FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended...........................................
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from April 1, 1999 to December 31, 1999
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Commission File Number 0-26584
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FIRST WASHINGTON BANCORP, INC.
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(Exact name of registrant as specified in its charter)
Washington 91-1691604
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10 S. First Avenue Walla Walla, Washington 99362
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(Address of principal executive offices and zip code)
(509) 527-3636
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(Registrant's telephone number, including area code)
N/A
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(Former name, former address and former fiscal year,
if changed since last report.)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to section 12(g) of the Act:
Common Stock $.01 par value per share
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(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 filing requirements for the past 90 days.
Yes X No
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Indicate by check mark if disclosure of delinquent files pursuant to Item 405
of Regulations 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
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The aggregate market value of the voting stock held by nonaffiliates of the
registrant as of February 29, 2000:
Common Stock - $156,784,026
The number of shares outstanding of the issuer's classes of common stock as of
February 29, 2000:
Common Stock, $.01 par value 11,198,859 shares
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DOCUMENT INCORPORATED BY REFERENCE
Portions of Proxy Statement for Annual Meeting of Shareholders to be held
April 21, 2000 are incorporated by reference into Part III.
FIRST WASHINGTON BANCORP, INC., AND SUBSIDIARIES
Table of Contents
PART I Page #
Item 1. Business....................................................... 3
General........................................................ 3
Acquisition and Mergers........................................ 4
Dividend Reinvestment and Stock Purchase Plan.................. 5
Lending Activities............................................. 5
Asset Quality..................................................13
Allowance for Loan Losses......................................16
Investment Activities..........................................19
Deposit Activities and Other Sources of Funds..................25
Personnel......................................................27
Taxation.......................................................27
Environmental Regulation.......................................29
Competition....................................................29
Regulation.....................................................30
Management Personnel...........................................35
Item 2. Properties.....................................................36
Item 3. Legal Proceedings..............................................36
Item 4. Submission of Matters to a Vote of Security Holders............36
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters...........................................37
Item 6. Selected Financial Data........................................38
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operation............................40
Comparison of Results of Operations
Nine months ended December 31, 1999 vs. 1998.............43
Years ended March 31, 1999 vs. 1998......................46
Market Risk and Asset/ Liability Management.................52
Liquidity and Capital Resources.............................57
Capital Requirements........................................58
Effect of Inflation and Changing Prices.....................58
Recent Accounting Standards Not Yet Adopted.................58
Item 8. Financial Statements and Supplementary Data....................59
Item 9. Changes in and Disagreements with Accountant
on Accounting and Financial Disclosure........................59
PART III
Item 10. Directors and Executive Officers of the Registrant.............60
Item 11. Executive Compensation.........................................60
Item 12. Security Ownership of Certain Beneficial Owners and Management.60
Item 13. Certain Relationships and Related Transactions.................60
PART IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K............................................61
SIGNATURES.....................................................62
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PART 1
Item 1 - Business
General
First Washington Bancorp, Inc. (the Company or FWWB), a Washington
corporation, is primarily engaged in the business of planning, directing and
coordinating the business activities of its wholly owned subsidiaries, First
Savings Bank of Washington (FSBW), Inland Empire Bank (IEB) and Towne Bank
(TB) (together, the Banks). FSBW is a Washington-chartered savings bank the
deposits of which are insured by the Federal Deposit Insurance Corporation
(FDIC) under the Savings Association Insurance Fund (SAIF). FSBW conducts
business from its main office in Walla Walla, Washington and its 23 branch
offices and four loan production offices located in Washington and Idaho.
Effective April 1, 1999 FSBW completed the acquisition of Seaport Citizens
Bank (SCB). SCB was merged with FSBW and its two branches in Lewiston, Idaho,
together with FSBW's Clarkston, Washington, branch operate as a division of
FSBW. Effective January 1, 1999, FWWB completed the acquisition of Whatcom
State Bancorp whose wholly-owned subsidiary, Whatcom State Bank (WSB), was
merged with FSBW and operates as Whatcom State Bank, a Division of First
Savings Bank of Washington. WSB, which is based in Bellingham, operates five
full service branches and a loan office in northwest Washington. IEB is an
Oregon-chartered commercial bank whose deposits are insured by the FDIC under
the Bank Insurance Fund (BIF). IEB conducts business from its main office in
Hermiston, Oregon and its six branch offices and two loan production offices
located in northeast Oregon. TB is a Washington-chartered commercial bank
whose deposits are insured by the FDIC under BIF. TB conducts business from
seven full service branches in the Seattle, Washington, metropolitan area.
The operating results of the Company depend substantially on its net interest
income, which is the difference between interest income on interest-earning
assets, consisting of loans and securities, and interest expense on interest-
bearing liabilities, composed primarily of deposits and borrowings. Net
interest income is a function of the Company's interest rate spread, which is
the difference between the yield earned on interest-earning assets and the
rate paid on interest-bearing liabilities, as well as a function of the
average balance of interest-earning assets as compared to the average balance
of interest-bearing liabilities. The Company's net income also is affected by
provisions for loan losses and the level of its other income, including
deposit service charges, loan servicing fees, and gains and losses on the sale
of loans and securities, as well as its non-interest operating expenses and
income tax provisions.
FSBW is a community oriented savings bank which has traditionally offered a
wide variety of deposit products to its retail customers while concentrating
its lending activities on real estate loans. Lending activities have been
focused primarily on the origination of loans secured by one- to four-family
residential dwellings, including significant emphasis on loans for
construction of residential dwellings. To an increasing extent, lending
activities also have included the origination of multifamily, commercial real
estate and consumer loans. FSBW's primary business has been that of a
traditional banking institution, originating loans for portfolio in its
primary market area. FSBW has also been an active participant in the
secondary market, originating residential loans for sale and on occasion
acquiring loans for portfolio.. More recently, FSBW has begun making non-
mortgage commercial and agribusiness loans to small businesses and farmers.
Non-mortgage lending, especially commercial lending, has received significant
attention and has become an increasingly important part of FSBW's operations
in recent years. The acquisitions of WSB and SCB have added to the amount of
non-mortgage loans held and being originated by FSBW. In addition to loans,
FSBW has maintained a significant portion of its assets in marketable
securities. The securities portfolio has been weighted toward mortgage-backed
securities secured by one- to four-family residential properties. This
portfolio also has included a significant amount of tax exempt municipal
securities, primarily issued by entities located in the State of Washington.
In addition to interest income on loans and investment securities, FSBW
receives other income from deposit service charges, loan servicing fees and
from the sale of loans and investments. FSBW also has a wholly-owned
subsidiary, Northwest Financial Corporation, which serves as the trustee under
FSBW's mortgage loan documents and receives commissions from the sale of
annuities.
IEB is a community oriented commercial bank which historically has offered a
wide variety of deposits and loan products to its consumer and commercial
customers. Lending activities have included origination of consumer,
commercial, agribusiness and real estate loans. IEB also has engaged in
mortgage banking activity with respect to residential lending within its local
markets, originating loans for sale generally on a servicing released basis.
Additionally, IEB has maintained a significant portion of its assets in
marketable securities, particularly U.S. Treasury and government agency
securities as well as tax exempt municipal securities issued primarily by
entities located in the State of Oregon. IEB operates a division, Inland
Financial Services, which
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offers insurance and brokerage services to its customers. IEB has two wholly
owned subsidiaries: Pioneer American Property Company, which owns a building
that is leased to IEB, and Inland Securities Corporation, which previously
made a market for IEB's stock but is currently inactive.
