UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended June 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to _________
COMMISSION FILE NUMBER 0-22772
WESTERFED FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 81-0487794
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
110 East Broadway, Missoula, Montana 59802-4511
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (406) 721-5254
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
requirements for the past 90 days. YES [X] NO [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of
the registrant, computed by reference to the closing price of such stock on the
NASDAQ National Market System as of September 15, 1998, was $89.2 million. (The
exclusion from such amount of the market value of the shares owned by any person
shall not be deemed an admission by the registrant that such person is an
affiliate of the registrant.)
As of September 15, 1998, there were issued and outstanding 5,588,862
shares of the Registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Parts II and IV of Form 10-K -- Portions of the Annual Report to Stockholders
for the fiscal year ended June 30, 1998.
Part III of Form 10-K -- Portions of the Proxy Statement for
1998 Annual Meeting of Stockholders.
<PAGE>
PART I
Item 1. Business
General
WesterFed Financial Corporation (the "Company"), a Delaware corporation, is
a unitary savings and loan holding company which was organized in 1994 at the
direction of Western Security Bank ("Western Security" or the "Bank") for the
purpose of owning all of the outstanding stock of the Bank to be issued in
connection with the Bank's conversion from mutual to stock form (the
"Conversion"). The Conversion was completed on January 6, 1994 at which time the
Company issued a total of 4,436,657 shares of its common stock. At June 30,
1998, the Company had total assets of $1.0 billion, deposits of $636.4 million
and stockholders' equity of $109.7 million (10.73% of total assets).
The Company's results of operations are dependent primarily on net interest
income and fee income. Net interest income is the difference between the
interest income earned on its loans, mortgage-backed securities, and investment
portfolio and its cost of funds, consisting of interest paid on its deposits and
borrowed money ("spread"). The Company's results of operations are also
significantly affected by general economic and competitive conditions,
particularly changes in market interest rates, government policies and actions
of regulatory authorities.
The Company serves the financial needs of communities throughout Montana
through its main office located in Missoula, 34 branch offices and two loan
servicing offices. The Company attracts deposits from the general public and
uses the deposits, together with borrowings and other funds, to originate loans
secured by mortgages on owner-occupied one- to four-family residences,
multi-family, commercial, agriculture and construction real estate loans and non
real estate commercial, agriculture and consumer loans. These loans are
generally originated for its primary market area. The Company also invests in
mortgage-backed securities, investment securities and other short-term liquid
assets.
On February 28, 1997, the Company completed its acquisition of Security
Bancorp (the "Acquisition"). The Acquisition was accounted for as a purchase
transaction and accordingly, the consolidated statement of income includes the
results of operations of Security Bancorp commencing March 1, 1997. Under this
method of accounting, assets and liabilities of Security Bancorp are adjusted to
their estimated fair value and combined with the historical recorded book value
of the assets and liabilities of the Company. The Company issued 1,150,175
shares of WesterFed Common Stock, options to acquire 94,696 common shares and
committed to pay $25,995,480 in cash for all of the outstanding shares of
Security Bancorp Common Stock, for total consideration (based on the $18.49 per
share average closing price of WesterFed Common Stock as reported on the NASDAQ
National Market System for the twenty business days from January 16, 1997
through February 12, 1997) of $48.7 million. In addition, as of such date,
Security Bank, a federally chartered stock savings bank and wholly-owned
subsidiary of Security Bancorp, merged with and into the Bank. At the time of
the merger, Security Bancorp had assets on a consolidated basis of $372.6
million, deposits of $286.5 million and stockholders' equity of $30.8 million.
After having received regulatory approval, the name of Western Federal Savings
Bank was changed to "Western Security Bank" in February, 1998. Unless the
context otherwise requires, reference herein to the Company includes WesterFed,
Western Security and its subsidiaries on a consolidated basis.
Forward-Looking Statements
When used in this Form 10-K or future filings by the Company with the
Securities and Exchange Commission, in the Company's press releases or other
public or shareholder communications, or in oral statements made with the
approval of an authorized executive officer, the words or phrases "will likely
result," "are expected to," "will continue," "is anticipated," "estimate,"
"project" or similar expressions are intended to identify "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. The Company wishes to caution readers not to place undue reliance on
any such forward-looking statements, which speak only as of the date made, and
to advise readers that various factors--including regional and national economic
conditions, substantial changes in levels of market interest rates, credit and
other risks of lending and investment activities and competitive and regulatory
factors--could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from those
anticipated or projected.
2
<PAGE>
The Company does not undertake--and specifically disclaims any
obligation--to update any forward-looking statements to reflect occurrence of
anticipated or unanticipated events or circumstances after the date of such
statements.
Market Areas
The Bank conducts operations through its main office in Missoula, Montana
and its 33 branch offices and 2 administrative offices in 18 diverse counties
located throughout the State.
Missoula. In Missoula the Bank operates its main office and six branch
offices which accounted for a total of $144.9 million of Missoula county's June
30, 1997 deposits, or a 15.0% market share, the latest date such information is
available. Missoula county's non-farm basic industries are trade center
activity, wood and paper products, motor carriers, Federal government, and the
University of Montana. Major employers include Missoula Community Hospital, St.
Patrick's Hospital, Stone Container (a paper mill), Louisiana Pacific (particle
board manufacturing), the University of Montana and the U.S. Forest Service.
Billings. The Bank operates six branches in the cities of Billings and
Laurel, located in Yellowstone county. Total deposits held by those branches
represented $173.6 million of the county's total June 30, 1997 deposits, or a
11.7% market share. Leading non-farm basic industries in Yellowstone county are
trade center activity, transportation, oil and gas, and Federal government. In
Billings, expansion of trade center activities continues.
Helena. Four Western Security offices are located in Helena and East
Helena, which is located in Lewis and Clark county. The four branches there have
total deposits of $47.0 million, which accounts for 6.7% of the county's total
June 30, 1997 deposits. Lewis and Clark county's basic leading non-farm
industries are State government, Federal government, and trade center activity.
Helena continues to be a regional health and financial services center.
Great Falls. The Bank operates three branches in the city of Great Falls,
located in Cascade county. These branches hold $39.2 million in deposits which
is 4.6% of the county's total June 30, 1997 deposits. In Great Falls, the
leading non-farm basic industries are Malmstrom Air Force Base, and trade center
activity. Agriculture has a major influence on the economy of Great Falls with
the surrounding counties being the state's leading wheat producers.
Bozeman. The Bank has one office located in the city of Bozeman in Gallatin
county. Deposits in the branch are $23.2 million for a 4.1% market share of the
county's June 30, 1997 total deposits. Leading non-farm basic industries in
Gallatin county are Montana State University, selected manufacturing, and
non-resident travel. The county's economy continues to benefit from growth in
non-resident travel.
Hamilton. The Bank has one branch office in Hamilton, located in Ravalli
county, where it holds deposits of $18.7 million of the county's June 30, 1997
deposits for a 6.0% market share. Ravalli county has benefitted recently from an
influx of retirees.
Conrad. One Bank office is located in the city of Conrad in Pondera county.
This branch has $7.5 million in deposits and a 8.5% market share of the county's
total June 30, 1997 deposits. The local economy is primarily agricultural in
nature.
Lewistown. The Bank has one office in the city of Lewistown, located in
Fergus county. The branch has $30.0 million in deposits for a 17.4% market share
of the county's total June 30, 1997 deposits. The local economy is primarily
agricultural in nature.
3
<PAGE>
Miles City. In Custer county, the Bank has one branch located in Miles
City, which has $13.5 million in deposits for a 6.0% market share of the
county's June 30, 1997 total deposits. Ranching is an important segment of the
local economy.
Hardin. The Bank has one branch located in the city of Hardin, in Big Horn
county. The branch has $8.4 million in deposits for a 11.5% market share of the
county's June 30, 1997 total deposits. The local economy is primarily
agricultural in nature.
Anaconda. The Bank has one branch located in the city of Anaconda, in Deer
Lodge county. The branch has $25.5 million in deposits for a 22.4% market share
of the county's June 30, 1997 total deposits. Anaconda continues to benefit from
restoration activities related to environmental superfund sites.
Kalispell. The Bank has one branch located in the city of Kalispell, in
Flathead county. The branch has $5.8 million in deposits for a 0.7% market share
of the county's June 30, 1997 total deposits. Kalispell's economy is supported
by natural resource industries and non-resident travel.
Havre. The Bank has one branch located in the city of Havre, in Hill
county. The branch has $22.8 million in deposits for a 9.9% market share of the
county's June 30, 1997 total deposits. The local economy is primarily
agricultural in nature.
Malta. The Bank has one branch located in the city of Malta, in Phillips
county. The branch has $3.9 million in deposits for a 4.7% market share of the
county's June 30, 1997 total deposits. The local economy is primarily
agricultural in nature.
Sidney. The Bank has one branch located in the city of Sidney, in Richland
county. The branch has $9.1 million in deposits for a 6.1% market share of the
county's June 30, 1997 total deposits. The local economy is primarily
agricultural in nature.
Plentywood. The Bank has one branch located in the city of Plentywood, in
Sheridan county. The branch has $17.0 million in deposits for a 16.2% market
share of the county's June 30, 1997 total deposits. The local economy is
primarily agricultural in nature.
Butte. The Bank has one branch located in the city of Butte, in Silverbow
county. The branch has $39.3 million in deposits for a 8.6% market share of the
county's June 30, 1997 total deposits. Butte is a trade center and continues to
be supported by various mining activities.
Glasgow. The Bank has one branch located in the city of Glasgow, in Valley
county. The branch has $8.0 million in deposits for a 6.2% market share of the
county's June 30, 1997 total deposits. The local economy is primarily
agricultural in nature.
Lending Activities
General. Historically the principal lending activity of the Bank has been
the origination, for portfolio and for sale, of first mortgage loans secured by
owner-occupied one-to-four family residential properties located in its primary
market areas. More recently, in order to increase the yield and better manage
the interest rate sensitivity of its portfolio, and in order to provide more
comprehensive financial services to communities in its market areas, the Bank
now also originates commercial, commercial real estate, consumer, multi-family,
agricultural, agricultural real estate and construction loans. With the 1997
merger with Security Bank, the Bank acquired a more expansive lending portfolio,
including loans and expertise in commercial non-real estate and agricultural
services. The Bank is also a major originator and servicer of Federal Housing
Administration/Veterans Administration ("FHA/VA") loans, which are subsequently
purchased by the Montana Board of Housing ("MBOH").
When fixed-rate conventional mortgage loans with terms over 15 years are
routinely sold into the secondary market, Western Security generally retains the
servicing rights on these loans, except for those loans sold pursuant to loan
correspondent agreements. See "Originations, Purchases and Sales of Loans and
Mortgage-Backed Securities." At June 30, 1998, Western Security serviced loans
with principal balances of approximately $260.3 million for others. The loan
servicing fees earned provided a supplement to the Bank's earnings.
4
<PAGE>
Loan Portfolio Composition. The following table sets forth information
regarding the composition of the Bank's loan portfolio in dollar amounts and in
percentages (before deductions for loans in process, deferred fees and discounts
and allowances for losses) as of the dates indicated.
<TABLE>
<CAPTION>
At June 30,
---------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
----------------- ----------------- ----------------- ----------------- -----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real Estate Loans:
One- to four-family(1) ............ $318,663 47.56% $348,577 53.82% $280,853 74.69% $247,331 76.94% $230,700 81.85%
Multi-family ...................... 42,716 6.38 40,237 6.21 19,939 5.30 18,985 5.91 14,430 5.12
Commercial ........................ 64,150 9.57 50,049 7.73 18,318 4.87 12,399 3.86 11,300 4.01
Agricultural ...................... 11,066 1.65 7,970 1.23 -- -- -- -- -- --
Construction ...................... 17,523 2.62 19,858 3.07 12,977 3.45 10,742 3.34 7,866 2.79
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate loans ....... 454,118 67.78 466,691 72.06 332,087 88.31 289,457 90.05 264,296 93.77
Other Loans:
Commercial (non-real estate) ...... 34,384 5.13 28,924 4.47 -- -- -- -- -- --
Agricultural (non-real estate) .... 24,036 3.59 18,866 2.91 -- -- -- -- -- --
Loans to depositors, secured by
deposits ........................ 3,194 0.48 4,101 0.63 2,337 0.62 2,138 0.67 2,034 0.72
Indirect consumer loans ........... 64,287 9.59 40,708 6.29 2,827 0.75 -- -- -- --
Other consumer loans--real estate
secured ......................... 54,619 8.15 58,551 9.04 30,814 8.19 24,757 7.69 10,150 3.60
Other consumer loans .............. 35,352 5.28 29,772 4.60 8,003 2.13 5,112 1.59 5,387 1.91
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total other loans ............. 215,872 32.22 180,922 27.94 43,981 11.69 32,007 9.95 17,571 6.23
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total gross loans ............. 669,990 100.00% 647,613 100.00% 376,068 100.00% 321,464 100.00% 281,867 100.00%
====== ====== ====== ====== ======
Less:
Unearned fees ..................... (1,453) (1,813) (1,625) (1,344) (1,301)
Undisbursed loan funds ............ (5,178) (9,489) (4,245) (4,988) (3,696)
Purchased discounts ............... (1,159) (1,383) -- -- --
Allowance for losses .............. (4,907) (4,651) (2,005) (2,011) (2,030)
-------- -------- -------- -------- --------
Total loans receivable, net ... $657,293 $630,277 $368,193 $313,121 $274,840
======== ======== ======== ======== ========
</TABLE>
- ----------
(1) Includes $8.6 million, $13.7 million, $7.5 million, $7.1 million and $8.9
million, of FHA and VA loans at June 30, 1998, 1997, 1996, 1995, and 1994
respectively.
5
<PAGE>
The following table illustrates the interest rate sensitivity of the Bank's
loan portfolio at June 30, 1998. Mortgages which have adjustable or renegotiable
interest rates are shown as maturing in the period during which the contract
matures. The schedule does not reflect the effects of possible prepayments or
enforcement of due-on-sale clauses.
<TABLE>
<CAPTION>
Real Estate
(dollars in thousands)
-----------------------------------------------------------------------------------------------------------------
One-to-Four Family Multi-Family Commercial Agricultural Construction Total Real Estate
------------------ ------------------ ------------------ ------------------ ------------------ ------------------
Weighted Weighted Weighted Weighted Weighted Weighted
Due During Years Average Average Average Average Average Average
Ending June 30, Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate
- ----------------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1999 ............ $ 76,186 7.89% $ 9,222 8.38% $ 17,664 9.31% $ 1,371 8.59% $ 12,733 9.43% $117,176 8.32%
2000 ............ 31,080 7.64 2,699 9.18 3,198 8.70 1,599 9.03 3,434 9.71 42,010 8.04
2001 ............ 21,948 7.60 4,170 8.99 8,057 8.82 1,678 8.66 274 8.77 36,127 8.09
2002 and 2003 ... 30,360 7.63 5,267 9.05 16,781 8.96 2,570 8.61 493 8.99 55,471 8.22
2004 and 2008 ... 77,056 7.53 8,476 8.84 13,542 9.02 2,569 8.76 429 8.97 102,072 7.87
2009 and 2013 ... 34,807 7.62 11,441 9.27 2,631 9.30 723 8.48 160 8.54 49,762 8.10
2014 and
Following ..... 47,226 7.52 1,441 8.60 2,277 9.43 556 9.19 -- -- 51,500 7.65
-------- ---- -------- ---- -------- ---- -------- ---- -------- ---- -------- ----
Total ........... $318,663 7.64% $ 42,716 8.93% $ 64,150 9.07% $ 11,066 8.71% $ 17,523 9.45% $454,118 8.06%
======== ==== ======== ==== ======== ==== ======== ==== ======== ==== ======== ====
</TABLE>
<TABLE>
<CAPTION>
Non-Real Estate
------------------------------------------------------------------------------ Total Real Estate and
Commercial Agriculture Consumer Total Non-Real Estate Non-Real Estate
------------------ ------------------ ------------------ --------------------- ---------------------
Weighted Weighted Weighted Weighted Weighted
Due During Years Average Average Average Average Average
Ending June 30, Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate
- ----------------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1999 (1) ........ $ 18,916 9.07% $ 17,205 9.40% $ 40,268 9.37% $ 76,389 9.30% $193,565 8.71%
2000 ............ 4,411 8.42 1,105 9.07 28,972 9.38 34,488 9.25 76,498 8.59
2001 ............ 4,525 8.44 1,456 9.04 26,276 9.38 32,257 9.23 68,384 8.63
2002 and 2003 ... 5,359 8.71 1,577 9.24 37,466 9.42 44,402 9.33 99,873 8.72
2004 and 2008 ... 790 9.35 2,136 8.60 19,391 9.86 22,317 9.72 124,389 8.21
2009 and 2013 ... 383 10.28 248 8.59 5,036 10.34 5,667 10.26 55,429 8.32
2014 and
Following ..... -- -- 309 8.54 43 8.79 352 8.57 51,852 7.66
-------- ----- -------- ---- -------- ----- -------- ----- -------- ----
Total ........... $ 34,384 8.90% $ 24,036 9.26% $157,452 9.47% $215,872 9.36% $669,990 8.48%
======== ===== ======== ==== ======== ===== ======== ===== ======== ====
</TABLE>
- ----------
(1) Includes demand loans and loans having no stated maturity.
6
<PAGE>
The following table sets forth the dollar amount of all loans at June 30,
1998 that have fixed interest rates, those that are contractually due after June
30, 1999 and have floating or adjustable interest rates that change after June
30, 1999.
Floating or
Fixed Adjustable
Rates Rates Total
-------- ----------- --------
(In Thousands)
Real Estate:
One- to four-family ................... $298,841 $19,822 $318,663
Multi-family .......................... 35,552 7,164 42,716
Commercial ............................ 38,080 26,070 64,150
Agricultural .......................... 3,175 7,891 11,066
Construction .......................... 17,203 320 17,523
Other loans
Agricultural .......................... 31,874 2,510 34,384
Commercial ............................ 22,359 1,677 24,036
Consumer .............................. 156,605 847 157,452
-------- ------- --------
Total ............................. $603,689 $66,301 $669,990
======== ======= ========
Under federal law, the aggregate amount of loans that the Bank is permitted
to make to any one borrower is generally limited to 15% of unimpaired capital
and surplus (25% if the security for such loan has a "readily ascertainable"
value or 30% for certain residential development loans). At June 30, 1998, based
on the above, the Bank's regulatory loans-to-one-borrower limit was
approximately $13.0 million. On the same date, the Bank's largest amount of
loans to one borrower or group of related borrowers were to two different
entities, 58 loans totaling approximately $6.1 million each, secured by
multi-family residential property and leased equipment, and these loans were
performing in accordance with their contractual terms at June 30, 1998.
Residential real estate loans are originated by employees who are
compensated on a salary or commission basis. In the case of commissioned loan
officers, processing and loan underwriting are handled by other personnel. In
the loan approval process, Western Security assesses both the borrower's ability
to repay the loan and the adequacy of the proposed security. Initially, Western
Security's loan underwriters analyze the loan application and the property
involved. As part of the loan application process, qualified outside appraisers
inspect and appraise the security property. All appraisals are subsequently
reviewed by staff underwriters. Western Security also obtains information
concerning the income, financial condition, employment and credit history of the
applicant. Western Security's policy is to require title, fire and extended
hazard coverage on its real estate loans.
If the loan terms and borrower meet Western Security's established
underwriting criteria and the loan amount does not exceed FHLMC conforming
limits, the loan may be approved by action of one to three members of the loan
committee depending on individual authority. Business division loan officers
have individual approval limits based upon their experience and expertise. All
loans (other than conforming jumbo residential loans) in excess of $500,000 must
be approved by the Board of Directors. The loan committee presently consists of
certain branch managers, certain employee loan originators, and the members of
the loan policy committee. The loan policy committee presently consists of seven
senior officers of the Bank. In addition, the Bank employs one- to four-family
residential underwriters who have no origination duties and can approve
residential loans up to Freddie Mac limits. Loan policy members have individual
authority up to $250,000 within this specialty area.
7
<PAGE>
All of the Bank's lending is subject to its written underwriting standards
and loan origination procedures. Decisions on loan applications are made on the
basis of detailed applications and property valuations (consistent with the
Bank's written appraisal policy) by qualified appraisers. The loan applications
are designed primarily to determine the borrower's ability to repay and the more
significant items on the application are verified through use of credit reports,
financial statements, tax returns and/or verifications of employment.
The Bank requires evidence of marketable title and lien position as well as
appropriate title insurance (except on certain home equity loans) on all loans
secured by real property and requires fire and extended coverage casualty
insurance in amounts at least equal to the principal amount of the loan or the
value of improvements on the property, depending on the type of loan. The Bank
may also require flood insurance to protect the property securing its interest.
One- to Four-Family Residential Real Estate Lending
The cornerstone of the Bank's lending program has long been the origination
of long-term permanent loans secured by mortgages on owner-occupied one- to
four-family residences. At June 30, 1998, $318.7 million, or 47.6%, of the
Bank's loan portfolio consisted of permanent loans on one- to four-family
residences. Substantially all of the residential loans originated by Western
Security are secured by properties located in the Bank's primary market area.
Historically, Western Security originated for retention in its own
portfolio, 30-year fixed-rate loans secured by one- to-four family residential
real estate. However, in order to reduce its exposure to changes in interest
rates, Western Security currently emphasizes the origination of adjustable rate
mortgage loans ("ARMs"), subject to market conditions and consumer preference.
As a result of continued consumer demand for long term fixed-rate loans,
particularly during periods of relatively low interest rates, Western Security
has continued to originate loans for sale in the secondary market in amounts and
at rates which are monitored for compliance with the Bank's asset/liability
management policy.
The Bank's loans are underwritten and documented to permit their sale,
consistent with the Bank's asset/liability management objectives. Since, under
the Bank's current policy, it may sell or securitize all of the newly originated
fixed-rate loans with terms of more than 15 years, the Bank's fixed-rate loans
are originated with terms which conform to secondary market standards (i.e.,
FHLMC standards). Such loans may be held for sale until they are sold or
securitized. Most of the Bank's newly originated fixed-rate residential loans
have contractual terms to maturity of 15 to 30 years. The Bank's decision to
hold or sell these loans is based on its asset/liability management policy and
goals and the market conditions for mortgages at any period in time. The Bank
typically retains the servicing of the conventional loans it originates and
sells to FHLMC. See "Originations, Purchases and Sales of Loans and
Mortgage-Backed Securities" for information regarding fees received by the Bank
in connection with loans serviced for others. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Interest Rate Risk
Management" in the Annual Report incorporated by reference herein as Exhibit 13.
The Bank has offered ARMs at rates, terms and points determined in
accordance with market and competitive factors. The programs currently offered
generally meet the standards and requirements of the secondary market for
residential loans. The Bank's current one- to four-family residential ARMs are
fully amortizing loans with contractual maturities of up to 30 years. The
interest rates on the ARMs originated by Western Security are subject to
adjustment at stated intervals based on a margin over a specified index and are
subject to lifetime adjustment limits.
Western Security presently offers several ARM products. The primary
offering utilizes the weekly average yield on U.S. Treasury securities adjusted
to a constant maturity of one year plus a margin depending on property type.
This loan adjusts annually subject to a limitation on the annual increase to 2%
and overall life of loan limitation of 6%. Western Security also offers various
other ARM products for portfolio or on a correspondent basis which are available
for sale into the secondary market. ARM products held in portfolio do not permit
negative amortization of principal and carry no prepayment restrictions. At June
30, 1998, the Bank had $75.6 million of one-to four-family ARM loans.
8
<PAGE>
It is Western Security's present policy generally not to lend more than 97%
of the property's appraised value in the case of first mortgage loans secured by
real property. Western Security presently requires private mortgage insurance in
specified amounts on all conventional residential loans with loan-to-value
ratios at origination exceeding 80%. The terms of the private mortgage insurance
have generally provided that Western Security would receive a payment equal to
17% to 30%, depending on the initial loan-to-value ratio, of the outstanding
principal amount of the loan if there has been a default, plus costs of
foreclosure.
Substantially all of Western Security's present real estate loans
(excluding mortgage-backed securities) are secured by properties located in
Montana. In view of the prevailing level of real estate values in the Bank's
market areas, the Bank rarely originates loans in excess of $227,150 (the
Federal Home Loan Mortgage Corporation ("FHLMC") one-family maximum).
The Bank's residential mortgage loans customarily include due-on-sale
clauses giving the Bank the right to declare the loan immediately due and
payable in the event that, among other things, the borrower sells or otherwise
disposes of the property subject to the mortgage and the loan is not repaid. The
Bank has enforced due-on-sale clauses in its mortgage contracts for the purpose
of increasing its loan portfolio yield. ARM loans may be assumed provided home
buyers meet the Bank's underwriting standards and the applicable fees are paid.
Multi-Family and Commercial Real Estate Lending
Western Security, due to its acquisition of Security Bank, has a mature
portfolio of multi-family and commercial real estate loans. New originations are
handled through the Bank's business division to allow a full line of commercial
products and services as a part of the customer relationship.
Western Security's lending guidelines generally require, in the case of
loans secured by multi-family or commercial income-producing property, that the
property securing such loans generate gross cash flow of 125% or more of all
operating expenses, including debt service but excluding depreciation, and have
a loan-to-value ratio of no more than 75%. Higher debt coverage ratios or lower
loan-to-value ratios may apply depending on property type and market.
The multi-family loans are generally secured by income producing properties
and may be made for the purchase or refinance of multi-family residential
properties. The commercial real estate loans originated by Western Security are
primarily secured by office buildings, small shopping centers, motels,
warehouses, and other income-producing properties. Commercial real estate
lending entails significant additional risks as compared with residential
property lending. Commercial real estate loans typically involve large loan
balances to single borrowers or groups of related borrowers. The payment
experience on such loans is typically dependent on the successful operation of
the real estate project and as such may be subject to adverse conditions in the
economy generally to a greater extent than residential loans. In dealing with
these risk factors, Western Security generally limits itself to a real estate
market and/or borrowers with which it has knowledge and experience. The Bank
also makes loans issued under the SBA's 504(B) program. Under this program, the
borrower's down payment may be as little as 10% and the Bank funds 50% of the
acquisition price with the SBA guaranteed loan financing, 40% of the acquisition
price in a subordinated position. While the borrower's equity contribution is
limited to 10%, the Bank's loan to value ratio does not exceed 50%. At June 30,
1998, $42.7 million, or 6.4% of the Bank's loan portfolio, consisted of
multi-family loans and $64.2 million, or 9.6% of the Bank's loan portfolio,
consisted of commercial real estate loans. In general, under Office of Thrift
Supervision ("OTS") regulations, total investments in commercial real estate
loans may not exceed 400% of the Bank's capital.
9
<PAGE>
Agricultural Real Estate Lending
The majority of the Bank's agricultural real estate loans are secured by
first liens on farm and ranch land located within the State of Montana. The
Bank's current policy is that loans on agricultural land may be made up to 65%
of the appraised value or purchase price, whichever is less. Underwriting
guidelines require that the cash flow generated by the borrower must be 110% to
125% of the annual debt service, depending on the leverage position of the
borrower. Loans secured by agricultural land are adjustable rate loans tied to
the two, three, or five year treasury constant maturity index plus a margin
established by management. The loans are amortized up to twenty years. At June
30, 1998, $11.1 million, or 1.6% of the Bank's loan portfolio, consisted of
agricultural real estate loans. In general, OTS regulations total investments in
agricultural real estate loans may not exceed 400% of the Bank's capital.
Commercial and Agricultural Non-Real Estate Lending
The Bank is permitted to make secured and unsecured loans for commercial,
corporate, business and agricultural purposes, including issuing letters of
credit and engaging in inventory financing and commercial leasing activities. In
general, the Bank's total investment in such loans is limited such that at any
one time it generally may not exceed 20% of assets, as defined in OTS
regulations. At June 30, 1998, $34.4 million, or 5.1% of the Bank's loan
portfolio, consisted of commercial non-real estate loans and $24.0 million, or
3.6% of the Bank's loan portfolio, consisted of agricultural non-real estate
loans.
Construction Lending
Historically, construction lending for one- to four-family residences has
always been an important part of Western Security's commitment to the
communities it serves. Loans to individuals are either 12-month fixed-rate loans
or long-term variable rate construction/permanent loans which provide for a
six-month construction period before converting to a fully amortizing 29
1/2-year or less adjustable-rate loan. Occasionally, Western Security originates
construction loans to builders for the speculative construction of one- to
four-family homes. Such loans are generally 12-month, fixed-rate loans and are
generally limited to one to five properties per builder. The Bank occasionally
makes acquisition and development loans to credit worthy borrowers for
residential projects within the Bank's market area. At June 30, 1998,
approximately $17.5 million, or 2.6% of the Bank's loan portfolio, consisted of
construction loans.
Most of the Bank's construction loans have been originated with fixed-rates
of interest. One- to four-family construction loans are generally made in
amounts of up to a maximum loan-to-value ratio of 90%. Prior to making a
commitment to fund a construction loan, the Bank requires an appraisal of the
property. Western Security obtains personal guarantees for substantially all of
its construction loans. The Bank generally requires that both borrowers and
guarantors provide personal financial statements. Virtually all of Western
Security's construction loans have been located in its primary market areas.
The Bank's construction loan agreements generally provide that loan
proceeds are disbursed in increments as construction progresses. The Bank
periodically reviews the progress of the underlying construction project.
Construction lending generally affords the Bank an opportunity to receive
interest at rates higher than those obtainable from residential lending and to
receive origination and other loan fees. In addition, such loans are generally
made for relatively short terms. Nevertheless, construction lending to persons
other than owner occupants is generally considered to involve a higher level of
credit risk than one- to four-family residential lending due to the
concentration of principal in a limited number of loans and borrowers and the
effects of general economic conditions on construction projects, real estate
developers and managers. In addition, the nature of these loans is such that
they are more difficult to evaluate and monitor. The Bank's risk of loss on a
construction loan is dependent largely upon the accuracy of the initial estimate
of the property's value upon completion of the project and the estimated cost
(including interest) of the project. If the estimate of value proves to be
inaccurate, the Bank may be confronted, at or prior to the maturity of the loan,
with a project with a value which is insufficient to assure full repayment.
Because defaults in repayment may not occur during the construction period it
may be difficult to identify problem loans at an early stage.
10
<PAGE>
Consumer Lending and Unused Lines of Credit
Management believes that offering consumer loan products helps expand the
Bank's customer base and creates stronger ties to its existing customer base. In
addition, because consumer loans generally have shorter terms to maturity and/or
adjustable rates and carry higher rates of interest than do residential mortgage
loans, they can be valuable asset/liability management tools. See "Management's
Discussion and Analysis of Financial Condition - Interest Rate Risk Management"
in the Annual Report incorporated by reference herein as Exhibit 13.
The Bank currently originates substantially all of its consumer loans in
its primary market areas. At June 30, 1998, the Bank's consumer loans totaled
$157.5 million, or 23.5%, of the Bank's loan portfolio.
Western Security offers a variety of real estate secured consumer loans for
various purposes with terms up to fifteen years. The majority of lending is for
home improvement, personal vehicles, equity loans and other personal purposes.
In addition, Western Security offers an in-house credit card program with
the credit card receivables owned by Western Security. The credit cards are
provided as an additional service to Western Security customers. At June 30,
1998, Western Security had $2.5 million of credit card receivables outstanding.
In addition, on such date, Western Security had $9.0 million in unused lines of
credit available to cardholders under this program.
The Bank also offers an open-end equity line of credit secured by real
estate with an interest rate indexed to the prime rate of interest. At June 30,
1998 the Bank had $7.9 million outstanding under this program with an additional
$4.6 million in unused lines of credit available to borrowers under this
program.
Western Security engaged the services of a manager/consultant to initiate a
Dealer Finance Program, which began May 1, 1996, to conduct indirect lending
activities for automobiles, trucks, and recreational vehicles and boats. As of
June 30, 1998, receivables for Dealer Finance totaled $64.3 million. Western
Security, consistent with its consumer loan policies, considers Dealer Finance
an additional opportunity to expand the installment portfolio offering better
yields. New accounts are identified for cross-selling to extend relationships
and expand customer base.
Consumer loan terms vary according to the type of collateral, term of the
loan, and credit-worthiness of the borrower. Unsecured loans are offered to
borrowers for a variety of purposes and personal needs. These are generally
fully amortizing with loan terms of 48 months or less. Underwriting for all
unsecured lending is substantially the same.
The Bank's secured lending for vehicles, household goods, mobile homes, and
real estate secured utilizes established loan-to-value ratios and restricted
terms to match the age and condition of the security. The underwriting standards
employed by the Bank for consumer loans include a determination of the
applicant's payment history on other debts and an assessment of the borrower's
ability to meet payments on the proposed loan along with his existing
obligations. In addition to the credit-worthiness of the applicant, the
underwriting process also includes a comparison of the value of the security, if
any, in relation to the proposed loan amount.
Consumer loans may entail greater risk than residential mortgage loans,
particularly in the case of consumer loans which are unsecured or secured by
rapidly depreciable assets such as automobiles. In such cases, any repossessed
collateral for defaulted consumer loans may not provide adequate sources of
repayment for the outstanding loan balances as a result of the greater
likelihood of damage, loss or depreciation. In addition, consumer loan
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be affected by adverse personal circumstances.
Furthermore, the application of various Federal and state laws, including
Federal and state bankruptcy and insolvency laws, may limit the amount which can
be recovered on such loans. Although the level of delinquencies in the Bank's
consumer loan portfolio has generally been low (at June 30, 1998, $1.7 million,
or approximately 1.1% of the consumer loan portfolio was 90 days or more
delinquent), there can be no assurance that delinquencies will not increase in
the future.
11
<PAGE>
Originations, Purchases and Sales of Loans and Mortgage-Backed Securities
In addition to originating and purchasing loans for its own loan portfolio,
Western Security from time to time participates in secondary mortgage market
activities by selling whole loans and participations in loans to FHLMC and
various institutional purchasers. Western Security generally receives in return
FHLMC participation certificates or cash for non-recourse sales to the FHLMC.
