro
forma earnings, is shown below:
<TABLE>
<CAPTION>
In thousands, except for per share amounts 1999 1998 1997
------------------------------------------ ----------- ----------- -----------
<S> <C> <C> <C>
Pro forma disclosures
Net income as reported $ 1,394 $ 1,481 $ 1,592
Additional compensation for fair value of
stock options (3) (2)
----------- ----------- -----------
Pro forma net income $ 1,391 $ 1,479 $ 1,592
=========== =========== ===========
Earnings per share
Basic
As reported $ 1.24 $ 1.46 $ 1.59
=========== =========== ===========
Pro forma $ 1.24 $ 1.46 $ 1.59
=========== =========== ===========
Diluted
As reported $ 1.21 $ 1.41 $ 1.53
=========== =========== ===========
Pro forma $ 1.21 $ 1.41 $ 1.53
=========== =========== ===========
</TABLE>
68
<PAGE>
NOTE 13 - STOCK OPTION PLAN (continued)
Information with respect to option transactions is summarized as
follows:
<TABLE>
<CAPTION>
Average
Exercise Currently Options
Authorized Price Exercised Outstanding Exercisable
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1996 159,070 $ 9.45 89,134 65,634 27,558
Granted 25.00 5,000
Exercised 6.70 13,500 (13,500) (13,500)
Expired and forfeitures 19.05 (5,250)
Vested 24,130
----------- ----------- ----------- ----------- -----------
Balance, December 31, 1997 159,070 10.69 102,634 51,884 38,188
1998 Option plan 100,000
Granted 33.00 13,750
Exercised 5.99 2,253 (2,253) (2,253)
----------- ----------- ----------- ----------- -----------
Balance, December 31, 1998 259,070 15.70 104,887 63,381 35,935
Granted 35.00 14,500
Exercised 8.68 4,390 (4,390) (4,390)
Expired and forfeitures 34.14 (8,750)
Vested 5,464
----------- ----------- ----------- ----------- -----------
Balance, December 31, 1999 259,070 $ 18.00 109,277 64,741 37,009
=========== =========== =========== =========== ===========
</TABLE>
Additional financial data pertaining to outstanding stock options is as
follows:
<TABLE>
<CAPTION>
Weighted Average Weighted Average
Remaining Weighted Average Number Exercise Price of
Range of Number of Contractual Exercise Price of Exercisable Exercisable
Exercise Prices Option Shares Life (In Years) Option Shares Option Shares Option Shares
----------------- --------------- ----------------- ---------------- --------------- -----------------
<S> <C> <C> <C> <C> <C>
$5.42 8,027 0.27 $5.42 8,027 $5.42
$9.70 - $12.36 30,806 3.16 $10.27 28,982 $10.14
$15.54 1,158 5.46 $15.54 - -
$23.81 5,250 7.89 $5.25 - -
$25 2,000 8.22 $25.00 - -
$35 17,500 9.26 $35.00 - -
</TABLE>
69
<PAGE>
NOTE 14 - EARNINGS PER SHARE
The numerators and denominators of basic and fully diluted earnings per
share are as follows:
<TABLE>
<CAPTION>
In thousands, except for per share amounts 1999 1998 1997
------------------------------------------ ------------ ------------ ------------
<S> <C> <C> <C>
Net income (numerator) $ 1,394 $ 1,481 $ 1,592
============ ============ ============
Shares used in the calculation (denominator)
Weighted average shares outstanding 1,119,780 1,012,844 1,001,013
Effect of dilutive stock options 32,796 34,901 37,586
Fully diluted shares 1,152,576 1,047,745 1,038,599
============ ============ ============
Basic earnings per share $1.24 $1.46 $1.59
============ ============ ============
Fully diluted earnings per share $1.21 $1.41 $1.53
============ ============ ============
</TABLE>
NOTE 15 - 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 fair value of commitments to customers is not considered material since they
are for relatively short periods of time and subject to customary credit terms.