TB is a community oriented commercial bank chartered in the State of
Washington. TB's lending activities consist of granting commercial loans,
including commercial real estate, land development and construction loans, and
consumer loans to customers throughout King and Snohomish counties in western
Washington. TB is a "Preferred Lender" with the Small Business Administration
(SBA) and generates SBA guaranteed loans for portfolio and for resale. TB
also offers a wide variety of deposit products to its consumer and commercial
customers.
The Company and the Banks are subject to regulation by the Federal Reserve
Board (FRB) and the FDIC, the State of Washington Department of Financial
Institutions, Division of Banks (Division), the State of Oregon Department of
Consumer and Business Services and the State of Idaho, Department of Finance.
During May 1999, the Company announced its decision to change its fiscal year
from April 1 through March 31 to January 1 through December 31. The current
fiscal period is for the transition period April 1, 1999 through December 31,
1999. For discussion and analysis purposes, the nine months ended December
31, 1999 are compared to the unaudited nine months ended December 31, 1998.
Acquisitions and Mergers
Seaport Citizens Bank
On April 1, 1999, FWWB and FSBW completed the acquisition of Seaport Citizens
Bank (SCB). FSBW paid $10.1 million in cash for all the outstanding common
shares of SCB, which was headquartered in Lewiston, Idaho. As a result of the
merger of SCB into FSBW, SCB became a division of FSBW. The acquisition was
accounted for as a purchase in the current period and resulted in the
recording of $6.1 million of costs in excess of the fair value of SCB's net
assets acquired (goodwill). Goodwill assets are being amortized over a 14-
year period and resulted in a current charge to earnings of $108,100 per
quarter, beginning in the first quarter of the current period, or $433,000 per
year. Founded in 1979, SCB is a commercial bank which had, before recording of
purchase accounting adjustments, approximately $45 million in total assets,
$41 million in deposits, $27 million in loans, and $4.1 million in
shareholders' equity at March 31, 1999. SCB operates two full service
branches in Lewiston, Idaho. SCB's results of operations are included in the
Company's consolidated results of operations (or financial statements) for the
nine months ended December 31, 1999.
Consolidation of Banking Operations
On July 22, 1999 the Company announced its plans to combine its three separate
banking subsidiaries into a single community banking franchise. The
combination was designed to strengthen the Company's commitment to community
banking by more effectively sharing the resources of the existing
subsidiaries, improving operating efficiency and developing a broader regional
brand identity.. The consolidation was intended to be done in stages. The
first phase, which was expected to be completed by January 1, 2000, included
the merger of TB and FSBW and the selection of a single name and charter to be
used by TB, FSBW, WSB and SCB. Final integration of all data processing into
a common system and the merger of Inland Empire Bank was scheduled for
completion by December 31, 2000.
On December 23, 1999, the Company announced its decision to temporarily
postpone the previously announced consolidation of its subsidiaries, TB and
IEB, into FSBW in light of the new Gramm-Leach-Bliley financial modernization
legislation. The recent legislation enacts Federal Home Loan Bank System
reforms that impact community financial institutions. A community financial
institution (CFI) is defined as a "member of the Federal Home Loan Bank
System, the deposits of which are insured by the FDIC and that has average
total assets (over the preceding 3 years) of less than $500 million." One
provision of the reforms provides community financial institutions with the
ability to obtain long-term FHLB advances to fund small business, small farm
and small agribusiness loans. In addition, community financial institutions
will be able to offer these loans as collateral for such borrowings. This
provision, which represents a change in policy from the previous requirement
that these funds be secured primarily by residential mortgage loans, will be
available only to community financial institutions. As independent
subsidiaries, TB and IEB currently qualify as community financial
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institutions. Merging either of these two subsidiaries into FSBW could
disqualify them and remove this favorable status. Based on the information
available at this time, the Company believes that TB and IEB could derive
significant benefits from this legislation. Rather than complete the proposed
bank mergers as previously announced, the Company has chosen to allow adequate
time for an in-depth review and interpretation of the regulations as they
pertain to future plans. Consolidation of support operations continues on
schedule and budget and First Washington expects to receive long-term benefits
from the proposed efficiencies. Postponement of the mergers will have minimal
impact on the operational changes. The previously announced name and charter
changes scheduled for spring 2000 are expected to proceed for FSBW, including
its WSB and SCB divisions.
Dividend Reinvestment and Stock Purchase Plan
In October 1997, the Company adopted a dividend reinvestment and stock
purchase plan. Under the terms of the plan all registered stockholders with
100 or more shares of stock may automatically reinvest all or a portion of
their cash dividends in additional shares of the Company's common stock. In
addition, qualifying participants may also make optional monthly cash payments
of $50 to $1,500 to purchase additional shares of Company stock.
Lending Activities
General: The Banks have offered a wide range of loan products to meet the
demands of their customers. The Banks originate loans for both their own loan
portfolios and for sale in the secondary market. Management's strategy has
been to maintain a significant percentage of assets in these loan portfolios
in loans with more frequent interest rate repricing terms or shorter
maturities than traditional long term fixed-rate mortgage loans. As part of
this effort, the Banks have developed a variety of floating or adjustable
interest rate products that correlate closer with the Banks' cost of funds.
However, in response to customer demand, the Banks continue to originate
fixed-rate loans including fixed interest rate mortgage loans with terms up to
30 years. The relative amount of fixed-rate loans and adjustable-rate loans
that can be originated at any time is largely determined by the demand for
each in a competitive environment.
Historically, FSBW's primary lending focus has been on the origination of
loans secured by first mortgages on owner-occupied, one- to four-family
residences and loans for the construction of one- to four-family residences.
FSBW also has originated, to a lesser degree, consumer, commercial real
estate, multifamily real estate and land loans. More recently, FSBW has begun
marketing non- mortgage commercial and agribusiness loans to small businesses
and farmers. Management expects this type of lending to increase at FSBW. At
December 31, 1999, FSBW's net loan portfolio totaled $890.6 million. Over 77%
of FSBW's first mortgage loans are secured by properties located in the State
of Washington.
The aggregate amount of loans that FSBW is permitted to make under applicable
federal regulations to any one borrower, including related entities, is the
greater of 20% of unimpaired capital and surplus or $500,000. At December 31,
1999, the maximum amount which FSBW could have lent to any one borrower and
the borrower's related entities was $21.6 million. At December 31, 1999, FSBW
had no loans to one borrower with an aggregate outstanding balance in excess
of this amount. FSBW had 49 borrowers with total loans outstanding in excess
of $2.0 million at December 31, 1999. At that date, the largest amount
outstanding to any one borrower and the borrower's related entities totaled
$13.2 million, which consisted of a medical facility located in Bellingham,
Washington other properties and a line of credit and as of December 31, 1999
the loans were performing in accordance with their terms.
Lending activities at Inland Empire Bank have included origination of
consumer, commercial, agribusiness and commercial real estate loans. In
particular, IEB has developed significant expertise and market share with
respect to small business and agricultural loans within its local markets. In
addition, IEB has originated one- to four-family residential real estate loans
for sale in the secondary market.