During fiscal 1998, Western Security sold or securitized $29.0 million of loans,
with servicing retained, to the FHLMC and other institutional investors
(exclusive of sales pursuant to loan correspondent agreements discussed below).
Western Security currently has loan correspondent agreements with mortgage
banking firms under which Western Security agrees to originate and sell
primarily conventional, FHA and VA loans to such firms. Under these programs,
Western Security processes loan applications and originates loans in accordance
with the buyers' underwriting policies. The loans, together with all servicing
rights, are then sold to such firms and Western Security retains any loan
origination fees and negotiates the retention of discount points. Under these
programs, the borrower locks in an interest rate, and Western Security
concurrently obtains a purchase commitment from the correspondent that does not
require delivery unless the loan is closed. Western Security's risk is generally
limited to its failure to comply with the agreement with the correspondent
institution or loan underwriting and documentation requirements of such
institution, which could result in rejection of the loan by the purchaser after
closing. However, under some of the correspondent agreements, Western Security
can be required to repurchase any loan which becomes 60 days or more delinquent
within four months of the sale. During fiscal 1998, Western Security sold $67.5
million of loans pursuant to correspondent agreements. While no prediction can
be made as to loan repurchases which may be required pursuant to correspondent
agreements in the future, as of June 30, 1998, Western Security has never had to
repurchase a delinquent loan from a loan correspondent.
Western Security also participates in loan programs financed by the Montana
Board of Housing ("MBOH"). Under these programs, Western Security originates
loans according to standards, underwriting, and qualifications prescribed by the
MBOH which are then purchased by the MBOH with funds generated by tax-exempt
revenue bonds. Loans are generally priced at a discount to market interest rates
for the benefit of low- to moderate-income borrowers. Western Security retains
servicing rights on all loans sold to the MBOH.
Typically, when loans or participations are sold (other than in respect of
the agreements with correspondent institutions described above), Western
Security retains responsibility for collecting and remitting loan payments,
inspecting the properties, making certain insurance and tax payments on behalf
of borrowers and otherwise servicing the loans, and receives a fee for
performing this service. Sales of whole loans, participation interests and
mortgage-backed securities generate income (or loss) at the time of sale,
produce future servicing income and provide funds for additional lending and
other purposes. Western Security was servicing mortgage loans for others in the
amount of $260.3 million at June 30, 1998.
Prior to the issuance of Statement of Financial Accounting Standards
("SFAS") No. 125, see Note 1 of the Notes to Consolidated Financial Statements
in the Annual Report incorporated by reference herein as Exhibit 13, the
contractual right to service mortgage loans that had been originated and sold
had an economic value that was not recognized in the Bank's financial
statements. SFAS No. 125 provides that the Bank recognize as a separate asset
rights to service loans for others, regardless of how those servicing rights are
acquired. Rights to service loans must also be assessed for impairment based on
the fair value of the servicing assets. The value results from the future income
stream of the servicing fees, the availability of the cash balances associated
with escrow funds collected monthly for real estate taxes and insurance, the
availability of the cash from monthly principal and interest payments from the
collection date to the remittance date, and the ability of the Bank to market
other products and services. The actual value of a servicing portfolio is
dependent upon such factors as the age, maturity, and prepayment rate of the
loans in the portfolio, the average dollar balance of the loans, the location of
the collateral property, the average amount of escrow funds held, the interest
rates and delinquency experience on the loans, the types of loans and other
factors.
12
<PAGE>
The marketability of loans, loan participations and mortgage-backed
securities depends on the purchasers' investment limitations, general market and
competitive conditions, mortgage loan demand, and other factors. Western
Security's sales of loans or participation are generally "without recourse"
(i.e., without remedy against the seller by the purchaser if the borrower
defaulted on payment under the loan) against Western Security in the event of
default, except in the case of the loan agreements with correspondent
institutions discussed above. Western Security does have contingent liability on
sold loans under warranty of conforming origination to FHLMC.
Gains or losses on the sale of mortgage loans and loan participations are
recognized and a premium or discount is recorded at the time of sale in an
amount reflecting the difference between the contractual interest rate of the
loans sold and the current market rate of interest.
13
<PAGE>
The following table sets forth the loan origination and mortgage-backed
security origination, purchase, and sale activity for the periods indicated.
Year Ended June 30,
----------------------------
1998 1997 1996
-------- -------- --------
(In Thousands)
Beginning of Period:
- --------------------
Loans, net .................................... $630,277 $368,193 $313,121
Mortgage-backed securities, net ............... 149,169 104,947 143,825
-------- -------- --------
Total loans and mortgage-backed securities
receivable, net, at beginning of period . $779,446 $473,140 $456,946
-------- -------- --------
Loan Originations:
- ------------------
Real Estate:
One- to four-family ......................... $149,959 $ 97,732 $111,355
Multi-family ................................ 5,107 4,101 1,215
Commercial and agricultural ................. 28,649 6,069 3,318
Construction ................................ 28,127 13,650 17,775
-------- -------- --------
Total real estate loan originations ....... 211,842 121,552 133,663
-------- -------- --------
Other Loans:
Commercial .................................. 44,245 11,684 --
Agricultural ................................ 19,420 9,024 --
Consumer .................................... 91,202 84,569 31,884
-------- -------- --------
Total other loan originations ............. 154,867 105,277 31,884
-------- -------- --------
Total loan originations ................... 366,709 226,829 165,547
-------- -------- --------
Purchases and Conversions:
- --------------------------
Real estate loans ............................. 1,055 1,488 7,022
Loans purchased in acquisition ................ -- 218,281 --
Mortgage-backed securities .................... 6,990 6,928 21,881
Mortgage-backed securities purchased
in acquisition .............................. -- 91,467 --
Real estate loans converted to mortgage-backed
securities .................................. -- -- --
-------- -------- --------
Total real estate loans and mortgage-backed
securities purchased and converted ...... 8,045 318,164 28,903
-------- -------- --------
Total real estate loans and mortgage-backed
securities originate, purchased and
converted ............................... 374,754 544,993 194,450
-------- -------- --------
Principal Repayments and Sales:
- -------------------------------
Principal Repayments:
Loans ....................................... 244,519 127,723 87,041
Mortgage-backed securities .................. 26,616 23,010 29,631
Sales:
Real estate loans ........................... 96,520 54,582 31,186
Mortgage-backed securities .................. 3,193 31,932 30,723
Real estate loans converted to mortgage-backed
securities .................................. -- -- --
-------- -------- --------
Total principal repayments, sales and
conversions ............................. 370,848 237,247 178,581
-------- -------- --------
Net loan and mortgage-backed securities activity 3,906 307,746 15,869
-------- -------- --------
Changes in allowance for losses, undisbursed
loan funds, and unearned fees and discounts:
Real estate loans ........................... 291 (2,209) 730
Mortgage-backed securities .................. 58 689 498
Change in unrealized loss on securities
available for sale ............................ 25 80 (903)
-------- -------- --------
End of Period:
- --------------
Loans, net .................................... 657,293 630,277 368,193
Mortgage-backed securities .................... 126,433 149,169 104,947
-------- -------- --------
Total loans and mortgage-backed securities
receivable, net, at end of period ....... $783,726 $779,446 $473,140
======== ======== ========
14
<PAGE>
Non-Accruing Loans and Delinquencies
Delinquency Procedures. When a borrower fails to make a required payment on
a loan, the Bank attempts to cause the delinquency to be cured by contacting the
borrower. In the case of real estate loans, a late notice is sent 15 days after
the due date. If the delinquency is not cured by the thirtieth day, a second
notice is mailed and, if appropriate, the borrower is contacted by telephone.
Additional written and verbal contacts are made with the borrower between 60 and
90 days after the due date.
In the event a real estate loan payment is past due for 90 days or more,
the Bank performs an in-depth review of the loan's status, the condition of the
property and circumstances of the borrower. Based upon the results of the
review, the Bank may negotiate and accept a repayment program with the Borrower,
accept a voluntary deed in lieu of foreclosure or, when deemed necessary,
initiate foreclosure proceedings. If foreclosed on, real property is sold at a
public sale and the Bank may bid on the property to protect its interest. A
decision as to whether and when to initiate foreclosure proceedings is made by
the Credit Supervisor with the consent of the Loan Servicing Manager and at
least one Loan Policy Committee member and is based on such factors as the
amount of the outstanding loan in relation to the original indebtedness, the
extent of delinquency and the borrower's ability and willingness to cooperate in
curing the delinquencies.
Consumer loans are charged off if they remain delinquent for 120 days. The
Bank's procedures for repossession and sale of consumer collateral are subject
to various requirements under Montana consumer protection laws.
Delinquencies on commercial properties are vigorously pursued at the 30-day
stage and a forbearance agreement or resolution must be negotiated to prevent
further legal action.
The following table sets forth the Bank's loan delinquencies by type, by
amount and by percentage of type at June 30, 1998.
<TABLE>
<CAPTION>
Loans Delinquent For:
----------------------------------------------------------------------------
30-59 Days 60-89 Days 90 Days and Over Total Delinquent Loans
------------------------ ------------------------ ------------------------ -------------------------
Percent Percent Percent Percent
of Loan of Loan of Loan of Loan
Number Amount Category Number Amount Category Number Amount Category Number Amount Category
------ ------ -------- ------ ------ -------- ------ ------ -------- ------ ------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One- to four-family ...... 104 $5,789 1.82% 26 $1,174 0.37% 49 $2,409 0.76% 179 $ 9,372 2.94%
Multi-family ............. 2 267 0.63 -- -- -- 1 89 0.21 3 356 0.83
Commercial ............... 5 173 0.18 4 270 0.27 5 77 0.08 14 520 0.53
Agricultural ............. 8 140 0.40 1 416 1.19 -- -- -- 9 556 1.58
Construction ............. 10 915 5.22 2 61 0.35 3 362 2.07 15 1,338 7.64
Consumer ................. 239 2,658 1.69 102 1,033 0.66 139 1,678 1.07 480 5,369 3.41
--- ------ --- ------ --- ------ --- -------
Total ................ 368 $9,942 135 $2,954 197 $4,615 700 $17,511
=== ====== === ====== === ====== === =======
</TABLE>
The following table sets forth the Bank's loan delinquencies by type, by
amount and by percentage of type at June 30, 1997.
<TABLE>
<CAPTION>
Loans Delinquent For:
----------------------------------------------------------------------------
30-59 Days 60-89 Days 90 Days and Over Total Delinquent Loans
------------------------ ------------------------ ------------------------ -------------------------
Percent Percent Percent Percent
of Loan of Loan of Loan of Loan
Number Amount Category Number Amount Category Number Amount Category Number Amount Category
------ ------ -------- ------ ------ -------- ------ ------ -------- ------ ------ --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One- to four-family ...... 136 $2,748 0.79% 55 $1,087 0.31% 62 $1,073 0.31% 253 $4,908 1.41%
Multi-family ............. -- -- -- 1 88 0.22 -- -- -- 1 88 0.22
Commercial ............... 12 396 0.50 2 155 0.31 2 102 0.13 16 653 0.83
Agricultural ............. 4 329 1.74 -- -- -- -- -- -- 4 329 1.74
Construction ............. 2 126 0.63 2 137 0.69 -- -- -- 4 263 1.32
Consumer ................. 123 1,064 0.80 82 1,018 0.76 127 1,178 0.88 332 3,260 2.45
--- ------ --- ------ --- ------ --- ------
Total ................ 277 $4,663 142 $2,485 191 $2,353 610 $9,501
=== ====== === ====== === ====== === ======
</TABLE>
15
<PAGE>
Classification of Assets. Federal regulations require that each savings
institution classify its own assets on a regular basis. In addition, in
connection with examinations of savings institutions, OTS and FDIC examiners
have authority to identify problem assets and, if appropriate, require them to
be classified. There are three classifications for problem assets: Substandard,
Doubtful and Loss. Substandard assets have one or more defined weaknesses and
are characterized by the distinct possibility that the savings association will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of Substandard assets, with the additional characteristics that
the weaknesses make collection or liquidation in full on the basis of currently
existing facts, conditions and values questionable, and there is a high
possibility of loss. An asset classified Loss is considered uncollectible and of
such little value that continuance as an asset of the institution is not
warranted. Assets classified as Substandard or Doubtful require the institution
to establish prudent general allowances for loan losses. If an asset or portion
thereof is classified as Loss, the institution must either establish specific
allowances for loan losses in the amount of 100% of the portion of the asset
classified Loss, or charge off such amount. Western Security internally
classifies its assets on a regular basis. On the basis of management's review of
its assets, at June 30, 1998 on a net basis, the Bank had classified $5.1
million as Substandard, $362,000 as Doubtful and $16,000 as Loss.
The following table sets forth as of June 30, 1998 the Bank's classified
assets by type. No multi-family real estate loans, commercial real estate or
construction loans were classified at June 30, 1998.
(Dollars in Thousands)
-----------------------------------------
Substandard Doubtful Loss Total
----------- -------- ---- ------
One- to four-family ............ $2,833 -- -- $2,833
Multi-family ................... 221 -- -- 221
Commercial Real Estate ......... 327 -- -- 327
Construction ................... 247 -- -- 247
Commercial ..................... 276 -- -- 276
Consumer ....................... 1,198 362 16 1,576
------ ---- ---- ------
Total ...................... $5,102 $362 $ 16 $5,480
====== ==== ==== ======
Non-Performing Assets. Loans are reviewed periodically and any loan whose
collectibility is doubtful is placed on non-accrual status. All loans other than
one- to four-family are placed on non-accrual status when either principal or
interest is 90 days or more past due, unless, in the judgment of management,
collectibility is considered highly probable and collection efforts are in
progress, in which case interest would continue to accrue. Residential, or one-
to four-family, real estate loans are placed on non-accrual status when either
principal or interest is 120 days or more past due.
An allowance is established for uncollectible interest on loans that are
contractually 90 days or more past due. The allowance is established by a charge
to interest income equal to all interest previously accrued, and income is
subsequently recognized only to the extent cash payments are received until the
loans are brought less than 90 days past due with respect to both principal and
interest and when, in the judgment of management, the loans are estimated to be
fully collectible as to both principal and interest.
Real estate acquired by Western Security as a result of foreclosure or by
deed in lieu of foreclosure is classified as other real estate owned until it is
sold. When property is acquired, it is recorded at the lower of the related loan
balance, less any specific allowance for loss, or fair value at the date of
foreclosure. Any write-down resulting therefrom is charged to the allowance for
loan losses. Upon disposition, all costs incurred in maintaining the property
are expensed. Costs relating to the development and improvement of the property,
however, are capitalized to the extent of net realizable value.
The Bank considers loans as in-substance foreclosed if the borrower has
little or no equity in the property based upon its current fair value, if
repayment can be expected only to come from operation or sale of the collateral
and if the borrower has effectively abandoned control of the collateral or has
continued to retain control of the collateral but because of the current
financial status of the borrowers, it is doubtful the borrower will be able to
repay in the foreseeable future.
16
<PAGE>
The following table sets forth the amounts and categories of non-performing
assets in the Bank's loan portfolio. For all periods presented, the Bank did not
have any troubled debt restructurings (which involve forgiving a portion of
interest or principal on any loans or making loans at a rate materially less
than market rates). Foreclosed assets include assets acquired in settlement of
loans, and are recorded at the lower of the related loan balance, less any
specific allowance for loss, or fair value at the date of foreclosure.
At June 30,
-------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
(Dollars in Thousands)
Non-accruing loans:
Real Estate:
One- to four-family ............. $1,967 $ 842 $ 21 $ -- $ 119
Multi-family .................... 89 -- -- -- --
Commercial ...................... 35 -- -- 166 207
Construction .................... 362 -- -- -- --
Commercial non-real estate ........ 32 102 -- -- --
Consumer .......................... 1,504 573 383 153 9
------ ------ ------ ------ ------
Total ......................... 3,989 1,517 404 319 335
------ ------ ------ ------ ------
Accruing loans delinquent
90 days or more:
Real Estate:
One- to four-family ............. 442 231 288 253 425
Multi-family .................... -- -- -- -- --
Commercial ...................... -- -- -- -- --
Construction .................... -- -- -- -- --
Commercial non-real estate ........ 10 -- -- -- --
Consumer .......................... 174 605 23 1 5
------ ------ ------ ------ ------
Total ......................... 626 836 311 254 430
------ ------ ------ ------ ------
Foreclosed assets:
Real Estate:
One- to four-family ............. 279 -- -- -- 85
Multi-family .................... -- -- -- -- --
Commercial ...................... -- -- -- -- --
Land ............................ 28 -- -- -- --
Consumer .......................... 114 82 -- -- --
------ ------ ------ ------ ------
Total ......................... 421 82 -- -- 85
------ ------ ------ ------ ------
Total non-performing assets ....... $5,036 $2,435 $ 715 $ 573 $ 850
====== ====== ====== ====== ======
Total as a percentage of
total assets .................... 0.49% 0.25% 0.13% 0.10% 0.16%
====== ====== ====== ====== ======
Total allowance for loan losses to
non-performing loans (exclusive
of foreclosed) .................. 106.33% 197.66% 280.42% 350.35% 265.36%
====== ====== ====== ====== ======
Total allowance for loan losses to
total non-performing assets ..... 97.44% 191.01% 280.42% 350.35% 238.82%
====== ====== ====== ====== ======
For the year ended June 30, 1998, gross interest income which would have
been recorded had the non-accruing loans been current in accordance with their
original terms amounted to approximately $271,000.
At June 30, 1998, Western Security's non-accruing loans were comprised of
43 one- to four-family loans totaling $2.0 million, 1 multi-family loan totaling
$89,000, 1 commercial real estate loan totaling $35,000, 3 construction loans
totaling $362,000, 3 commercial non-real estate loans totaling $32,000 and 118
consumer loans totaling $1.5 million. Accruing loans delinquent 90 days or more
at June 30, 1998, includes 6 one- to four-family loans totaling $442,000, 1
commercial non-real estate loan totaling $10,000 and 21 consumer loans totaling
$174,000 of which all were loans 100% secured by savings accounts. These loans
continue to accrue interest due to management's belief that the borrowers will
repay these loans.
There were $279,000 in foreclosed real estate loans at June 30, 1998 and
$28,000 in one foreclosed commercial land loan.
17
<PAGE>
Other Loans of Concern. In addition to the classified assets and
non-performing loans and foreclosed assets set forth in the preceding tables, as
of June 30, 1998, there were no other loans identified by the Bank with respect
to the majority of which known information about the possible credit problems of
the borrowers or the cash flows of the security properties have caused
management to have some doubts as to the ability of the borrowers to comply with
present loan repayment terms and which may result in the future inclusion of
such items in the non-performing asset categories.
Management has considered the Bank's non-performing assets and other loans
"of concern" assets in establishing its allowance for loan losses.
Loan Loss Reserve Analysis. The allowance for estimated loan losses is
established through a provision for losses on loans based on management's
evaluation of the risk inherent in its loan portfolio and changes in the nature
and volume of its loan activity. Such evaluation, which includes a review of all
loans of which full collectibility may not be reasonably assured, considers the
estimated net realizable value of the underlying collateral, economic
conditions, historical loan loss experience and other factors that warrant
recognition in providing for an adequate allowance for loan losses. In
determining the general reserves under these policies historical charge-offs and
recoveries, changes in the mix and levels of the various types of loans, net
realizable values, the current loan portfolio and current economic conditions
are considered. The Bank also requires additional reserves for all delinquent
loans and other loans of concern.
While management believes that it uses the best information available to
determine the allowance for loan losses, unforeseen market conditions could
result in adjustments to the allowance for loan losses, and net earnings could
be significantly affected, if circumstances differ substantially from the
assumptions used in making the final determination.
The following table sets forth an analysis of the Bank's allowance for loan
losses.
Year Ended June 30,
-------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
(Dollars in Thousands)
Balance at beginning of period .... $4,651 $2,005 $2,011 $2,030 $2,058
------ ------ ------ ------ ------
Charge-Offs:
Real Estate:
One- to four-family ........... -- (53) -- (2) (15)
Commercial .................... -- (43) -- -- --
Other:
Commercial .................... (26) (47) -- -- --
Consumer ...................... (611) (110) (11) (26) (22)
------ ------ ------ ------ ------
Total charge-offs ................. (637) (253) (11) (28) (37)
------ ------ ------ ------ ------
Recoveries:
Other:
Commercial .................... 3 -- -- -- --
Consumer ...................... 50 18 5 9 9
------ ------ ------ ------ ------
Total recoveries .................. 53 18 5 9 9
------ ------ ------ ------ ------
Net charge-offs ................... (584) (235) (6) (19) (28)
Provisions charged to operations .. 840 400 -- -- --
Reserves acquired ................. -- 2,481 -- -- --
------ ------ ------ ------ ------
Balance at end of period .......... $4,907 $4,651 $2,005 $2,011 $2,030
====== ====== ====== ====== ======
Ratio of net charge-offs during
the period to average loans
outstanding during the period ... 0.09% 0.05% --% 0.01% 0.01%
====== ====== ====== ====== ======
Ratio of net charge-offs during
the period to average non-
performing assets during the
period .......................... 11.92% 13.12% 1.39% 2.91% 3.27%
====== ====== ====== ====== ======
Ratio of allowance for loan
losses to loans receivable,
net ............................. 0.74% 0.73% 0.54% 0.64% 0.73%
====== ====== ====== ====== ======
18
<PAGE>
The following table sets forth the distribution of the Bank's allowance for
loan losses at the dates indicated is summarized as follows:
<TABLE>
<CAPTION>
At June 30,
-------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
----------------- ----------------- ----------------- ----------------- -----------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in Each in Each in Each in Each in Each
Category Category Category Category Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ -------- ------ -------- ------ -------- ------ -------- ------ --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real Estate:
One- to four-family ........... $ 927 47.56% $2,244 53.82% $ 539 74.69% $ 175 76.94% $ 175 81.85%
Multi-family .................. 300 6.38 259 6.21 136 5.30 12 5.91 10 5.12
Commercial .................... 550 9.57 479 7.73 152 4.87 75 3.86 65 4.01
Agricultural .................. 150 1.65 471 1.23 -- -- -- -- -- --
Construction .................. 250 2.62 128 3.07 164 3.45 5 3.34 -- 2.79
Other loans:
Commercial .................... 450 5.13 -- 4.47 -- -- -- -- -- --
Agricultural .................. 400 3.59 -- 2.91 -- -- -- -- -- --
Consumer ...................... 1,480 23.50 918 20.56 126 11.69 132 9.95 150 6.23
Unallocated ..................... 400 -- 152 -- 888 -- 1,612 -- 1,630 --
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total ....................... $4,907 100.00% $4,651 100.00% $2,005 100.00% $2,011 100.00% $2,030 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
19
<PAGE>
Investment Activities
Securities. As part of its asset/liability management strategy, the Company
invests in U.S. and local government and agency securities, high quality short-
and medium-term securities, primarily investment grade corporate obligations and
mutual funds and interest-bearing deposits. At June 30, 1998, the Company did
not own any securities of a single issuer which exceeded 10% of the Company's
stockholders' equity, other than U.S. government or federal agency obligations.
At June 30, 1998, the Bank owned $2.4 million of bank qualified local government
agency securities.
The Bank is required by federal regulations to maintain a minimum amount of
liquid assets that may be invested in specified securities and is also permitted
to make certain other securities investments. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -Liquidity and Capital
Resources" in the Annual Report incorporated by reference herein as Exhibit 13.
Cash flow projections are regularly reviewed and updated to assure that adequate
liquidity is provided. As of June 30, 1998, the Bank's liquidity ratio (liquid
assets as a percentage of net withdrawable savings and current borrowings) was
18.8% as compared to the OTS requirement of 4.0%.
The Bank will, in order to reduce interest rate risk, purchase financial
instruments that lock in a spread between interest-earning assets and
interest-bearing liabilities. While these types of financial instruments limit
risk, they also reduce the Bank's ability to maximize profits during periods of
favorable interest trends. See Note 15 of the Notes to Consolidated Financial
Statements in the Annual Report incorporated by reference herein as Exhibit 13.
At June 30, 1998 the Bank had no structured notes.
The following tables set forth the composition of the securities portfolio
at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
---------------------------------------------------------
1998 1997 1996
----------------- ---------------- ----------------
Book % of Book % of Book % of
Value Total Value Total Value Total
-------- ------ ------- ------ ------- ------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Investments held-to-maturity:
Federal agency obligations ............................... $ 2,994 2.39% $18,804 23.76% $ 4,010 8.91%
U.S. Government obligations .............................. 100 0.08 297 0.38 -- --
Corporate obligations .................................... 11,473 9.15 5,980 7.55 5,333 11.86
Other investments ........................................ 2,280 1.82 2,385 3.01 4 0.01
-------- ------ ------- ------ ------- ------
Total investment securities held-to-maturity ........... 16,847 13.44 27,466 34.70 9,347 20.78
-------- ------ ------- ------ ------- ------
Investments available-for-sale:
Federal agency obligations ............................... 89,781 71.62 45,969 58.08 32,630 72.54
Corporate obligations .................................... 18,720 14.93 5,675 7.17 2,980 6.62
Other .................................................... 10 0.01 39 0.05 27 0.06
-------- ------ ------- ------ ------- ------
Total investments available for sale ................... 108,511 86.56 51,683 65.30 35,637 79.22
-------- ------ ------- ------ ------- ------
Total investment securities ............................ $125,358 100.00% $79,149 100.00% $44,984 100.00%
======== ====== ======= ====== ======= ======
Average remaining life or term to repricing of securities .. 33 mos. 41 mos. 27 mos.
</TABLE>
For information regarding the estimated market value of the securities at
June 30, 1998, see Note 4 of the Notes to Consolidated Financial Statements in
the Annual Report incorporated by reference herein as Exhibit 13.
20
<PAGE>
The following table sets forth the composition and maturities of the
investment securities portfolio as of June 30, 1998.
<TABLE>
<CAPTION>
At June 30, 1998
-----------------------------------------------------------------------------
Less Than 1 to 5 5 to 10 Over 10
1 Year Years Years Years Total Securities
---------- ---------- ---------- ---------- -------------------------
Book Value Book Value Book Value Book Value Book Value Market Value
---------- ---------- ---------- ---------- ---------- ------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Investments held-to-maturity:
U.S. government securities ...................... $ 100 $ -- $ -- $ -- $ 100 $ 100
Federal agency obligations ...................... -- -- 2,994 -- 2,994 3,021
Corporate obligations ........................... -- -- 11,473 -- 11,473 11,560
Other investments ............................... 72 -- 236 1,972 2,280 2,293
------- ------- ------- ------ -------- --------
Total investment securities held-to-maturity .. 172 -- 14,703 1,972 16,847 16,974
------- ------- ------- ------ -------- --------
Investments available-for-sale:
Federal agency obligations ...................... 28,313 60,352 -- 1,128 89,793 89,781
Corporate obligations ........................... 10,974 7,683 -- -- 18,657 18,720
Other investments ............................... 3 -- -- -- 3 10
------- ------- ------- ------ -------- --------
Total investments available for sale .......... 39,290 68,035 -- 1,128 108,453 108,511
------- ------- ------- ------ -------- --------
Total securities .............................. $39,462 $68,035 $14,703 $3,100 $125,300 $125,485
======= ======= ======= ====== ======== ========
Average weighted yield ............................ 5.51% 6.38% 6.75% 7.54% 6.14%
==== ==== ==== ==== ====
</TABLE>
21
<PAGE>
Mortgage-Backed Securities. The Bank purchases mortgage-backed securities
to supplement residential loan production. The type of securities purchased is
based upon the Bank's asset/liability management strategy and balance sheet
objectives. For instance, most of the mortgage-backed investments purchased by
the Bank over the last several years have had adjustable interest rates or short
or intermediate effective terms to maturity. In addition, the Bank has purchased
investment grade, fixed-rate and variable-rate Collateralized Mortgage
Obligations ("CMOs") having estimated average lives from one to twenty years.
CMOs are securities derived by reallocating cash flows from mortgage-backed
securities or from pools of mortgage loans held by a trust. The CMOs acquired by
the Bank are not interest-only or principal-only or residual interests except
for one interest-only CMO totaling $22,000. At June 30, 1998, the book value of
the CMOs was $48.6 million. The book value of all the Bank's mortgage-backed
securities at June 30, 1998 was $126.4 million. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Interest Rate Risk
Management" in the Annual Report incorporated by reference herein as Exhibit 13.
At June 30, 1998, the Bank did not own mortgage-backed securities of a single
issuer which exceeded 10% of the Company's stockholders' equity, other than U.S.
government agency obligations.
The Bank's mortgage-backed securities are classified as either
held-to-maturity or available-for-sale. Those mortgage-backed securities
classified as held-to-maturity are carried at amortized cost in the Bank's
financial statements. While those mortgage-backed securities classified as
available-for-sale are carried at fair value.
Substantially all of the Bank's mortgage-backed securities are backed by
federal agencies or have received the highest rating by a nationally recognized
rating agency as of June 30, 1998. The Bank also holds $3.1 million of
mortgage-backed securities issued by private institutions.
On July 1, 1995, the Company adopted SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." Accordingly, mortgage-backed
securities not categorized as either held to maturity or trading account
securities are classified as securities available for sale. See Note 1 of the
Notes to Consolidated Financial Statements in the Annual Report incorporated by
reference herein as Exhibit 13.
The following table sets forth the book value of the mortgage-backed
securities portfolio, net, in dollar amounts as of the dates indicated.
At June 30,
------------------------------
1998 1997 1996
-------- -------- --------
(In Thousands)
Issuers:
Federal Home Loan Mortgage Corporation ....... $ 51,776 $ 66,070 $ 77,105
Federal National Mortgage Association ........ 7,752 12,344 16,674
Government National Mortgage Association ..... 15,218 18,850 2,067
Collateralized Mortgage Obligations--federal
agency ..................................... 48,578 45,815 9,101
Other ........................................ 3,109 6,090 --
-------- -------- --------
Total ...................................... $126,433 $149,169 $104,947
======== ======== ========
22
<PAGE>
The following table sets forth the contractual maturities, without giving
effect to repricing, of the mortgage-backed securities portfolio, net, at June
30, 1998.
<TABLE>
<CAPTION>
Market June 30,
1 - 3 3 - 5 5 - 10 10 - 15 Over 15 Value 1998
Years Years Years Years Years Adjustment Total
----- ------ ------- ------- ------- ---------- --------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Held-to-Maturity:
Federal Home Loan Mortgage Corporation ..... $ -- $2,342 $34,980 $ -- $ 2,186 $ -- $ 39,508
Federal National Mortgage Corporation ...... -- -- -- -- -- -- --
Government National Mortgage Association ... -- -- 37 14,776 -- -- 14,813
Collateralized Mortgage Obligations--
Federal Agency ........................... -- -- 398 7,906 36,601 -- 44,905
Other ...................................... -- -- -- 3,072 -- -- 3,072
---- ------ ------- ------- ------- ---- --------
Subtotal ................................. -- 2,342 35,415 25,754 38,787 -- 102,298
---- ------ ------- ------- ------- ---- --------
Available for sale:
Federal Home Loan Mortgage Corporation ..... -- -- 1,992 -- 10,273 3 12,268
Federal National Mortgage Corporation ...... -- -- -- -- 7,742 (21) 7,721
Government National Mortgage Association ... -- 1 -- -- 437 4 442
Collateralized Mortgage Obligations--
Federal Agency ........................... -- -- -- -- 3,711 (7) 3,704
Other ...................................... -- -- -- -- -- -- --
---- ------ ------- ------- ------- ---- --------
Subtotal ................................. -- 1 1,992 -- 22,163 (21) 24,135
---- ------ ------- ------- ------- ---- --------
Total .................................. $ -- $2,343 $37,407 $25,754 $60,950 $(21) $126,433
==== ====== ======= ======= ======= ==== ========
</TABLE>
The following schedule sets forth the contractual maturity and repricing of
the Bank's mortgage-backed securities portfolio, net, at June 30, 1998. Those
which have adjustable or renegotiable interest rates are shown as maturing in
the period during which the contract is subject to repricing.
<TABLE>
<CAPTION>
After 1 After 2 After 3 After 5 After 10 Market June 30,
1 Year Through Through Through Through Through Over 15 Value 1998
or Less 2 Years 3 Years 5 Years 10 Years 15 Years Years Adjustment Total
------- ------- ------- ------- -------- -------- ------- ---------- --------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-Backed Securities
Held-to-Maturity ..................... $20,034 $ -- $2,342 $6,431 $28,618 $ -- $ -- $ -- $ 57,425
Mortgage-Backed Securities
Available-for-Sale ................... 20,444 -- 1 -- -- -- -- (14) 20,431
Collateralized Mortgage Obligations
Held-to-Maturity ..................... 9,792 -- -- 1,415 59 33,607 -- -- 44,873
Collateralized Mortgage Obligations
Available-for-Sale ................... 3,711 -- -- -- -- -- -- (7) 3,704
------- ---- ------ ------ ------- ------- ---- ---- --------
Total ............................ $53,981 $ -- $2,343 $7,846 $28,677 $33,607 $ -- $(21) $126,433
======= ==== ====== ====== ======= ======= ==== ==== ========
</TABLE>
Cash Surrender Value of Life Insurance Policies. Western Security currently
maintains Key Person Insurance coverage on certain of its executive officers.
The purpose of this insurance purchase was twofold: (1) Key Person Insurance
coverage for the Bank on those job positions and (2) funding of death and salary
continuation plan benefits for certain of those employees. At June 30, 1998 the
Bank had $6.7 million in cash surrender value of life insurance policies.
23
<PAGE>
Sources of Funds
General. Deposit accounts have traditionally been the principal source of
the Bank's funds for use in lending and for other general business purposes. In
addition to deposits, the Bank derives funds from loan repayments and cash flows
generated from operations. Scheduled loan payments are a relatively stable
source of funds, while deposit inflows and outflows and the related cost of such
funds have varied. Other potential sources of funds available to the Bank
include borrowings from the Federal Home Loan Bank ("FHLB") of Seattle and other
borrowings.