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
(a) CASH AND DUE FROM BANKS, INTEREST-BEARING DEPOSITS WITH BANKS,
OTHER BORROWED FUNDS AND FEDERAL FUNDS SOLD - For these short-term instruments,
the carrying amount is a reasonable estimate of fair value.
(b) SECURITIES - For securities, fair values are based on
quoted market prices or dealer quotes, if available. If a quoted market price
is not available, fair value is estimated using quoted market prices for
similar securities.
(c) LOANS - The fair value of loans generally is estimated by
discounting the future cash flows using the current rates at which similar loans
would be made to borrowers with similar credit ratings and for the same
remaining maturities. For certain homogeneous categories of loans, such as Small
Business Administration guaranteed loans, fair value is estimated using the
quoted market prices for securities backed by similar loans, adjusted for
differences in loan characteristics.
(d) DEPOSITS - The fair value of demand deposits, savings
accounts and certain money market deposits, is the amount payable on demand
at the reporting date. The fair value of fixed-maturity certificates of
deposit is estimated by discounting the future cash flows using the rates
currently offered for deposits of similar remaining maturities.
(e) LIMITATIONS - The fair value estimates presented herein are
based on pertinent information available to management as of the applicable
date.
70
<PAGE>
NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)
The estimated fair values of the Company's financial instruments at
December 31, are as follows (dollars in thousands):
<TABLE>
<CAPTION>
1999 1998
---------------------------- --------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ ----------- ------------ -----------
<S> <C> <C> <C> <C>
Financial Assets:
Cash and due from banks, interest-
bearing deposits with banks,
and federal funds sold $ 14,819 $ 14,819 $ 19,430 $ 19,430
Securities $ 34,503 $ 34,509 $ 33,617 $ 33,644
Federal Home Loan Bank stock $ 420 $ 420 $ 355 $ 355
Loans $ 78,634 $ 77,667 $ 67,724 $ 68,408
Financial Liabilities:
Deposits $ 113,809 $ 113,725 $ 110,283 $ 110,339
Other borrowed funds $ 539 $ 539 $ 234 $ 234
</TABLE>
NOTE 16 - PARENT COMPANY (ONLY) FINANCIAL INFORMATION
Condensed balance sheet at December 31, 1999 and 1998 (dollars in
thousands):
<TABLE>
<CAPTION>
1999 1998
-------------- ---------------
<S> <C> <C>
ASSETS
Cash and due from bank $ 1,131 $ 1,592
Investment in Banks 16,613 12,461
Other assets 980 145
-------------- ---------------
Total assets $ 18,724 $ 14,198
============== ===============
LIABILITIES
Accounts payable $ 120
---------------
Total liabilities 120
---------------
TOTAL STOCKHOLDERS' EQUITY $ 18,724 14,078
-------------- ---------------
Total liabilities and stockholders' equity $ 18,724 $ 14,198
============== ===============
</TABLE>
71
<PAGE>
NOTE 16 - PARENT COMPANY (ONLY) FINANCIAL INFORMATION (continued)
Condensed statement of income for the year ended December 31, 1999 and
for the period from inception (July 1, 1998) to December 31, 1998 (dollars in
thousands):
<TABLE>
<CAPTION>
1999 1998
-------------- --------------
<S> <C> <C>
INCOME
Dividend from Bank $ 900 $ 2,075
Other income 27
-------------- --------------
Total income 927 2,075
-------------- --------------
EXPENSES
Other expenses 15 131
-------------- --------------
Total expenses 15 131
-------------- --------------
NET INCOME BEFORE FEDERAL INCOME TAX AND
EQUITY IN UNDISTRIBUTED INCOME OF BANK 912 1,944
INCOME TAX (13) 44