At December 31, 1999, IEB's net loan portfolio totaled $149.5 million. The
aggregate amount of loans that IEB is permitted to make under applicable state
and federal regulations to any one borrower, including related entities, is
15% of the aggregate paid-up and unimpaired capital and surplus. At December
31, 1999, the maximum amount IEB could have lent to any one borrower and the
borrower's related entities was $3.3 million ($5.3 million if secured by real
estate). At that date, the largest amount outstanding to any one borrower of
IEB totaled $3.3 million and was a participation with FSBW (see above) on a
loan secured by a medical facility located in Bellingham, WA.
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Lending activities at Towne Bank have included origination of consumer,
commercial, commercial real estate and construction loans. In particular, TB
has developed significant expertise and growing market share with respect to
small business loans within its local markets.
At December 31, 1999, TB's net loan portfolio totaled $268.0 million. The
aggregate amount of loans TB is permitted to make under applicable state and
federal regulations to any one borrower, including related entities, is 20% of
the aggregate paid-up and unimpaired capital and surplus. At December 31,
1999, the maximum amount TB could have lent to any one borrower and the
borrower's related entities was $5.4 million. At that date, the largest
amount outstanding to any one borrower of TB totaled $2.5 million consisted of
a two-motel operation in the Seattle area.
One- to Four-Family Residential Real Estate Lending: The Banks originate
loans secured by first mortgages on owner-occupied, one- to four-family
residences and loans for the construction of one- to four-family residences in
the communities where they have established full service branches. In
addition, the Banks operate loan production offices in Bellevue, Puyallup, Oak
Harbor and Spokane, Washington and LaGrande and Condon, Oregon. FSBW also has
a significant relationship with a mortgage loan broker in the greater
Portland, Oregon market. At December 31, 1999, $436.7 million, or 30.9% of
the Company's loan portfolio, consisted of permanent loans on one- to four-
family residences.
Historically, FSBW has originated both fixed-rate loans and adjustable-rate
residential loans for its portfolio. Fixed-rate residential loans generally
have been sold into the secondary market; however, a portion of the fixed-rate
loans originated by FSBW have been retained in the loan portfolio to meet
asset/liability management objectives. The number of fixed-rate loans
retained by FSBW increased substantially during 1996 and remained high in
fiscal years 1997 and 1998 in response to the capital deployment and growth
objectives of the Company. For the past two years FSBW has been selling a
larger portion of its newly originated fixed rate loans as a part of its
interest rate risk management and asset allocation strategies. Both before
and after their acquisition by the Company, WSB and SCB engaged in residential
lending, including secondary market activities, in a fashion very similar to
FSBW.
Historically, Inland Empire Bank has sold most of its residential loans into
the secondary market and has continued to do so subsequent to its acquisition
by the Company. Generally IEB has sold loans on a servicing-released basis
such that no revenue is realized by IEB after the sale.
Generally, Towne Bank has not engaged in one- to four-family residential
lending.
In the loan approval process, the Banks assess the borrower's ability to repay
the loan, the adequacy of the proposed security, the employment stability of
the borrower and the creditworthiness of the borrower. As part of the loan
application process, qualified independent appraisers inspect and appraise the
security property. All appraisals are subsequently reviewed by a loan
underwriter and, if necessary, by the Banks' chief appraiser.
The Banks' residential loans are generally underwritten and documented in
accordance with the guidelines established by Freddie Mac and Fannie Mae.
Government insured loans are generally underwritten and documented in
accordance with the guidelines established by the Department of Housing and
Urban Development (HUD) and the Veterans Administration (VA). The Banks' loan
underwriters are approved as underwriters under HUD's delegated underwriter
program.
The Banks sell whole loans on either a servicing-retained or servicing-
released basis. All loans are sold without recourse. Occasionally, the Banks
will sell a participation interest in a loan or pool of loans to an investor.
In these instances, the Banks retain a small percentage of the loan(s) and
pass through a net yield to the investor on the percentage sold. The decision
to hold or sell loans is based on asset/liability management goals and
policies and market conditions. Recently, FSBW has sold a significant portion
of its conventional fixed-rate mortgage originations and all of its government
insured loans into the secondary market. IEB has continued to sell most of
its residential loan originations.
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The Banks offer adjustable-rate mortgages (ARMs) at rates and terms
competitive with market conditions. The Banks offer several ARM products which
adjust annually after an initial period ranging from one to five years subject
to a limitation on the annual increase of 1.0% to 2.0% and an overall
limitation of 5.0% to 6.0%. Certain ARM loans are originated with an option
to convert the loan to a 30-year fixed-rate loan at the then prevailing market
interest rate. Generally these ARM products utilize the weekly average yield
on one-year U.S. Treasury securities adjusted to a constant maturity of one
year plus a margin of 2.75% to 3.25%. ARM loans held in the Banks' portfolios
do not permit negative amortization of principal and carry no prepayment
restrictions. Borrower demand for ARM loans versus fixed-rate mortgage loans
is a function of the level of interest rates, the expectations of changes in
the level of interest rates and the difference between the initial interest
rates and fees charged for each type of loan. In recent years borrower demand
for ARM loans has been limited and the Banks have chosen not to aggressively
pursue ARM loans by offering minimally profitable deeply discounted teaser
rates. As a result ARM loans have represented only a very small portion of
loans originated during this period.
The retention of ARM loans in the Banks' loan portfolios can help reduce the
Company's exposure to changes in interest rates. There are, however,
unquantifiable credit risks resulting from the potential of increased interest
to be paid by the customer due to increases in interest rates. It is possible
that, during periods of rising interest rates, the risk of default on ARM
loans may increase as a result of repricing and the increased costs to the
borrower. Furthermore, because the ARM loans originated by the Banks
generally provide, as a marketing incentive, for initial rates of interest
below the rates which would apply were the adjustment index plus the margin
used for pricing initially, these loans are subject to increased risks of
default or delinquency. The Banks attempt to reduce the potential for
delinquencies and defaults on ARM loans by qualifying the borrower based on
the borrower's ability to repay the ARM loan assuming that the maximum
interest rate that could be charged at the first adjustment period remains
constant during the loan term. Another consideration is that although ARM
loans allow the Banks to increase the sensitivity of their asset bases to
changes in the interest rates, the extent of this interest sensitivity is
limited by the periodic and lifetime interest rate adjustment limits (caps).
Because of these considerations, the Company has no assurance that yields on
ARM loans will be sufficient to offset increases in its cost of funds.
It is the Banks' normal policy to lend up to 95% of the lesser of the
appraised value of the property or purchase price of the property on
conventional loans, although ARM loans are normally restricted to not more
than 90%. Higher loan-to-value ratios are available on certain government
insured programs and on a recently introduced limited program strictly
underwritten and insured by United Guaranty Insurance Corporation. The Banks
generally require private mortgage insurance on residential loans with a
loan-to-value ratio at origination exceeding 80%.
Construction and Land Lending: FSBW and TB invest a significant proportion of
their loan portfolio in residential construction loans to professional home
builders. This activity has been prompted by favorable economic conditions in
the Northwest, lower long-term interest rates and an increased demand for
housing units as a result of the migration of people from other parts of the
country to the Northwest. To a lesser extent, FSBW and TB also originate land
loans and construction loans for commercial and multifamily real estate. IEB
also originates construction and land loans although to a much smaller degree
than FSBW and TB. At December 31, 1999, construction and land loans totaled
$263.1 million, (including $9.3 million of land loans and $51.9 million of
commercial and multifamily real estate construction loans) or 18.6% of total
loans of the Company.