Deposits. The Bank attracts both short-term and long-term deposits by
offering a wide assortment of accounts and rates. The Bank offers regular
savings accounts, NOW accounts, non-interest bearing demand accounts, money
market accounts and certificates of deposits with varying maturities. Western
Security has not actively sought deposits outside of its primary market area.
Western Security does not have any brokered deposits at this time but may
consider the use of such funds in the future to fund loan growth. The Bank also
accepts deposits of $100,000 or more from municipalities and individuals within
its market area.
The flow of deposits is influenced by general economic conditions, changes
in money market and prevailing interest rates and competition. The variety of
accounts offered by the Bank has allowed it to be competitive in obtaining funds
and to respond to changes in consumer demand. However, the Bank has become more
susceptible to short term fluctuations in deposit flows, as customers have
become more interest rate conscious. In setting rates, Western Security
regularly evaluates (i) its internal cost of funds, (ii) the rates offered by
competing institutions, (iii) its investment and lending opportunities, (iv) its
liquidity position and (v) its asset/liability position. In order to decrease
the volatility of its deposits, Western Security imposes penalties on early
withdrawal on its certificates of deposit.
Based on its experience, the Bank believes that the majority of its regular
savings, NOW, non-interest bearing demand accounts, and money market accounts
are relatively stable sources of deposits. The Bank believes that a portion of
regular savings and money market accounts represent certain depositors'
preference for short-term investments in a rising interest rate environment
while certificates of deposit are preferred by those depositors in a declining
interest rate environment. The Bank's ability to attract and maintain
certificates of deposit, and the rates paid thereon, has been and will continue
to be significantly affected by market rates.
24
<PAGE>
The following table sets forth the dollar amount of savings deposits in the
various types of deposit programs offered by the Bank for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------------------------------------------
1998 1997 1996
------------------ ------------------ ------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
-------- -------- -------- -------- -------- --------
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Transactions and Savings Deposits:
- ----------------------------------
Passbook and savings accounts (2.70 - 2.75%) ... $ 94,557 14.86% $102,923 16.31% $ 64,889 18.53%
Money market accounts (2.96 - 4.98%) ........... 55,464 8.71 49,062 7.78 24,018 6.86
NOW accounts (1.50%) ........................... 74,673 11.73 76,582 12.14 49,848 14.23
Non-Interest bearing demand .................... 30,524 4.80 26,050 4.13 -- --
-------- ------ -------- ------ -------- ------
Total non-certificates ......................... 255,218 40.10 254,617 40.36 138,755 39.62
-------- ------ -------- ------ -------- ------
Certificates:
- -------------
0.00 - 3.99% ................................... $ 1,894 0.30% $ 1,276 0.20% $ 1,731 0.49%
4.00 - 5.99% ................................... 269,590 42.36 288,440 45.72 159,275 45.48
6.00 - 7.99% ................................... 109,731 17.24 86,341 13.69 50,447 14.41
8.00 - and over ................................ 8 -- 195 0.03 4 --
-------- ------ -------- ------ -------- ------
Total certificates ............................. 381,223 59.90 376,252 59.64 211,457 60.38
-------- ------ -------- ------ -------- ------
Total deposits ................................. $636,441 100.00% $630,869 100.00% $350,212 100.00%
======== ====== ======== ====== ======== ======
</TABLE>
The following table sets forth the rate and maturity information for the
Bank's certificates of deposit as of June 30, 1998.
<TABLE>
<CAPTION>
0.00- 4.00- 6.00- 8.00% or Percent
3.99% 5.99% 7.99% Greater Total of Total
------ -------- -------- -------- -------- --------
(Dollars In Thousands)
Certificate accounts maturing
in quarter ending:
<S> <C> <C> <C> <C> <C> <C>
September 30, 1998 .............. $1,268 $ 84,590 $ 8,656 $ 8 $ 94,522 24.80%
December 31, 1998 ............... 413 65,626 14,524 -- 80,563 21.13
March 31, 1999 .................. 76 42,534 17,866 -- 60,476 15.86
June 30, 1999 ................... 115 36,467 9,996 -- 46,578 12.22
September 30, 1999 .............. -- 7,108 8,872 -- 15,980 4.19
December 31, 1999 ............... 22 7,639 11,217 -- 18,878 4.95
March 31, 2000 .................. -- 7,065 10,802 -- 17,867 4.69
June 30, 2000 ................... -- 7,375 2,665 -- 10,040 2.63
September 30, 2000 .............. -- 776 4,894 -- 5,670 1.49
December 31, 2000 ............... -- 1,211 5,601 -- 6,812 1.79
March 31, 2001 .................. -- 1,584 6,432 -- 8,016 2.10
June 30, 2001 ................... -- 3,807 316 -- 4,123 1.08
Thereafter ...................... -- 3,808 7,890 -- 11,698 3.07
------ -------- -------- ---- -------- ------
Total ......................... $1,894 $269,590 $109,731 $ 8 $381,223 100.00%
====== ======== ======== ==== ======== ======
Percent of total .............. -- -- -- -- -- --
</TABLE>
25
<PAGE>
The following table sets forth the amount of the Bank's certificates of
deposit and other deposits by time remaining until maturity as of June 30, 1998.
<TABLE>
<CAPTION>
Maturity
---------------------------------------
Over Over
3 Months 3 to 6 6 to 12 Over 12
or Less Months Months Months Total
-------- ------- -------- ------- --------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Certificates of deposit less than $100,000 ..... $75,312 $70,987 $ 94,511 $88,426 $329,236
Certificates of deposit of $100,000 or more .... 9,652 7,523 10,462 10,652 38,289
Public funds(1) ................................ 9,690 2,008 1,993 7 13,698
------- ------- -------- ------- --------
Total certificates of deposit .................. $94,654 $80,518 $106,966 $99,085 $381,223
======= ======= ======== ======= ========
</TABLE>
- ----------
(1) Deposits from governmental and other public entities.
For additional information regarding the composition of the Bank's
deposits, see Note 9 of the Notes to the Consolidated Financial Statements in
the Annual Report incorporated by reference herein as Exhibit 13.
Borrowings. Western Security's other available sources of funds include
advances from the FHLB of Seattle and other borrowings. As a member of the FHLB
of Seattle, the Bank is required to own capital stock in the FHLB of Seattle and
is authorized to apply for advances from the FHLB of Seattle. Each FHLB credit
program has its own interest rate, which may be fixed or variable, and range of
maturities. The FHLB of Seattle may prescribe the acceptable uses for these
advances, as well as limitations on the size of the advances and repayment
provisions.
The Bank borrows funds from the FHLB of Seattle under its various fixed
rate, variable rate, and amortizing advance lending programs, with terms
requiring monthly interest payments. Principal payments are due monthly under
the amortizing advance program and upon maturity for all other advance programs.
The Bank is generally required to pay a commitment fee upon application and is
normally subject to a prepayment fee if the advance is prepaid by the Bank. See
Note 11 of the Notes to Consolidated Financial Statements in the Annual Report
incorporated by reference herein as Exhibit 13.
The following table sets forth the maximum month-end balance and average
balance of FHLB advances, CMO and other borrowings for the periods indicated.
Year Ended June 30,
------------------------------
1998 1997 1996
-------- -------- --------
(In Thousands)
Maximum Balance:
FHLB Advances ................................ $248,133 $190,338 $145,388
Collateralized Mortgage Obligations .......... 775 1,117 1,584
Other Borrowings and Repurchase Agreements ... 26,099 8,101 --
Average Balance:
FHLB Advances ................................ 244,339 145,446 134,211
Collateralized Mortgage Obligations .......... 625 967 1,380
Other Borrowings and Repurchase Agreements ... 12,022 2,731 --
26
<PAGE>
The following table sets forth certain information as to the Bank's FHLB
advances and CMO's at the dates indicated.
June 30,
------------------------------
1998 1997 1996
-------- -------- --------
(Dollars in Thousands)
FHLB Advances ................................. $248,133 $190,338 $124,663
Collateralized Mortgage Obligations ........... 511 797 1,175
Other Borrowings and Repurchase Agreements .... 6,542 8,101 --
-------- -------- --------
Total Borrowings .......................... $255,186 $199,236 $125,838
======== ======== ========
Weighted Average Interest Rate of FHLB Advances 5.83% 6.14% 6.26%
======== ======== ========
Weighted Average Interest Rate of
Collateralized Mortgage Obligations ......... 11.48% 11.37% 11.27%
======== ======== ========
Weighted Average Interest Rate of Other
Borrowings and Repurchase Agreements ........ 5.05% 5.30% --%
======== ======== ========
Interest Rate Caps and Interest Rate Swaps
As explained under Interest Rate Risk Management in Management's Discussion
and Analysis of Financial Condition and Results of Operations and Note 15 of the
Notes to Consolidated Financial Statements in the Annual Report incorporated by
reference herein as Exhibit 13, the Bank was party to three interest rate
exchange agreements. These agreements were interest rate cap agreements covering
a total of $15.0 million in notional principal amounts wherein the interest rate
caps entitle the Bank to receive various interest payments in exchange for
payment of a transaction fee, provided the three-month LIBOR exceeds an agreed
upon interest rate. Transaction fees paid in connection with interest rate cap
agreements are amortized to interest expense as an adjustment of the interest
cost of liabilities. Interest rate cap agreements are used to manage interest
rate risk by synthetically extending the life of interest bearing liabilities.
Because the Bank receives various interest payments if the three-month LIBOR
exceeds the agreed upon interest rate, the Bank is generally at risk to the
extent of the unamortized premium paid if the three-month LIBOR does not exceed
the agreed upon interest rate. At June 30, 1998 the amount of the unamortized
premiums paid related to the interest rate cap transactions was $135,000.
Subsidiary Activities
General. The Company has no direct subsidiaries other than the Bank.
Western Security has four wholly owned service corporation subsidiaries:
WesterFed Insurance Services, Inc. ("WesterFed Insurance"), Service Corp. of
Montana, Inc. ("Service Corp."), Western Security Investment Services, Inc.
("Western Security Investment") and a special-purpose finance subsidiary, Monte
Mac I, Inc. ("Monte Mac"). At June 30, 1998, Western Security's investment in
the four wholly owned service corporations totaled $2.8 million, or
approximately 0.27% of unconsolidated assets, at such date.
Federal associations generally may invest up to 2% of their assets in
service corporations, plus an additional 1% of assets for community purposes. In
addition, federal associations may invest up to 50% of their total capital in
conforming loans to their service corporations in which they own more than 10%
of the capital stock. Federal associations are also permitted to invest an
unlimited amount in operating subsidiaries engaged solely in activities which a
federal association may engage in directly.
The following is a description of Western Security's service corporations:
Westerfed Insurance Services, Inc. Westerfed Insurance, which was
incorporated in 1981, is an insurance agency currently engaged in the sale of
tax deferred annuities and depositor group health insurance programs, although
it may offer a wider range of insurance services in the future. This subsidiary
was acquired by Western Security in connection with its acquisition of Home
Federal in 1983. Western Security's investment in WesterFed Insurance was
$156,000 at June 30, 1998.
27
<PAGE>
Service Corp. of Montana, Inc. Service Corp. was acquired December 1988, in
connection with the acquisition of Great Falls Federal. This service corporation
owns and operates a 30-unit apartment complex in Lewistown, Montana and a single
family residence in Hamilton, Montana. Western Security's investment in Service
Corp. totaled $404,000 at June 30, 1998.
Western Security Investment Services, Inc. Western Security Investment was
acquired in February 1997, in connection with the acquisition of Security
Bancorp. Western Security Investment conducts a securities brokerage business in
Western Security's Billings Office and a real estate rental business. At June
30, 1998, Western Security's investment in Western Security Investment totaled
$572,000.
Monte Mac I, Inc. Monte Mac was formed in 1985 for the purpose of
participating in a collateralized mortgage obligation conduit program. Monte Mac
had participated in three series of CMO issuances. The CMOs are collateralized
by FHLMC participation certificates transferred by Western Security to Monte
Mac. The transferred FHLMC certificates had a book value of $1.5 million at June
30, 1998. Western Security's investment in Monte Mac as of June 30, 1998,
included approximately $1.0 million in FHLMC certificates in excess of
collateralized mortgage obligations. The payments received on the FHLMC
certificates are used to pay down the CMOs. If the CMOs are paid as originally
projected, the remaining investment in Monte Mac is expected to be minimal.
Regulation
General. The Bank is a federally chartered Bank, the deposits of which are
federally insured and backed by the full faith and credit of the United States
Government. Accordingly, the Bank is subject to broad federal regulation and
oversight extending to all of its operations. The Bank is a member of the FHLB
of Seattle and is subject to certain limited regulation by the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board"). As the
savings and loan holding company of the Bank, the Company is subject to federal
regulation and oversight. The purpose of the regulation of the Company and other
holding companies is to protect subsidiary savings associations. The Bank is a
member of the Savings Association Insurance Fund ("SAIF"), which together with
the Bank Insurance Fund (the "BIF") are the two deposit insurance funds
administered by the FDIC, and the deposits of the Bank are insured by the
Federal Deposit Insurance Corporation (the "FDIC"). As a result, the FDIC has
certain regulatory and examination authority over the Bank.
Certain of these regulatory requirements and restrictions are discussed
below or elsewhere in this document.
Federal Regulation of Savings Associations. The OTS has extensive authority
over the operations of savings associations. As part of this authority, the Bank
is required to file periodic reports with the OTS and is subject to periodic
examinations by the OTS and the FDIC. The last regular OTS and FDIC examinations
of the Bank were December 1997 and March 1990, respectively. Under agency
scheduling guidelines, it is likely that another examination will be initiated
in the near future. When these examinations are conducted by the OTS and the
FDIC, the examiners may require the Bank to provide for higher general or
specific loan loss reserves.
All savings associations are subject to a semi-annual assessment, based
upon the savings association's total assets, to fund the operations of the OTS.
The Bank's OTS assessment for the fiscal year ended June 30, 1998, was
approximately $200,000. Savings associations (unlike the Bank) that are
classified as "troubled" (i.e., having a supervisory rating of "4" or "5" or
subject to a conservatorship) are required to pay higher premiums.
The OTS also has extensive enforcement authority over all savings
institutions and their holding companies, including the Bank and the Company.
This enforcement authority includes, among other things, the ability to assess
civil money penalties, to issue cease-and-desist or removal orders and to
initiate injunctive actions. In general, these enforcement actions may 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 the OTS. Except
under certain circumstances, public disclosure of final enforcement actions by
the OTS is required.
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In addition, the investment, lending and branching authority of the Bank is
prescribed by federal laws, and it is prohibited from engaging in any activities
not permitted by such laws. For instance, no savings association may invest in
non-investment grade corporate debt securities. In addition, the permissible
level of investment by federal associations in loans secured by non-residential
real property may not exceed 400% of total capital, except with approval of the
OTS. Federal savings associations are also generally authorized to branch
nationwide. The Bank is in compliance with the noted restrictions.
The Bank's permissible lending limit for loans to one borrower is equal to
the greater of $500,000 or 15% of unimpaired capital and surplus (except for
loans fully secured by certain readily marketable collateral, in which case this
limit is increased to 25% of unimpaired capital and surplus). At June 30, 1998,
the Bank's lending limit under this restriction was approximately $13.0 million.
The Bank is in compliance with the loans-to-one-borrower limitation.
The OTS, as well as the other federal banking agencies, has adopted
guidelines establishing safety and soundness standards on such matters as loan
underwriting and documentation, internal controls and audit systems, asset
quality, earnings standards, internal controls and audit systems, interest rate
risk exposure and compensation and other employee benefits. Any institution
which fails to comply with these standards must submit a compliance plan. A
failure to submit a plan or to comply with an approved plan will subject the
institution to further enforcement action.
Insurance of Accounts and Regulation by the FDIC. The deposits of the Bank
are presently insured by the SAIF. Deposits are insured up to applicable limits
by the FDIC and such insurance is backed by the full faith and credit of the
United States Government. As insurer, the FDIC imposes deposit insurance
premiums and is authorized to conduct examinations of and to require reporting
by FDIC-insured institutions. It also may prohibit any FDIC-insured institution
from engaging in any activity the FDIC determines by regulation or order to pose
a serious risk to the SAIF or the BIF. The FDIC also has the authority to
initiate enforcement actions against savings associations, after giving the OTS
an opportunity to take such action, and may terminate the deposit insurance if
it determines that the institution has engaged in unsafe or unsound practices,
or is in an unsafe or unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums, based upon their level of
capital and supervisory evaluation. See Note 3 of the Notes to Consolidated
Financial Statements in the Annual Report incorporated by reference herein as
Exhibit 13. Risk classification of all insured institutions will be made by the
FDIC for each semi-annual assessment period.
The FDIC is authorized to increase assessment rates, on a semiannual basis,
if it determines that the reserve ratio of the SAIF will be less than the
designated reserve ratio of 1.25% of SAIF insured deposits. In setting these
increased assessments, the FDIC must seek to restore the reserve ratio to that
designated reserve level, or such higher reserve ratio as established by the
FDIC. The FDIC may also impose special assessments on SAIF members to repay
amounts borrowed from the United States Treasury or for any other reason deemed
necessary by the FDIC.
Regulatory Capital Requirements. Federally insured savings associations,
such as the Bank, are required to maintain a minimum level of regulatory
capital. The OTS has established capital standards, including a tangible capital
requirement, a leverage ratio (or core capital) requirement and a risk-based
capital requirement applicable to such savings associations. These capital
requirements must be generally as stringent as the comparable capital
requirements for national banks. The OTS is also authorized to impose capital
requirements in excess of these standards on individual associations on a
case-by-case basis.
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The capital regulations require tangible capital of at least 1.5% of
adjusted total assets (as defined by regulation). Tangible capital generally
includes common stockholders' equity, adjusted to eliminate unrealized gains and
losses on certain available-for-sale securities and retained income, and certain
non-cumulative perpetual preferred stock and related income. All intangible
assets must be deducted from tangible capital for calculating compliance with
the requirement. At June 30, 1998, the Bank had unamortized purchased mortgage
servicing rights of $1.0 million and goodwill and core deposit intangible
relating to the purchase of Security Bancorp of $20.3 million, all of which was
required to be deducted from tangible capital.
The OTS regulations establish special capitalization requirements for
savings associations that own subsidiaries in determining tangible capital. In
determining compliance with the capital requirements, all subsidiaries engaged
solely in activities permissible for national banks or engaged in certain other
activities solely as agent for its customers are "includable" subsidiaries that
are consolidated for capital purposes in proportion to the Bank's level of
ownership, including the assets of includable subsidiaries in which the
association has a minority interest that is not consolidated for purposes of
generally accepted accounting principles ("GAAP"). For excludable subsidiaries
the debt and equity investments in such subsidiaries are deducted from assets
and capital. At June 30, 1998, the Bank was required to deduct $561,000 of its
investment in Service Corp. of Montana, Inc. and $572,000 of its investment in
Western Security Investment under these rules.
At June 30, 1998, the Bank had tangible capital of $82.1 million, or 8.27%
of adjusted total assets, which is approximately $67.2 million above the minimum
requirement of 1.5% of adjusted total assets in effect on that date.
The capital standards also require core capital equal to at least 3% of
adjusted total assets. Core capital generally consists of tangible capital plus
certain intangible assets, including a limited amount of purchased credit card
relationships. As a result of the prompt corrective action provisions discussed
below, however, a savings association must maintain a core capital ratio of at
least 4% to be considered adequately capitalized unless its supervisory
condition is such to allow it to maintain a 3% ratio. At June 30, 1998, the Bank
had no such intangible assets.
At June 30, 1998, the Bank had core capital equal to $82.1 million, or
8.27% of adjusted total assets, which is $42.4 million above the minimum
leverage ratio requirement of 3% as in effect on that date.
The OTS risk-based capital requirement requires savings associations to
have total capital of at least 8% of risk-weighted assets. Total capital
consists of core capital, as defined above, and supplementary capital.
Supplementary capital consists of certain permanent and maturing capital
instruments that do not qualify as core capital and general valuation loan and
lease loss allowances up to a maximum of 1.25% of risk-weighted assets.
Supplementary capital may be used to satisfy the risk-based requirement only to
the extent of core capital. The OTS is also authorized to require a savings
association to maintain an additional amount of total capital to account for
concentration of credit risk and the risk of non-traditional activities. At June
30, 1998, the Bank had no capital instruments that qualify as supplementary
capital and had $4.9 million of general loss reserves, which was less than 1.25%
of risk-weighted assets, and were included in the $87.0 million of risk-based
capital at June 30, 1998.
Certain exclusions from capital and assets are required to be made for the
purpose of calculating total capital. Such exclusions consist of equity
investments (as defined by regulation) and that portion of land loans and
nonresidential construction loans in excess of an 80% loan-to-value ratio and
reciprocal holdings of qualifying capital instruments. The Bank had no such
exclusions from capital and assets at June 30, 1998.
In determining the amount of risk-weighted assets, all assets, including
certain off-balance sheet items, will be multiplied by a risk weight ranging
from 0% to 100% based on the risk inherent in this type of asset. For example,
the OTS has assigned risk weight of 50% for prudently underwritten permanent
one- to four-family first lien mortgage loans not more than 90 days delinquent
and having a loan-to-value ratio of not more than 80% at origination unless
insured to such ratio by an insurer approved by the FNMA or FHLMC.
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On June 30, 1998, the Bank had total risk-based capital of $87.0 million
(including $82.1 million in core capital and $4.9 million in qualifying
supplementary capital) and risk-weighted assets of $629.9 million (including
$70,000 in converted off-balance sheet assets); or total risk-based capital of
13.8% of risk-weighted assets. This amount was $36.6 million above the current
8% requirement in effect on that date.
The OTS and the FDIC are authorized and, under certain circumstances
required, to take certain actions against savings associations that fail to meet
their capital requirements. The OTS is generally required to take action to
restrict the activities of an "undercapitalized association" (generally defined
to be one with less than either a 4% core capital ratio, a 4% Tier 1
risked-based capital ratio or an 8% risk-based capital ratio). Any such
association must submit a capital restoration plan and until such plan is
approved by the OTS may not increase its assets, acquire another institution,
establish a branch or engage in any new activities, and generally may not make
capital distributions. The OTS is authorized to impose the additional
restrictions that are applicable to significantly undercapitalized associations.
As a condition to the approval of the capital restoration plan, any company
controlling an undercapitalized association must agree that it will enter into a
limited capital maintenance guarantee with respect to the institution's
achievement of its capital requirements.
Any savings association that fails to comply with its capital plan or is
"significantly undercapitalized" (i.e., Tier 1 risk-based or core capital ratios
of less than 3% or a risk-based capital ratio of less than 6%) must be made
subject to one or more of additional specified actions and operating
restrictions which may cover all aspects of its operations and include a forced
merger or acquisition of the association. An association that becomes
"critically undercapitalized" (i.e., a tangible capital ratio of 2% or less) is
subject to further mandatory restrictions on its activities in addition to those
applicable to significantly undercapitalized associations. In addition, the OTS
must appoint a receiver (or conservator with the concurrence of the FDIC) for a
savings association, with certain limited exceptions, within 90 days after it
becomes critically undercapitalized. Any undercapitalized association is also
subject to other general enforcement actions by the OTS and the FDIC including
the appointment of a conservator or a receiver.
The OTS is also generally authorized to reclassify an association into a
lower capital category and impose the restrictions applicable to such category
if the institution is engaged in unsafe or unsound practices or is in an unsafe
or unsound condition.
The imposition by the OTS or the FDIC of any of these measures on the Bank
may have a substantial adverse effect on the Bank's operations and
profitability. Holding Company shareholders do not have preemptive rights, and
therefore, if the Holding Company is directed by the OTS or the FDIC to issue
additional shares of Common Stock, such issuance may result in the dilution in
the percentage of ownership of the Holding Company.
Limitations on Dividends and Other Capital Distributions. OTS regulations
impose various restrictions on savings associations with respect to their
ability to make distributions of capital which include dividends, stock
redemptions or repurchases, cash-out mergers and other transactions charged to
the capital account. OTS regulations also prohibit a savings association from
declaring or paying any dividends or from repurchasing any of its stock if, as a
result, the regulatory capital of the association would be reduced below the
amount required to be maintained for the liquidation account established in
connection with its mutual to stock conversion.
Generally, savings associations, such as the Bank, that before and after
the proposed distribution meet their capital requirements, may make capital
distributions during any calendar year equal to the greater of 100% of net
income for the year-to-date plus 50% of the amount by which the lesser of the
association's tangible, core or risk-based capital exceeds its capital
requirement for such capital component, as measured at the beginning of the
calendar year, or 75% of their net income for the most recent four quarter
period. However, an association deemed to be in need of more than normal
supervision by the OTS may have its dividend authority restricted by the OTS.
Western Security may pay dividends in accordance with this general authority.
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Savings associations proposing to make any capital distribution need only
submit written notice to the OTS 30 days prior to such distribution. Savings
associations that do not, or would not meet their current minimum capital
requirements following a proposed capital distribution, however, must obtain OTS
approval prior to making such distribution. The OTS may object to the
distribution during that 30-day period notice based on safety and soundness
concerns. See "Regulatory Capital Requirements."
The OTS has proposed regulations that would revise the current capital
distribution restrictions. Under the proposal a savings association may make a
capital distribution without notice to the OTS (unless it is a subsidiary of a
holding company) provided that it has a CAMELS 1 or 2 rating, is not of
supervisory concern and would remain adequately capitalized (as defined in the
OTS prompt corrective action regulations) following the proposed distribution.
Savings associations that would remain adequately capitalized following the
proposed distribution but do not meet the other noted requirements must notify
the OTS 30 days prior to declaring a capital distribution. The OTS stated it
will generally regard as permissible that amount of capital distributions that
do not exceed 50% of the institution's excess regulatory capital plus net income
to date during the calendar year. A savings association may not make a capital
distribution without prior approval of the OTS and the FDIC if it is
undercapitalized before, or as a result of, such a distribution. As under the
current rule, the OTS may object to a capital distribution if it would
constitute an unsafe or unsound practice. No assurance may be given as to
whether or in what form the regulations may be adopted.
Liquidity. All savings associations, including the Bank, are required to
maintain an average daily balance of liquid assets equal to a certain percentage
of the sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. For a discussion of what the Bank
includes in liquid assets, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital
Resources." This liquid asset ratio requirement may vary from time to time
(between 4% and 10%) depending upon economic conditions and savings flows of all
savings associations. At the present time, the minimum liquid asset ratio is 4%.
The Bank's regulatory ratio was 18.8% at June 30, 1998.
Accounting. An OTS policy statement applicable to all savings associations
clarifies and re-emphasizes that the investment activities of a savings
association must be in compliance with approved and documented investment
policies and strategies, and must be accounted for in accordance with GAAP.
Under the policy statement, management must support its classification of and
accounting for loans and securities (i.e., whether held for investment, sale or
trading) with appropriate documentation. The Bank is in compliance with these
amended rules. OTS accounting regulations, which may be made more stringent than
GAAP, require that transactions be reported in a manner that best reflects their
underlying economic substance and inherent risk and that financial reports must
incorporate any other accounting regulations or orders prescribed by the OTS.
Qualified Thrift Lender Test. All savings associations, including the Bank,
are required to meet a qualified thrift lender ("QTL") test to avoid certain
restrictions on their operations. This test requires a savings association to
have at least 65% of its portfolio assets (as defined by regulation) in
qualified thrift investments on a monthly average for nine out of every 12
months on a rolling basis. As an alternative, the savings association may
maintain 60% of its assets in those assets specified in Section 7701(a)(19) of
the Internal Revenue Code. Under either test, such assets primarily consist of
residential housing related loans and investments. At June 30, 1998, the Bank
met the test and has always met the test since its effectiveness.
Any savings association that fails to meet the QTL test must convert to a
national bank charter, unless it re-qualifies as a QTL and thereafter remains a
QTL. If an association does not re-qualify and converts to a national bank
charter, it must remain SAIF-insured until the FDIC permits it to transfer to
the BIF. If an association has not yet re-qualified and or converted to a
national bank, its new investments and activities are limited to those
permissible for both a savings association and a national bank, and it is
limited to national bank branching rights in its home state. In addition, the
association is immediately ineligible to receive any new FHLB borrowings and is
subject to national bank limits for payment of dividends. If such association
has not re-qualified or converted to a national bank within three years after
the failure, it must divest of all investments and cease all activities not
permissible for a national bank. In addition, it must repay promptly any
outstanding FHLB borrowings, which may result in prepayment penalties. If any
association that fails the QTL test is controlled by a holding company, then
within one year after the failure, the holding company must register as a bank
holding company and become subject to all the restrictions on bank holding
companies. See "Company Regulation."
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Community Reinvestment Act. Under the Community Reinvestment Act ("CRA"),
every FDIC insured institution has a continuing and affirmative obligation
consistent with safe and sound banking practices to help meet the credit needs
of its entire community, including low and moderate income neighborhoods. The
CRA does not establish specific lending requirements or programs for financial
institutions nor does it limit an institution's discretion to develop the types
of products and services that it believes are best suited to its particular
community, consistent with the CRA. The CRA requires the OTS, in connection with
the examination of the Bank, to assess the institution's record of meeting the
credit needs of its community and to take such record into account in its
evaluation of certain applications, such as a merger or the establishment of a
branch, by the Bank. An unsatisfactory rating may be used as the basis for the
denial of an application by the OTS.
The federal banking agencies, including the OTS, have recently revised the
CRA regulations and the methodology for determining an institution's compliance
with the CRA. Due to the heightened attention being given to the CRA in the past
few years, the Bank may be required to devote additional funds for investment
and lending in its local community. The Bank was examined for CRA compliance in
October 1997 and received a rating of satisfactory.
Transactions with Affiliates. Generally, transactions between a savings
association or its subsidiaries and its affiliates are required to be on terms
as favorable to the association as transactions with non-affiliates. In
addition, certain of these transactions, such as loans to an affiliate, are
restricted to a percentage of the association's capital. Affiliates of the Bank
include the Company and any company which is under common control with the
Company. In addition, a savings association may not lend to any affiliate
engaged in activities not permissible for a bank holding company or acquire the
securities of most affiliates. The Bank's subsidiaries are not deemed
affiliates; however, the OTS has the discretion to treat subsidiaries of savings
associations as affiliates on a case-by-case basis.
Certain transactions with directors, officers or controlling persons are
also subject to conflict of interest regulations enforced by the OTS. These
conflict of interest regulations and other statutes also impose restrictions on
loans to such persons and their related interests. Among other things, such
loans must be made on terms substantially the same as for loans to unaffiliated
individuals.
Holding Company Regulation. The Company is a unitary savings and loan
holding company subject to regulatory oversight by the OTS. As such, the Company
is required to register and file reports with the OTS and is subject to
regulation and examination by the OTS. In addition, the OTS has enforcement
authority over the Company and its non-savings association subsidiaries which
also permits the OTS to restrict or prohibit activities that are determined to
be a serious risk to the subsidiary savings association.
As a unitary savings and loan holding company, the Company generally is not
subject to activity restrictions. If the Company acquires control of another
savings association as a separate subsidiary, it would become a multiple savings
and loan holding company, and the activities of the Company and any of its
subsidiaries (other than Western Security or any other SAIF-insured savings
association) would become subject to such restrictions unless such other
associations each qualify as a QTL and were acquired in a supervisory
acquisition.
If Western Security fails the QTL test, the Company must obtain the
approval of the OTS prior to continuing after such failure, directly or through
its other subsidiaries, any business activity other than those approved for
multiple savings and loan holding companies or their subsidiaries. In addition,
within one year of such failure the Company must register as, and will become
subject to, the restrictions applicable to bank holding companies. The
activities authorized for a bank holding company are more limited than are the
activities authorized for a unitary or multiple savings and loan holding
company. See " Qualified Thrift Lender Test."
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The Company must obtain approval from the OTS before acquiring control of
any other SAIF-insured association. Such acquisitions are generally prohibited
if they result in a multiple savings and loan holding company controlling
savings associations in more than one state. However, such interstate
acquisitions are permitted based on specific state authorization or in a
supervisory acquisition of a failing savings association.
Federal Securities Law. The Company is registered with the Securities and
Exchange Commission ("SEC") under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). The Company is subject to the information, proxy
solicitation, insider trading restrictions and other requirements of the SEC
under the Exchange Act.
Company stock held by persons who are affiliates (generally officers,
directors and principal stockholders) of the Company may not be resold without
registration or unless sold in accordance with certain resale restrictions. If
the Company meets specified current public information requirements, each
affiliate of the Company is able to sell in the public market, without
registration, a limited number of shares in any three-month period.
Federal Reserve System. The Federal Reserve Board requires all depository
institutions to maintain non-interest-bearing reserves at specified levels
against their transaction accounts (primarily checking, NOW and Super NOW
checking accounts). At June 30, 1998, the Bank was in compliance with these
reserve requirements. The balances maintained to meet the reserve requirements
imposed by the Federal Reserve Board may be used to satisfy liquidity
requirements that may be imposed by the OTS. See "Liquidity."
Savings associations are authorized to borrow from the Federal Reserve Bank
"discount window," but Federal Reserve Board regulations require associations to
exhaust other reasonable alternative sources of funds, including FHLB
borrowings, before borrowing from the Federal Reserve Bank.
Federal Home Loan Bank System. The Bank is a member of the FHLB of Seattle,
which is one of 12 regional FEDERAL HOME LOAN BANK OF SEATTLE, that administers
the home financing credit function of savings associations. Each FHLB serves as
a reserve or central bank for its members within its assigned region. It is
funded primarily from proceeds derived from the sale of consolidated obligations
of the FHLB System. It makes loans to members (i.e., advances) in accordance
with policies and procedures established by the board of directors of the FHLB,
which are subject to the oversight of the Federal Housing Finance Board. All
advances from the FHLB are required to be fully secured by sufficient collateral
as determined by the FHLB. In addition, all long-term advances are required to
provide funds for residential home financing.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Seattle. At June 30, 1998, the Bank had $13.6 million in FHLB stock,
which was in compliance with this requirement. In past years, the Bank has
received substantial dividends on its FHLB stock. Over the past five calendar
years such dividends have averaged 7.17% and were 7.74% and 8.00% for calendar
years 1996 and 1997 respectively.