-------------- --------------
NET INCOME BEFORE EQUITY IN UNDISTRIBUTED
INCOME OF BANK 899 1,988
EQUITY IN UNDISTRIBUTED INCOME OF BANK 495
DISTRIBUTIONS RECEIVED IN EXCESS OF BANK INCOME (1,294)
-------------- --------------
NET INCOME $ 1,394 $ 694
============== ==============
</TABLE>
72
<PAGE>
NOTE 16 - PARENT COMPANY (ONLY) FINANCIAL INFORMATION (continued)
Condensed statement of cash flows for the year ended December 31, 1999
and for the period from inception (July 1, 1998) to December 31, 1998 (dollars
in thousands):
<TABLE>
<CAPTION>
1999 1998
-------------- --------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,394 $ 694
Adjustments to reconcile net income to net cash
from operating activities
Distributions received in excess of subsidiary bank income (495) 1,294
Other operating activities (54) 26
-------------- --------------
Net cash from operating activities 845 2,014
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of real estate (776) (50)
Investment in Valley Bank (4,025)
-------------- --------------
Net cash from investing activities (4,801) (50)
CASH FLOWS FROM FINANCING ACTIVITIES
Sale of Common Stock 3,630 13
Dividend (135) (385)
-------------- --------------
Net cash from financing activities 3,495 (372)
NET INCREASE (DECREASE) IN CASH (461) 1,592
CASH, beginning of year 1,592
-------------- --------------
CASH, end of year $ 1,131 $ 1,592
============== ==============
</TABLE>
NOTE 17 - SUBSEQUENT EVENT
(a) DIVIDENDS - On January 26, 2000, the Board of Directors of the
Company declared a cash dividend of $.50 per share. The dividend was paid
during February 2000 to those shareholders of record on December 31, 1999.
The dividend was approximately $563,000.
73
<PAGE>
VALLEY COMMUNITY BANCSHARES, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(unaudited)
(dollars in Thousands)
<TABLE>
<CAPTION>
March 31, December 31,
----------------- ---------------
2000 1999
----------------- ---------------
<S> <C> <C>
ASSETS
Cash and due from banks $ 5,359 $ 5,127
Interest-bearing deposits with banks 6,991 9,692
Federal funds sold
Securities available-for-sale 31,910 33,262
Securities held-to-maturity 1,214 1,241
Federal Home Loan Bank stock 426 420
----------------- ---------------
45,900 49,742
Loans 83,932 78,634
Less allowance for loan losses 986 959
----------------- ---------------
Loans, net 82,946 77,675
Accrued interest receivable 786 851
Premises and equipment, net 4,935 4,717
Real estate held for investment 224 224
Other assets 708 628
----------------- ---------------
Total assets $ 135,499 $ 133,837
================= ===============
LIABILITIES
Deposits
Noninterest-bearing $ 22,831 $ 21,349
Interest-bearing 92,727 92,460
----------------- ---------------
Total deposits 115,558 113,809
Other borrowed funds 510 539
Accrued interest payable 422 347
Other liabilities 550 418
----------------- ---------------
Total liabilities 117,040 115,113
----------------- ---------------
STOCKHOLDERS' EQUITY
Common stock, par value $1 per share; 5,000,000 shares authorized;
1,125,561 shares issued and outstanding in 2000 and 1999 1,126 1,126
Additional paid-in capital 16,286 16,286
Retained earnings 1,383 1,569
Accumulated other comprehensive income (loss), net of tax (336) (257)
----------------- ---------------
Total stockholders' equity 18,459 18,724
----------------- ---------------
Total liabilities and stockholders' equity $ 135,499 $ 133,837
================= ===============
</TABLE>
The accompanying notes are an integral part of these financial statements.