Construction loans made by the Banks include both those with a sale contract
or permanent loan in place for the finished homes and those for which
purchasers for the finished homes may be identified either during or following
the construction period. The Banks monitor the number of unsold homes in
their construction loan portfolios, and generally maintain the portfolios so
approximately 30% of their construction loans are secured by homes for which
there is a sale contract in place.
Construction and land lending affords the Banks the opportunity to achieve
higher interest rates and fees with shorter terms to maturity than does
single-family permanent mortgage lending. Construction and land lending,
however, is generally considered to involve a higher degree of risk than
single-family permanent mortgage lending because of the inherent difficulty in
estimating both a property's value at completion of the project and the
estimated cost of the project. The nature of these loans is such that they
are generally more difficult to evaluate and monitor. If the estimate of
construction cost proves to be inaccurate, the Banks may be required to
advance funds beyond the amount originally committed to permit completion of
the project. If the estimate of value upon completion proves to be
inaccurate, the Banks may be confronted at, or prior to, the maturity of the
loan with a project whose value is insufficient to assure full repayment.
Projects may also be jeopardized by disagreements between borrowers and
builders and by the failure of builders to pay subcontractors. Loans to
builders to construct homes for which no
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purchaser has been identified carry more risk because the payoff for the loan
is dependent on the builder's ability to sell the property prior to the time
that the construction loan is due. The Banks have sought to address these
risks by adhering to strict underwriting policies, disbursement procedures,
and monitoring practices.
The maximum number of speculative loans approved for each builder is based on
a combination of factors, including the financial capacity of the builder, the
market demand for the finished product, and the ratio of sold to unsold
inventory the builder maintains. The Banks have chosen to diversify the risk
associated with speculative construction lending by doing business with a
large number of smaller builders spread over a relatively large geographic
area.
Loans for the construction of one- to four-family residences are generally
made for a term of 12 months. The Banks' loan policies include maximum
loan-to-value ratios of up to 80% for speculative loans. Each individual
speculative loan request is supported by an independent appraisal of the
property and the loan file includes a set of plans, a cost breakdown and a
completed specifications form. All speculative construction loans must be
approved by senior loan officers. At December 31, 1999, the Company's
speculative construction portfolio included loans to 209 individual builders
in 91 separate communities. At December 31, 1999, the Company had 33 home
builders who, individually, in the aggregate, had construction loans
outstanding with balances exceeding $1.0 million.
The Company regularly monitors the construction loan portfolio and the
economic conditions and housing inventory in each of its markets and will
decrease construction lending if it perceives there are unfavorable market
conditions. The Company believes that the internal monitoring system in place
mitigates many of the risks inherent in its construction lending.
To a lesser extent, the Banks make land loans to developers, builders and
individuals to finance the acquisition and/or development of improved lots or
unimproved land. In making land loans the Banks follow underwriting policies
and disbursement procedures similar to those for construction loans. The
initial term on land loans is typically one to three years with interest only
payments, payable monthly, and provisions for principal reduction as lots are
sold and released.
Commercial and Multifamily Real Estate Lending: The Banks also originate loans
secured by multifamily and commercial real estate. At December 31, 1999, the
Company's loan portfolio included $95.9 million in multifamily and $356.0
million in commercial real estate loans (including $51.9 million of commercial
and multifamily real estate construction lending). Multifamily and commercial
real estate lending affords the Banks an opportunity to receive interest at
rates higher than those generally available from one- to four-family
residential lending. However, loans secured by such properties are generally
greater in amount, more difficult to evaluate and monitor and, therefore,
involve a greater degree of risk than one- to four-family residential mortgage
loans. Because payments on loans secured by multifamily and commercial
properties are often dependent on the successful operation and management of
the properties, repayment of such loans may be affected by adverse conditions
in the real estate market or the economy.
In all multifamily and commercial real estate lending, the Banks consider the
location, marketability and overall attractiveness of the properties. The
Banks' current underwriting guidelines for commercial real estate loans
require an appraisal from a qualified independent appraiser and an economic
analysis of each property with regard to the annual revenue and expenses, debt
service coverage and fair value to determine the maximum loan amount. In the
approval process the Banks assess the borrowers willingness and ability to
repay and the adequacy of the collateral.
Multifamily and commercial real estate loans originated by the Banks are
predominately fixed rate loans with intermediate terms of ten years. More
recently originated multifamily and commercial loans are linked to various
constant maturity U.S. Treasury indices or certain prime rates. Rates on these
ARM loans generally adjust annually after an initial period ranging from one
to ten years. Rate adjustments for the more seasoned ARM loans in the
portfolio predominantly reflect changes in the Federal Home Loan Bank (FHLB)
National Monthly Median Cost of Funds index. The Banks' commercial real estate
portfolios consist of loans on a variety of property types including motels,
nursing homes, office buildings, and mini-warehouses. Multifamily loans
generally are secured by small to medium sized projects.
At December 31, 1999, the Banks' loan portfolio included 144 multifamily
loans, the average loan balance of which was $674,000. At December 31, 1999,
the Banks had 59 multifamily or commercial real estate loans with balances
over $1.0 million, the largest of which was $16.5 million (FSBW and IEB
sharing participation). Most of the properties securing these
8
<PAGE>
multifamily and commercial real estate loans are located in the Northwest;
however, the Company has acquired some participation loans on properties
located in California.
Commercial/agriculture Lending. Inland Empire Bank has been very active in
small business and agricultural lending. Towne Bank has also been very active
in commercial lending; however, TB generally has not engaged in agricultural
lending. IEB and TB's management have devoted a great deal of effort to
developing customer relationships and the ability to serve this type of
borrower. It is management's belief that many very large banks have in the
past neglected small business lending, thus contributing to IEB's and TB's
success. IEB and TB will continue to emphasize this segment of lending in
their market areas. Management intends to leverage their past success and
local decision making ability to continue to expand this market niche.
Historically, Towne Bank has sold most of its small business administration
guaranteed loans into the secondary market, servicing retained, and has
continued to do so subsequent to its acquisition by the Company.
First Savings Bank has recently begun making non-mortgage agricultural and
commercial loans. FSBW has staffed its Walla Walla, Tri-Cities, Clarkston,
Yakima and Wenatchee offices with experienced commercial bankers and
anticipates a steady growth in the origination of small business and
agricultural loans. It is expected the growth will come primarily from
FSBW's existing customer base and referrals from officers and Directors. In
addition to providing higher yielding assets, it is anticipated that this type
of lending will increase the deposit base of these branches. Expanding non-
mortgage agricultural/commercial lending is currently an area of significant
effort at FSBW. Similar to IEB and TB, WSB and SCB have been active in
commercial lending. The WSB and SCB commercial lending operations have been
integrated with those at FSBW.
Similar to consumer loans, agricultural and commercial loans may entail
greater risk than do residential mortgage loans. Agricultural and commercial
loans may be unsecured or secured by special purpose or rapidly depreciating
assets, such as equipment, crops, live stock, inventory and receivables which
may not provide an adequate source of repayment on defaulted loans. In
addition, agricultural and commercial loans are dependent on the borrower's
continuing financial stability and management ability as well as market
conditions for various products, services and commodities. For these reasons,
agricultural and commercial loans generally provide higher yields than
residential loans but also require more administrative and management
attention. Interest rates on agricultural and commercial loans may be either
fixed or adjustable. Loan terms including the fixed or adjustable interest
rate, the loan maturity and the collateral considerations vary significantly
and are negotiated on an individual loan basis. At December 31, 1999,
agribusiness/commercial loans totaled $250.6 million, or 17.8% of total loans
of the Company.