Under federal law the FEDERAL HOME LOAN BANK OF SEATTLE are required to
provide funds for the resolution of troubled savings associations and to
contribute to low- and moderately priced housing programs through direct loans
or interest subsidies on advances targeted for community investment and low- and
moderate-income housing projects. These contributions have affected adversely
the level of FHLB dividends paid and could continue to do so in the future.
These contributions could also have an adverse effect on the value of FHLB stock
in the future. A reduction in value of the Bank's FHLB stock may result in a
corresponding reduction in the Bank's capital.
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For the fiscal year ended June 30, 1998, dividends paid by the FHLB of
Seattle to the Bank totaled $975,000, which constitutes a $264,000 increase over
the amount of dividends received in fiscal year 1997. There can be no assurance
that such dividends will continue in the future.
Federal and State Taxation. The Company, the Bank, and its non-bank
subsidiaries file a consolidated federal and Montana income tax return using the
accrual method of accounting. For fiscal years beginning before January 1, 1997,
Montana state statute prevented filing of a consolidated Montana income tax
return including the Bank; thus, separate returns were filed by the Company
(including the non-bank subsidiaries) and the Bank. Generally, the Company, the
Bank and its non-bank subsidiaries are subject to federal income taxes in the
same manner as other corporations.
The following discussion of tax matters is intended solely as a summary and
does not purport to be a comprehensive description of all the tax rules
applicable to the Company, the Bank, or its non-bank subsidiaries.
For taxable years beginning prior to January 1, 1996, savings institutions,
such as the Bank, which met certain definitional tests primarily relating to
their assets and the nature of their business ("qualifying thrifts"), were
permitted to establish a reserve for bad debts and to make annual additions
thereto. These additions may, within specified formula limits, have been
deducted in arriving at their taxable income. The Bank's deduction with respect
to "qualifying loans," which are generally loans secured by certain interests in
real property including various types of mortgage-backed securities, may have
been computed using an amount based on the Bank's actual loss experience or a
percentage equal to 8% of the Bank's taxable income, computed with certain
modifications and reduced by the amount of any permitted additions to the
non-qualifying reserve. The Bank's deduction with respect to non-qualifying
loans was computed under the experience method which essentially allows a
deduction based on the Bank's actual loss experience over a period of several
years. Each year the Bank selected the most favorable method to calculate the
deduction attributable to an addition to the tax bad debt reserve.
Federal legislation repealed the reserve method of accounting for bad debt
reserves for tax years beginning after December 31, 1995. As a result, savings
institutions can no longer calculate their deduction for bad debts using the
percentage-of-taxable-income method. Instead, such institutions are required to
compute their deductions based on specific charge-offs during the taxable year
when they otherwise qualify to use the experience method. This legislation also
requires savings institutions to recapture into income over a six-year period
their post-1987 additions to their tax bad debt reserves, thereby generating
additional current tax liability. The Bank's post-1987 reserves that will be
recaptured into income ratably over a six-year period is $3.2 million. At June
30, 1998 the Bank's bad debt reserve for tax purposes was approximately $13.8
million. (See Note 12 of the Notes to Consolidated Financial Statements in the
Annual Report incorporated by reference as Exhibit 13.)
Corporate Alternative Minimum Tax - Federal tax law imposes a tax on
alternative minimum taxable income ("AMTI") at a rate of 20%. Only 90% of AMTI
can be offset by net operating loss carry-overs. AMTI is increased by an amount
equal to 75% of the amount by which the Bank's adjusted current earnings exceed
its AMTI (determined without regard to this preference and prior to reduction
for net operating losses).
Dividends-Received Deduction and Other Matters - The Company may eliminate
from its taxable income dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends-received deduction is
generally 70% in the case of dividends received from unaffiliated corporations
with which the Company and the Bank will not file a consolidated tax return,
except that if the Company or the Bank owns more than 20% of the stock of a
corporation distributing a dividend, then 80% of any dividends received may be
deducted.
The Company and its consolidated subsidiaries have been audited by the IRS
with respect to consolidated federal income tax returns through June 30, 1989.
In the opinion of management, any examination of still open returns (including
returns of subsidiaries and predecessors, or entities merged with and into the
Company or the Bank) would not result in a deficiency which could have a
material adverse effect on the financial condition of the Company, the Bank and
its consolidated subsidiaries.
35
<PAGE>
Montana Taxation - Under Montana taxation law, savings institutions, such
as the Bank, are subject to corporation license tax, which incorporates or is
substantially similar to applicable provisions of the Federal Internal Revenue
Code. The corporation license tax is imposed on federal taxable income, subject
to certain adjustments at a rate of 6.75% for fiscal year 1998.
Delaware Taxation - As a Delaware holding company, the Company is exempted
from Delaware corporate income tax but is required to file an annual report with
and pay an annual fee to the State of Delaware. The Company is also subject to
an annual franchise tax imposed by the State of Delaware.
Impact of New Accounting Standards
See Note 1, Summary of Significant Accounting Policies and Note 16, Recent
Accounting Pronouncements Not Yet Adopted in Notes to Consolidated Financial
Statements in the Annual Report incorporated by reference herein as Exhibit 13.
Competition
The Bank generally faces strong competition both in originating loans and
in attracting deposits. Competition in originating loans comes primarily from
other savings institutions, commercial banks, mortgage bankers, credit unions,
insurance companies and government agencies who also make loans located in the
Bank's primary market areas. The Bank competes for loans principally on the
basis of the interest rates and loan fees it charges, the types of loans it
originates and the quality of services it provides to borrowers.
The Bank faces substantial competition in attracting deposits from other
savings institutions, commercial banks, securities firms, money market and
mutual funds, credit unions and other investment vehicles. The ability of the
Bank to attract and retain deposits depends on its ability to provide an
investment opportunity that satisfies the requirements of investors as to rate
of return, liquidity, risk, convenient locations and other factors. The Bank
competes for these deposits by offering a variety of deposit accounts at
competitive rates, convenient business hours, a customer oriented staff,
advertising and a branch network in twenty Montana cities.
36
<PAGE>
The Bank estimates its market share of the savings deposits in the counties
where it has branch offices to be as follows:
June 30, 1997
County Deposit Share(1) City
- ------------- ---------------- ----------------------
Missoula ........................... 15.0% Missoula
Yellowstone ........................ 11.7 Billings and Laurel
Lewis & Clark ...................... 6.7 Helena and East Helena
Cascade ............................ 4.6 Great Falls
Gallatin ........................... 4.1 Bozeman
Ravalli ............................ 6.0 Hamilton
Pondera ............................ 8.5 Conrad
Fergus ............................. 17.4 Lewistown
Custer ............................. 6.0 Miles City
Big Horn ........................... 11.5 Hardin
Deer Lodge ......................... 22.4 Anaconda
Flathead ........................... 0.7 Kalispell
Hill ............................... 9.9 Havre
Phillips ........................... 4.7 Malta
Richland ........................... 6.1 Sidney
Sheridan ........................... 16.2 Plentywood
Silverbow .......................... 8.6 Butte
Valley ............................. 6.2 Glasgow
- ----------
(1) Based on data supplied by Ferguson & Company Branch Source as of June 1997,
Western Security held approximately a 6.6% market share of deposits in
Montana. Based on this market share, Western Security ranked 4th out of 196
financial institutions located in Montana. See "Market Areas" for
information regarding the Bank's deposit share in each county in its market
area.
Western Security's competition for residential real estate loans is
principally from mortgage bankers, other savings institutions, commercial banks
and other institutional lenders. Competition for commercial real estate loans is
primarily from commercial banks in Missoula and other savings institutions in
Missoula, Helena, Billings, Great Falls, and Bozeman. Competition for consumer
loans is from commercial banks, credit unions, other savings institutions and
consumer finance companies. Western Security competes for loans principally
through the interest rates and loan fees charged. Western Security's competition
for loans varies from time to time depending upon numerous factors, including
the general availability of lending funds and credit, economic conditions,
current interest rate levels, volatility in the mortgage markets and other
factors which are not readily predictable.
Executive Officers of the Company
The following table sets forth certain information at June 30, 1998
regarding the executive officers of the Company and the Bank who are not also
directors.
<TABLE>
<CAPTION>
Name Age Position(s) Held
- ------------------- --- ---------------------------------------------------------------------------
<S> <C> <C>
Douglas G. Bardwell 56 Executive Vice President and Secretary of the Company and
Executive Vice President and Chief Operating Officer of the Bank
James A. Salisbury 47 Treasurer and Chief Financial Officer of the Company and the Bank
Jack E. Lovell 61 Senior Vice President and Credit Administrator of the Bank
Dale W. Brevik 46 Senior Vice President and Marketing Director/Investor Relations of the Bank
Charles E. Eiseman 48 Senior Vice President/Retail Lending Manager of the Bank
</TABLE>
37
<PAGE>
The business experience of each executive officer who is not also a
director is set forth below.
Douglas G. Bardwell. Mr. Bardwell became Executive Vice President and
Secretary of the Company in September 1993. Mr. Bardwell joined the Bank in
August 1973. He was appointed Chief Operating Officer in 1983 and Executive Vice
President in 1989. He also serves on the Board of Directors of Western Security
Investment Services, Inc., Monte Mac I, and Service Corporation of Montana. Mr.
Bardwell is responsible for the supervision of the Bank's savings and operations
departments. Mr. Bardwell is a graduate of the University of Montana.
James A. Salisbury. Mr. Salisbury became Treasurer and Chief Financial
officer of the Company in September 1993. Mr. Salisbury joined Western Security
as Treasurer and Chief Financial Officer in 1983. Prior to such time, he was
employed as the Chief Financial Officer for Home Federal from 1980 to 1983. From
1978 to 1980, he was in private practice as a certified public accountant. Mr.
Salisbury is responsible for the formulation and implementation of the policies
and objectives of the Bank's finance, accounting and audit function. He also
serves as Treasurer and Chief Financial Officer of Western Security Investment
Services Inc., Monte Mac I and Service Corporation of Montana. Mr. Salisbury is
a graduate of the University of Montana and is a certified public accountant.
Jack E. Lovell. Mr. Lovell has been employed by Western Security since
September 1975 and was promoted to Senior Vice President/Credit Administrator in
October, 1996. He previously held the title of Loan Department Chairman since
1979. As Credit Administrator he is responsible for policy formulation related
to all Credit Administration and has direct oversight responsibility for Loan
Servicing and Quality Control Departments. Mr. Lovell is a graduate of the
University of Montana.
Dale W. Brevik. Mr. Brevik has been with Western Security since May 1979
and became Senior Vice President/Marketing Director/Investor Relations Manager
in October, 1996. He has served as Marketing Director since 1983. In addition to
his duties as Marketing Director, Mr. Brevik is the Investor Relations Manager
and coordinates new product development and oversees Western Security's
insurance programs. Mr. Brevik is a graduate of the University of Montana.
Charles E. Eiseman. Mr. Eiseman has been employed by Western Security since
December 1975 and became Senior Vice President/Retail Lending Manager in
October, 1996. Since 1988, Mr. Eiseman's duties have included supervision of all
retail lending activities in all cities where Western Security has loan
origination centers. Mr. Eiseman is a graduate of the University of Montana.
Employees
At June 30, 1998, the Company had a total of 336 full-time employees and 72
part-time employees. None of the Bank employees are represented by any
collective bargaining group.
38
<PAGE>
Item 2. Properties
The following table sets forth information concerning the main office and
each branch office and loan production office of the Bank at June 30, 1998. At
June 30, 1998, the Bank's premises and equipment had an aggregate net book value
of approximately $22.7 million.
<TABLE>
<CAPTION>
Year Owned or Lease Expiration Net Book
Location Acquired Leased Date Value
- -------------------------------- -------- -------- ---------------- --------------
(In Thousands)
<S> <C> <C> <C> <C>
Main Office
110 East Broadway ............ 1957 Owned N/A $ 218
Missoula, Montana
Full Service Branches
100 East Broadway ............ 1957 Owned N/A(1) 418
Missoula, Montana
2230 Brooks .................. 1966 Owned N/A 362
Missoula, Montana
1610 S. Third West ........... 1977 Leased July 1, 1999 --
Missoula, Montana
2601 Garfield ................ 1979 Owned N/A 1,149
Missoula, Montana
321 Fuller ................... 1983 Owned N/A 143
Helena, Montana
101 Lane Avenue .............. 1983 Owned N/A 66
East Helena, Montana
601 N. Montana ............... 1983 Leased December 31, 1999 7
Helena, Montana
3171 N. Montana .............. 1996 Owned N/A 650
Helena, Montana
501 N. First Street .......... 1980 Owned N/A 1,645
Hamilton, Montana
2425 10th Avenue South ....... 1988 Owned N/A 151
Great Falls, Montana
25 Fifth Street North ........ 1988 Owned N/A 886
Great Falls, Montana
900 Third Street, NW ......... 1988 Owned N/A 438
Great Falls, Montana
702 South Main ............... 1988 Owned N/A 186
Conrad, Montana
2929 Third Avenue North ...... 1991 Owned N/A 1,624
Billings, Montana
1101 Main Street ............. 1991 Owned N/A 62
Miles City, Montana
524 North Cheyenne Avenue .... 1991 Owned N/A 93
Hardin, Montana
219 North 26th Street ........ 1967 Owned N/A 793
Billings, Montana
2675 King Avenue West ........ 1995(3) Owned N/A 2,007
Billings, Montana
1941 West Main ............... 1983 Owned N/A 337
</TABLE>
39
<PAGE>
<TABLE>
<CAPTION>
Year Owned or Lease Expiration Net Book
Location Acquired Leased Date Value
- -------------------------------- -------- -------- ---------------- --------------
(In Thousands)
<S> <C> <C> <C> <C>
Bozeman, Montana
2401 Grand Avenue ............ 1975 Owned N/A 2,139
Billings, Montana
1546 Main Street ............. 1975 Owned N/A 498
Billings, Montana
2845 Old Hardin Road ......... 1997 Owned N/A 972
Billings, Montana
19 Montana Avenue ............ 1987 Owned N/A 487
Laurel, Montana
405 Main Street .............. 1979 Owned N/A 377
Kalispell, Montana
320 West Broadway ............ 1980(4) Leased January 1, 2008 49
Missoula, Montana
2350 South Reserve ........... 1995 Leased December 30, 1999 123
Missoula, Montana
221 Second Street NW ......... 1989 Owned N/A 376
Sidney, Montana
324 Third Avenue ............. 1989 Owned N/A 1,346
Havre, Montana
135 South Second Street East . 1994 Owned N/A 127
Malta, Montana
125 Fourth Street South ...... 1989 Leased Monthly(2) --
Glasgow, Montana
102 North Main ............... 1989 Owned N/A 340
Plentywood, Montana
1880 Harrison Avenue ......... 1994 Owned N/A 1,140
Butte, Montana
401 West Main ................ 1994 Owned N/A 699
Lewistown, Montana
307 East Park Street ......... 1994 Leased March 1, 1999 13
Anaconda, Montana
2901 West Main ............... 1995 Leased April 15, 2031 853
Bozeman, Montana
Loan Administration
1100 South Avenue ............ 1993 Owned N/A 1,097
Missoula, Montana
1105 West Sussex ............. 330
Missoula, Montana
Construction in Progress ....... --
Land for future branch expansion 546
-------
Total $22,747
=======
</TABLE>
- ----------
(1) Includes lease for drive-up window which expires in May 2001.
(2) Lease is on a month-to-month basis.
(3) Branch opened 12/97
(4) Property sold 12/97 - leased for 10 years.
40
<PAGE>
The Company replaced the branch at 300 South 24th Street, Billings, with
the Billings King Avenue branch. Properties located at 424 West Main Street,
Lewistown and at 320 West Broadway, Missoula, were sold. A lease was signed to
use a portion of the property at 320 West Broadway in Missoula for 10 years.
The Bank's accounting and record-keeping activities are maintained on an
on-line basis with an independent service bureau. The net book value of the
Bank's computer and other equipment (including furniture, fixtures and
automobiles) at June 30, 1998, totaled $6.1 million. In addition, subsidiaries
of the Bank hold properties and equipment with a net book value of $1.3 million.
See "Business - Subsidiary Activities."
Item 3. Legal Proceedings
From time to time, the Company and Western Security are involved as
plaintiff or defendant in various legal proceedings arising in the normal course
of its business. While the ultimate outcome of these various legal proceedings
cannot be predicted with certainty, it is the opinion of management that the
resolution of these legal actions should not have a material effect on the
Company's consolidated financial position or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders, through the
solicitation of proxies or otherwise, during the quarter ended June 30, 1998.
PART II
Item 5. Market for the Registrant's Common Stock and
Related Security Holder Matters
The caption "General Corporate and Stockholders' Information" contained in
excerpts from the Company's Annual Report (beginning at page 60 thereto) filed
at Exhibit 13 hereto is incorporated in its entirety by reference under this
Item 5.
Item 6. Selected Financial Data
The caption "Selected Consolidated Financial and Other Data" contained in
excerpts from the Company's Annual Report (beginning at page 8 thereto) filed at
Exhibit 13 hereto is incorporated in its entirety by reference under this Item
6.
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
The caption "Management's Discussion and Analysis of Financial Condition
and Results of Operations" contained in excerpts from the Company's Annual
Report (beginning at page 9 thereto) filed at Exhibit 13 hereto is incorporated
in its entirety by reference under this Item 7.
Item 8. Financial Statements and Supplementary Data
The caption "Consolidated Financial Statements" contained in excerpts from
the Company's Annual Report (beginning at page 26 thereto) filed at Exhibit 13
hereto is incorporated in its entirety by reference under this Item 8.
41
<PAGE>
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure
There has been no Current Report on Form 8-K filed within 24 months prior
to the date of the most recent financial statements reporting a change of
accountants and/or reporting disagreements on any matter of accounting principle
or financial statement disclosure.
PART III
Item 10. Directors and Executive Officers of the Registrant
Information concerning Directors of the Registrant is incorporated herein
by reference from the Corporation's definitive Proxy Statement for the Annual
Meeting of Stockholders scheduled to be held on October 27, 1998, except for
information contained under the heading "Compensation Committee Report on
Executive Compensation" and "Stockholder Return Performance Presentation", a
copy of which will be filed not later than 120 days after the close of the
fiscal year. See "Business - Executive Officers of the Company" in Part I of the
Form 10-K for information regarding executive officers.
Item 11. Executive Compensation
Information concerning executive compensation is incorporated herein by
reference from the Corporation's definitive Proxy Statement for the Annual
Meeting of Stockholders scheduled to be held on October 27, 1998, except for
information contained under the heading "Compensation Committee Report on
Executive Compensation" and "Stockholder Return Performance Presentation", a
copy of which will be filed not later than 120 days after the close of the
fiscal year.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information concerning security ownership of certain beneficial owners and
management is incorporated herein by reference from the Corporation's definitive
Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on
October 27, 1998, except for information contained under the heading
"Compensation Committee Report on Executive Compensation" and "Stockholder
Return Performance Presentation", a copy of which will be filed not later than
120 days after the close of the fiscal year.
Item 13. Certain Relationships and Related Transactions
Information concerning certain relationships and transactions is
incorporated herein by reference from the Corporation's definitive Proxy
Statement for the Annual Meeting of Stockholders scheduled to be held on October
27, 1998, except for information contained under the heading "Compensation
Committee Report on Executive Compensation" and "Stockholder Return Performance
Presentation", a copy of which will be filed not later than 120 days after the
close of the fiscal year.
42
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) Financial Statements:
The following information appearing in the Registrant's Annual Report to
Stockholders for the year ended June 30, 1998, is incorporated by reference in
this Form 10-K Annual Report as Exhibit 13.
Pages in
Annual
Annual Report Section Report
- --------------------- --------
Consolidated Financial Information .................................... 26
Independent Auditors' Report .......................................... 27
Consolidated Balance Sheets--June 30, 1997 and 1998 ................... 28
Consolidated Statements of Income--Each of the Years in the
Three-Year Period Ended June 30, 1998 ............................... 29
Consolidated Statements of Stockholders' Equity--Each of the Years
in the Three-Year Period Ended June 30, 1998 ........................ 30
Consolidated Statements of Cash Flows--Each of the Years in the
Three-Year Period Ended June 30, 1998 ............................... 31
Notes to Consolidated Financial Statements ............................ 32
Supplementary Financial Data .......................................... 59
43
<PAGE>
(a)(2) Financial Statement Schedules:
All financial statement schedules have been omitted as the information is
not required under the related instructions or is inapplicable.
(a)(3) Exhibits:
Reference to Prior
Filing of Exhibit
Regulation S-K Number Attached
Exhibit Number Document Hereto
- -------------- -------------------------------------------- ------------------
2 Plan of acquisition, reorganization,
arrangement, liquidation or succession None
3 (i) Articles of Incorporation (ii) By-laws *
4 Instruments defining the rights of security
holders, including indentures *
9 Voting trust agreement None
10.1 Stock Option and Incentive Plan **
10.2 Employee Stock Ownership Plan *
10.3 Recognition and Retention Plan **
10.4 Salary Continuation Plan *
10.5 Directors Deferred Compensation Plan *
10.6 Benefit Equalization Plan *
10.7 Employment Agreements for Messrs. Grimes,
Bardwell and Salisbury **
10.8 Employment Agreements for Messrs. Brevik,
Eiseman and Lovell and Ms. Dumontier **
10.9 Annual Management Incentive Plan **
10.10 Wage Continuation Agreements for Messrs.
Grimes, Bardwell and Salisbury **
10.11 Equity Incentive Plan ***
10.12 Employment Agreement for David W. Jorgenson,
Elaine F. Hine, Stanley R. Hill and
Scott W. Sanders ***
11 Statement re: computation of per share earnings None
12 Statement re: computation of ratios Not required
13 Annual Report to Security Holders 13
16 Letter re: change in certifying accountant None
18 Letter re: change in accounting principles None
19 Report furnished to security holders None
21 Subsidiaries of Registrant 21
22 Published report regarding matters submitted
to vote of security holders None
23 Consent of experts and counsel 23
24 Power of Attorney Not required
27 Financial Data Schedule 27
28 Information from reports furnished to State
insurance regulatory authorities None
99 Additional exhibits None
- ----------
* Filed on September 21, 1993, as exhibits to the Registrant's Form S-1
registration statement (Registration No. 33-69168) pursuant to the
Securities Act of 1933. All of such previously filed documents are hereby
incorporated herein by reference in accordance with Item 601 of Regulation
S-K.
** Filed on September 27, 1995, as the exhibits listed above to the
Registrant's Annual Report on Form 10-K for the year ended June 30, 1995
pursuant to the Securities Exchange Act of 1934 (File No. 0-22772). All of
such previously filed documents are hereby incorporated herein by reference
in accordance with Item 601 of Regulation S-K.
*** Filed on November 19, 1996, as the exhibits listed above to the
Registrant's Form S-4 registration statements (Registration No. 533-16428)
pursuant to the Securities Act of 1933 all of such previously filed
documents are hereby incorporated herein by reference.
(b) Reports on Form 8-K:
No reports on Form 8-K have been filed during the three-month period ended
June 30, 1998.
44
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
WESTERFED FINANCIAL CORPORATION
Date: By: /s/ Lyle R. Grimes
--------------------------------
Lyle R. Grimes
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
By: /s/ Lyle R. Grimes By: /s/ Dr. Marvin Reynolds
---------------------------------- --------------------------------
Lyle R. Grimes, Chairman of Dr. Marvin Reynolds, Director
the Board, President, Chief
Executive Officer and Director
(Principal Executive and Operating
Officer)
Date: Date:
By: /s/ Dr. Otto G. Klein, Jr. By: /s/ John E. Roemer
---------------------------------- --------------------------------
Dr. Otto G. Klein, Jr., Director John E. Roemer, Vice Chairman
Date: Date:
By: /s/ Laurie C. DeMarois By: /s/ James A. Salisbury
---------------------------------- --------------------------------
Laurie C. DeMarois, Director James A. Salisbury, Treasurer and
Chief Financial Officer (Principal
Financial and Accounting Officer)
Date: Date:
By: /s/ Robert F. Burke By: /s/ David W. Jorgenson
---------------------------------- --------------------------------
Robert F. Burke, Director David W. Jorgenson, Director and
Vice President
Date: Date:
By: /s/ William Leslie
----------------------------------
William Leslie, Director
Date:
45
Exhibit 13
Annual Report to Security Holders
<PAGE>
President's letter
- ------------------
Lyle R. Grimes, President/Chief Executive Officer
When Meriwether Lewis and William Clark set out on their journey nearly two
hundred years ago, they faced enormous challenges. However, their desire to
improve their country's fortunes motivated them to meet those challenges
head-on. We at WesterFed are inspired by their legendary journey as we face the
enormous challenges of enhancing long-term shareholder value in today's
competitive financial world.
As I reported to you a year ago, WesterFed took a major step in meeting these
challenges in February, 1997, when we purchased Security Bank to merge with our
only subsidiary, the former Western Federal Savings Bank. I am pleased to report
that the two banks have been successfully merged as Western Security Bank.
- ------------------------------------
Western Federal Savings Bank and
Security Bank have been successfully
merged as Western Security Bank.
- ------------------------------------
Our confidence has grown as we have spent the past year planning and preparing
for our future. That includes the near flawless computer conversion to a
commercial banking data system. In this conversion, all of our 34 branches (18
former Western Federal branches and 16 former Security branches) moved on to a
Y2K certified, commercial banking platform and software systems.
Since the computer conversion meant change or modification in virtually every
service the bank offers, our primary objective was to make sure no failures in
service occurred in the process. That's why we executed a carefully planned
computer training program for each of our employees. That planning paid off as
employees at each branch were well prepared (though understandably nervous) on
"opening day."
Customer response to the bank's new name and direction has been enthusiastic
throughout the state. Our customers are especially pleased that they can now
access their accounts at any Western Security office, as their account records
are available through the unified system.
WESTERFED FINANCIAL CORPORATION
1
<PAGE>
Since our customers are the lifeblood of our business, we are constantly
searching for new and innovative ways to serve them. That's why all our
employees completed a formal sales and customer service training program this
year. This program was designed and overseen by a professional training company,
giving each employee new insight to identifying customer needs and matching the
bank's services to those needs. Cross-selling was a major focus of this program.
We have 73,600 customers and each Western Security household uses an average of
just 1.6 services, meaning we have a lot of opportunity to enhance our current
customer relationships.
- --------------------------------------
Acquiring a sense of unity is vital in
developing pride within the Bank and
building positive employee attitudes.
- --------------------------------------
Also on the subject of employees, I am happy to report that members of our
hard-working staff have taken advantage of opportunities to get to know each
other during the year. The sales and computer classes were held in different
locations around the state, bringing department and branch employees together. I
feel this was an important step in combining two large corporations with
hundreds of employees spread across Montana. Acquiring a sense of unity is vital
in developing pride within the Bank and building positive employee attitudes.
As we prepared and executed the conversion and integration of the two banks, we
kept our eye on the ball in conducting day-to-day operations. For example, we
opened a new branch in Billings in the growing commercial area on King Avenue
West. Our deposit accounts grew to $636.4 million and loan originations reached
a record of $366.7 million. And, perhaps best of all, we met our goal of
broadening the bank's lending business with consumer, commercial and
agricultural lending as we carefully added to our portfolio in those areas.
Consumer, commercial and agricultural loans increased 16.9% last year to 43% of
our gross loan portfolio from 36.9%. We also added commercial lenders and
support staff in Billings, Butte, Missoula and Great Falls. Theses lenders,
along with our new commercial software, will enhance the ability of those
branches to
WESTERFED FINANCIAL CORPORATION
2
<PAGE>
serve business customers. This will also allow us to enter the commercial
banking deposit services market in other Montana communities where we previously
provided retail services only.
With these major changes and preparations, we have positioned the bank to reach
future goals of maintaining or improving net interest margin, increasing fee
income, increasing consumer and commercial lending, expanding our customer base
and improving our efficiency ratio.
Maintaining net interest margin is quite a challenge in our current rate
environment. A flat interest rate yield curve with intense competition for
deposits and loan business have squeezed that ratio in the banking industry for
some time. That makes our growth in the higher-yield lending arena a very
important strategy right now. Increasing low-interest checking accounts on both
the retail and commercial levels, and increasing our competitive position in
consumer and commercial lending are vital to net interest margin and fee income.
Western Security Bank spent about $0.68 to produce $1.00 in income during fiscal
year 1997-98. Improving this ratio will be our primary focus during our next
fiscal year. By using our time and new technology more efficiently, we are
attempting to improve that rate by lowering costs and increasing income. Adding
more efficient (cost-versus-income) services and eliminating inefficient
services will help us achieve this goal.
Our overall objective has always been to increase long-term shareholder value. I
feel we can do that by taking advantage of all the attributes of the new Western
Security. We will continue to work hard and enhance our appeal to the customers
we serve. Since I recently witnessed our employees rise to the enormous
challenge of changing their "tool box" while maintaining "business as usual," I
am extremely confident we will make the progress necessary to meet our
objectives. Just as Lewis and Clark capitalized on their strengths and overcame
their weaknesses, so too will we meet the challenges we face and continue to
prosper.
Sincerely,
/s/ Lyle R. Grimes
Lyle R. Grimes
President/Chief Executive Officer
WESTERFED FINANCIAL CORPORATION
3
<PAGE>
Opportunities on the horizon
- ----------------------------
The legendary journey of Lewis & Clark required heart, character and vision. The
result of their determination and fortitude was a new horizon full of
opportunities and growth for our nation. As Montana prepares to celebrate the
bicentennial of the Corps of Discovery, we at WesterFed are facing new horizons
of our own.
These horizons are the result of a growth strategy for WesterFed's only
subsidiary, Western Security Bank, formerly Western Federal Savings Bank. Our
1997 acquisition of Security Bank not only helped create a new name, but also a
new dimension for the bank. Security's commercial lending expertise perfectly
complemented Western Federal's strong mortgage and consumer lending background,
making for an exciting future with a world of possibilities.
- ----------------------------------
Our 1997 acquisition of Security
Bank meant not only new name, but
also a new dimension for the bank.
- ----------------------------------
Changing the name of the subsidiary and combining the resources of the two banks
required a one-time investment of more than $3 million. That investment is
already showing results. Initial announcements of the name change helped bring
in thousands of new accounts, and the bank saw a 22.5% increase this year in the
number of commercial and consumer loans.
A large portion of the capital spent on the merger of the two banks was for
computer hardware and software, which not only allowed the two banks to be part
of a unified data processing system, but also brought many other advantages to
the new bank. For example, we're happy to report that in bringing the two banks
together and upgrading our computers, we took major steps in becoming compliant
with Year 2000 requirements. While this problem continues to plague many
companies, Western Security believes it has made nearly all of the necessary
upgrades.
Updated technology also expanded the bank's horizons by improving customer
services. For example, our customers
WESTERFED FINANCIAL CORPORATION
4
<PAGE>
can now access their accounts at any of our 34 offices, located throughout 20
different Montana communities.
[CHART TITLED "DIVIDENDS DECLARED" SUMMARIZED BELOW]
March 31, 1996 .................... 0.085
June 30, 1996 (1) ................. 0.123
September 30, 1996 ................ 0.095
December 31, 1996 ................. 0.100
March 31, 1997 .................... 0.105
June 30, 1997 (2) ................. 0.151
September 30, 1997 ................ 0.115
December 31, 1997 ................. 0.120
March 31, 1998 .................... 0.125
June 30, 1998 (3) ................. 0.180
- ----------
(1) Declared June 26, 1996, payable August 20 to stockholders of record August
6. Includes a special dividend of $0.033 per share.
(2) Declared June 30, 1997, payable August 20 to stockholders of record August
6. Includes a special dividend of $0.041 per share.
(3) Declared June 23, 1998, payable August 24 to stockholders of record August
10. Includes a special dividend of $0.05 per share.
Technology also brought "batch deposit processing" to Western Security. This
system allows customers to make high item volume deposits in just seconds. Since
our commercial customers often make several deposits throughout a business day,
this improves the efficiency of the bank and makes us more competitive.
These technological improvements will help Western Security achieve the goal of
creating long-term shareholder value by providing quality services. However,
technology is not enough. The human factor will always be of primary importance
to our success. That's why we've been promoting a "sales and service culture"
throughout our offices. Every bank employee has been trained in cross-selling
and tailoring bank products to customers' individual needs. Keeping all our
customers informed of the many services we offer will continue to create longer,
more profitable relationships.
- --------------------------------------
We took major steps in becoming
compliant with Year 2000 requirements.
- --------------------------------------
A sales culture also emphasizes creating a customer-friendly atmosphere that
many customers appreciate. While some of our competitors continue to lose their
"home-town" touch, Western Security is determined to give customers the option
of face-to-face banking while remaining on the cutting edge of bank technology.
WESTERFED FINANCIAL CORPORATION
5
<PAGE>
Percent of Total Loan Portfolio
The following pie charts detail how the bank's total loan
portfolio continues to become more diversified.
1998 1997
---- ----
Consumer ................................ 23.5% 20.6%
Agriculture ............................. 5.2% 4.1%
Commercial .............................. 14.3% 12.2%
Construction ............................ 2.6% 3.1%
Residential Mortgage .................... 54.4% 60.0%
On the facilities front, the unification process allowed us to consolidate
operations and close two redundant offices. The building in Lewistown has been
sold, while the Bozeman building is currently on the market. We also opened a
new office in Billings in the rapidly growing commercial area on King Avenue
West. Customers have found this new full-service office to be extremely
convenient.
[PHOTO OMITTED]
Our new Billings office is in the rapidly growing
commercial area on King Avenue West.
The horizons we face as a result of these changes are bright, indeed. We've
remained a strong institution for more than 87 years by displaying heart,
character and vision. These traits have allowed us to adapt and prosper in the
always-changing financial world. We are now a $1 billion bank that originated
$366.7 million in loans last year.
As Montana's largest savings bank, we are proud of the accomplishments we made
last year. More importantly, we look forward to putting these accomplishments to
work in the future to stay competitive in the mortgage and consumer market,
increase our share of the commercial banking business and increase long-term
shareholder value.