74
<PAGE>
VALLEY COMMUNITY BANCSHARES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(unaudited)
(dollars in thousands, except for share amounts)
<TABLE>
<CAPTION>
Accumulated
Common Stock Additional Other Total
----------------------- Paid-In Retained Comprehensive Stockholders'
Shares Amount Capital Earnings Income (Loss), net Equity
------------ --------- ----------- ------------ ------------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1999 1,125,561 $ 1,126 $ 16,286 $ 1,569 $ (257) $ 18,724
Net income 377 377
Unrealized loss on securities (79) (79)
Common stock issued -
Cash dividend (563) (563)
------------ --------- ----------- ------------ ------------------- -------------
Balance at Merck 31, 2000 1,125,561 $ 1,126 $ 16,286 $ 1,383 $ (336) $ 18,459
============ ========== =========== ============ =================== =============
</TABLE>
<TABLE>
<CAPTION>
COMPREHENSIVE INCOME Three Months Ended
March 31,
-------------------------
2000 1999
-------------- ----------
<S> <C> <C>
Net income, as reported $ 377 $ 284
Increase (decrease) in unrealized loss on
securities
Available for sale, net of tax of $(41),
and $(27) respectively. (79) (54)
-------------- ----------
Comprehensive income $ 298 $ 230
============== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
75
<PAGE>
VALLEY COMMUNITY BANCSHARES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
(unaudited)
(dollars in thousands, except for per share amounts)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
---------------------------------
2000 1999
------------------ --------------
<S> <C> <C>
INTEREST INCOME
Interest and fees on loans $ 1,812 $ 1,474
Interest on federal funds sold and deposits in banks 103 215
Interest on securities 485 445
------------------ --------------
Total interest income 2,400 2,134
------------------ --------------
INTEREST EXPENSE
Interest on deposits 768 726
Interest on federal funds and other short-term borrowings 5 4
------------------ --------------
Total interest expense 773 730
------------------ --------------
Net interest income 1,627 1,404
PROVISION FOR LOAN LOSSES 27 15
------------------ --------------
Net interest income after provision
for loan losses 1,600 1,389
------------------ --------------
NONINTEREST INCOME
Service charges 74 80
Origination fees on mortgage loans brokered 3 23
Other operating income 65 51
------------------ --------------
Total noninterest income 142 154
------------------ --------------
NONINTEREST EXPENSE
Salaries 494 454
Employee benefits 117 106
Occupancy 119 112
Equipment 110 113
Other operating expenses 363 357
------------------ --------------
Total noninterest expense 1,203 1,142
------------------ --------------
INCOME BEFORE INCOME TAX 539 401
PROVISION FOR INCOME TAX 162 117
------------------ --------------
NET INCOME $ 377 $ 284
================== ==============
EARNINGS PER SHARE
Basic $ 0.33 $ 0.26
Diluted $ 0.33 $ 0.25
Weighted average shares outstanding 1,125,562 1,108,227
Weighted average diluted shares outstanding 1,154,009 1,142,447
</TABLE>
The accompanying notes are an integral part of these financial statements.
76
<PAGE>
VALLEY COMMUNITY BANCSHARES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(unaudited)
(dollars in thousands, except for per share amounts)
<TABLE>
<CAPTION>
Three Months Ended,
March 31,
--------------------------------
2000 1999
---------------- ---------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 377 $ 285
Adjustments to reconcile net income to net cash
from operating activities
Provisions for loan losses 27 15
Depreciation 94 103
Deferred income tax 2 (8)
Net amortization on securities 10 22
FHLB stock dividends (6) (7)
Increase in accrued interest receivable 65 79
Increase (decrease) in other assets (41) 6
Increase (decrease) in accrued interest payable 75 (7)
Increase (decrease) in other liabilities 132 (67)
---------------- ---------------
Net cash from operating activities 735 421
---------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net increase in federal funds sold - (70)
Net decrease in interest-bearing deposits with banks 2,701 2,902
Purchase of securities available-for-sale (1,306) (8,202)
Proceeds from maturities of securities available-for-sale 2,528 5,448
Proceeds from maturities of securities held-to-maturity 27 214
Purchase stock in FHLB - (20)
Net increase in loans (5,298) (3,488)
Additions to premises and equipment (312) (747)
---------------- ---------------
Net cash from investing activities (1,660) (3,963)
---------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits 1,749 (1,576)
Net increase (decrease) in other borrowed funds (29) 141
Cash dividends paid (563) (135)
Common stock issued - 3,591
Stock options exercised - 28
---------------- ---------------
Net cash from financing activities 1,157 2,049
---------------- ---------------
NET INCREASE (DECREASE) IN CASH AND DUE 232 (1,493)
FROM BANKS
CASH AND DUE FROM BANKS, beginning of year 5,127 5,630
---------------- ---------------
CASH AND DUE FROM BANKS, at end of period $ 5,359 $ 4,137
================ ===============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for
Interest $ 698 $ 724
SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITIES
Unrealized gains (losses) on securities available-for-sale $ (120) $ (81)
================ ===============
Common stock issued for land $ - $ 125
================ ===============
Deferred tax on unrealized gains (losses) on securities
available-for-sale $ 41 $ 27
================ ===============
</TABLE>
The accompanying notes are an integral part of these financial statements.