In all agricultural and commercial lending, the Banks consider the borrowers
credit worthiness and ability to repay and the adequacy of the offered
collateral. Current underwriting guidelines for agricultural/commercial loans
require an economic analysis with regard to annual revenue and expenses, debt
service coverage, collateral and fair value to determine the maximum loan
amount. Before the Banks make a commercial loan, the borrower must obtain the
approval of various levels of Bank personnel, depending on the size and
characteristics of the loan.
Consumer and Other Lending: The Banks originate a variety of consumer loans,
including secured second mortgage loans, automobile loans, credit card loans
and loans secured by deposit accounts. Consumer and other lending has
traditionally been a small part of FSBW's and TB's business. However, recent
efforts at FSBW have led to a modest increase in consumer loans primarily to
its existing customer base. Inland Empire Bank, on the other hand, has been
an active originator of consumer loans. At December 31, 1999, the Company had
$61.6 million, or 4.4% of its loans receivable, in outstanding consumer and
other loans.
Consumer loans often entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans which are unsecured or secured by
rapidly depreciating assets such as automobiles. In such cases, any
repossessed collateral for a defaulted consumer loan may not provide an
adequate source of repayment of the outstanding loan balance as a result of
the greater likelihood of damage, loss or depreciation. The remaining
deficiency often does not warrant further substantial collection efforts
against the borrower beyond obtaining a deficiency judgment. In addition,
consumer loan collections are dependent on the borrower's continuing financial
stability, and thus are more likely to be adversely affected by job loss,
divorce, illness or personal bankruptcy. Furthermore, the application of
various federal and state laws, including federal and state bankruptcy and
insolvency laws, may limit the amount which can be recovered on such loans.
Such loans may also give rise to claims and
9
<PAGE>
defenses by a consumer loan borrower against an assignee of such loans such as
the Banks, and a borrower may be able to assert against such assignee claims
and defenses that it has against the seller of the underlying collateral.
Loan Solicitation and Processing: The Banks originate real estate loans by
direct solicitation of real estate brokers, builders, depositors, and walk-in
customers. Loan applications are taken by the Banks' loan officers and are
processed in each branch location. Most underwriting and all audit functions
are performed by loan administration personnel at each Bank's main office.
Applications for fixed-rate and adjustable-rate mortgages on one- to four-
family properties are generally underwritten and closed based on Freddie Mac/
Fannie Mae standards, and other loan applications are underwritten and closed
based on the Banks' own written guidelines.
Consumer loans are originated through various marketing efforts directed
primarily toward existing deposit and loan customers of the Banks. Consumer
loan applications may be processed at branch locations or by administrative
personnel at the Banks' main offices.
Commercial and agricultural loans are solicited by loan officers of each Bank
by means of call programs focused on local businesses and farmers. Credit
decisions on significant commercial and agricultural loans are made by senior
loan officers or in certain instances by the Board of Directors of each Bank
or the Company.
Loan Originations, Sales and Purchases
While the Banks originate a variety of loans, their ability to originate loans
and their ability to originate each type of loan is dependent upon the
relative customer demand and competition for loans in each market. For the
nine months ended December 31, 1999 and the years ended March 31, 1999 and
1998, the Banks originated and disbursed $759.6 million, $717.0 million and
$511.4 million of loans, respectively. The Company's net loan portfolio grew
$205.5 million or 18.6% during the nine months ended December 31, 1999 ($178.5
million excluding acquisitions) compared to $345.8 million of growth during
the year ended March 31, 1999 ($146.4 million excluding acquisitions) and
$111.0 million of growth in the year ended March 31, 1998.
In recent years prior to 1996 the Company generally sold most of its 30-year
fixed-rate one- to four-family residential mortgage loans to secondary market
purchasers. For the years ended March 31, 1996 and 1997 the Company sold a
smaller portion of its fixed-rate loan originations choosing to retain loans
in response to its capital deployment and growth objectives. Beginning in the
second half of fiscal year 1998 the Company increased the amount of new fixed-
rate residential loans sold as part of its interest rate risk management
strategy. Proceeds from sales of loans by the Company for the nine months
ended December 31, 1999 and the years ended March 31, 1999 and 1998 totaled
$98.2 million, $124.6 million and $80.2 million, respectively. Sales of whole
loans generally are beneficial to the Company since these sales may generate
income at the time of sale, provide funds for additional lending and other
investments and increase liquidity. The Company sells loans on both a
servicing-retained and a servicing-released basis. See "Loan Servicing Loan
Servicing Portfolio." At December 31, 1999, the Company had $9.5 million in
loans held for sale.
The Banks, especially FSBW, purchase whole loans and loan participation
interests primarily during periods of reduced loan demand in their primary
market. Any such purchases are made consistent with the Banks' underwriting
standards; however, the loans may be located outside of the Banks' normal
lending area. During the nine months ended December 31, 1999 and the years
ended March 31, 1999 and 1998, the Company purchased $13.2 million, $86.2
million and $51.0 million, respectively, of loans and loan participation
interests.
10
<PAGE>
<TABLE>
Loan Portfolio Analysis. The following table sets forth the composition of the Company's loan portfolio
(including loans held for sale) by type of loan as of the dates indicated.
December 31 March 31
------------------- ---------------------------------------------------------------------
1999 1999 1998 1997 1996
------------------- ------------------- --------------- --------------- ---------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in thousands)
Type of Loan:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Secured by real
estate loans:
One- to four-
family $ 436,679 30.93% $ 407,673 34.24% $423,850 51.53% $395,418 55.86% $311,472 68.24%
Commercial/
multifamily 399,992 28.33 324,858 27.28 167,859 20.41 129,198 18.25 77,613 16.99
Construction/
land 263,093 18.63 217,094 18.23 132,409 16.10 110,262 15.58 62,177 13.62
Commercial/
agriculture
business 250,566 17.75 196,743 16.52 67,611 8.22 47,846 6.76 871 .19
Consumer,
credit card
and other 61,580 4.36 44,346 3.73 30,842 3.74 25,092 3.55 4,333 .96
---------- ------ ---------- ------ -------- ------ -------- ------ -------- ------
Total loans 1,411,910 100.00% 1,190,714 100.00% 822,571 100.00% 707,816 100.00% 456,466 100.00%
====== ====== ====== ====== ======
Loans in progress (84,894) (71,638) (54,500) (52,412) (35,244)
Deferred loan
fees, discounts
and premiums (5,311) (4,146) (3,297) (2,775) (1,876)
Net loans ---------- ---------- -------- -------- --------
before allow-
ance or
loan losses 1,321,705 1,114,930 764,774 652,629 419,346
Allowance for
loan losses (13,541) (12,261) (7,857) (6,748) (4,051)
Total loans ---------- ---------- -------- -------- --------
receivable,
net $1,308,164 $1,102,669 $756,917 $645,881 $415,295
========== ========== ======== ======== ========
11
</TABLE>
<PAGE>
<TABLE>
Loan Maturity and Repricing
The following table sets forth certain information at December 31, 1999 regarding the dollar amount of loans
maturing in the Company's portfolio based on their contractual terms to maturity, but does not include
scheduled payments or potential prepayments. Demand loans, loans having no stated schedule of repayments
and no stated maturity, and overdrafts are reported as due in one year or less. Loan balances are net of
loans in progress (undisbursed loan proceeds), unamortized premiums and discounts, and exclude the allowance
for loan losses (in thousands):
Maturing Maturing Maturing
Maturing within within within Maturing
Within 1 to 3 3 to 5 5 to 10 Beyond
One Year Years Years Years 10 Years Total
-------- -------- -------- -------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
One-to four-family real estate loans $ 5,716 $ 7,023 $ 5,747 $ 25,866 $374,727 $ 419,079
Commercial/multifamily real estate
loans 39,568 48,526 54,808 162,580 91,320 396,802
Construction/land 153,670 26,552 3,374 5,109 6,206 194,911
Commercial/agriculture business 151,328 21,492 36,974 30,237 8,617 248,648
Consumer, credit card and other 24,389 10,514 14,945 4,363 8,054 62,265
-------- -------- -------- -------- -------- ----------
Total loans $374,671 $114,107 $115,848 $228,155 $488,924 $1,321,705
======== ======= ======== ======== ======== ==========
</TABLE>
<TABLE>
Contractual maturities of loans do not reflect the actual life of such assets. The average life of
loans is substantially less than their contractual maturities because of scheduled principal
repayments and prepayments. In addition, due-on-sale clauses on loans generally give the Company
the right to declare loans immediately due and payable in the event that the borrower sells the real
property subject to the mortgage and the loan is not repaid. The average life of mortgage loans
tends to increase, however, when current mortgage loan market rates are substantially higher than
rates on existing mortgage loans and, conversely, decreases when rates on existing mortgage loans
are substantially higher than current mortgage loan market rates.