WESTERFED FINANCIAL CORPORATION
6
<PAGE>
Our Financial Performance
--------------------------------------------------
Table of Contents
8 Selected Financial Data
9 Management's Discussion and Analysis
27 Independent Auditor's Report
28 Consolidated Financial Statements and Notes
59 Corporate Information
64 Branch Locations
WESTERFED FINANCIAL CORPORATION
7
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Selected Consolidated Financial and Other Data
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
At June 30, 1998 1997 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------
Selected Financial Condition Data:
<S> <C> <C> <C> <C> <C>
Total assets $1,022,136 $ 955,639 $ 563,931 $ 563,285 $ 515,675
Loans receivable, net and loans held for sale 657,293 630,277 368,193 313,121 274,840
Mortgage-backed securities, net 126,433 149,169 104,947 143,825 145,025
Investment securities, FHLB stock and other
interest-earning assets 155,351 98,885 64,108 82,375 74,168
Deposits 636,441 630,869 350,212 344,155 349,121
Borrowed funds and repurchase agreements 255,186 199,236 125,838 134,704 85,087
Stockholders' equity 109,700 104,259 78,607 75,146 74,168
Book value per common share 19.64 18.74 17.88 17.09 16.03
Tangible book value per common share 16.01 14.99 17.88 17.09 16.03
- ----------------------------------------------------------------------------------------------------------------
Year Ended June 30, 1998 1997 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------
Selected Operations Data:
Total interest income $ 74,524 $ 51,260 $ 42,544 $ 37,783 $ 31,933
Total interest expense 42,286 28,407 24,737 20,984 16,391
- ----------------------------------------------------------------------------------------------------------------
Net interest income 32,238 22,853 17,807 16,799 15,542
Provision for loan losses (840) (400) -- -- --
Non-interest income 8,381 4,685 3,312 2,670 2,999
Non-interest expense (27,759) (20,568) (14,004) (12,868) (11,426)
- ----------------------------------------------------------------------------------------------------------------
Income before income taxes
and cumulative effect of change in
accounting for income taxes 12,020 6,570 7,115 6,601 7,115
Income taxes (4,760) (2,063) (2,556) (2,473) (2,681)
- ----------------------------------------------------------------------------------------------------------------
Income before cumulative effect
of change in accounting for income taxes 7,260 4,507 4,559 4,128 4,434
Cumulative effect of change in accounting for
income taxes -- -- -- -- 795
- ----------------------------------------------------------------------------------------------------------------
Net income $ 7,260 $ 4,507 $ 4,559 $ 4,128 $ 5,229
================================================================================================================
Net income per share:
Income before cumulative effect of change in
accounting for income taxes - diluted $ 1.29 $ 0.96 $ 1.08 $ 1.01 1.04
Cumulative effect of change in accounting for
income taxes -- -- -- -- 0.19
- ----------------------------------------------------------------------------------------------------------------
Net income per share - diluted $ 1.29 $ 0.96 $ 1.08 $ 1.01 1.23
================================================================================================================
Dividends per share $ 0.54 $ 0.45 $ 0.36 $ 0.30 0.05
================================================================================================================
Dividend payout ratio(1) 41.86% 46.88% 33.33% 29.70% 4.07%
================================================================================================================
Selected Financial Ratios and Other Data:
Return on assets (ratio of net income to average
total assets) 0.72% 0.65% 0.79% 0.76% 1.14%
Return on equity (ratio of net income to
average equity) 6.73 5.15 5.90 5.54 10.07
Interest rate spread, at end of period 2.99 3.38 2.67 2.38 2.80
Net interest margin(2) 3.46 3.53 3.23 3.23 3.54
Ratio of non-interest expense to average
total assets 2.67 2.98 2.43 2.47 2.60
Non-performing assets to total assets, at
end of period 0.49 0.25 0.13 0.10 0.16
Total allowance for loan losses to total
non-performing assets 97.44 191.01 280.42 350.35 238.82
Stockholders' equity to total assets,
at end of period 10.73 10.91 13.94 13.34 14.38
Ratio of average interest-earning assets to
average interest-bearing liabilities 105.74 110.56 113.58 113.51 110.16
Number of offices 34 36 19 18 18
=================================================================================================================
</TABLE>
- ------------------
(1) Dividends paid per share divided by net income per share.
(2) Net interest income divided by average interest-earning assets.
8
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations
- --------------------------------------------------------------------------------
GENERAL
WesterFed Financial Corporation ("WesterFed" or the "Company") was formed as
part of the conversion of Western Security Bank ("Western Security" or the
"Bank"), then known as Western Federal Savings Bank of Montana, from a federal
mutual to a stock savings bank, which was completed on January 6, 1994 (the
"Conversion"). Currently the Company has no business activity other than acting
as the holding company for Western Security. As a result, the following
discussion relates primarily to the activities of the Bank.
The Company's results of operations are dependent primarily on net interest
income and fee income. Net interest income is the difference between the
interest income earned on its loans, mortgage-backed securities, and investment
portfolio and its cost of funds, consisting of interest paid on its deposits and
borrowed money ("spread"). The Company's results of operations are also
significantly affected by general economic and competitive conditions,
particularly changes in market interest rates, government policies and actions
of regulatory authorities.
The Company serves the financial needs of communities throughout Montana through
its main office located in Missoula, 34 branch offices, one loan servicing
office and two loan processing offices. The Company attracts deposits from the
general public and uses the deposits, together with borrowings and other funds,
to originate loans secured by mortgages on owner-occupied one- to four-family
residences, multi-family, commercial, agriculture and construction real estate
loans and non real estate commercial, agriculture and consumer loans in its
primary market areas. The Company also invests in mortgage-backed securities,
investment securities and other short-term liquid assets.
On February 28, 1997, the Company completed its acquisition of Security Bancorp
(the "Acquisition"), accounted for as a purchase transaction and accordingly,
the consolidated statements of income include the results of operations of
Security Bancorp commencing March 1, 1997. Under the purchase method of
accounting, assets and liabilities of Security Bancorp are adjusted to their
estimated fair value and combined with the historical recorded book value of the
assets and liabilities of the Company. The Company issued 1,150,175 shares of
WesterFed Common Stock and paid $25,995,480 in cash for all of the outstanding
shares of Security Bancorp Common Stock, for total consideration (based on the
$18.49 per share average closing price of WesterFed Common Stock as reported on
the NASDAQ National Market System for the twenty business days from January 16,
1997 through February 12, 1997) of $48.7 million. At the time of the merger,
Security Bancorp had assets on a consolidated basis of $372.6 million, deposits
of $286.5 million and stockholders equity of $30.8 million. In addition, as of
such date, Security Bank, a federally chartered stock savings bank and wholly
owned subsidiary of Security Bancorp, merged with and into the Bank. After
having received regulatory approval, the name of Western Federal Savings Bank
was changed to Western Security Bank in February, 1998.
Changes in Financial Condition, June 30, 1997 to June 30, 1998
Total assets increased $66.4 million to $1.0 billion at June 30, 1998 from
$955.6 million at June 30, 1997. Loans receivable and loans available- for- sale
increased $27.0 million, investment securities, Federal Home Loan Bank (FHLB)
stock and all other interest earning assets increased $56.5 million and other
assets increased $5.7 million while mortgage-backed securities decreased $22.8
million.
Loans receivable increased $27.0 million to $657.3 million at June 30, 1998 from
$630.3 million at June 30, 1997. The $27.0 million increase was primarily the
result of $366.7 million in new loan originations and $1.0 million in purchases
of loans, which were partially offset by principal repayments of $244.5 million
and the sale of whole loans of $96.5 million. Included in the $366.7 million in
new loan originations were $91.2 million in consumer loans, $63.7 million in
commercial and agriculture non-real estate loan originations and $28.6 million
in non-residential real estate secured loans. The consumer loan portfolio
increased $24.4 million, or 18.3%, to $157.5 million at June 30, 1998 from
$133.1 million at June 30, 1997, which includes $45.2 million in loans
originated through the Bank's indirect auto and recreational dealer lending
program. The $366.7 million in new loan originations represents an
9
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
- --------------------------------------------------------------------------------
increase of $139.9 million from fiscal 1997. Included in loans receivable at
June 30, 1998 were $11.1 million of agriculture real estate loans and non-real
estate commercial and agriculture loans of $34.4 million and $24.0 million
respectively as compared to $8.0 million, $28.9 million and $18.9 million
respectively at June 30, 1997.
Mortgage-backed securities decreased $22.8 million to $126.4 million at June 30,
1998 from $149.2 million at June 30, 1997. The $22.8 million decrease was
primarily the result of principal repayments of $26.6 million and the sale of
mortgage-backed securities available-for-sale of $3.2 million, partially offset
by the purchase of 7.0 million of mortgage-backed securities. The decrease
reflects management's goal to increase loan related assets through the retail
markets as compared to the non-retail markets in an attempt to obtain higher
yields on assets.
Investment securities, FHLB stock and other interest earning assets increased
$56.5 million to $155.4 million at June 30, 1998 from $98.9 million at June 30,
1997. The $56.5 million increase was primarily the result of the purchase of
$148.8 million of investment securities, increases in interest-bearing deposits
and due from banks of $7.6 million and increases of $2.7 million in FHLB stock
and the cash surrender value of life insurance policies. These increases were
partially offset by maturities and principal payments of $87.3 million and the
sale of $16.1 million of investment securities.
Deposits increased $5.6 million to $636.4 million at June 30, 1998 from $630.9
million at June 30, 1997. Checking accounts increased $2.6 million, money market
accounts increased $6.4 million, certificates of deposit increased $4.9 million
while savings accounts decreased $8.3 million. Interest credited to deposit
accounts for fiscal 1998 was $26.9 million.
Borrowed funds and repurchase agreements increased $56.0 million to $255.2
million, at June 30, 1998 from $199.2 million at June 30, 1997. There were
$344.2 million of additional new borrowings, of which $4.7 million were advances
of five years or more to partially fund new longer term fixed rate loans added
to the portfolio, $221.2 million were less than one year in maturity and were
used to fund short-term cash requirements and $118.3 million were advances with
maturities of one to four years. Net change in repurchase agreements and
principal repayments on borrowed funds were $288.3 million.
Stockholders' equity increased $5.4 million, or 5.2%, to $109.7 million at June
30, 1998 from $104.3 million at June 30, 1997. This increase was primarily due
to $7.3 million of net income offset by $2.9 million for dividends declared
during the fiscal year and $379,000 for the purchase of 17,500 shares of
treasury stock. Stockholders' equity also increased $58,000 related to the
change in unrealized gain associated with investment securities classified as
available-for-sale being adjusted to market value in accordance with Statement
of Financial Accounting Standards No. 115, and $1.4 million was related to
contributions to the Employee Stock Ownership Plan, shares earned under the
Recognition and Retention Plan and 37,978 shares issued under the Stock Option
Plan.
10
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
- --------------------------------------------------------------------------------
Results of Operations
Net Interest Income Analysis. The following table presents for the periods
indicated the total dollar amount of interest income from average
interest-earning assets and the resultant yields, as well as the interest
expense on average interest-bearing liabilities, expressed both in dollars and
rates. No tax equivalent adjustments were made. Non-accruing loans have been
included in the table as loans carrying a zero yield.
<TABLE>
<CAPTION>
Year Ended June 30, 1998
-------------------------------------------------------------------
Average Interest
Outstanding Earned/ Yield/
Balance(1) Paid Rate
- --------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Interest-Earnings Assets:
<S> <C> <C> <C> <C>
Loans receivable(2)(3) $ 662,536 $ 56,261 8.49%
Mortgage-backed securities 140,994 9,675 6.86
Investments 113,412 7,581 6.68
Other interest-earning assets(4) 8,702 675 7.76
Cash surrender value of life insurance 6,540 332 5.08
- --------------------------------------------------------------------------------------------------------------------
Total interest-earning assets $ 932,184 $ 74,524 7.99%
====================================================================================================================
Interest-Bearing Liabilities:
Certificates of deposit $ 380,726 $ 21,824 5.73%
Savings deposits 96,966 2,658 2.74
Demand and NOW deposits 106,392 1,209 1.14
Money market accounts 52,496 2,112 4.02
- --------------------------------------------------------------------------------------------------------------------
Total deposits 636,580 27,803 4.37
FHLB advances and other borrowed money 244,339 14,364 5.88
Collateralized mortgage obligations 625 119 19.04
- --------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities $ 881,544 $ 42,286 4.80%
====================================================================================================================
Net interest income $ 32,238
====================================================================================================================
Net interest rate spread 3.19%
====================================================================================================================
Net interest-earning assets $ 50,640
====================================================================================================================
Net interest margin(5) 3.46%
====================================================================================================================
Average interest-earning assets to average
interest-bearing liabilities 105.74%
====================================================================================================================
</TABLE>
- -----------------
(1) Based on average monthly balances.
(2) Calculated net of deferred loan fees, loan discounts, loans in process and
loss reserves.
(3) Includes loans held for sale.
(4) Includes primarily short-term liquid assets.
(5) Net interest income divided by average interest-earning assets.
11
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended June 30, 1997 Year Ended June 30, 1996
----------------------------------------------------------------------------
Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
Balance(1) Paid Rate Balance(1) Paid Rate
- --------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Interest-Earnings Assets:
<S> <C> <C> <C> <C> <C> <C> <C>
Loans receivable(2)(3) $ 451,771 $ 37,923 8.39% $ 347,084 $ 28,640 8.25%
Mortgage-backed securities 116,836 8,185 7.01 132,629 9,167 6.91
Investments 61,241 3,884 6.34 59,004 3,769 6.39
Other interest-earning assets(4) 13,732 1,045 7.61 9,533 787 8.26
Cash surrender value of life insurance 4,187 223 5.33 3,059 181 5.92
- --------------------------------------------------------------------------------------------------------------------
Total interest-earning assets $ 647,767 $ 51,260 7.91% $ 551,309 $ 42,544 7.72%
====================================================================================================================
Interest-Bearing Liabilities:
Certificates of deposit $ 264,588 $ 14,986 5.66% $212,458 $ 12,405 5.84%
Savings deposits 76,829 2,223 2.89 64,881 1,940 2.99
Demand and NOW deposits 66,203 883 1.33 47,664 889 1.87
Money market accounts 31,873 1,146 3.60 24,786 851 3.43
- --------------------------------------------------------------------------------------------------------------------
Total deposits 439,493 19,238 4.38 349,789 16,085 4.60
FHLB advances and other borrowed money 145,446 9,011 6.20 134,211 8,442 6.29
Collateralized mortgage obligations 967 158 16.33 1,380 210 15.22
- --------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities $ 585,906 $ 28,407 4.85% $ 485,380 $ 24,737 5.10%
====================================================================================================================
Net interest income $ 22,853 $ 17,807
====================================================================================================================
Net interest rate spread 3.06% 2.62%
====================================================================================================================
Net interest-earning assets $ 61,861 $ 65,929
====================================================================================================================
Net interest margin(5) 3.53% 3.23%
====================================================================================================================
Average interest-earning assets to
average interest-bearning liabilities 110.57% 113.58%
====================================================================================================================
</TABLE>
- ----------------
(1) Based on average monthly balances.
(2) Calculated net of deferred loan fees, loan discounts, loans in process and
loss reserves.
(3) Includes loans held for sale.
(4) Includes primarily short-term liquid assets.
(5) Net interest income divided by average interest-earning assets.
12
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
- --------------------------------------------------------------------------------
Rate/Volume Analysis
The following table presents the dollar amount of changes in interest income and
interest expense for components of interest-earning assets and interest-bearing
liabilities. It distinguishes between the increase related to higher outstanding
balances and that due to the volatility of interest rates. For each category of
interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to (i) changes in volume (i.e., changes in
volume multiplied by old rate), (ii) changes in rate (i.e., changes in rate
multiplied by old volume), (iii) changes in rate-volume (changes in rate
multiplied by the change in volume), and (iv) the net change.
<TABLE>
<CAPTION>
1998 vs 1997 1997 vs 1996
--------------------------------------- ----------------------------------------
Increase/(Decrease) Due To: Increase/(Decrease) Due To:
Total Total
Rate/ Increase Rate/ Increase
Volume Rate Volume (Decrease) Volume Rate Volume (Decrease)
- ----------------------------------------------------------------------------- ----------------------------------------
(Dollars In Thousands)
Interest-Earning Assets:
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans receivable $17,692 $ 443 $ 203 $ 18,338 $8,639 $ 493 $ 151 $ 9,283
Mortgage-backed securities 1,693 (168) (35) 1,490 (1,092) 124 (14) (982)
Investments 3,596 52 49 3,697 (423) 607 (69) 115
Other interest-earning assets (63) (327) 20 (370) 1,078 (346) (474) 258
Cash surrender value of life
insurance 125 (10) (6) 109 67 (18) (7) 42
- ----------------------------------------------------------------------------- ----------------------------------------
Total interest-earning assets $23,043 $ (10) $ 231 $ 23,264 $8,269 $ 860 $ (413) $ 8,716
============================================================================= ========================================
Interest-Bearing Liabilities:
Certificates of deposit $ 6,578 $ 180 $ 80 $ 6,838 $2,530 $ 37 $ 14 $ 2,581
Savings deposits 583 (117) (31) 435 636 (269) (84) 283
Demand and NOW deposits 536 (131) (79) 326 346 (253) (99) (6)
Money market accounts 742 136 88 966 243 40 12 295
- ----------------------------------------------------------------------------- ----------------------------------------
Total Deposits $ 8,439 $ 68 $ 58 $ 8,565 $3,755 $ (445) $ (157) $ 3,153
FHLB advances and other borrowed
money 6,126 (460) (313) 5,353 707 (128) (10) 569
Collateralized mortgage obligations (56) 26 (9) (39) (63) 15 (4) (52)
- ----------------------------------------------------------------------------- ----------------------------------------
Total interest-bearing
liabilities $14,509 $ (366) $ (264) $ 13,879 $4,399 $ (558) $ (171) $ 3,670
============================================================================= ========================================
Changes to net interest income $ 8,534 $ 356 $ 495 $ 9,385 $3,870 $ 1,418 $ (242) $ 5,046
============================================================================= ========================================
</TABLE>
13
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
- --------------------------------------------------------------------------------
The following table sets forth the weighted average yields on the Company's
interest-earning assets, the weighted average interest rates on interest-bearing
liabilities and the interest rate spread between the weighted average yields and
rates for the Company at the dates indicated. Non-accruing loans have been
included in the table as loans carrying a zero yield.
<TABLE>
<CAPTION>
At June 30,
-----------------------------------------
1998 1997 1996
- ---------------------------------------------------------------------------------------------
Weighted average yield on:
<S> <C> <C> <C>
Loans receivable(1)(2) 8.34% 8.49% 8.12%
Mortgage-backed securities 6.73 7.27 7.06
Investments 6.32 6.73 6.25
Other interest-earning assets 6.15 5.58 5.31
Cash surrender value of life insurance 5.22 5.11 6.50
- ---------------------------------------------------------------------------------------------
Combined weighted average yield on interest-
earning assets 7.78 8.08 7.68
- ---------------------------------------------------------------------------------------------
Weighted average rate paid on:
Certificates of deposit 5.77 5.52 5.82
Savings deposits 2.77 2.80 3.00
Demand and NOW deposits 0.96 1.15 1.66
Money market accounts 4.10 3.94 3.46
- ---------------------------------------------------------------------------------------------
Total deposits 4.38 4.24 4.54
FHLB advances and other borrowed money 5.81 6.11 6.26
Collateralized mortgage obligations 11.48 11.37 11.27
- ---------------------------------------------------------------------------------------------
Combined weighted average rate paid on interest-
bearing liabilities 4.79 4.70 5.01
- ---------------------------------------------------------------------------------------------
Interest rate spread 2.99% 3.38% 2.67%
=============================================================================================
</TABLE>
- ----------------
(1) Calculated net of deferred loan fees, loan discounts and loans in process.
(2) Does not include interest on loans 90 days or more delinquent.
14
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
- --------------------------------------------------------------------------------
The following table summarizes the major components of the Company's net income
for the last three fiscal years and the changes which occurred between the
periods shown:
<TABLE>
<CAPTION>
Year Ended June 30,
Components of net income: 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------
(In Thousands)
Amount Change Amount Change Amount
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Interest income $ 74,524 $ 23,264 $ 51,260 $ 8,716 $ 42,544
Interest expense 42,286 13,879 28,407 3,670 24,737
- ----------------------------------------------------------------------------------------------------------
Net interest income 32,238 9,385 22,853 5,046 17,807
Provision for loan losses (840) (440) (400) (400) --
Non-interest income 8,381 3,696 4,685 1,373 3,312
Non-interest expense (27,759) (7,191) (20,568) (6,564) (14,004)
- ----------------------------------------------------------------------------------------------------------
Income before income taxes 12,020 5,450 6,570 (545) 7,115
Income taxes (4,760) (2,697) (2,063) (493) (2,556)
- ----------------------------------------------------------------------------------------------------------
Net income increase (decrease) $ 7,260 $ 2,753 $ 4,507 $ (52) $ 4,559
==========================================================================================================
</TABLE>
Comparison of Operating Results for the Years Ended June 30, 1998
and June 30, 1997
General. Net income increased $2.8 million to $7.3 million for the fiscal year
ended June 30, 1998 as compared to $4.5 million for the fiscal year ended June
30, 1997. Included in net income for the fiscal year ended June 30, 1997 was a
one-time after-tax charge to earnings of $1.4 million, levied on all thrift
institutions, to recapitalize the Savings Association Insurance Fund ("SAIF").
The $2.8 million increase in net income was comprised of an increase in net
interest income of $9.4 million and a $3.7 million increase in non-interest
income, offset by an increase in non-interest expense of $7.2 million, an
increase in provision for loan losses of $440,000 and an increase in income tax
expense of $2.7 million. Only four months of combined operations resulting from
the Acquisition are included in net income for the fiscal year ended June 30,
1997. The interest rate spread decreased to 2.99% at June 30, 1998 from 3.38% at
June 30, 1997. While the Company has adopted interest rate risk policies in an
effort to protect net interest income from significant increases in short term
interest rates, the Company's net income could still be adversely affected by a
narrowing of its net interest rate spread. See "Interest Rate Risk Management."
Interest Income. Interest income increased $23.2 million to $74.5 million for
the fiscal year ended June 30, 1998 from $51.3 million for the fiscal year ended
June 30, 1997. This increase resulted from an increase in the average balance of
interest earning assets of $284.4 million to $932.2 million during fiscal 1998
from $647.8 million during fiscal 1997 and an increase in the average yield on
interest-earning assets to 7.99% during fiscal 1998 from 7.91% during fiscal
1997.
Interest earned on loans receivable increased $18.3 million due primarily to a
$210.7 million increase in the average balance of loans receivable to $662.5
million during fiscal 1998 from $451.8 million during fiscal 1997. In addition,
the average yield on loans increased to 8.49% during fiscal 1998 from 8.39%
during fiscal 1997. The increase in the average balance of loans receivable and
the increase in yield was primarily the result of having the higher yielding
loans from the Acquisition for the full fiscal year 1998 as compared to only a
portion for fiscal 1997.
15
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
- --------------------------------------------------------------------------------
Interest earned on mortgage-backed securities increased $1.5 million due
primarily to a $24.2 million increase in the average balance of mortgage-backed
securities outstanding to $141.0 million during fiscal 1998 from $116.8 million
during fiscal 1997. The increase in the average balance of mortgage-backed
securities was the result of having the mortgage-backed securities purchased in
the Acquisition for the full fiscal year 1998 as compared to only a portion for
fiscal 1997.
Interest earned on investment securities increased $3.7 million due primarily to
a $52.2 million increase in the average balance of investment securities to
$113.4 million during the fiscal year 1998 from $61.2 million during fiscal
1997. The increase in the average balance of investment securitiess was
primarily the result of having the securities purchased in the Acquisition for
the full fiscal year 1998 as compared to a portion for fiscal 1997 and the
purchase of securities in excess of maturities and sales. Management purchases
the securities in the institutional markets in an attempt to increase earnings
using excess available capital.
Interest earned on other interest-earning assets and cash surrender value of
life insurance decreased $261,000 due primarily to a decrease in the average
balance of other interest-earning assets of $2.7 million to $15.2 million during
fiscal 1998 from $17.9 million during fiscal 1997.
Interest Expense. Interest expense increased $13.9 million to $42.3 million in
fiscal 1998 from $28.4 million in fiscal 1997. This increase resulted from an
increase in the average balance of interest-bearing liabilities of $295.6
million to $881.5 million during fiscal 1998 from $585.9 million during fiscal
1997. Interest expense on deposits increased $8.6 million primarily due to an
increase in the average balance of deposits of $197.1 million to $636.6 million
during fiscal 1998 from $439.5 million during fiscal 1997. The average rate paid
on deposits decreased slightly to 4.37% during fiscal 1998 from 4.38% during
fiscal 1997. The increase in the average balance of deposits was the result of
the purchase of $287.0 million of deposits related to the Acquisition in fiscal
1997. Interest expense on FHLB advances and other borrowed money increased $5.3
million to $14.5 million in fiscal 1998 from $9.2 million in fiscal 1997. This
increase was the result of an increase of $104.6 million in the average balance
of FHLB advances and other borrowed money to $244.3 million during fiscal 1998
from $145.4 million during fiscal 1997. The increase in FHLB advances was
primarily to fund the growth in investment securities.
Provision for Loan Losses. The provision for loan losses is determined by
management as the amount to be added to the allowance for loan losses after net
charge-offs have been deducted to bring the allowance to a level which is
considered adequate to absorb losses inherent in the loan portfolio in
accordance with generally accepted accounting principles. The Company provided
$840,000 for loan losses for the fiscal year ended June 30, 1998. At June 30,
1998, the Company had $5.0 million of non-performing assets (representing 0.49%
of total assets) compared to $2.4 million at June 30, 1997 (representing 0.25%
of total assets). At June 30, 1998, the Company had allowance for loan losses to
non-performing assets of 97.44% as compared to 191.01% at June 30, 1997.
Management's evaluation of the adequacy of its loan loss reserves, the quality
of the loan portfolio and economic conditions in Montana resulted in the
$840,000 provision for loan losses. Future additions to the Company's allowance
for loan losses and any change in the related ratio of the allowance for loan
losses to non-performing loans are dependent upon the performance and
composition of the Company's loan portfolio, the economy, inflation, changes in
real estate values and interest rates and the view of the regulatory authorities
toward adequate reserve levels.
Non-interest Income. Non-interest income increased $3.7 million to $8.4 million
in fiscal 1998 from $4.7 million during 1997. The $3.7 million increase resulted
from increases in loan origination fees, service fees, net gain on sale of loans
and securities available-for-sale and other operating income of $1.6 million,
$1.5 million, $375,000 and $268,000 respectively. The $1.6 million increase in
loan origination fees was primarily the result of increased loan production and
the subsequent sale of loans to the secondary markets. The lower interest rate
environment in fiscal 1998 as compared to the prior year resulted in substantial
increases in loan refinancing volume and the loan origination volume also was
greater than the prior year due to a full year of loan production as result of
the Acquisition. The $1.5 million increase in service fees was primarily the
result of increases in checking fees and ATM fees from the
16
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
- --------------------------------------------------------------------------------
promotion of checking accounts and the increased fee income received on
transaction accounts purchased in the Acquisition and were earned for the full
fiscal 1998 as compared to a portion of fiscal 1997.
Non-interest Expense. Non-interest expense increased $7.2 million to $27.8
million in fiscal 1998 from $20.6 million in fiscal 1997. The $7.2 million
increase was primarily the result of the Acquisition and the resulting expenses
for the full fiscal year 1998 as compared to a portion of fiscal 1997. In
addition, expenses in excess of $700,000 were incurred in the conversion of data
centers and approximately $3.0 million of new equipment was purchased related to
the data center conversion, resulting in increased depreciation costs. Fiscal
1997 included a one-time $2.3 million special assessment to recapitalize the
SAIF.
Income Taxes. Income tax expenses increased $2.7 million to $4.8 million for
fiscal 1998 from $2.1 million for fiscal 1997. The $2.7 million increase in
income tax expense was primarily the result of an increase in income before
income tax expense of $5.4 million and the non-tax deductibility of $633,000 of
goodwill amortization for fiscal 1998.
Comparison of Operating Results for the Years Ended June 30, 1997
and June 30, 1996
General. Net income remained relatively stable at $4.5 million for the fiscal
year ended June 30, 1997 as compared to $4.6 million for the fiscal year ended
June 30, 1996. The decrease was the result of a one-time after-tax charge to
earnings of $1.4 million, levied on all thrift institutions, to recapitalize the
Savings Association Insurance Fund ("SAIF"). The $52,000 decrease in net income
was comprised of an increase in net interest income of $5.0 million, a $1.4
million increase in non-interest income and a decrease in income tax expense of
$493,000, offset by an increase in non-interest expense of $6.6 million and an
increase in provision for loan losses of $400,000. Only four months of combined
operations resulting from the Acquisition are included in net income for the
fiscal year ended June 30, 1997. The interest rate spread increased to 3.38% at
June 30, 1997 from 2.67% at June 30, 1996.
Interest Income. Interest income increased $8.8 million to $51.3 million for the
fiscal year ended June 30, 1997 from $42.5 million for the fiscal year ended
June 30, 1996. This increase resulted from an increase in the average balance of
interest earning assets of $96.5 million to $647.8 million during fiscal 1997
from $551.3 million during fiscal 1996 and an increase in the average yield on
interest-earning assets to 7.91% during fiscal 1997 from 7.72% during fiscal
1996.
Interest earned on loans receivable increased $9.3 million due primarily to a
$104.7 million increase in the average balance of loans receivable to $451.8
million during fiscal 1997 from $347.1 million during fiscal 1996. In addition,
the average yield on loans increased to 8.39% during fiscal 1997 from 8.25%
during fiscal 1996. The increase in the average balance of loans receivable was
the result of continued loan production in excess of principal repayments and
the sale and securitization of loans as well as the purchase of $218.3 million
of loans as a result of the Acquisition. The increase in yield was the result of
new loans being originated at rates higher than the average rate of those loans
being repaid as a result of an increase in originations of non-real estate loans
that have higher interest rates than real estate loans.
Interest earned on mortgage-backed securities decreased $1.0 million due
primarily to a $15.8 million decrease in the average balance of mortgage-backed
securities outstanding to $116.8 million during fiscal 1997 from $132.6 million
during fiscal 1996. The decrease in the average balance of mortgage-backed
securities was the result of management's decision during the fiscal year to use
a portion of the mortgage-backed securities portfolio to partially fund the
growth in loans receivable in an attempt to earn yields greater than those
available on mortgage-backed securities.
Interest earned on investment securities increased $115,000 due primarily to a
$2.2 million increase in the average balance of investment securities to $61.2
million during the fiscal year 1997 from $59.0 million during fiscal 1996.
17
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
- --------------------------------------------------------------------------------
Interest earned on other interest-earning assets and cash surrender value of
life insurance increased $300,000 due primarily to an increase in the average
balance of other interest-earning assets of $4.2 million to $13.7 million during
fiscal 1997 from $9.5 million during fiscal 1996.
Interest Expense. Interest expense increased $3.7 million to $28.4 million in
fiscal 1997 from $24.7 million in fiscal 1996. This increase resulted from an
increase in the average balance of interest-bearing liabilities of $100.5
million to $585.9 million during fiscal 1997 from $485.4 million during fiscal
1996. Interest expense on deposits increased $3.2 million primarily due to an
increase in the average balance of deposits of $89.7 million to $439.5 million
during fiscal 1997 from $349.8 million during fiscal 1996. The average rate paid
on deposits decreased to 4.38% during fiscal 1997 from 4.60% during fiscal 1996.
The increase in the average balance of deposits was the result of the purchase
of $287.0 million of deposits related to the Acquisition. Interest expense on
FHLB advances and other borrowed money increased $517,000 to $9.2 million in
fiscal 1997 from $8.7 million in fiscal 1996. This increase was the result of an
increase of $11.2 million in the average balance of FHLB advances and other
borrowed money to $145.4 million during fiscal 1997 from $134.2 million during
fiscal 1996.
Provision for Loan Losses. The provision for loan losses is determined by
management as the amount to be added to the allowance for loan losses after net
charge-offs have been deducted to bring the allowance to a level which is
considered adequate to absorb losses inherent in the loan portfolio in
accordance with generally accepted accounting principles. The Company provided
$400,000 for loan losses for the fiscal year ended June 30, 1997. At June 30,
1997, the Company had $2.4 million of non-performing assets (representing 0.25%
of total assets) compared to $715,000 at June 30, 1996 (representing 0.13% of
total assets). At June 30, 1997, the Company had allowance for loan losses to
non-performing assets of 191.0% as compared to 280.4% at June 30, 1996.
Management's evaluation of the adequacy of its loan loss reserves, the quality
of the loan portfolio and economic conditions in Montana resulted in the
$400,000 provision for loan losses.
Non-interest Income. Non-interest income increased $1.4 million to $4.7 million
in fiscal 1997 from $3.3 million during 1996. The $1.4 million increase resulted
from increases in loan origination fees, service fees, net gain on sale of loans
and securities available-for-sale and other operating income of $319,000,
$914,000, $101,000 and $39,000 respectively. The $914,000 increase in service
fees was the result of increases in checking fees and ATM fees from the
promotion of checking accounts and the increased fee income received on
transaction accounts purchased in the Acquisition.
Non-interest Expense. Non-interest expense increased $6.6 million to $20.6
million in fiscal 1997 from $14.0 million in fiscal 1996. The $6.6 million
increase in expenses was partially the result of a $2.3 million one-time special
assessment to recapitalize the SAIF and the increased costs associated with the
Acquisition, including $532,000 for the amortization of Acquisition related
intangibles. The Bank incurred significant expenses during the fiscal year 1997
related to extensive training of all Bank employees in sales skills in an effort
to improve the Bank's ability to meet the increasing competition in the
financial services market.