77
<PAGE>
VALLEY COMMUNITY BANCSHARES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
Valley Community Bancshares, Inc. (the "Company") has prepared the
consolidated financial statements of the Company for the three-month period
ended March 31, 2000 and March 31, 1999 without audit by the Company's
independent auditors. However, the financial statements have been prepared in
accordance with generally accepted accounting principals for interim
financial information and with instructions to Form 10-Q and Article 10 of
Regulation S-X. In the opinion of the Company's management, all adjustments
consisting of normal recurring accruals necessary for a fair presentation of
the financial condition and results of operations for the interim periods
included herein have been made. The consolidated balance sheet of the Company
as of December 31, 1999 has been derived from the audited consolidated
balance sheet of the Company as of that date. The results of operations for
the three months ended March 31, 2000, are not necessarily indicative of the
results to be anticipated for the year ending December 31, 2000.
Certain information and note disclosures normally included in the Company's
annual financial statement prepared in accordance with generally accepted
accounting principals have been condensed or omitted. Therefore, these
consolidated financial statements and notes thereto should be read in
conjunction with a reading of the financial statements and notes thereto
included in the Company's Form 10 for the year ended December 31, 1999.
Certain amounts in the 1999 financial statements have been reclassified to
conform to the 2000 presentation.
2. Earnings per share
Basic earnings per share amounts are computed based on the weighted average
number of shares outstanding during the period after giving retroactive
effect to stock dividends and stock splits. Diluted earnings per share
amounts are computed by determining the number of additional shares that are
deemed outstanding due to stock options under the treasury stock method.
The following table sets forth the computation of basic and diluted earnings
per share for the three months ended March 31, 2000 and 1999 (dollars in
thousands, except per share amounts).
<TABLE>
<CAPTION>
VALLEY COMMUNITY BANCSHARES, INC. Three Months Ended
Earnings Per Share March 31,
------------------------------
2000 1999
-------------- ------------
<S> <C> <C>
NUMERATOR:
Net income $ 377 $ 284
DENOMINATOR:
Denominator for basic earnings per share:
Weighted average shares 1,125,562 1,108,227
Effect of dilutive securities - stock options 28,447 34,220
Denominator for diluted earnings per share:
Weighted average shares and assumed
conversion of dilutive stock options 1,154,009 1,142,447
Basic earnings per share $ 0.33 $ 0.26
Dilutied earnings per share $ 0.33 $ 0.25
</TABLE>
78
<PAGE>
ITEM 14. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 15. FINANCIAL STATEMENTS AND EXHIBITS
(1) Independent Auditor's Report
(2) Consolidated Balance Sheet at December 31, 1999 and December
31,1998
(3) Consolidated Statement of Income for the years ended December
31, 1999, December 31, 1998 and December 31, 1997
(4) Consolidated Statement of Cash Flows for the years ended
December 31, 1999, December 31, 1998 and December 31, 1997
(5) Consolidated Statement of Changes in Stockholders' Equity for
the years ended December 31, 1999, December 31, 1998 and
December 31, 1997
(6) Notes to Consolidated Year-End Financial Statements
(7) Consolidated Balance Sheet at March 31, 2000
(8) Consolidated Statement of Income for quarter ended March 31,
2000
(9) Consolidated Statement of Cash Flow for quarter ended
March 31, 2000
(10) Notes to Consolidated Financial Statements for quarter ended
March 31, 2000.