The following table sets forth the dollar amount of all loans due after December 31, 2000, which have fixed
interest rates and floating or adjustable interest rates (in thousands).
Fixed Floating or
Rates Adjustable Rates Total
----- ---------------- -----
<S> <C> <C> <C>
One-to four-family real estate loans $345,088 $ 68,275 $ 413,363
Commercial/multifamily real estate loans 225,393 131,841 357,234
Construction/land 13,732 27,509 41,241
Commercial/agriculture business 54,570 42,750 97,320
Consumer, credit card and other 30,792 7,084 37,876
-------- -------- ---------
Total $669,575 $277,459 $ 947,034
======== ======== =========
12
</TABLE>
<PAGE>
Loan Servicing
General: The Banks receive fees from a variety of institutional owners in
return for performing the traditional services of collecting individual
payments and managing portfolios of sold loans. At December 31, 1999, the
Banks were servicing $273.9 million of loans for others. Loan servicing
includes processing payments, accounting for loan funds and collecting and
paying real estate taxes, hazard insurance and other loan-related items such
as private mortgage insurance. When the Banks receive the gross loan payment
from individual borrowers, they remit to the investor a predetermined net
amount based on the yield on that loan. The difference between the coupon on
the underlying loan and the predetermined net amount paid to the investor is
the gross loan servicing fee. In addition, the Banks retain certain amounts
in escrow for the benefit of the lender for which the Banks incur no interest
expense but are able to invest the funds into earning assets. At December 31,
1999, the Banks held $2.5 million in escrow for their portfolios of loans
serviced for others.
Loan Servicing Portfolio: The loan servicing portfolio at December 31, 1999
was composed primarily of $32.0 million of Fannie Mae mortgage loans and
$188.9 million of Freddie Mac mortgage loans. The balance of the loan
servicing portfolio at December 31, 1999, consisted of loans serviced for a
variety of private investors. At December 31, 1999, the portfolio included
loans secured by property located primarily in the states of Washington or
Oregon. For the nine months ended December 31, 1999, $430,000 of loan
servicing fees, net of $215,000 of servicing rights amortization, were
recognized in operations.
Mortgage Servicing Rights: In addition to the origination of mortgage
servicing rights (MSRs) on the loans that FWWB originates and sells in the
secondary market on a servicing retained basis, FWWB has also purchased
mortgage servicing rights. The cost of MSRs is capitalized and amortized in
proportion to, and over the period of, the estimated future net servicing
income. For the nine months ending December 31, 1999 and the year ending March
31, 1999 FWWB capitalized $128,000 and $981,000, respectively, of mortgage
servicing rights relating to loans sold with servicing retained. No MSRs were
purchased in the nine months ending December 31, 1999 and the fiscal years
ended March 31, 1999 and 1998. Amortization of MSR's for the nine months ended
December 31, 1999 was $215,000 compared to $277,000 for the year ended March
31, 1999. Management periodically evaluates the estimates and assumptions
used to determine the carrying values of MSRs and the amortization of MSRs.
These carrying values are adjusted when the valuation indicates the carrying
value is impaired. At December 31, 1999, MSRs were carried by FWWB at a
value, net of amortization, of $1,671,000, and no valuation allowance for
impairment was considered necessary. MSRs generally are adversely affected by
current and anticipated prepayments resulting from decreasing interest rates.
Asset Quality
Each Bank's asset classification committee meets at least monthly to review
all classified assets, to approve action plans developed to resolve the
problems associated with the assets and to review recommendations for new
classifications, any changes in classifications and recommendations for
reserves. The committee reports to the Board of Directors quarterly as to the
current status of classified assets and action taken in the preceding quarter.
State and Federal regulations require that the Banks review and classify their
problem assets on a regular basis. In addition, in connection with
examinations of insured institutions, state and federal 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 must have one or more defined weaknesses
and are characterized by the distinct possibility that the insured institution
will sustain some loss if the deficiencies are not corrected. Doubtful assets
have the weaknesses of substandard assets with the additional characteristic
that the weaknesses make collection or liquidation in full on the basis of
currently existing facts, conditions and values questionable, and there is a
significant 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. The regulations have also created a special
mention category, described as assets which do not currently expose an insured
institution to a sufficient degree of risk to warrant classification but do
possess credit deficiencies or potential weaknesses deserving management's
close attention. If an asset or portion thereof is classified loss, the
insured institution establishes specific allowances for loan losses for the
full amount of the portion of the asset classified loss. A portion of general
loan loss allowances established to cover possible losses related to assets
classified substandard or doubtful may be included in determining an
institution's regulatory capital, while specific valuation allowances for loan
losses generally do not qualify as regulatory capital.
13
<PAGE>
At December 31, 1999 and March 31, 1999 and 1998, the aggregate amounts of the
Banks' classified assets (as determined by the Banks) were as follows (in
thousands):
December 31 At March 31
----------- ----------------------
1999 1999 1998
---- ---- ----
Loss $ -- $ 60 $ --
Doubtful -- 58 --
Substandard assets 6,637 8,302 2,776
Special mention 1,762 3,008 --
Non-performing Assets and Delinquencies.
Real Estate Loans: When a borrower fails to make a required payment when due,
the Banks follow established collection procedures. The first notice is mailed
to the borrower within 10 to 17 days after the payment due date and attempts
to contact the borrower by telephone begin within five to ten days after the
late notice is mailed to the borrower. If the loan is not brought current by
30 days after the payment due date, the Banks will mail a second written
notice to the borrower. If a satisfactory response is not obtained,
continuous follow-up contacts are attempted until the loan has been brought
current. Generally, for residential loans within 30 to 45 days into the
delinquency procedure, the Banks notify the borrower that home ownership
counseling is available. In most cases, delinquencies are cured promptly;
however, if after 90 days of delinquency no response has been received nor an
approved reinstatement plan established, foreclosure according to the terms of
the security instrument and applicable law is initiated. Interest income on
loans after 90 days of delinquency is no longer accrued and the full amount of
accrued and uncollected interest is reversed.