Income Taxes. Income tax expenses decreased $493,000 to $2.1 million for fiscal
1997 from $2.6 million for fiscal 1996. The $493,000 decrease in income tax
expense was primarily the result of a decrease in income before income tax
expense of $545,000, the non-tax deductibility of $200,000 of goodwill
amortization for fiscal 1997 and the reversal of deferred income taxes related
to the cash surrender value of insurance policies which resulted in an
additional reduction in income tax expense of $489,000.
18
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
- --------------------------------------------------------------------------------
LOAN QUALITY
The following table sets forth the amounts and categories of non-performing
assets in the Company's loan portfolio. For all periods presented, the Company
did not have any troubled debt restructuring which involved forgiving a portion
of interest or principal on any loans or making loans at a rate materially less
than market rates. Foreclosed assets include assets acquired in settlement of
loans, and are recorded at the lower of the related loan balance, less any
specific allowance for loss, or fair value at the date of foreclosure.
<TABLE>
<CAPTION>
June 30,
---------------------------------------------------------------
1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Non-accruing loans:
Real Estate:
One- to four-family $ 1,967 $ 842 $ 21 $ -- $ 119
Multi-family 89 -- -- -- --
Commercial 35 -- -- 166 207
Construction 362 -- -- -- --
Commercial - non-real estate 32 102 -- -- --
Consumer 1,504 573 383 153 9
- --------------------------------------------------------------------------------------------------------------------
Total 3,989 1,517 404 319 335
- --------------------------------------------------------------------------------------------------------------------
Accruing loans delinquent 90 days or more:
Real Estate:
One- to four-family 442 231 288 253 425
Multi-family -- -- -- -- --
Commercial -- -- -- -- --
Construction -- -- -- -- --
Commercial - non-real estate 10 -- -- -- --
Consumer 174 605 23 1 5
- --------------------------------------------------------------------------------------------------------------------
Total 626 836 311 254 430
- --------------------------------------------------------------------------------------------------------------------
Foreclosed assets:
Real Estate:
One- to four-family 279 -- -- -- 85
Multi-family -- -- -- -- --
Commercial -- -- -- -- --
Land 28 -- -- -- --
Consumer 114 82 -- -- --
- --------------------------------------------------------------------------------------------------------------------
Total 421 82 -- -- 85
- --------------------------------------------------------------------------------------------------------------------
Total non-performing assets $ 5,036 $ 2,435 $ 715 $ 573 $ 850
====================================================================================================================
</TABLE>
Total non-performing assets increased $2.6 million to $5.0 million at fiscal
year end June 30, 1998 from $2.4 million at fiscal year end June 30, 1997. The
$2.6 million increase was due primarily to an increase in non-performing
residential, construction, consumer, and foreclosed assets of $1.5 million,
$362,000, $500,000, and $339,000 respectively. Non-performing assets as a
percentage of total assets increased to 0.49% at June 30, 1998 from 0.25%
19
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
- --------------------------------------------------------------------------------
at June 30, 1997 and decreased from 0.64% at March 31, 1998. The national
composite for thrifts was updated to 0.94% at June 30, 1998, which is the latest
available information as reported by the Office of Thrift Supervision. In
addition to the non-performing loans and foreclosed assets set forth in the
preceding table, as of June 30, 1998, there were no additional loans identified
by the Company with respect to which information known about the possible credit
problems of the borrowers or the cash flows of the security properties have
caused management to have some concerns as to the ability of the borrowers to
comply with present loan repayment terms and which may result in the future
inclusion of such items in the non-performing asset categories.
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
As a financial institution, the Company's primary component of market risk is
interest rate volatility. Fluctuations in interest rates will ultimately impact
both the level of income and expense recorded on a large portion of the
Company's assets and liabilities, and the market value of all interest-earning
assets, other than those which possess a short term to maturity. All significant
interest rate risk management procedures are performed at the Company level.
Based upon the Company's nature of operations, the Company is not subject to
foreign currency exchange or commodity price risk. The Company's loan portfolio
is concentrated primarily within the State of Montana and is subject to risks
associated with the local economy. See Comparison of Operating Results for the
years ended June 30, 1998 and June 30, 1997 - Provision for Loan Losses. The
Company does not own any trading assets.
In an attempt to manage its exposure to changes in interest rates, management
closely monitors the Bank's interest rate risk position. The Bank has an
Asset/Liability Management Committee consisting of certain members of senior
management and two non-employee members of the Board of Directors (the "Board").
This committee meets to review the Bank's interest rate risk position and makes
recommendations for adjusting such position to the Board. In addition, the Board
reviews on a quarterly basis the Bank's interest rate risk position, including
simulations of the effect on the Bank's capital of various interest rate
scenarios.
The Bank has an Investment Committee consisting of certain members of the senior
management which meets at least monthly to review the Bank's interest rate risk
position using the Office of Thrift Supervision ("OTS") and the Bank's internal
model simulating the effect on the Bank's capital in various interest rate
scenarios. The Investment Committee makes recommendations for adjusting such
position to the Bank's Asset/Liability Management Committee. The Asset/Liability
Management Committee reviews the Bank's investments, mortgage-backed securities,
loan portfolio, loan production, borrowed funds and deposit structure. The
Committees develop investment strategies and oversee the timing and
implementation of transactions to assure attainment of Board objectives in the
most effective manner.
In managing its asset/liability mix, the Bank, depending on the relationship
between long- and short-term interest rates, market conditions and consumer
preference, may place somewhat greater emphasis on maximizing its net interest
margin than on more closely matching the interest rate sensitivity of its assets
and liabilities in an effort to improve its net interest income Management
believes that the increased net interest income resulting from a mismatch in the
maturity of its asset and liability portfolios can, during periods of declining
or stable interest rates, provide high enough returns to justify the increased
exposure to negative effects which can result from sudden and unexpected
increases in interest rates.
To the extent consistent with its interest rate spread objectives, the Bank
attempts to reduce its interest rate risk and has taken a number of steps to
more closely match the maturities of its assets and liabilities. To accomplish
this objective the Bank has focused its lending efforts on the origination of
non-residential loans for its portfolio and increased its marketing effort to
increase the Bank's balance of non-interest bearing demand accounts. The
non-residential loans being originated for portfolio generally mature or change
interest rates within five to seven years as compared to the origination of
fixed rate fifteen and thirty year residential mortgages. The Bank also sold in
fiscal
20
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
- --------------------------------------------------------------------------------
1998 $96.5 million of primarily 30 year-fixed rate 1-4 family residential
mortgage loans to the secondary market in an attempt to limit the exposure to
rising interest rates.
In addition, depending on the Bank's interest rate risk position, the Bank may
also sell or convert to Federal Home Loan Mortgage Corporation ("FHLMC")
participation certificates ("PC's") newly originated 30-year, fixed-rate
residential loans. The Bank securitizes such loans to limit credit risk and
increase its liquidity. The Bank's policy is to carry FHLMC PC's created in this
manner in its "available-for-sale" portfolio until a rising interest rate
scenario or the need for liquidity dictates their sale.
Additionally, since the mid-1980's, the Bank has used interest rate exchange
(i.e., "swap" and "cap") agreements to assist in synthetically extending the
life of interest-bearing liabilities. Under the Bank's current investment
policy, the Bank may engage in swap and cap agreements with the Federal Home
Loan Bank ("FHLB") of Seattle or certain investment firms approved in the Bank's
investment policy.
At June 30, 1998, the Bank was a party to three interest rate exchange
agreements, two of which were agreements with the FHLB of Seattle covering a
total of $10.0 million in notional principal amounts and one for $5.0 million
with an investment firm. Historically, the swaps and caps have been used to
reduce the Bank's cost of funds during periods of high interest rates; however,
in the interest rate environment experienced during most of fiscal 1998, these
swaps and caps had the effect of increasing the Bank's cost of funds. During
fiscal 1998, the increase in the cost of funds attributable to these swaps and
caps was $110,000. The Bank's interest rate caps expire in 1999 and 2000.
At June 30, 1998 the Bank did not have any interest rate swap agreements in
place.
The Board of Directors reviews the level of interest rate risk management
activity on a monthly basis. Currently, the Board of Directors has authorized
management to engage in interest rate swaps and caps with notional principal of
up to $108 million. An increase in this type of activity may result in a
decrease in the Bank's income in the future if interest rates do not rise
significantly. See Note 15 of the Notes to Consolidated Financial Statements.
OTS regulations provide a Net Portfolio Value ("NPV") approach to the
quantification of interest rate risk. NPV is defined as the net present value of
an institution's existing assets, liabilities, and off-balance sheet contracts.
An institution's NPV ratio for a given interest rate scenario is calculated by
dividing the net portfolio value that would result in that scenario by the
present value of the institution's assets in that same scenario and is expressed
in percentage terms. The NPV ratio is analogous to the capital-to-assets ratio
used to measure regulatory capital, but NPV is measured in economic values (or
present values) in a particular rate scenario. The Bank's Asset/Liability
Management Committee has established the minimum NPV ratio that they are willing
to allow under current interest rates and for a range of hypothetical interest
rate scenarios. These six scenarios are represented by immediate, permanent,
parallel movements in the term structure of interest rates of plus and minus
100, 200, and 300 basis points from the actual term structure at quarter end.
21
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
- --------------------------------------------------------------------------------
Presented below, as of June 30, 1998, is an OTS analysis of the Bank's interest
rate risk as measured by changes in NPV for instantaneous and sustained parallel
shifts in the yield curve, in 100 basis point increments, up and down 300 basis
points and compared to Board policy limits. Assumptions used in calculating the
amounts in this table are OTS assumptions.
Actual at June 30, 1998
as Measured by OTS
--------------------------------------
Board NPV as a % of PV of assets
Change in Marked Minimum ------------------------------------
Interest Rate Permissible Change
(Basis Points) NPV Rate NPV Ratio (Basis Points)
------------------- ----------------- ----------------- ----------------
+300 7.00 7.91% -282
+200 7.00 9.01% -172
+100 8.00 9.99% -74
-0- 8.50 10.73% -0-
-100 9.00 11.31% +58
-200 9.50 11.71% +98
-300 10.00 12.25% +152
The OTS has established guidelines for determining the level of interest rate
risk for an OTS regulated institution and has developed an interagency uniform
ratings system establishing several levels of interest rate risk: "minimal,
"moderate", "significant," "high'" and "imminent threat." Based on a 200 basis
point increase in interest rates the Bank's post-shock 9.0% NPV ratio,
representing a 172 basis point change from the 10.73% pre-shock NPV ratio,
indicates a risk rating of minimal for the Bank at June 30, 1998.
Management has structured its assets and liabilities to attempt to control its
exposure to interest rate risk. In the event of a 300 basis point decrease in
interest rates, the Bank would experience a 152 basis point increase in NPV in a
declining rate environment and a 282 basis point decrease in a rising rate
environment. During periods of rising rates, the value of monetary assets and
monetary liabilities declines. Conversely, during periods of falling rates, the
value of monetary assets and liabilities increases. However, the amount of
change in value of specific assets and liabilities due to changes in rates is
not the same in a rising rate environment as in a falling rate environment
(i.e., the amount of value increase under a specific rate decline may not equal
the amount of value decrease under an identical upward rate movement). The 282
basis point decrease in NPV as a result of a 300 basis point increase in
interest rates indicates that the Bank is susceptible to a reduction in net
interest income in a rising interest rate environment due to interest-bearing
liabilities potentially repricing more rapidly than interest-earning assets.
In evaluating the Bank's exposure to interest rate risk, certain shortcomings
inherent in the method of analysis presented in the foregoing table must be
considered. For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in different degrees
to changes in market interest rates. Also, the interest rates on certain types
of assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Further, in the event of a change in interest rates, prepayments and
early withdrawal levels would likely deviate significantly from those assumed in
calculating the table. Finally, the ability of many borrowers to service their
debt may decrease in the event of an interest rate increase. As a result, the
actual effect of changing interest rates may differ from that presented in the
foregoing table.
22
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
- --------------------------------------------------------------------------------
Liquidity and Capital Resources
The Company's primary sources of funds are new deposits and the payment of
principal and interest on loans, mortgage-backed securities and maturing
investments. While maturities and scheduled amortization of loans and
mortgage-backed securities are a predictable source of funds, deposit flows and
mortgage prepayments are greatly influenced by market interest rates, economic
conditions and competition. In a period of declining interest rates, it is
anticipated that mortgage prepayments would increase. As a result, these
proceeds from mortgage prepayments would be invested in lower yielding loans or
other investments which have the effect of reducing interest income. In a period
of rising interest rates, it is anticipated that mortgage prepayments would
decrease and the proceeds from such prepayments would be invested in higher
yielding loans or investments which would have the effect of increasing interest
income.
The Company's liquidity, represented by cash and cash equivalents, is a result
of its operations, investing and financing activities. These activities are
summarized below for the fiscal years ended June 30, 1998, 1997 and 1996.
<TABLE>
<CAPTION>
For the Year Ended June 30,
-----------------------------------------
1998 1997 1996
(In Thousands)
--------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net Income $ 7,260 $ 4,507 $ 4,559
Adjustments to reconcile net income to net
cash provided by operating activities 23,475 19,598 14,998
--------------------------------------------------------------------------------------------------
Net cash provided by operating activities 30,735 24,105 19,557
Net cash (used) by investing activities (51,101) (21,642) (2,018)
Net cash provided (used) by financing activities 32,275 1,397 (19,614)
--------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash
equivalents 11,909 3,860 (2,075)
Cash and cash equivalents at beginning of period 17,159 13,299 15,374
--------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 29,068 $ 17,159 $ 13,299
==================================================================================================
</TABLE>
The primary investing activities of the Company are the origination of loans and
the purchase of investment and mortgage-backed securities. During the fiscal
years ended June 30, 1998, 1997 and 1996, the Company's loan originations
totaled $366.7 million, $226.8 million and $165.5 million, respectively. Loan
originations increased in the last fiscal year due to an increase in loan
refinancing activity and an increase in commercial real estate loans and
consumer loans resulting from an interest rate environment that was generally
lower than the prior year and management's emphasis on increasing the commercial
and agricultural real estate loans and other commercial, agricultural and
consumer loans.
Purchases of mortgage-backed securities totaled $7.0 million, $98.4 million and
$22.3 million for fiscal years ended June 30, 1998, 1997 and 1996, respectively.
Purchases of investment securities totaled $148.8 million, $109.7 million and
$35.9 million for the fiscal years ended June 30, 1998, 1997 and 1996,
respectively. Mortgage-backed securities and investment securities purchased in
fiscal 1997 included $91.4 million and $20.0 million respectively, related to
the Acquisition.
During fiscal 1997 a net $10.8 million of cash ($26.8 million paid in cash
consideration and direct Acquisition costs less $16.0 million in cash and cash
equivalents purchased) was used to acquire Security Bancorp.
During the fiscal years ended June 30, 1998, 1997 and 1996, investing activities
were funded primarily by principal repayments on loans and mortgage-backed
securities and investment securities and the maturity of investment securities
and the sale of loans, mortgage-backed securities and investments totaling
$474.2 million, $313.5 million, and $232.3 million for the respective fiscal
years.
23
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
- --------------------------------------------------------------------------------
The major sources of cash flows from financing activities are deposits into
savings accounts and additional borrowings. The major uses of cash flows from
financing activities are withdrawals from savings accounts and payments on
borrowings. For the fiscal year ended June 30, 1998 and 1997 the net increase in
cash flows from financing activities was $32.3 million and $1.4 million
respectively, and a net decrease of $19.6 million for the fiscal year ended June
30, 1996.
The Bank is required to maintain minimum levels of liquid assets as defined by
OTS regulations. This requirement, which may be waived at the direction of the
OTS depending upon economic conditions and deposit flows, is based upon a
percentage of deposits and short-term borrowings. The required ratio is 5%. The
Bank's regulatory liquidity ratio was 18.8% at June 30, 1998.
The Bank's most liquid assets are cash and cash in banks and highly liquid,
short-term investments. The levels of these assets are dependent on the Bank's
operating, financing, lending, and investing activities during any given period.
At June 30, 1998, the Bank's regulatory liquid assets totaled $139.1 million.
Liquidity management for the Bank is both a daily and long-term function of the
Company's management strategy. Excess funds are generally invested in short-term
investments such as FHLB certificates of deposit. If the Bank should require
funds beyond its ability to generate them internally, additional sources of
funds are available through the use of FHLB of Seattle advances. At June 30,
1998, the Bank had outstanding borrowings of $255.2 million, which included
$248.1 million of FHLB advances, $511,000 of collateralized mortgage obligations
and $6.6 million of repurchase agreements and other borrowed money.
At June 30, 1998, the Bank had outstanding commitments to originate loans of
$18.9 million, of which $8.9 million was at fixed interest rates. These loans
are to be secured by properties located in the Bank's primary market areas. The
Bank anticipates that it will have sufficient funds available to meet its
current loan commitments. Certificates of deposit scheduled to mature in less
than one year from June 30, 1998 totaled $282.1 million.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and Notes thereto presented herein have
been prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without considering the changes in the relative purchasing
power of money over time due to inflation. The impact of inflation is reflected
in the increased cost of the Company's operations. Unlike most industrial
companies, nearly all the assets and liabilities of the Company are monetary in
nature. As a result, interest rates have a greater impact on the Company's
performance than do the effects of general levels of inflation. Interest rates
do not necessarily move in the same direction or to the same extent as the price
of goods and services.
Dividends
The Board of Directors intends to continue the payment of quarterly cash
dividends, dependent on the results of operations and financial condition of the
Bank, tax considerations, industry standards, economic conditions, general
business practices and other factors. The Company's ability to pay dividends is
dependent on the dividend payments it receives from its subsidiary, Western
Security, which are subject to regulations and the Bank's continued compliance
with all regulatory capital requirements. See Notes 2 and 3 of the Notes to
Consolidated Financial Statements for information regarding limitations of the
Bank's ability to pay dividends to the Company.
24
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
- --------------------------------------------------------------------------------
Year 2000 Compliance
As the year 2000 approaches, significant concerns have been expressed with
respect to the ability of existing computer software programs and operating
systems to function properly with respect to data containing dates in the year
2000 and thereafter. Many existing application software products were designed
to accommodate only a two digit year (e.g., 1998 is reflected as "98"). The
Company's operating, processing and accounting operations are computer reliant
and could be affected by the Year 2000 issues. Both the Bank and the Company are
reliant on third-party vendors for their data processing needs as well as
certain other significant functions and services (e.g., securities safekeeping
services, securities pricing data, etc.). The Company currently is working with
its third-party vendors in order to assess their Year 2000 readiness. While no
assurance can be given that such third party vendors will be Year 2000
compliant, management believes that such vendors are taking appropriate steps to
address the issues on a timely basis. Based on certain preliminary estimates,
the Company currently believes that its costs related to upgrading its systems
and software for Year 2000 issues will not exceed $600,000. While the Company
currently has no reason to believe that the cost of addressing such issues will
materially affect the Bank's products, services or ability to compete
effectively, no assurance can be made that the Company or the third party
vendors on which it relies will become Year 2000 compliant in a successful and
timely fashion. Nevertheless, the Company does not believe that the cost of
addressing the Year 2000 issues will be a material event or uncertainty that
would cause reported financial information not to be necessarily indicative of
future operating results or financial conditions, nor does it believe that the
costs or the consequences of incomplete or untimely resolution of its Year 2000
issues represent a known material event or uncertainty that is reasonably likely
to affect its future financial results, or cause its reported financial
information not to be necessarily indicative of future financial condition.
25
<PAGE>
WESTERFED FINANCIAL CORPORATION
AND SUBSIDIARIES
Consolidated Financial Statements
Three years ended June 30, 1998
(With Independent Auditors' Report Thereon)
26
<PAGE>
Independent Auditors' Report
----------------------------
The Board of Directors
WesterFed Financial Corporation:
We have audited the accompanying consolidated balance sheets of WesterFed
Financial Corporation and subsidiaries as of June 30, 1998 and 1997, and the
related consolidated statements of income, stockholders' equity, and cash flows
for each of the years in the three-year period ended June 30, 1998. These
consolidated financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of WesterFed Financial
Corporation and subsidiaries as of June 30, 1998 and 1997, and the results of
their operations and their cash flows for each of the years in the three-year
period ended June 30, 1998 in conformity with generally accepted accounting
principles.
Billings, Montana
July 24, 1998
27
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Consolidated Balance Sheets
- --------------------------------------------------------------------------------
(Dollars in thousands, except share and per share data)
June 30,
--------------------
1998 1997
---------- -------
Assets
- ------
Cash and due from banks ................................. $ 19,440 16,999
Interest-bearing due from banks ......................... 9,628 160
---------- -------
Cash and cash equivalents ......................... 29,068 17,159
Interest-bearing deposits ............................... 100 2,000
Investment securities available-for-sale ................ 108,511 51,683
Investment securities, at amortized cost (estimated
fair value of $16,974 in 1998 and $27,728 in 1997) .... 16,847 27,466
Stock in Federal Home Loan Bank of Seattle, at cost ..... 13,560 11,456
Mortgage-backed securities available-for-sale ........... 24,135 31,388
Mortgage-backed securities, at amortized cost
(estimated fair value of $104,962 in 1998
and $119,193 in 1997) ................................. 102,298 117,781
Loans available-for-sale ................................ 6,922 3,700
Loans receivable, net ................................... 650,371 626,577
Interest receivable ..................................... 7,778 6,957
Premises and equipment, net ............................. 30,089 29,291
Core deposit intangible ................................. 4,518 5,276
Goodwill ................................................ 15,762 15,562
Cash surrender value of life insurance policies ......... 6,705 6,120
Other assets ............................................ 5,472 3,223
---------- -------
$1,022,136 955,639
========== =======
- --------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
- ------------------------------------
Deposits ................................................ $ 636,441 630,869
Repurchase agreements ................................... 6,233 7,786
Borrowed funds .......................................... 248,953 191,450
Advances from borrowers for taxes and insurance ......... 4,052 3,753
Income taxes - current and deferred ..................... 2,289 3,504
Accrued interest payable ................................ 4,480 3,593
Accrued expenses and other liabilities .................. 9,988 10,425
---------- -------
Total liabilities ................................. 912,436 851,380
---------- -------
Stockholders' equity:
Preferred stock, $.01 par value, 5,000,000 shares
authorized; none outstanding ........................ -- --
Common stock, $.01 par value, 10,000,000 shares
authorized; 5,836,691 shares issued, 5,585,303
outstanding in 1998; 5,798,713 shares issued,
5,564,904 outstanding in 1997 ....................... 56 56
Paid-in capital ....................................... 68,923 67,941
Common stock acquired by ESOP/RRP ..................... (2,520) (2,936)
Treasury stock, at cost ............................... (3,461) (3,081)
Net unrealized gain (loss) on securities
available-for-sale .................................. 23 (35)
Retained earnings ..................................... 46,679 42,314
---------- -------
Total stockholders' equity ........................ 109,700 104,259
---------- -------
Commitments and contingencies ........................... $1,022,136 955,639
========== =======
Book value per common share outstanding ................. $ 19.64 18.74
========== =======
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
28
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Consolidated Statements of Income
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
Year Ended June 30,
---------------------------
1998 1997 1996
------- ------ ------
Interest income:
Loans receivable .............................. $56,261 37,923 28,640
Mortgage-backed securities .................... 9,676 8,185 9,167
Investment securities ......................... 7,580 3,884 3,769
Interest-bearing deposits ..................... 675 1,045 787
Other ......................................... 332 223 181
------- ------ ------
Total interest income ..................... 74,524 51,260 42,544
------- ------ ------
Interest expense:
NOW and money market demand ................... 3,321 2,029 1,740
Savings ....................................... 2,658 2,223 1,940
Certificates of deposit ....................... 21,714 14,737 12,074
Cost of Swaps and Caps ........................ 110 249 331
------- ------ ------
27,803 19,238 16,085
Borrowed funds ................................ 14,483 9,169 8,652
------- ------ ------
Total interest expense .................... 42,286 28,407 24,737
------- ------ ------
Net interest income ....................... 32,238 22,853 17,807
Provision for loan losses ....................... 840 400 --
------- ------ ------
Net interest income after provision
for loan losses ......................... 31,398 22,453 17,807
------- ------ ------
Non-interest income:
Loan origination fees on loans sold ........... 2,268 667 348
Service fees .................................. 4,486 3,034 2,120
Net gain on sale of loans and securities
available-for-sale .......................... 1,053 678 577
Other ......................................... 574 306 267
------- ------ ------
Total non-interest income ................. 8,381 4,685 3,312
------- ------ ------
Non-interest expense:
Compensation and employee benefits ............ 13,149 9,342 7,523
Net occupancy expense of premises ............. 2,153 1,373 880
Equipment and furnishings ..................... 1,846 1,009 643
Data processing ............................... 1,644 962 632
Deposit insurance premium ..................... 358 517 806
SAIF assessment ............................... -- 2,297 --
Intangibles amortization ...................... 1,391 532 --
Marketing and advertising ..................... 789 571 559
Other ......................................... 6,429 3,965 2,961
------- ------ ------
Total non-interest expense ................ 27,759 20,568 14,004
------- ------ ------
Income before income taxes ................ 12,020 6,570 7,115
Income taxes .................................... 4,760 2,063 2,556
------- ------ ------
Net income ................................ $ 7,260 4,507 4,559
======= ====== ======
Net income per common share:
Basic ......................................... $ 1.37 1.01 1.13
======= ====== ======
Diluted ....................................... $ 1.29 .96 1.08
======= ====== ======
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
29
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Consolidated Statements of Stockholders' Equity
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Net
unrealized
gain (loss)
on securities
Common Paid-in ESOP/ Treasury available- Retained
stock capital RRP stock for-sale earnings Total
------ ------- ------ -------- ------------- -------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1995 ............................ $ 46 45,232 (4,271) (3,066) 295 36,910 75,146
Net income .......................................... -- -- -- -- -- 4,559 4,559
ESOP shares committed to be released ................ -- 219 227 -- -- -- 446
Amortization of RRP ................................. -- -- 473 -- -- -- 473
Shares forfeited by RRP participants--1,252 shares .. -- -- 13 (13) -- -- --
Net change in unrealized gain on securities
available-for-sale, net of income taxes of $317 ... -- -- -- -- (521) -- (521)
Cash dividends declared ($.36 per share) ............ -- -- -- -- -- (1,496) (1,496)
---- ------ ------ ------ ---- ------ -------
Balance at June 30, 1996 ............................ 46 45,451 (3,558) (3,079) (226) 39,973 78,607
Net income .......................................... -- -- -- -- -- 4,507 4,507
ESOP shares committed to be released ................ -- 265 227 -- -- -- 492
Amortization of RRP ................................. -- -- 499 -- -- -- 499
Shares forfeited by RRP participants--195 shares .... -- -- 2 (2) -- -- --
Common stock acquired by RRP (5,418 shares) ........ -- 106 (106) -- -- -- --
Common stock options exercised (13,768 shares) ...... -- 184 -- -- -- -- 184
Common stock issued (534 shares) .................... -- 10 -- -- -- -- 10
Security Bancorp acquisition:
Issuance of 1,150,175 shares, net of issuance
costs of $200 ................................... 10 21,052 -- -- -- -- 21,062
Issuance of options allowing holders to
acquire 94,696 shares ........................... -- 873 -- -- -- -- 873
Net change in unrealized loss on securities
available-for-sale, net of income taxes of $112 ... -- -- -- -- 191 -- 191
Cash dividends declared ($.45 per share) ............ -- -- -- -- -- (2,166) (2,166)
---- ------ ------ ------ ---- ------ -------
Balance at June 30, 1997 ............................ 56 67,941 (2,936) (3,081) (35) 42,314 104,259
Net income .......................................... -- -- -- -- -- 7,260 7,260
Purchase of treasury stock, at cost--17,500 shares .. -- -- -- (379) -- -- (379)
ESOP shares committed to be released ................ -- 425 227 -- -- -- 652
Amortization of RRP ................................. -- -- 188 -- -- -- 188
Shares forfeited by RRP participants--75 shares ..... -- -- 1 (1) -- -- --
Common stock options exercised (37,978 shares) ...... -- 557 -- -- -- -- 557
Net change in unrealized loss on securities
available-for-sale, net of income taxes of $34 .... -- -- -- -- 58 -- 58
Cash dividends declared ($.54 per share) ............ -- -- -- -- -- (2,895) (2,895)
---- ------ ------ ------ ---- ------ -------
Balance at June 30, 1998 ............................ $ 56 68,923 (2,520) (3,461) 23 46,679 109,700
==== ====== ====== ====== ==== ====== =======
</TABLE>
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
30
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Consolidated Statements of Cash Flows
- --------------------------------------------------------------------------------
(Dollars in thousands)
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------------------
1998 1997 1996
--------- -------- -------
<S> <C> <C> <C>
Net cash provided by operating activities .................. $ 30,735 24,105 19,557
--------- -------- -------
Cash flows from investing activities:
Net change in interest-bearing deposits .................. 1,900 1,000 (898)
Purchases of:
FHLB stock ............................................. (1,129) -- (200)
Investment securities .................................. (5,483) (9,956) (4,594)
Investment securities available-for-sale ............... (143,279) (79,804) (31,325)
Mortgage-backed securities ............................. -- (5,950) (990)
Mortgage-backed securities available-for-sale .......... (6,990) (983) (21,274)
Proceeds from maturities:
Investment securities .................................. 16,316 9,351 8,100
Investment securities available-for-sale ............... 70,545 61,289 40,536
Proceeds from sales of:
Investment securities available-for-sale ............... 16,065 5,192 3,840
Mortgage-backed securities available-for-sale .......... 3,222 31,937 30,862
Principal payments from:
Investment securities available-for-sale ............... 437 385 1,102
Mortgage-backed securities ............................. 15,661 8,897 8,896
Mortgage-backed securities available-for-sale .......... 10,955 14,113 20,721
Net change in loans receivable ........................... (24,516) (43,911) (53,541)
Proceeds from sales of premises and equipment ............ 1,162 -- --
Purchases of premises and equipment ...................... (5,682) (2,426) (3,253)
Purchase of life insurance policies ...................... (285) -- --
Acquisition of Security Bancorp, net of cash and cash
equivalents acquired of $16,013 ........................ -- (10,776) --
--------- -------- -------
Net cash used in investing activities ................ (51,101) (21,642) (2,018)
--------- -------- -------
Cash flows from financing activities:
Net change in deposits ................................... (21,366) (25,093) (9,667)
Net change in repurchase agreements ...................... (1,553) 974 --
Proceeds from borrowings ................................. 344,165 136,090 77,720
Payments on borrowings ................................... (286,719) (108,606) (86,658)
Net change in advances from borrowers for taxes
and insurance .......................................... 299 (295) (54)
Dividends paid to stockholders ........................... (2,729) (1,867) (955)
Proceeds from exercise of options and stock issuances .... 557 194 --
Payments to acquire treasury stock ....................... (379) -- --
--------- -------- -------
Net cash provided by (used in) financing activities .. 32,275 1,397 (19,614)
--------- -------- -------
Net increase (decrease) in cash and cash equivalents ....... 11,909 3,860 (2,075)
Cash and cash equivalents at beginning of year ............. 17,159 13,299 15,374
--------- -------- -------
Cash and cash equivalents at end of year ................... $ 29,068 17,159 13,299
========= ======== =======
Supplemental disclosure of cash flow information:
Payments during the period for:
Interest ............................................... $ 13,900 8,942 8,938
Income taxes, net ...................................... 4,080 3,014 2,441
========= ======== =======
</TABLE>
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
31
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Financial Statement Presentation
WesterFed Financial Corporation ("WesterFed," and collectively with its
subsidiary, the "Company") serves the financial needs of 20 communities in the
state of Montana through its wholly-owned subsidiary, Western Security Bank (the
"Bank"), a federally chartered savings bank. In addition to traditional
financial institution services, the Company provides insurance, investment and
other related services through Western Security Investment Services, Inc.,
WesterFed Insurance Services, Service Corporation of Montana, Monte Mac I, Inc.
and COAD Limited Partnership, all wholly-owned subsidiaries of the Bank.
The Company's consolidated financial statements have been prepared in conformity
with generally accepted accounting principles. All significant intercompany
balances and transactions have been eliminated in consolidation. In preparing
the consolidated financial statements, management is required to make estimates
and assumptions that affect the reported amounts of assets and liabilities as of
the date of the balance sheet and revenues and expenses for the period. Actual
results could differ significantly from those estimates.
Material estimates that are particularly susceptible to significant change in
the near-term relate to the determination of the allowance for loan losses. In
connection with the determination of the allowance for loan losses, management
generally obtains independent appraisals for significant properties. A
substantial portion of the Company's loans are secured by collateral in the
state of Montana. Accordingly, as with most financial institutions in the market
area, the collectibility of a substantial portion of the carrying value of the
Company's loan portfolio is susceptible to changes in market conditions.
Management believes the allowance for loan losses is adequate. While management
uses available information to recognize losses on loans, future additions to the
allowance may be necessary based on changes in economic conditions in the
Company's market area and the composition of the loan portfolio. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Company's allowance for loan losses. Such agencies may
require the Company to recognize additions to the allowance based on their
judgments about information available to them at the time of their examination.
Fiscal Year
The Company's fiscal year ends on June 30 each year. Reference to a fiscal year
refers to the year in which such fiscal year ends.
Cash Equivalents
For purposes of the statements of cash flows, cash equivalents consist of daily
interest demand deposits, non-interest-bearing deposits with banks and
interest-bearing deposits having original maturities of three months or less.
Investment and Mortgage-Backed Securities
Investment and mortgage-backed securities available-for-sale include securities
that management intends to use as part of its overall asset/liability management
strategy and that may be sold in response to changes in interest rates and
resultant prepayment risk and other related factors. Securities
available-for-sale are carried at fair value, and unrealized gains and losses
(net of related tax effects) are excluded from earnings and included as a
separate component of stockholders' equity. Upon realization, gains and losses
are included in earnings using the specific identification method. Investment
securities and mortgage-backed securities, other than those designated as
available-for-sale or trading, are comprised of debt securities for which the
Bank has positive intent and ability to hold to maturity and are carried at
cost. All securities are adjusted for amortization of premiums and accretion of
discounts using the level-yield method over the estimated lives of the
securities.