The Exhibits are described in the Exhibit Index immediately following the
signature page filed as a part of this Registration Statement.
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange
Act of 1934, the registrant has duly caused this Registration Statement to be
signed on its behalf by the undersigned, thereunto duly authorized.
VALLEY COMMUNITY BANCSHARES, INC.
(Registrant)
Date: 9-6-00 By: /s/ David H. Brown
------------------------ ---------------------------------------
David H. Brown
President and Chief Executive Officer
79
<PAGE>
POWER OF ATTORNEY
We, the undersigned directors and officers of Valley Community
Bancshares, Inc., do hereby severally constitute and appoint David H. Brown
our true and lawful attorney and agent to do any and all things and acts in
our names in the capacities indicated below and to execute all instruments
for us on our names in the capacities indicated below which said David H.
Brown may deem necessary or advisable to enable Valley Community Bancshares,
Inc., to comply with any rules, regulations and requirements of the
Securities and Exchange Commission, in connection with the Registration
Statement on Form 10 relating to the registering of Valley Community
Bancshares, Inc.'s Common Stock, including specifically but not limited to,
power and authority to sign for us or any of us in our names in the
capacities indicated below the Registration Statement and any and all
amendments (including post-effective amendments) thereto; and we hereby
ratify and confirm all that David H. Brown shall do or cause to be done by
virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
as amended, this Registration Statement has been signed below by the
following persons in the capacities and on the dates indicated.
<TABLE>
<S> <C> <C>
/s/ Chairman of the Board April 23, 2000
-------------------------------------
Thomas R. Absher
/s/ Director, President and CEO April 23, 2000
-------------------------------------
David H. Brown
/s/ Director April 23, 2000
-------------------------------------
Warren D. Hunt
/s/ Director April 23, 2000
-------------------------------------
A. Eugene Hammermaster
/s/ Director April 23, 2000
-------------------------------------
William E. Fitchett
/s/ Director April 23, 2000
-------------------------------------
David K. Hamry
/s/ Director April 23, 2000
-------------------------------------
Steven M. Harris
/s/ Director April 23, 2000
-------------------------------------
Roger L. Knutson
/s/ Senior Vice President and CFO April 23, 2000
-------------------------------------
Joseph E. Riordan
/s/ Senior Vice President April 23, 2000
-------------------------------------
Roy W. Thompson
/s/ President of Valley Bank April 23, 2000
-------------------------------------
Richard D. Pickett
</TABLE>
80
<PAGE>
EXHIBIT INDEX
<TABLE>
<S> <C>
3.1 Articles of Incorporation of the Company
3.2 Bylaws of the Company
4.1 Specimen Stock Certificate
4.2 Reference is made to Exhibits 3.1 and 3.2
10.1 Severance agreement for Mr. Brown
10.2 Severance agreement for Mr. Thompson
10.3 Severance agreement for Mr. Riordan
10.4 Severance agreement for Mr. Pickett
10.5 Deferred Compensation Agreement for Mr. Brown
10.6 1998 Stock Option Plan
10.7 Valley Bank Construction Agreement dated November 18, 1999
10.8 401(k) Defined Contribution Plan and Noncontributory Profit
Sharing Plan Adoption Agreement
11 Statement re: computation of per share earnings
21 Subsidiaries of the Company
24 Power of Attorney is set forth on the signature page of this
Registration Statement
27 Financial Data Schedule
</TABLE>
81