Commercial/agriculture and Consumer Loans: When a borrower fails to make
payments as required, a late notice is sent to the borrower. If payment is
still not made the responsible loan officer is advised and contact is made by
telephone or letter. Continuous follow-up contacts are attempted until the
loan has been brought current. Generally, if the loan is not current within
45 to 60 days, action is initiated to take possession of the security. A
small claims or lawsuit is normally filed on unsecured loans or deficiency
balances at 90 to 120 days. Loans over 90 days delinquent, repossessions,
loans in foreclosure and bankruptcy no longer accrue interest unless a
satisfactory repayment plan has been agreed upon, the loan is a full recourse
contract or fully secured by a deposit account.
14
<PAGE>
The following table sets forth information with respect to the Banks' non-
performing assets and restructured loans within the meaning of SFAS No. 15,
Accounting by Debtors and Creditors for Troubled Debt Restructuring, at the
dates indicated (dollars in thousands).
December
31 At March 31
-------- ---------------------------------
1999 1999 1998 1997 1996
---- ---- ---- ---- ----
Loans accounted for on a
nonaccrual basis:
Loans secured by real estate:
One- to four-family $ 623 $3,564 $ 448 $1,644 $ 526
Commercial/multifamily 129 351 -- 187 --
Construction/land 2,514 767 367 -- --
Commercial/agriculture business 1,203 1,439 414 206 --
Consumer, credit card and other 9 17 41 45 --
------ ------ ------ ------ ------
Total 4,478 6,138 1,270 2,082 526
Accruing loans which are ------ ------ ------ ------ ------
contractually past due 90 days
or more:
Loans secured by real estate:
One-to four family real 155 20 52 -- --
Commercial/multifamily -- 384 33 -- --
Construction/land -- -- 32 -- --
Commercial/agriculture business 359 1,052 -- -- --
Consumer, credit card and other 79 82 33 30 12
------ ------ ------ ------ ------
Total 593 1,538 150 30 12
------ ------ ------ ------ ------
Total non-performing loans 5,071 7,676 1,420 2,112 538
Real estate/repossessed assets
held for sale 3,576 1,644 882 1,057 712
------ ------ ------ ------ ------
Total non-performing assets $8,647 $9,320 $2,302 $3,169 $1,250
====== ====== ====== ====== ======
Restructured loans (1) $ 369 $ 380 $ 305 $ 238 $ 156
Total non-performing loans to
net loans 0.38% 0.69% 0.19% 0.33% 0.13%
Total non-performing loans to
total assets 0.28% 0.47% 0.12% 0.21% 0.07%
Total non-performing assets to
total assets 0.48% 0.57% 0.20% 0.31% 0.17%
(1) These loans are performing under their restructured terms but are
classified substandard.
For the nine months ended December 31, 1999, $235,000 in interest income would
have been recorded had nonaccrual loans been current, and no interest income
on such loans was included in net income for such period.
Real Estate/Repossessed Assets, Held for Sale: Real estate acquired by the
Company as a result of foreclosure or by deed-in-lieu of foreclosure is
classified as real estate held for sale until it is sold. When property is
acquired it is recorded at the lower of its cost (the unpaid principal balance
of the related loan plus foreclosure costs), or net realizable value.
Subsequent to foreclosure, the property is carried at the lower of the
foreclosed amount or net realizable value. Upon receipt of a new appraisal
and market analysis, the carrying value is written down through the
establishment of a specific reserve to the anticipated sales price less
selling and holding costs. At December 31, 1999, the Company had $3.3 million
of real estate owned and $283,000 of other repossessed assets.
15
<PAGE>
Allowance for Loan Losses
General: In originating loans, the Banks recognize that losses will be
experienced and that the risk of loss will vary with, among other things, the
type of loan being made, the creditworthiness of the borrower over the term of
the loan, general economic conditions and, in the case of a secured loan, the
quality of the security for the loan. As a result, the Banks maintain an
allowance for loan losses consistent with the generally acceptable accounting
principles (GAAP) guidelines outlined in SFAS No. 5, Accounting for
Contingencies.. The Banks have established systematic methodologies for the
determination of the adequacy of their allowance for loan losses. The
methodologies are set forth in a formal policy and take into consideration the
need for an overall general valuation allowance as well as specific allowances
that are tied to individual problem loans. The Banks increase their allowance
for loan losses by charging provisions for possible loan losses against the
Banks' income.
On April 1, 1995, the Company and its subsidiary Banks adopted SFAS No. 114,
Accounting by Creditors for Impairment of a Loan, and SFAS No. 118, Accounting
by Creditors for Impairment of a Loan - Income Recognition and Disclosures, an
amendment of SFAS No. 114. These statements require that impaired loans that
are within their scope be measured based on the present value of expected
future cash flows discounted at the loan's effective interest rate or, as a
practical expedient, at the loan's observable market price or the fair value
of collateral if the loan is collateral dependent. Subsequent changes in the
measurement of impaired loans shall be included within the provision for loan
losses in the same manner in which impairment initially was recognized or as a
reduction in the provision that would otherwise be reported. The adoption of
these statements had no material impact on the Company's or Banks' financial
condition or results of operations. Prior to the adoption of these statements
a reserve for specific losses was provided for loans when any significant,
permanent decline in value was deemed to have occurred. As of December 31,
1999, the Company and its subsidiary Banks had identified $3.0 million of
impaired loans as defined by the statement and had established $117,000 of
specific reserves for these loans. The statements also apply to all loans that
are restructured in a troubled debt restructuring, subsequent to the adoption
of SFAS No. 114, as defined by SFAS No. 15. A troubled debt restructuring is
a restructuring in which the creditor grants a concession to the borrower that
it would not otherwise consider. At December 31, 1999, the Company had
$369,000 of restructured loans that, though performing, were classified
substandard.
The allowance for losses on loans is maintained at a level sufficient to
provide for estimated losses based on evaluating known and inherent risks in
the loan portfolio and upon management's continuing analysis of the factors
underlying the quality of the loan portfolio. These factors include changes in
the size and composition of the loan portfolio, delinquency rates, actual loan
loss experience, current economic conditions, detailed analysis of individual
loans for which full collectibility may not be assured, and determination of
the existence and realizable value of the collateral and guarantees securing
the loans. Additions to these allowances are charged to earnings. Realized
losses and charge-offs that are related to specific loans are applied as a
reduction of the carrying value of the assets and charged immediately against
the allowance for losses. Recoveries on previously charged off loans are
credited to the allowance. The reserve is based upon factors and trends
identified by management at the time financial statements are prepared. The
Company's methodology for assessing the appropriateness of the allowance
consists of several key elements, which include specific allowances, an
allocated formula allowance, and an unallocated allowance. Losses on specific
loans are provided for when the losses are probable and estimable. The formula
allowance is calculated by applying loss factors to outstanding loans,
excluding loans with specific allowances. Loss factors are based on the
Company's historical loss experience adjusted for significant factors
including the experience of other banking organizations that, in management's
judgment, affect the collectibility of the portfolio as of the evaluation
date. The unallocated allowance is based upon management's evaluation of
various factors that are not directly measured in the determination of the
formula and specific allowances. Although management uses the best information
available, future adjustments to the allowance may be necessary due to
economic, operating, regulatory and other conditions beyond the Banks'
control.