Management determines the appropriate classification of investment and
mortgage-backed securities at the purchase date.
32
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
Stock in Federal Home Loan Bank
Member institutions of the Federal Home Loan Bank (FHLB) system are required to
hold common stock of its district FHLB according to predetermined formulas. FHLB
provides a source of borrowed funds for its member institutions which are
secured by this FHLB stock.
Loans Receivable, Net
Loans receivable, other than loans available-for-sale, are stated at the unpaid
principal balance, net of premiums, unearned discounts, net deferred loan
origination fees, and the allowance for loan losses.
Loans are placed on nonaccrual status when collection of principal or interest
is considered doubtful (generally loans past due 90 days or more). Interest
income previously accrued on these loans, but not yet received, is reversed in
the current period. Interest subsequently recovered is credited to income in the
period collected. Discounts are accreted and premiums amortized to income using
the level-yield method over the estimated lives of the loans. Loans that can be
contractually prepaid or otherwise settled in such a way that the Company would
not recover substantially all of its recorded investment are measured like debt
securities available-for-sale.
Loan fees and certain direct loan origination costs are deferred, and the net
fee or cost is recognized in interest income using the level-yield method over
the estimated life of the individual loans, adjusted for actual prepayments.
Amortization of deferred loan origination fees are suspended during periods in
which the related loan is in nonaccrual status.
Loans available-for-sale are carried at the lower of cost or market using the
aggregate method. Valuation adjustments, if applicable, are reflected in current
operations. Gains and losses on sales are recorded using the specific
identification method.
Management determines the appropriate classification of loans as either held to
maturity or available-for-sale at origination, in conjunction with the Company's
overall asset/liability management strategy.
The cost of loan servicing rights acquired is included in other assets and
amortized in proportion to, and over the period of, estimated net servicing
revenues.
The carrying value of loan servicing rights and the amortization thereon is
periodically evaluated in relation to estimated future net servicing revenues.
The Company evaluates the carrying value of the servicing portfolio for
impairment by estimating the future net servicing income of the portfolio based
on management's best estimate of remaining loan lives and contractual interest
rates.
Allowance for Loan Losses
The allowance for loan losses is based on management's evaluation of the
adequacy of the allowance, including an assessment of known and inherent risks
in the portfolio, review of individual loans for adverse situations that may
affect the borrower's ability to repay, the estimated value of any underlying
collateral, and consideration of current economic conditions.
Additions to the allowance arise from charges to operations through the
provision for loan losses or from the recovery of amounts previously charged
off. The allowance is reduced by loan charge-offs. Loans are charged off when
management believes there has been permanent impairment of their carrying
values.
The Company also provides an allowance for losses on specific loans which are
deemed to be impaired. Groups of small balance homogeneous basis loans
(generally the Company's consumer loans) are evaluated for impairment
collectively. A loan is considered impaired when, based upon current information
and events, it is probable that the Bank will be unable to collect, on a timely
basis, all principal and interest according to the contractual terms of the
loan's original agreement. When a specific loan is determined to be impaired,
the allowance for possible loan losses is increased through a charge to expense
for the amount of the impairment. For all non-consumer loans, impairment is
measured based on value of the underlying collateral. The value of the
underlying collateral is determined by reducing the collateral's estimated
current value by anticipated selling costs. The Company's impaired loans are the
same as those non-consumer loans currently reported as non-accrual. The Company
recognizes interest income on impaired loans only to the extent that cash
payments are received.
33
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
Real Estate Owned
Real estate owned is recorded at the fair value at the date of acquisition, with
a charge to the allowance for loan losses for any excess of cost over fair
value. Subsequently, real estate owned is carried at the lower of cost or fair
value, less estimated selling costs. Certain costs incurred in preparing
properties for sale are capitalized, and expenses of holding foreclosed
properties are charged to operations as incurred. Other assets include $421 and
$82 of real estate and other personal property acquired through foreclosure at
June 30, 1998 and 1997, respectively.
Cash Surrender Value of Life Insurance
The Company has acquired life insurance policies covering certain key employees
for which the Company is the beneficiary. The Company makes one-time lump-sum
payments as key employees are identified. Earnings on the premiums paid, usually
in the form of lump-sum payments, are expected to exceed future premiums and
expenses associated with the policies and thus result in an increase in the cash
surrender value of the policies.
Premises and Equipment
Premises and equipment, including leasehold improvements, are stated at cost,
less accumulated amortization and depreciation. Depreciation and amortization
are computed using the straight-line and double declining balance methods over
the estimated useful lives of the assets or leases ranging from 5 to 40 years.
Long-Lived Assets
Long-lived assets and identifiable intangibles are reviewed for impairment
whenever events or circumstances provide evidence that suggests the carrying
amount of the asset may not be recoverable. An impairment loss is recognized if
the sum of the expected future cash flows is less than the carrying amount of
the asset.
Goodwill
Goodwill reflects the excess of cost over fair value of identifiable net assets
which were acquired during 1997. Goodwill is amortized over 25 years.
Accumulated amortization at June 30, 1998 and 1997 was $833 and $200,
respectively.
Core Deposit Intangible
Core deposit intangible represents the intangible value of depositor
relationships resulting from deposit liabilities assumed in a 1997 acquisition
and is amortized using an accelerated method based on an estimated runoff of the
related deposits, not exceeding 10 years. Accumulated amortization at June 30,
1998 and 1997 was $1,080 and $332, respectively.
Collateralized Mortgage Obligations
Bonds issued are recorded at par value net of discounts. Discounts are accreted
to interest expense using the level-yield method over the estimated life of the
bonds.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using the enacted tax
rates applicable to taxable income for the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
WesterFed and its subsidiaries file consolidated Federal and state income tax
returns.
Financial Instruments
The Company periodically enters into interest rate exchange agreements (Swaps)
and interest rate cap agreements (Caps) as part of its overall asset/liability
management strategies. Estimated amounts to be received or paid on the Swap
settlement dates are accrued when realized. The net Swap settlements are
reflected in interest expense. Transaction fees on Caps are amortized to
interest expense over the life of the related Caps using the straight-line
method. Any payments received on Caps are reflected in operations.
34
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
Stock Based Compensation
The cost of stock based compensation issued to third parties is measured at the
grant date based on the fair value of the award. For grants to employees,
compensation cost is the excess of the market price of the stock at the grant
date over the amount an employee must pay to acquire the stock.
Per Share Data
The Company adopted Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings Per Share." SFAS No. 128 revises the manner in which earnings per
share (EPS) is calculated by replacing the presentation of primary and fully
diluted EPS with a presentation of basic and diluted EPS. Fiscal 1998 EPS have
been presented in accordance with SFAS No. 128 and all prior periods presented
have been restated to conform with SFAS No. 128.
Basic earnings per common share is calculated by dividing net income by the
weighted average number of common shares outstanding during the period less
unvested RRP and unallocated ESOP shares. Diluted earnings per common share is
calculated by dividing net income by the weighted average number of common
shares used to compute basic EPS plus the incremental amount of potential common
stock determined by the treasury stock method.
- --------------------------------------------------------------------------------
(2) CONVERSION TO STOCK OWNERSHIP
WesterFed was formed in September 1993. On January 6, 1994, the Bank completed
its conversion from a mutual to a stock form savings bank at which time
WesterFed issued 4,436,657 shares of common stock at $10 per share realizing
$43,057 after deducting stock offering expense of $1,309. WesterFed used $21,529
to purchase 100 percent of the common stock of the Bank.
As part of the conversion, the Bank established a liquidation account for the
benefit of eligible depositors who continue to maintain their deposit accounts
in the Bank after conversion. In the unlikely event of a complete liquidation of
the Bank, each eligible depositor will be entitled to receive a liquidation
distribution from the liquidation account, in the proportionate amount of the
then current adjusted balance for deposit accounts held, before distribution may
be made with respect to the Bank's common stock. The Bank may not declare or pay
a cash dividend to its holding company, WesterFed, on, or repurchase any of, its
common stock if the effect thereof would cause the regulatory capital of the
Bank to be reduced below the amount required for the liquidation account. Except
for such restrictions, the existence of the liquidation account does not
restrict the use or application of retained earnings.
- --------------------------------------------------------------------------------
(3) REGULATORY MATTERS
WesterFed's ability to pay dividends is dependent upon the dividends it receives
from the Bank, which are subject to regulations and the Bank's continued
compliance with all regulatory capital requirements as specified by the Office
of Thrift Supervision (OTS). A "Tier 1" institution, which is defined as an
institution that has capital immediately prior to a proposed capital
distribution that is equal to or greater than the amount of its fully phased-in
capital requirement, is authorized to make capital distributions during a
calendar year up to the higher of 100% of its net income to date during the
calendar year plus the amount that would reduce by one-half its surplus capital
ratio at the beginning of the calendar year, or 75% of its net income over the
most recent four-quarter period. The Bank is a Tier 1 institution.
Capital standards require the Bank to have minimum regulatory tangible capital
equal to 1.5% of adjusted total assets, a minimum 3.0% core capital ratio and an
8.0% risk-based capital ratio. In addition, federal banking agencies have
adopted regulations which establish a system for prompt regulatory corrective
action with respect to depository institutions which do not meet minimum capital
requirements. The "prompt corrective action" regulations established five
categories related to the level of capital of the depository institution: (1)
well-capitalized, (2) adequately capitalized, (3) under-capitalized, (4)
significantly undercapitalized, and (5) critically
35
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
undercapitalized. A "well-capitalized" institution meets the minimum level
required by regulation (i.e., total risk-based capital ratio of 10% or greater,
a Tier 1 risk-based capital ratio of 6% or greater and a leverage ratio of 5% or
greater). The Bank's total risk-based, Tier 1 and core capital ratios were
13.81%, 13.03% and 8.27% at June 30, 1998. The Bank's total risk-based, Tier 1
and core capital ratios were 14.54%, 13.75% and 8.54% at June 30, 1997. At June
30, 1998, the Bank was categorized as "well-capitalized."
The Bank's compliance with capital requirements at June 30, 1998 and 1997
follows:
<TABLE>
<CAPTION>
Minimum to Minimum
be adequately to be well
capitalized under capitalized under
prompt corrective prompt corrective
Actual actions provision actions provision
--------------- ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C>
As of June 30, 1998:
Total capital (to
risk-weighted assets) ... $86,975 13.81% $50,394 8.00% $62,992 10.00%
Core (Tier 1) capital (to
risk-weighted assets) ... 82,084 13.03 25,197 4.00 37,795 6.00
Core (Tier 1) capital (to
adjusted assets) ........ 82,084 8.27 39,724 4.00 49,655 5.00
Tangible capital (to
tangible assets) ........ 82,084 8.27 14,896 1.50 14,896 1.50
======= ===== ======= ==== ======= =====
As of June 30, 1997:
Total capital (to
risk-weighted assets) ... $84,393 14.54% $46,424 8.00% $58,030 10.00%
Core (Tier 1) capital (to
risk-weighted assets) ... 79,768 13.75 23,212 4.00 34,818 6.00
Core (Tier 1) capital (to
adjusted assets) ........ 79,768 8.54 37,377 4.00 46,722 5.00
Tangible capital (to
tangible assets) ........ 79,768 8.54 14,016 1.50 14,016 1.50
======= ===== ======= ==== ======= =====
</TABLE>
The following is a reconciliation of capital as shown on the consolidated
financial statements and tangible, core and risk-based regulatory capital of the
Bank at June 30, 1998 and 1997:
1998 1997
-------- -------
Capital per consolidated financial statements ............. $109,700 104,259
Less: Nonqualifying equity .............................. (6,263) (3,597)
Goodwill and other intangibles .................... (20,280) (20,838)
Nonqualifying purchased mortgage loan servicing ... (1,062) (14)
Unrealized losses on certain securities
available-for-sale .............................. (11) (42)
-------- -------
Tangible and Core capital ................................. 82,084 79,768
Add: general valuation allowance ....................... 4,891 4,625
-------- -------
Risk-based capital ........................................ $ 86,975 84,393
======== =======
36
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
(4) INVESTMENT SECURITIES
The amortized cost and estimated fair values of investment securities at June
30, 1998 and 1997 are summarized as follows:
<TABLE>
<CAPTION>
1998
-----------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Investment securities held-to-maturity:
Federal agency obligations .......................... $ 2,994 27 -- 3,021
U.S. Government obligations ......................... 100 -- -- 100
Corporate obligations ............................... 11,473 87 -- 11,560
Other investments ................................... 2,280 13 -- 2,293
-------- ---- ---- -------
Total investment securities held-to-maturity .... 16,847 127 -- 16,974
======== ==== ==== =======
Investment securities available-for-sale:
Federal agency obligations .......................... $ 89,792 100 (111) 89,781
Corporate obligations ............................... 18,658 62 -- 18,720
Other ............................................... 3 7 -- 10
-------- ---- ---- -------
Total investment securities available-for-sale .. $108,453 169 (111) 108,511
======== ==== ==== =======
</TABLE>
<TABLE>
<CAPTION>
1997
-----------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Investment securities held-to-maturity:
Federal agency obligations .......................... $ 18,804 184 -- 18,988
U.S. Government obligations ......................... 297 1 -- 298
Corporate obligations ............................... 5,980 66 -- 6,046
Other investments ................................... 2,385 13 (2) 2,396
-------- ---- ---- -------
Total investment securities held-to-maturity .... $ 27,466 264 (2) 27,728
======== ==== ==== =======
Investment securities available-for-sale:
Federal agency obligations .......................... $ 46,067 113 (211) 45,969
Corporate obligations ............................... 5,622 54 (1) 5,675
Other ............................................... 3 36 -- 39
-------- ---- ---- -------
Total investment securities available-for-sale .. $ 51,692 203 (212) 51,683
======== ==== ==== =======
</TABLE>
37
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
Expected maturities may differ from contractual maturities because issuers may
have the right to call or repay obligations at par value without prepayment
penalties. The cost and estimated fair value of investment securities at June
30, 1998, by contractual maturity, are shown below:
Fair
Cost Value
-------- -------
Investment securities held-to-maturity
Due in:
Less than one year .................................... $ 100 100
One to five years ..................................... 14,538 14,651
Five to ten years ..................................... 236 236
After ten years ....................................... 1,973 1,987
-------- -------
$ 16,847 16,974
======== =======
Investment securities available-for-sale
Due in:
Less than one year .................................... $ 39,288 39,244
One to five years ..................................... 68,034 68,126
After ten years ....................................... 1,128 1,070
Other ................................................. 3 71
-------- -------
$108,453 108,511
======== =======
Gross proceeds from sales of investment securities available-for-sale for 1998,
1997 and 1996 were $16,065, $5,192 and $3,840, respectively. These sales
resulted in gross gains of $68, $18 and $23 in 1998, 1997 and 1996,
respectively, and gross losses of $0, $34 and $27 in 1998, 1997 and 1996,
respectively.
Pursuant to a collateral agreement with the FHLB, all unpledged, qualifying
investment securities, including those available-for-sale, are pledged to secure
advances from the FHLB.
- --------------------------------------------------------------------------------
(5) MORTGAGE-BACKED SECURITIES
A summary of mortgage-backed securities at June 30, 1998 and 1997 is as follows:
<TABLE>
<CAPTION>
1998
-----------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Mortgage-backed securities held-to-maturity:
FHLMC .................................................. $ 39,508 786 -- 40,294
GNMA ................................................... 14,776 194 -- 14,970
Collateralized mortgage obligations--federal agency .... 44,874 1,666 -- 46,540
Other .................................................. 3,140 49 (31) 3,158
-------- ----- ---- -------
Total mortgage-backed securities held-to-maturity .... $102,298 2,695 (31) 104,962
======== ===== ==== =======
</TABLE>
38
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
1998
-----------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Mortgage-backed securities available-for-sale:
FHLMC .................................................. $ 12,265 112 (109) 12,268
GNMA ................................................... 438 4 -- 442
FNMA ................................................... 7,742 49 (70) 7,721
Collateralized mortgage obligations--federal agency .... 3,711 -- (7) 3,704
-------- ----- ---- -------
Total mortgage-backed securities available-for-sale .. $ 24,156 165 (186) 24,135
======== ===== ==== =======
</TABLE>
<TABLE>
<CAPTION>
1997
-----------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Mortgage-backed securities held-to-maturity:
FHLMC .................................................. $ 49,630 354 (200) 49,784
GNMA ................................................... 18,291 223 -- 18,514
Collateralized mortgage obligations--federal agency .... 45,815 842 (86) 46,571
Other .................................................. 4,045 279 -- 4,324
-------- ----- ---- -------
Total mortgage-backed securities held-to-maturity .... $117,781 1,698 (286) 119,193
======== ===== ==== =======
Mortgage-backed securities available-for-sale:
FHLMC .................................................. $ 16,496 106 (162) 16,440
GNMA ................................................... 562 -- (3) 559
FNMA ................................................... 12,372 73 (101) 12,344
Other .................................................. 2,004 41 -- 2,045
-------- ----- ---- -------
Total mortgage-backed securities available-for-sale .. $ 31,434 220 (266) 31,388
======== ===== ==== =======
</TABLE>
Gross proceeds from sales of mortgage-backed securities available-for-sale for
1998, 1997 and 1996 were $3,222, $31,937 and $30,862, resulting in gross gains
of $40, $76 and $673 and gross losses of $11, $19 and $279, respectively.
Expected maturities of mortgage-backed securities will differ from contractual
maturities because issuers may have the right to prepay obligations with or
without penalties. The contractual weighted average life of mortgage-backed
securities is 18.4 years at June 30, 1998.
Mortgaged backed securities with amortized cost of $39,350 and $35,582 at June
30, 1998 and 1997, respectively, were pledged to secure public deposits and
securities sold under repurchase agreements. The approximate market value of
securities pledged at June 30, 1998 and 1997 was $40,189 and $35,939,
respectively.
Mortgage-backed securities with a recorded value of approximately $1,474 and
$1,920 have been pledged to secure collateralized mortgage obligations at June
30, 1998 and 1997, respectively.
39
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
(6) LOANS RECEIVABLE
A summary of loans receivable at June 30, 1998 and 1997 is summarized as
follows:
1998 1997
-------- -------
Loans secured by real estate:
1-4 residential units ............................. $310,062 334,894
5 or more residential units ....................... 42,716 40,237
Construction ...................................... 17,523 19,858
Commercial ........................................ 61,415 49,348
Agriculture ....................................... 11,066 7,970
Other nonresidential .............................. 2,735 701
FHA insured or VA guaranteed ...................... 8,601 13,683
-------- -------
Total real estate loans ....................... 454,118 466,691
Less:
Net deferred loan origination fees ................ (1,453) (1,813)
Undisbursed loan funds ............................ (5,178) (9,489)
Purchased discounts ............................... (1,159) (1,383)
Allowance for loan losses ......................... (2,177) (2,631)
-------- -------
Net real estate loans ......................... 444,151 451,375
Other loans:
Commercial (Non real estate) ...................... 34,384 28,924
Agriculture (Non real estate) ..................... 24,036 18,866
Loans to depositors, secured by deposits .......... 3,194 4,101
Indirect consumer loans ........................... 64,287 40,708
Other consumer loans--real estate secured ......... 54,619 58,551
Other consumer loans .............................. 35,352 29,772
Allowance for loan losses ......................... (2,730) (2,020)
-------- -------
Net other loans ............................... 213,142 178,902
-------- -------
657,293 630,277
Less loans available-for-sale ....................... (6,922) (3,700)
-------- -------
$650,371 626,577
======== =======
The Bank has pledged, under a blanket assignment, its unpledged and qualifying
mortgage portfolio to secure advances from the FHLB.
A summary of nonperforming loans at June 30, 1998 and 1997 follows:
1998 1997
-------- ------
Nonaccrual loans ...................................... $3,989 1,517
Loans 90 days or more delinquent and still accruing ... 626 836
------ -----
Total nonperforming loans ....................... $4,615 2,353
====== =====
40
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
If interest income on nonaccrual loans had been accrued in accordance with their
original terms, approximately $271, $71 and $22 of interest income would have
been recorded in 1998, 1997 and 1996, respectively. Interest income recognized
on nonaccrual loans during the years ended June 30, 1998, 1997, and 1996 was
insignificant. At June 30, 1998, there were no commitments to lend additional
funds to borrowers whose loans are classified as nonperforming.
An analysis of the allowance for loan losses for each of the years ended June
30, 1998, 1997 and 1996 is as follows:
1998 1997 1996
------ ----- -----
Balance at beginning of year ..................... $4,651 2,005 2,011
Reserves acquired ................................ -- 2,481 --
Provision charged to operations .................. 840 400 --
Charge-offs ...................................... (637) (253) (11)
Recoveries ....................................... 53 18 5
------ ----- -----
Balance at end of year ........................... $4,907 4,651 2,005
====== ===== =====
- --------------------------------------------------------------------------------
(7) INTEREST RECEIVABLE
A summary of interest receivable at June 30, 1998 and 1997 is as follows:
1998 1997
------ -----
Loans ....................................................... $5,520 4,768
Mortgage-backed securities .................................. 776 1,004
Investment securities ....................................... 1,475 1,148
Interest-bearing deposits ................................... 7 37
------ -----
$7,778 6,957
====== =====
- --------------------------------------------------------------------------------
(8) PREMISES AND EQUIPMENT
Premises and equipment at June 30, 1998 and 1997 is summarized as follows:
1998 1997
------- -------
Land ........................................................ $ 5,593 6,007
Office buildings and leasehold improvements ................. 26,887 28,013
Furniture, fixtures and equipment ........................... 10,789 7,509
------- -------
43,269 41,529
Less accumulated depreciation and amortization .............. (13,180) (12,238)
------- -------
$30,089 29,291
======= =======
41
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
(9) DEPOSITS
Deposits at June 30, 1998 and 1997 are summarized as follows:
1998 1997
-------- -------
Certificates of deposit .................................... $381,223 376,252
Savings accounts ........................................... 94,557 102,923
Money market accounts ...................................... 55,464 49,062
NOW accounts ............................................... 74,673 76,582
Noninterest-bearing demand ................................. 30,524 26,050
-------- -------
$636,441 630,869
======== =======
Certificates of deposit at June 30, 1998 mature as follows:
<TABLE>
<CAPTION>
Less One to Two to Three Four to
than two three to four five There-
one year years years years years after Total
-------- ------ ------ ------- ------- ------ -------
<S> <C> <C> <C> <C> <C> <C> <C>
2.00% to 3.99% ...................... $ 1,572 22 -- -- -- -- 1,594
4.00% to 4.99% ...................... 6,748 148 -- -- -- -- 6,896
5.00% to 5.99% ...................... 192,004 27,330 7,151 2,079 1,412 31 230,007
6.00% to 6.99% ...................... 35,295 26,153 15,112 1,796 4,749 -- 83,105
7.00% to 8.99% ...................... 5,979 2,443 -- -- 6 -- 8,428
-------- ------ ------ ----- ----- ---- -------
241,598 56,096 22,263 3,875 6,167 31 330,030
Jumbo ............................... 40,541 6,670 2,357 927 698 -- 51,193
-------- ------ ------ ----- ----- ---- -------
Total certificates of deposit ... $282,139 62,766 24,620 4,802 6,865 31 381,223
======== ====== ====== ===== ===== ==== =======
</TABLE>
- --------------------------------------------------------------------------------
(10) REPURCHASE AGREEMENTS
Repurchase agreements generally mature on the next banking day. The securities
underlying agreements to repurchase are for the same securities originally sold
and are held in a custody account by a third party. For the years ended June 30,
1998 and 1997, securities sold under agreements to repurchase averaged
approximately $8,113 and $7,557, respectively. The maximum outstanding at any
month end during the years ended June 30, 1998 and 1997 was approximately $9,645
and $7,786, respectively.
- --------------------------------------------------------------------------------
(11) BORROWED FUNDS
Advances from the FHLB and other borrowings at June 30, 1998 and 1997 are
summarized as follows:
1998 1997
-------- -------
Advances from Federal Home Loan Bank of Seattle ............ $248,133 190,338
Collateralized mortgage obligations ........................ 511 797
8.5% contract payable ...................................... 309 315
-------- -------
$248,953 191,450
======== =======
42
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
Advances from Federal Home Loan Bank of Seattle bear interest at rates from
4.75% to 8.11% and mature as follows:
Years ending June 30
--------------------
1999 ...................................... $171,768
2000 ...................................... 15,000
2001 ...................................... 13,156
2002 ...................................... 19,658
2003 ...................................... 6,691
Thereafter ................................ 21,860
--------
$248,133
========
Advances from the FHLB are secured by pledges of FHLB stock of $13,560 and
$11,456 at June 30, 1998 and 1997, respectively, and a blanket assignment (the
blanket assignment) of the Bank's unpledged, qualifying mortgage loans,
mortgage-backed securities and investment securities.
The Bank is party to two $400,000 forward commitments with the FHLB. The
commitments bear interest at 6.15% and have a seven year term. The commitments
must be drawn by July 31, 1998 and October 31, 1998.
The contract payable requires monthly payments of principal and interest of $3,
maturing in November 2016. The contract payable is secured by real estate.
- --------------------------------------------------------------------------------
(12) INCOME TAXES
Prior to July 1, 1996, if certain conditions were met, the Company was allowed a
special bad debt deduction in determining income for tax purposes. The deduction
was based on either a specified experience formula or a percentage of taxable
income before such deduction (most recently 8%). Under new legislation enacted
in August 1996, the special bad debt deduction was eliminated effective for tax
years beginning after December 31, 1995.
Retained earnings at June 30, 1998 includes approximately $13,800 for which no
provision for income tax has been made. This amount primarily represents income
offset by the percentage bad debt deduction for income tax purposes only. This
amount is treated as a permanent difference and deferred taxes are not
recognized unless it appears that this amount will result in taxable income in
the foreseeable future. Also included in the August 1996 legislation were
provisions which require the Bank to recapture bad debt deductions taken in
excess of its base year reserves. The Company has provided a deferred tax
liability on the excess deductions which are payable over six years beginning in
1997. At June 30, 1998, management does not foresee any events under which the
base year amount of $13,800 would become taxable.
A summary of the provision for income taxes for the years ended June 30, 1998,
1997 and 1996 follows:
1998 1997 1996
------ ----- -----
Federal:
Current ......................................... $3,582 2,095 1,894
Deferred ........................................ 315 (408) 254
------ ----- -----
3,897 1,687 2,148
------ ----- -----
State:
Current ......................................... 753 440 377
Deferred ........................................ 110 (64) 31
------ ----- -----
863 376 408
------ ----- -----
$4,760 2,063 2,556
====== ===== =====
43
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
In the fourth quarter of 1997, the Company entered into split-dollar life
insurance agreements with certain key officers which resulted in the reversal of
previously provided deferred income taxes related to the increase in cash
surrender values. The effective tax rates for 1998, 1997 and 1996 are 39.6%,
31.4% and 35.9%, respectively.
A reconciliation between the income tax expense and the amount computed by
multiplying the applicable statutory federal income tax rate for 1998, 1997 and
1996 is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------ ----- -----
<S> <C> <C> <C>
Computed "expected" tax expense ............................. $4,086 2,234 2,419
Accumulated earnings on life insurance policies ............. (99) (53) (50)
State income taxes, net of Federal income tax benefit ....... 567 248 270
Reversal of deferred taxes--cash surrender value increases .. -- (397) --
Goodwill amortization ....................................... 215 68 --
Tax credit .................................................. (77) (74) --
Other ....................................................... 68 37 (83)
------ ----- -----
$4,760 2,063 2,556
====== ===== =====
</TABLE>
The tax effects of temporary differences that give rise to deferred tax assets
and liabilities at June 30, 1998 and 1997 are as follows:
1998 1997
------ -----
Deferred tax assets:
Loans, principally allowance for loan losses ................. $2,112 1,789
Purchased excess tax bases ................................... 1,283 1,400
Loan servicing premium ....................................... 277 326
Deposits, principally difference in bases .................... 113 182
Investment securities, principally differences in bases ...... 669 781
Employee benefits, principally deferred compensation and
accrued vacation ........................................... 1,043 1,199
Market value adjustment of investment securities and
mortgage-backed securities available-for-sale .............. -- 20
Other ........................................................ 6 135
------ -----
Gross deferred income tax assets ......................... 5,503 5,832
------ -----
Deferred tax liabilities:
FHLB stock dividends ......................................... 3,002 2,626
Core deposit intangible ...................................... 1,738 2,029
Deferred loan fees and origination costs ..................... 315 348
Life insurance contract income ............................... 43 470
Loans, due primarily to tax bad debt reserves in excess
of base year amount ........................................ 612 902
Loans, principally difference in bases ....................... 446 525
Fixed assets, principally difference in bases
and depreciation ........................................... 1,475 2,296
Market value adjustment of investment securities and
mortgage-backed securities available-for-sale .............. 14 --
Other ........................................................ 36 --
------ -----
Gross deferred income tax liabilities .................... 7,681 9,196
------ -----
Net deferred income tax liability ........................ $2,178 3,364
====== =====
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the existence of, or generation of, taxable income in the periods
which those temporary differences are deductible. Management considers the
scheduled reversal of
44
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
deferred tax liabilities, taxes paid in carryback years, projected future
taxable income, and tax planning strategies in making this assessment. Based
upon the level of historical taxable income and projection for future taxable
income over the periods which the deferred tax assets are deductible, at June
30, 1998, management believes it is more likely than not that the Company will
realize the benefits of these deductible differences.
- --------------------------------------------------------------------------------
(13) COMMITMENTS AND CONTINGENCIES
The Company leases certain land, premises and equipment from third parties under
operating leases. The total future minimum rental commitments required under
operating leases that have initial or remaining noncancelable lease terms in
excess of one year at June 30, 1998 are as follows:
Years ended June 30, Amount
-------------------- ------
1999 ...................................... $ 205
2000 ...................................... 207
2001 ...................................... 206
2002 ...................................... 136
2003 ...................................... 136
Thereafter ................................... 1,505
------
Total minimum future rental expense ............... $2,395
======
The Company is the lessor of office space in certain of its branch office
buildings under operating leases expiring in future years. Management expects as
operating leases expire in the normal course of business, they will be renewed
or replaced by leases on other properties at current market rental rates at the
time of renewal. Approximate minimum future rentals to be received under
non-cancelable leases subsequent to June 30, 1998 are as follows:
Years ended June 30, Amount
-------------------- ------
1999 ...................................... $ 533
2000 ...................................... 403
2001 ...................................... 286
2002 ...................................... 61
2003 ...................................... 35
Thereafter ................................... 46
------
Total minimum future rental income ................ $1,364
======
The deposits of the Bank are insured by the Savings Association Insurance Fund
(SAIF), one of two funds administered by the Federal Deposit Insurance
Corporation (FDIC). Prior to September 1, 1996 the Bank paid premiums of
approximately 0.23% of deposits. On September 30, 1996, the Deposit Insurance
Funds Act of 1996 was signed, which authorized the FDIC to impose a special
assessment on certain deposits held by thrift institutions. This special
assessment, was intended to recapitalize the SAIF. The assessment of $2,297 and
a related tax benefit of approximately $900 were recorded by the Bank on
September 30, 1996. The assessment was paid in November 1996.
The Bank is a defendant in various matters of litigation generally incidental to
its business. In the opinion of management, following consultation with legal
counsel, liabilities arising from these proceedings, if any, will not have a
material impact on the Company's liquidity, financial condition or results of
operations.
45
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
The Year 2000 issues involve the use of only two digits to identify a year in a
date field, potentially causing application failures or erroneous results at the
Year 2000. The Company and its customers' operating, processing and accounting
operations are computer reliant and could be affected by the Year 2000 issues.
The Company is reliant on third-party vendors for their data processing needs as
well as certain other significant functions and services (e.g., securities
safekeeping services, securities pricing data, etc.). The Company is currently
working with its third-party vendors in order to assess their Year 2000
readiness. While no assurance can be given that such third party vendors will be
Year 2000 compliant, management believes that such vendors are taking
appropriate steps to address the issues on a timely basis. Based on certain
preliminary estimates, the Company currently believes that its costs related to
upgrading its systems and software for Year 2000 issues will not exceed
$600,000. While the Company currently has no reason to believe that the cost of
addressing such issues will materially affect the Company's products, services
or ability to compete effectively, no assurance can be made that the Company,
its customers or the third party vendors on which it relies will become Year
2000 compliant in a successful and timely fashion.
- --------------------------------------------------------------------------------
(14) EMPLOYEE BENEFIT PLANS
Employee Stock Ownership Plan (ESOP)
Effective July 1, 1993 the Board of Directors approved the adoption of an ESOP
covering substantially all employees. The ESOP purchased 354,933 shares of
WesterFed's common stock for $10 per share in connection with the conversion to
stock ownership. The ESOP borrowed $3,549 from WesterFed to fund the purchase,
evidenced by a note receivable recorded by WesterFed, secured by the common
stock purchased by the ESOP. The terms of the note require quarterly principal
payments from the ESOP of approximately $57, bearing interest at 7.26%, maturing
December 2008. Contributions of cash or common stock are made from the Bank to
the ESOP at the discretion of the Board of Directors. Dividends on common shares
held by the ESOP are paid to the ESOP and, together with Bank contributions, are
used by the ESOP to repay principal and interest on the outstanding note. For
financial reporting purposes, the note receivable is classified as a reduction
of consolidated stockholders' equity and amounts paid to WesterFed for interest
have been eliminated in consolidation.
The Company records compensation expense equal to the fair value of shares at
the date such shares are made available for allocation to plan participants'
accounts. Shares become available for allocation as the ESOP repays the note
receivable recorded by WesterFed. The Company recognized expense relating to the
ESOP of $652, $492 and $446 during the years ended June 30, 1998, 1997 and 1996,
respectively.
The ESOP shares as of June 30, 1998 and 1997 were as follows:
1998 1997
------- -------
Allocated shares ............................... 141,344 114,842
Unallocated shares ............................. 213,589 240,091
------- -------
Original ESOP common shares .................. 354,933 354,933
Shares distributed to participants ............. (15,820) (10,847)
------- -------
Common shares held by ESOP ................... 339,113 344,086
======= =======
At June 30, 1998, the fair value of the unallocated shares was approximately
$5,233.
Recognition and Retention Plan (RRP)
Under the RRP, common stock has been granted to certain officers, directors and
employees. Deferred compensation is recorded at the date of the stock award
based on the fair value of the shares granted. Vesting occurs in four equal,
annual installments and the related deferred compensation is expensed over the
same period. For financial reporting purposes the unamortized deferred
compensation balance is classified as a reduction of consolidated stockholders'
equity. Officers, directors and employees awarded shares retain voting rights
and, if dividends are paid, dividend privileges during the vesting period. RRP
compensation expense of $188, $499 and $473 has been recorded for the years
ended June 30, 1998, 1997 and 1996, respectively.
46
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
Stock Option and Incentive Plan
The stockholders have approved a Stock Option and Incentive Plan (the Stock
Option Plan). The terms of the Stock Option Plan provide for the granting of up
to 443,665 shares of common stock to certain officers and directors. The Stock
Option Plan provides for the granting of incentive stock options, nonqualified
stock options, stock appreciation rights, limited stock appreciation rights, or
restricted stock, or any combination thereof (collectively, the Awards).
The Company has granted incentive stock options and nonqualified stock options
(the options). The term of the options may not exceed 10 years from the date the
options are granted. Incentive stock options granted to stockholders with more
than 10% of the total combined voting power of all classes of stock of the
Company shall be granted at an option price of not less than 110% of the fair
market value at the grant date, and the term of the option may not exceed 5
years from the date of grant. For incentive stock options, a maximum of 10,000
shares per Stock Option Plan participant are exercisable per year. All incentive
and nonqualified stock options awarded are exercisable at the grant date.
Equity Incentive Plan
In conjunction with the acquisition of Security Bancorp (see Note 24), the
stockholders of the Company approved the Equity Incentive Plan (the "Incentive
Plan"). The Incentive Plan provides for granting various awards to directors,
officers, and employees of WesterFed or any of its subsidiary corporations of
various awards up to 250,000 shares of Common Stock. The Incentive Plan provides
for awards in the form of stock options, stock appreciation rights, other
securities and property and restricted stock (collectively, Incentive Awards).
The Company has granted Incentive Awards during the year ended June 30, 1997
which allow holders to acquire 42,000 common shares. The term of the options may
not exceed 15 years from the date the options are granted. The exercise price
for the purchase of shares subject to a stock option may not be less than 100%
of the market value of the shares covered by the option on the date of grant.
During any calendar year, no participant may be granted Incentive Awards under
the Incentive Plan with respect to more than 50,000 shares. There were no awards
granted in the year ended June 30, 1998.
The following table reflects options for both the Stock Option Plan and
Incentive Plan:
Common
Shares Exercise Price
------- --------------
Year ending June 30, 1996:
Options outstanding, beginning of year ............ 419,707 $10.00-12.13
Granted ........................................... -- --
-------
Outstanding, end of year .......................... 419,707 $10.00-12.13
Year ending June 30, 1997:
Granted in conjunction with acquisition
of Security Bancorp ............................. 36,668 3.65- 6.54
Granted in conjunction with acquisition
of Security Bancorp ............................. 58,028 10.67-12.72
Granted ........................................... 72,169 16.75-21.50
Exercised ......................................... (13,768) 10.00-14.12
-------
Outstanding, end of year .......................... 572,804 $ 3.65-21.50
Year ending June 30, 1998:
Granted ........................................... -- --
Exercised ......................................... (37,978) 3.65-12.72
-------
Outstanding, end of year .......................... 534,826 $ 3.65-21.50
=======
47
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
Information regarding options outstanding and exercisable at June 30, 1998
follows:
Options Outstanding Options Exercisable
--------------------------------------- ------------------------
Weighted
Range of Weighted average Weighted
exercise Common average remain Common average
price shares exercise price life in yrs. shares exercise price
- ------------ ------- -------------- ------------ ------- --------------
$ 3.65- 6.54 35,066 $ 5.35 3.7 35,066 $ 5.35
10.00-12.72 427,591 10.28 5.6 426,105 10.28
16.75-21.50 72,169 20.51 8.6 72,169 20.51
------- -------
534,826 11.34 533,340 11.34
======= =======
No compensation cost has been recognized in the consolidated statements of
operations for options granted under the plans. Had compensation cost for
options granted been determined based on the estimated fair value of the options
issued at the dates of grant, the Company's net income and income per common
share amounts for the years ended June 30 would have been as follows:
1998 1997
------ -----
Net income, as reported ........................... $7,260 4,507
====== =====
Net income, pro forma ............................. $7,228 4,367
====== =====
Income per common share:
As reported:
Basic ......................................... $ 1.37 1.01
====== =====
Diluted ....................................... $ 1.29 .96
====== =====
Pro forma:
Basic ......................................... $ 1.36 .98
====== =====
Diluted ....................................... $ 1.29 .93
====== =====
No options were granted during the years ended June 30, 1998 and 1996.
The fair value of the options granted during the year ended June 30, 1997 was
estimated using the Black-Scholes model with the following assumptions: for
1997; dividend yield of 2.4%; expected life of 7 years; volatility of 19% and a
risk-free interest rate of 6.4%. The effects of applying SFAS No. 123 in this
pro-forma disclosure may not be indicative of future results as the pro forma
disclosures do not apply to awards prior to July 1, 1995.
Additional awards in future years are anticipated.
Pension Plan
The Company participates in a non-contributory multi-employer defined benefit
pension plan covering substantially all employees. Actuarially determined
pension costs are funded as accrued. Separate actuarial valuations are not
prepared for each employer in the plan. Substantially all employees who attain
the age of 21 years and complete one year of service are eligible to participate
in this plan. Retirement benefits are based upon a formula utilizing years of
service and average compensation, as defined. Participants are vested 100% upon
the completion of five years of service. Total pension expense, including
administrative charges, was approximately $48 and $321 for the years ended June
30, 1997 and 1996, respectively.
Former Security Bank employees are included in a noncontributory multi-employer
trustee defined benefit pension plan. Actuarially determined pension costs are
funded as required by the plan trustee. Contributions to the plan and
administrative charges amounted to approximately $38 during the year ended June
30, 1997.
Effective February 1998, the employees of the former Security Bank were included
in the Company's non-contributory multi-employer defined benefit pension plan.
Total pension expense, including administrative charges, was approximately $20
for the year ended June 30, 1998.
48
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
Deferred Compensation Agreements
The Company has entered into deferred compensation agreements with certain key
employees that provide for predetermined periodic payments over 10 years upon
retirement or death.
Former key employees of Security Bank are covered by deferred compensation
agreements that provide for predetermined periodic payments over 15 years upon
retirement or death. The agreements specify a vesting schedule where by the key
employees vest 10% per year, but are not eligible for benefits if termination
occurs prior to completing three years of service beginning on the date of the
agreement. In the event of acquisition of the Company by a third party, the
deferred compensation agreements require any successor corporation to assume the
obligations of the agreements.
Amounts expensed under these agreements totaled approximately $346, $86 and $144
for 1998, 1997 and 1996, respectively.
Savings Plan
The Company has adopted an employee savings plan. To be eligible for the plan,
an employee must complete one year of full time employment. Annual contributions
match 50% of an employee's contributions, up to a maximum of 3% of the
participating employee's wages. Contributions for 1997 and 1996 totaled
approximately $77 and $86, respectively.
Former employees of Security Bank were covered under a separate plan until
February 1998. The Company matched 50% of an employee's contributions up to a
maximum of 3% of the participating employee's wages. Savings plan expense for
the year ended June 30, 1997 was approximately $26.
Effective February 1998, the Company merged the two savings plans. Savings plan
expense for the year ended June 30, 1998 for the combined plan was approximately
$184.
Employment Agreements
The Company has entered into employment contracts with certain senior officers
that provide benefits under certain conditions following a termination without
cause or a change in control of the Company.
- --------------------------------------------------------------------------------
(15) FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Company is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers and
to reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to extend credit and interest rate cap
agreements. These instruments involve, to varying degrees, elements of credit
and interest rate risk in excess of amounts recognized in the consolidated
balance sheets. The contract or notional amounts of these instruments reflect
the extent of involvement the Bank has in particular classes of financial
instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend 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. For interest rate cap agreements, the
contract or notional amounts do not represent exposure to credit loss. The
Company controls the credit risk of those instruments through credit approvals,
limits, and monitoring procedures.
49
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
Commitments to Extend Credit
Commitments to extend credit at June 30, 1998 are as follows:
Fixed rate ................................................. $ 8,925
Variable rate .............................................. 10,022
-------
$18,947
=======
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 terms which specify commitment periods of 45 days at interest
rates which approximate current market rates, adjusted for management's
assessment of the creditworthiness of the customer. In some cases, customers may
be required to pay a fee for the Company's commitment to lend. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. The
Company evaluates each customer's creditworthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary, upon extension of credit is
based on management's evaluation of the counterparty. Collateral held varies but
may include personal property, residential real property, and income-producing
commercial properties.
Interest Rate Caps
Interest rate caps entitle the Company to receive various interest payments in
exchange for payment of a transaction fee, provided the three-month LIBOR
exceeds an agreed upon interest rate. Transaction fees paid in connection with
interest rate cap agreements are amortized to interest expense as an adjustment
of the interest cost of liabilities. Interest rate cap agreements are used to
manage interest rate risk by synthetically extending the life of
interest-bearing liabilities.
The following summarizes interest rate cap agreements at June 30, 1998:
Notional principal amount Agreement termination Cap
------------------------- --------------------- ---
$5,000 (1) July 1999 6.5%
5,000 (1) July 1999 7.0%
5,000 (2) July 2000 6.0%
(1) The counterparty to the cap agreement is the FHLB of Seattle.
(2) The counterparty to the cap agreement is Merrill Lynch.
- --------------------------------------------------------------------------------
(16) RECENT ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED
In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No.
130, "Reporting Comprehensive Income" which the Company will be required to
adopt on July 1, 1998. SFAS No. 130 requires companies to report comprehensive
income. Comprehensive income will include net income, as well as other changes
in stockholders' equity that result from transactions and economic events other
than those with stockholders. The Company's only significant element of
comprehensive income is the unrealized gains and losses on available-for-sale
securities.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." SFAS No. 131 requires public business
enterprises to disclose selected information about operating segments including
segment income, revenues and asset data. It also establishes standards for
related disclosures about products and services, geographic areas and major
customers. SFAS No. 131
50
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
is effective for financial statements for periods beginning after December 15,
1997. Management of the Company is current assessing the effect of SFAS No. 131,
if any, on its financial statements.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. SFAS
No. 133 requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met.
Management of the Company is currently assessing the effect, if any, on its
financial statements of implementing SFAS No. 133. The Company will be required
to adopt the standard on July 1, 1999.
- --------------------------------------------------------------------------------
(17) RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
The reconciliation of net income to net cash provided by operating activities
for fiscal 1998, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------- -------
<S> <C> <C> <C>
Net income ...................................................................... $ 7,260 4,507 4,559
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of:
Deferred loan origination fees .............................................. (440) (439) (445)
Premiums and discounts on securities, loans and borrowings .................. (900) (1,138) (63)
RRP deferred compensation ..................................................... 188 499 473
ESOP shares committed to be released .......................................... 652 492 446
Provision for loan losses ..................................................... 840 400 --
Net (gain) loss on sales of:
Mortgage-backed securities available-for-sale ............................... (29) (57) (394)
Investment securities available-for-sale .................................... (68) 16 4
Loans ....................................................................... (956) (637) (187)
Premises and equipment ...................................................... (17) -- 127
Depreciation and amortization of premises and equipment ....................... 2,147 1,208 740
Goodwill and core deposit amortization ........................................ 1,391 532 --
Federal Home Loan Bank stock dividends ........................................ (975) (712) (521)
Origination of loans available-for-sale ....................................... (96,520) (54,396) (31,185)
Proceeds from sales of loans available-for-sale ............................... 94,254 55,300 30,365
Decrease (increase) in interest receivable .................................... (821) (562) 180
Interest expense credited to deposit accounts ................................. 26,938 18,704 15,724
Changes in other assets and liabilities ....................................... (2,209) 388 (266)
-------- ------- -------
Net cash provided by operating activities ................................. $ 30,735 24,105 19,557
======== ======= =======
</TABLE>
- --------------------------------------------------------------------------------
(18) NON-CASH INVESTING AND FINANCING ACTIVITIES
On June 23, 1998, the Company declared a dividend of approximately $1,005 which
is recorded in accrued expenses and other liabilities at June 30, 1998.
On June 24, 1997, the Company declared a dividend of approximately $840 which is
recorded in accrued expenses and other liabilities at June 30, 1997.
51
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
On June 28, 1996, the Company declared a dividend of approximately $541 which is
recorded in accrued expenses and other liabilities at June 30, 1996.
Effective December 31, 1995, the Company reclassified approximately $10,608 of
mortgage-backed securities from the held-to-maturity to the available-for-sale
classification. The net unrealized loss related to these mortgage-backed
securities was approximately $140 at the date of reclassification.
During 1997, the Company issued common stock under the RRP and recorded deferred
compensation of approximately $106. No common stock was issued under the RRP in
fiscal 1998 or 1996.
Real estate owned acquired through foreclosures of loans receivable was
approximately $546 for 1998. No real estate owned was acquired in fiscal 1997 or
1996.
Treasury stock of approximately $1, $2 and $13 was recorded due to forfeitures
of unearned RRP shares for fiscal 1998, 1997 and 1996, respectively.
In conjunction with the acquisition of Security Bancorp, the Company issued
common shares valued at $21,062 and options with an intrinsic value of $873.
- --------------------------------------------------------------------------------
(19) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following fair value estimates, methods and assumptions were used to measure
the fair value of each class of financial instrument for which it is practical
to estimate that value.
Cash and Cash Equivalents and Interest-Bearing Deposits
For such cash and short-term investments, the carrying amount was considered to
be a reasonable estimate of fair value.
Investment and Mortgage-Backed Securities
For investment and mortgage-backed securities, fair values were based on quoted
market prices or dealer quotes. If a quoted market price was not available, fair
values were estimated using quoted market prices for similar securities.
Stock in Federal Home Loan Bank of Seattle
For FHLB stock, the carrying amount was considered to be a reasonable estimate
of fair value.
Loans
Fair values were estimated for portfolios of performing and nonperforming loans
with similar financial characteristics. For certain analogous categories of
loans, such as residential mortgages, home equity loans, non-residential
mortgages, and consumer loans, fair value was estimated using the quoted market
prices for securities backed by similar loans, adjusted for differences in loan
characteristics. The fair value of other performing loan types was estimated by
discounting the future cash flows using market discount rates that reflect the
credit, collateral, and interest rate risk inherent in the loan.
Deposits
The fair value of demand deposits, savings deposits and money market accounts
were the amounts payable on demand at June 30, 1998 and 1997. The fair value of
certificates of deposit is estimated based on the discounted value of
contractual cash flows using rates derived from the U.S. Treasury yield curve,
adjusted for certificate redemption features.
Short-Term Borrowings
For short-term borrowings, the carrying amount was considered to be a reasonable
estimate of fair value.
Long-Term Borrowings
The fair value for long-term borrowings was based upon the discounted value of
the cash flows. The discount rates utilized were based on rates currently
available with similar terms and maturities.
52
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
The estimated fair values of financial instruments at June 30 are as follows:
<TABLE>
<CAPTION>
1998 1997
------------------ -----------------
Carrying Fair Carrying Fair
value value value value
-------- ------- -------- -------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents ...................... $ 29,068 29,068 17,159 17,159
Interest-bearing deposits ...................... 100 100 2,000 2,000
Investment securities .......................... 16,847 16,974 27,466 27,728
Investment securities available-for-sale ....... 108,511 108,511 51,683 51,683
Stock in Federal Home Loan Bank of Seattle ..... 13,560 13,560 11,456 11,456
Mortgage-backed securities ..................... 102,298 104,962 117,781 119,193
Mortgage-backed securities available-for-sale .. 24,135 24,135 31,388 31,388
Loans, net ..................................... 650,371 654,037 626,577 628,058
Loans available-for-sale ....................... 6,922 6,922 3,700 3,700
Financial liabilities:
Deposits ....................................... 636,441 637,529 630,869 630,171
Repurchase agreements .......................... 6,233 6,233 7,786 7,786
Borrowed funds ................................. 248,953 249,792 191,450 190,115
Off-balance-sheet items:
Interest rate cap agreements: notional
amount of $15,000 and $10,000 ................ -- 24 -- 58
======== ======= ======= =======
</TABLE>
Limitations
The foregoing fair value estimates are made at a specific point in time, based
on pertinent market data and relevant information on the financial instrument.
These estimates do not include any premium or discount that could result from an
offer to sell, at one time, the entire holdings of a particular financial
instrument or category thereof. Since no market exists for a substantial portion
of the financial instruments, fair value estimates were necessarily based on
judgments with respect to future expected loss experience, current economic
conditions, risk assessments of various financial instruments involving a myriad
of individual borrowers, and other factors. Given the innately subjective nature
of these estimates, the uncertainties surrounding them and the matters of
significant judgment that must be applied, these fair value estimations cannot
be calculated with precision. Modifications in such assumptions could
meaningfully alter these estimates.
Since these fair value approximations were made solely for on- and off-balance
sheet financial instruments, no attempt was made to estimate the value of
anticipated future business and the value of nonfinancial statement assets and
liabilities. Other important elements which are not deemed to be financial
assets or liabilities include the value of the Company's retail branch delivery
system, its existing core deposit base, premises and equipment and goodwill.
Further, certain tax implications related to the realization of the unrealized
gains and losses could have a substantial impact on these fair value estimates
and have not been incorporated into any of the estimates.
53
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
(20) MORTGAGE BANKING ACTIVITIES
Mortgage banking revenues for fiscal 1998, 1997 and 1996 are presented below:
1998 1997 1996
------ ----- -----
Origination fees .................................. $2,268 667 348
Servicing fees .................................... 795 694 626
Net gains on sales of loans ....................... 956 637 187
------ ----- -----
Total mortgage banking revenues ................... $4,019 1,998 1,161
====== ===== =====
Mortgage loans serviced for others are not included in the accompanying
consolidated financial statements. The unpaid balances of these loans were
approximately $260,300, $268,600 and $183,300 at June 30, 1998, 1997 and 1996,
respectively.
Mortgage servicing rights were approximately $1,062 and $1,239 at June 30, 1998
and 1997, respectively, and are recorded in other assets. Included in these
amounts are $721 and $847 of unamortized servicing rights related to the
acquisition of Security Bancorp at June 30, 1998 and 1997, respectively.
Amortization of the mortgage servicing rights was approximately $214, $114 and
$54 for fiscal 1998, 1997 and 1996, respectively.
- --------------------------------------------------------------------------------
(21) WESTERFED INFORMATION
The summarized condensed financial information for WesterFed Financial
Corporation as of and for the years ending June 30, 1998 and 1997 are presented
below:
Condensed Balance Sheets 1998 1997
- ------------------------ -------- -------
Assets:
Cash and cash equivalents ............................... $ 17 4
Interest-bearing and due from banks deposits ............ 402 963
Investment securities available-for-sale ................ 5,146 2,541
Taxes receivable ........................................ 336 --
Other assets ............................................ 47 134
Investment in subsidiaries .............................. 104,897 102,033
-------- -------
Total assets ........................................ $110,845 105,675
======== =======
Liabilities and Stockholders' Equity:
Other liabilities ....................................... $ 1,145 1,416
Stockholders' Equity:
Common stock .......................................... 56 56
Additional paid-in capital ............................ 68,860 67,941
Common stock acquired by ESOP/RRP ..................... (2,457) (2,936)
Treasury stock at cost ................................ (3,461) (3,081)
Net unrealized gain (loss) on securities
available-for-sale .................................. 23 (35)
Retained earnings ..................................... 46,679 42,314
-------- -------
Total stockholders' equity .......................... 109,700 104,259
-------- -------
Total liabilities and stockholders' equity .......... $110,845 105,675
======== =======
54
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
Year ended June 30,
-------------------
Condensed Statements of Income 1998 1997
- ------------------------------ -------- -------
Dividends from the Bank ................................. $ 5,000 14,000
Interest income ......................................... 233 735
Non-interest expense .................................... (677) (428)
-------- -------
Income before income taxes ............................ 4,556 14,307
Income taxes ............................................ 79 (140)
-------- -------
Income before undistributed earnings of subsidiaries .. 4,635 14,167
Undistributed (distributions in excess of) earnings
of subsidiaries ....................................... 2,625 (9,660)
-------- -------
Net income ............................................ $ 7,260 4,507
======== =======
Condensed Statements of Cash Flows
- ----------------------------------
Operating Activities:
Net income ............................................ $ 7,260 4,507
Adjustments to reconcile net income to net cash
provided by operating activities:
Distributions in excess of (equity in undistributed)
earnings of subsidiaries .......................... (2,625) 9,660
Amortization of premiums on investments and
mortgage-backed securities available-for-sale ..... (182) (298)
ESOP shares committed to be released ................ 652 492
Net loss on sale of mortgage-backed securities ...... -- 6
Increase in other assets and liabilities, net ....... (686) 561
-------- -------
Net cash provided by operating activities ......... 4,419 14,928
-------- -------
Investing Activities:
Net change in interest-bearing deposits ............... 561 (189)
Purchase of investment securities ..................... (23,766) (20,142)
Principal payments and sales proceeds of
mortgage-backed securities .......................... -- 3,059
Proceeds from maturities of investment securities ..... 21,350 30,784
Acquisition of Security Bancorp, including direct
acquisition costs of $794 ........................... -- (26,789)
Other ................................................. -- 12
-------- -------
Net cash used in investing activities ............. (1,855) (13,265)
-------- -------
Financing Activities:
Dividends paid to stockholders ........................ (2,729) (1,867)
Proceeds from exercise of stock options and
stock issuances ..................................... 557 194
Purchase of treasury stock ............................ (379) --
-------- -------
Net cash used in financing activities ............. (2,551) (1,673)
-------- -------
Increase (decrease) in cash and cash equivalents ........ 13 (10)
Cash and cash equivalents at beginning of year .......... 4 14
-------- -------
Cash and cash equivalents at end of year .......... $ 17 4
======== =======
55
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
(22) CONDENSED QUARTERLY RESULTS OF OPERATIONS
Fiscal 1998
-------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest income ........................ $18,565 18,866 18,764 18,329
Interest expense ....................... 10,460 10,843 10,651 10,332
------- ------- ------- -------
Net interest income ................ 8,105 8,023 8,113 7,997
Provision for loan losses .............. (210) (210) (256) (164)
Noninterest income ..................... 2,300 2,123 1,995 1,963
Noninterest expense .................... (6,910) (7,581) (6,415) (6,853)
------- ------- ------- -------
Income before income tax expense ... 3,285 2,355 3,437 2,943
Income tax expense ..................... (1,292) (995) (1,339) (1,134)
------- ------- ------- -------
Net income ......................... $ 1,993 1,360 2,098 1,809
======= ======= ======= =======
Net income per share:
Basic ................................ $ .37 .26 .40 .34
======= ======= ======= =======
Diluted .............................. $ .35 .24 .37 .32
======= ======= ======= =======
Fiscal 1997
-------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest income ........................ $18,565 18,866 18,764 18,329
Interest income ........................ $17,454 12,585 10,628 10,593
Interest expense ....................... 9,623 6,929 5,905 5,950
------- ------ ------ ------
Net interest income ................ 7,831 5,656 4,723 4,643
Provision for loan losses .............. (297) (61) (27) (15)
Noninterest income ..................... 1,927 1,020 903 835
Noninterest expense .................... (6,780) (4,606) (3,451) (5,731)
------- ------ ------ ------
Income (loss) before income tax
expense .......................... 2,681 2,009 2,148 (268)
Income tax (expense) benefit ........... (542) (814) (796) 89
------- ------ ------ ------
Net income (loss) .................. $ 2,139 1,195 1,352 (179)
======= ====== ====== ======
Net income (loss) per share:
Basic................................. $ .41 .27 .33 (.04)
======= ====== ====== ======
Diluted............................... $ .38 .25 .32 (.04)
======= ====== ====== ======
56
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
(23) EARNINGS PER SHARE
The following table sets forth the compilation of basic and diluted earnings per
share:
<TABLE>
<CAPTION>
For the year ended June 30, 1998 1997 1996
- --------------------------- --------- --------- ---------
<S> <C> <C> <C>
Number of shares on which basic earnings per share
is calculated:
Average outstanding shares during the fiscal year ...... 5,317,577 4,458,079 4,036,979
Add: Incremental shares under stock option plans ....... 293,866 220,259 148,599
Incremental shares related to RRPs ................ 12,723 25,901 36,085
--------- --------- ---------
Number of shares on which diluted earnings per
share is calculated ...................................... 5,624,166 4,704,239 4,221,663
--------- --------- ---------
Net income applicable to common stockholders ............... $ 7,260 4,507 4,559
========= ========= =========
Basic earnings per share ................................... $ 1.37 1.01 1.13
========= ========= =========
Diluted earnings per share ................................. $ 1.29 .96 1.08
========= ========= =========
</TABLE>
Stock options to purchase 57,085 shares in 1997 were outstanding, but were not
included in the computation of diluted earnings per share because the options'
exercise price was greater than the average market price of the common shares
and, therefore, the effect would be antidilutive. No stock options were excluded
from the computation of diluted earnings per share in 1998 or 1996.
- --------------------------------------------------------------------------------
(24) ACQUISITION
On February 28, 1997, WesterFed completed the acquisition of Security Bancorp,
accounted for as a purchase transaction and, accordingly, the consolidated
statement of income for 1997 includes the results of operations of Security
Bancorp commencing March 1, 1997. Under this method of accounting, assets and
liabilities of Security Bancorp are adjusted to their estimated fair value and
combined with the historical recorded book values of the assets and liabilities
of the Bank. WesterFed issued 1,150,175 shares of common stock, options to
acquire 94,696 common shares and committed to pay $25,995 in cash for all of the
outstanding shares of Security Bancorp common stock, for total consideration of
$48,724. Pursuant to a Merger Agreement, Security Bancorp stockholders were
given the opportunity to elect to receive either cash, WesterFed common stock or
a combination of both in exchange for Security Bancorp common stock. As a
result, stockholders who elected to receive cash or did not make an election,
received $30 for each share of Security Bancorp common stock. Stockholders who
elected to receive stock, or a combination of cash and stock, exchanged
approximately 46.42% of the outstanding Security Bancorp common stock in
exchange for WesterFed common stock (based on a ratio of 1.78 shares of
WesterFed common stock for each share of Security Bancorp common stock) and the
remainder in cash. Stockholders who were due a fractional share, received cash
in lieu of the fractional share, paid on the basis of $30 per share. In
addition, as of such date, Security Bank, a federally chartered stock savings
bank and wholly-owned subsidiary of Security Bancorp, merged with and into the
Bank.
57
<PAGE>
WesterFed Financial Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
During February 1998, WesterFed finalized its allocation of purchase price
related to the acquisition. Changes in preliminary estimates of the fair values
were as follows:
Decrease in premises and equipment ........................ $(1,592)
Decrease in other assets .................................. (603)
Decrease in deferred tax liabilities ...................... 1,753
Increase in other liabilities ............................. (391)
-------
Decrease in goodwill ...................................... $ (833)
=======
58
<PAGE>
Corporate Information
[Graphic omitted]
WESTERFED FINANCIAL CORPORATION
59
<PAGE>
General Corporate and Stockholders' Information
CORPORATE HEADQUARTERS
110 E. Broadway
Missoula, MT 59802
(406) 721-5254
INDEPENDENT ACCOUNTANTS
KPMG Peat Marwick LLP
Billings, MT
GENERAL COUNSEL
Worden, Thane and Haines, P.C.
Missoula, MT
SPECIAL COUNSEL
Silver, Freedman and Taff, LLP
Washington, D.C.
TRANSFER AGENT, REGISTRAR AND
DIVIDEND DISBURSING AGENT
Stockholder inquiries regarding transfer requirements, dividends, lost
certificates and changes of address should be directed to the transfer agent:
Davidson Trust Co.
9 Third Street North, Suite 200
P.O. Box 2309
Great Falls, MT 59403-2309
1-800-634-5526
ANNUAL MEETING
The annual meeting of stockholders will be held on Tuesday, October 27, 1998,
beginning at 9 a.m. at the Southgate Office, 2601 Garfield, Missoula, MT
FORM 10-K
This report is available to stockholders of record without charge upon written
request to:
Douglas G. Bardwell
Corporate Secretary
WesterFed Financial Corporation
110 E. Broadway
Missoula, MT 59802
STOCK INFORMATION
WesterFed stock is traded in the over-the-counter market with quotations through
the Nasdaq National Market System under the symbol WSTR.
At June 30, 1998, there were 1,099 stockholders of record.
At June 30, 1998 there were approximately 2,285 beneficial stockholders.
To request information on dividend reinvestment, please contact:
Dale Brevik
Investor Relations
WesterFed Financial Corporation
110 E. Broadway
Missoula, MT 59802
Phone: 406-543-1315
WESTERFED FINANCIAL CORPORATION
60
<PAGE>
General Corporate and Stockholders' Information
Stock Prices Dividends
Quarter Ended High Low Declared
- ------------- ---- --- --------
March 31, 1996 $ 16.75 14.75 .085
June 30, 1996 $ 14.88 14.00 .123*
September 30, 1996 $ 16.13 13.88 .095
December 31, 1996 $ 18.75 15.63 .10
March 31, 1997 $ 21.75 17.75 .105
June 30, 1997 $ 20.75 17.25 .151**
September 30, 1997 $ 26.75 20.00 .115
December 31, 1997 $ 27.00 22.25 .12
March 31, 1998 $ 26.75 24.50 .125
June 30, 1998 $ 26.63 24.00 .18***
* Declared June 26, 1996, payable August 20 to stockholders of record August 6.
Includes a special dividend of $0.033 per share.
** Declared June 30, 1997, payable August 20 to stockholders of record August 6.
Includes a special dividend of $0.041 per share.
*** Declared June 23, 1998, payable August 24 to stockholders of record August
10. Includes a special dividend of $0.05 per share.
MARKET MAKERS
Sandler O'Neill & Partners
Keefe, Bruyette & Woods, Incorporated
Hoefer & Arnett, Incorporated
Troster Singer Corporation
D.A. Davidson & Company, Incorporated
Friedman Billings Ramsey & Company
Everen Securities Incorporated
Piper Jaffray Companies Incorporated
WESTERFED OFFICERS
Lyle R. Grimes
President, Chairman and Chief Executive Officer
James A. Salisbury, CPA
Treasurer/Chief Financial Officer
Douglas G. Bardwell
Vice President/Secretary
David W. Jorgenson
Vice President
Ronald F. Halls
Assistant Secretary
WESTERFED DIRECTORS
Lyle R. Grimes
Chairman
John E. Roemer
Vice Chairman
Dr. Marvin Reynolds
Dr. Otto Klein, Jr.
Robert F. Burke
Laurie DeMarois
David W. Jorgenson
William Leslie
WESTERFED FINANCIAL CORPORATION
61
Exhibit 21
Subsidiaries of Registrant
<PAGE>
SUBSIDIARIES OF THE REGISTRANT
<TABLE>
<CAPTION>
Percent State of
of Incorporation
Parent Subsidiary Ownership or Organization
- ------------------------------- ------------------------------------------ --------- ---------------
<S> <C> <C> <C>
WesterFed Financial Corporation Western Security Bank 100% Federal
Western Security Bank Monte Mac I 100% Montana
Western Security Bank Western Security Investment Services, Inc. 100% Montana
Western Security Bank Service Corporation of Montana 100% Montana
Western Security Bank WesterFed Insurance Services, Inc. 100% Montana
</TABLE>
Exhibit 23
Consent of Experts and Counsel
<PAGE>
Independent Accountants' Consent
The Board of Directors
WesterFed Financial Corporation:
We consent to incorporation by reference in the registration statement on Form
S-8 (No. 33-85350) of WesterFed Financial Corporation of our report dated July
24, 1998, relating to the consolidated balance sheets of WesterFed Financial
Corporation and subsidiaries as of June 30, 1998 and 1997, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the years in the three-year period ended June 30, 1998, which report appears
in the June 30, 1998 annual report on Form 10-K of WesterFed Financial
Corporation.
KPMG Peat Marwick LLP
Billings, Montana
September 24, 1998
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE ANNUAL
REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED JUNE 30, 1998 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-END> JUN-30-1998
<CASH> 29,068
<INT-BEARING-DEPOSITS> 100
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 132,646
<INVESTMENTS-CARRYING> 132,705
<INVESTMENTS-MARKET> 135,496
<LOANS> 657,293
<ALLOWANCE> 4,907
<TOTAL-ASSETS> 1,022,136
<DEPOSITS> 636,441
<SHORT-TERM> 171,768
<LIABILITIES-OTHER> 20,809
<LONG-TERM> 76,365
<COMMON> 56
0
0
<OTHER-SE> 109,644
<TOTAL-LIABILITIES-AND-EQUITY> 1,022,136
<INTEREST-LOAN> 56,261
<INTEREST-INVEST> 17,931
<INTEREST-OTHER> 332
<INTEREST-TOTAL> 74,524
<INTEREST-DEPOSIT> 27,803
<INTEREST-EXPENSE> 42,286
<INTEREST-INCOME-NET> 32,238
<LOAN-LOSSES> 840
<SECURITIES-GAINS> 97
<EXPENSE-OTHER> 6,429
<INCOME-PRETAX> 12,020
<INCOME-PRE-EXTRAORDINARY> 7,260
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,260
<EPS-PRIMARY> 1.37
<EPS-DILUTED> 1.29
<YIELD-ACTUAL> 0
<LOANS-NON> 3,989
<LOANS-PAST> 626
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 4,651
<CHARGE-OFFS> 637
<RECOVERIES> 53
<ALLOWANCE-CLOSE> 4,907
<ALLOWANCE-DOMESTIC> 4,907
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 400
</TABLE>