16
<PAGE>
At December 31, 1999, the Company had an allowance for loan losses of $13.5
million which represented 1.02% of net loans and 267% of non-performing loans
compared to 1.10% and 160%, respectively, at March 31, 1999. The decrease in
the provision for losses reflects the amount required to maintain the
allowance for losses at an appropriate level based upon management's
evaluation of the adequacy of general and specific loss reserves as more fully
explained in the following paragraphs. The higher provision in the prior
period reflected more significant changes in the portfolio mix and non-
performing loans and a higher level of net charge-offs during that period than
occurred in the most recent nine months. A comparison of the allowance for
loan losses at December 31, 1999 and 1998 shows an increase of $2.8 million
from $10.7 million at December 31, 1998 to $13.5 million at December 31, 1999.
The allowance for loan losses increased by $1.2 million, to $13.5 million at
December 31, 1999, compared to $12.3 million at March 31, 1999 (see Notes 7
and 8 to the Consolidated Financial Statements for further analysis of the
loan portfolio mix and allowance for loan losses).
While the Company believes that the Banks have established their existing
allowance for loan losses in accordance with Generally Accepted Accounting
Principles (GAAP), there can be no assurance that regulators, in reviewing the
Banks' loan portfolio, will not request the Banks to increase significantly
their allowance for loan losses. In addition, because future events affecting
borrowers and collateral cannot be predicted with certainty, there can be no
assurance that the existing allowance for loan losses is adequate or that
substantial increases will not be necessary should the quality of any loans
deteriorate as a result of the factors discussed above. Any material increase
in the allowance for loan losses may adversely affect the Company's financial
condition and results of operations.
The following table sets forth an analysis of the Company's gross allowance
for possible loan losses for the periods indicated (dollars in thousands).
Nine months
Ended December 31 Years Ended March 31
----------------- -------------------------------------
1999 1999 1998 1997 1996
---- ---- ---- ---- ----
Allowance at beginning
of period $ 12,261 $ 7,857 $ 6,748 $ 4,051 $ 3,549
Acquisitions 477 2,693 -- 1,416 --
Provision for loan
losses 1,885 2,841 1,628 1,423 524
Recoveries:
Loans secured by real
estate:
One - to four-family -- -- 6 38 --
Commercial/multifamily 1 60 -- -- --
Construction/land -- -- -- -- --
Commercial/agriculture
business 456 144 29 -- --
Consumer, credit card and
other 11 21 16 16 --
-------- ------- ------- ------- -------
Total recoveries 468 225 51 54 --
-------- ------- ------- ------- -------
Charge-offs:
Loans secured by real
estate:
One - to four-family (532) (25) (359) (127) --
Commercial/multifamily -- (35) -- -- --
Construction/land (24) (69) (11) -- --
Commercial/agriculture
business (860) (916) (19) (3) --
Consumer, credit card
and other (134) (310) (181) (66) (22)
-------- ------- ------- ------- -------
Total charge-offs (1,550) (1,355) (570) (196) (22)
-------- ------- ------- ------- -------
Net charge-offs (1,082) (1,130) (519) (142) (22)
-------- ------- ------- ------- -------
Balance at end of
period $ 13,541 $12,261 $ 7,857 $ 6,748 $ 4,051
======== ======= ======= ======= =======
Ratio of allowance to
net loans outstanding
at the end of the
period 1.02% 1.10% 1.03% 1.03% 0.97%
Ratio of net loan
charge-offs to the
average net book
value of loans
outstanding during
the period 0.09% 0.14% 0.08% 0.04% 0.01%
17
<PAGE>
<TABLE>
The following table sets forth the breakdown of the allowance for loan losses by loan category for the
periods indicated.
At December 31 At March 31
----------------- ----------------------------------------------------------------------
1999 1999 1998 1997 (2) 1996
----------------- ----------------- ----------------- ----------------- ----------------
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>
Specific or allocated
loss allowances:
Loans secured by
real estate:
One- to four-
family $ 2,334 30.93% $ 2,757 34.24% $ 1,059 51.53% $ 1,098 55.86% $ -- 68.24%
Commercial/
multifamily 4,273 28.33 3,567 27.28 849 20.41 547 18.25 -- 16.99
Construction/
land 1,638 18.63 1,597 18.23 856 16.10 844 15.58 -- 13.62
Commercial/
agriculture
business 2,830 17.75 2,522 16.52 835 8.22 422 6.76 -- .19
Consumer,
credit card
and other 1,023 4.36 841 3.73 307 3.74 237 3.55 -- .96
Unallocated
general loss
allowance(1)(2) 1,443 N/A 977 N/A 3,951 N/A 3,600 N/A 4,051 N/A
------- ------ ------- ------ ------- ------ ------- ------ ------ ------
Total allowance
for loan
losses $13,541 100.00% $12,261 100.00% $ 7,857 100.00% $ 6,748 100.00% $ 4,051 100.00%
======= ====== ======= ====== ======= ====== ======= ====== ======= ======
- --------------
(1) The Company establishes specific loss allowances when individual loans are identified that present a
possibility of loss (i.e., that full collectibility is not reasonably assured). The remainder of the
allowance for loan losses is established for the purpose of providing for estimated losses which are
inherent in the loan portfolio.
(2) For 1997 the Company had not changed how it determines the adequacy of its allowance for loan losses
other than to allocate the non-specific loan loss reserves to loan categories that were the basis for
its accrual. In the periods prior to 1997, it was not the Company's practice to allocate general
loan loss allowances to specific loan categories.
18
</TABLE>
<PAGE>
Investment Activities
Under Washington and Oregon state law, banks are permitted to invest in
various types of marketable securities. Authorized securities include but are
not limited to U.S. Treasury obligations, securities of various federal
agencies, mortgage-backed securities, certain certificates of deposit of
insured banks and savings institutions, banker's acceptances, repurchase
agreements, federal funds, commercial paper, corporate debt and equity
securities and obligations of states and their political sub-divisions. The
investment policies of the Banks are designed to provide and maintain adequate
liquidity and to generate favorable rates of return without incurring undue
interest rate or credit risk. The Banks' policies generally limit investments
to U.S. Government and agency securities, municipal bonds, certificates of
deposit, marketable corporate debt obligations and mortgage-backed securities.
Investment in mortgage-backed securities includes those issued or guaranteed
by Freddie Mac (FHLMC), Fannie Mae (FNMA), Government National Mortgage
Association (GNMA) and privately-issued collateralized mortgage-backed
securities that have an AA credit rating or higher. A high credit rating
indicates only that the rating agency believes there is a low risk of loss or
default. However, all of the Banks' investment securities, including those
that have high credit ratings, are subject to market risk in so far as a
change in market rates of interest or other conditions may cause a change in
an investment's market value.
At December 31, 1999, the Company's consolidated investment portfolio totaled
$362.1 million and consisted principally of U.S. Government and agency
obligations, mortgage-backed securities, municipal bonds, corporate debt
obligations, and stock of FNMA and FHLMC. From time to time, investment
levels may be increased or decreased depending upon yields available on
investment alternatives, and management's projections as to the demand for
funds to be used in the Banks' loan originations, deposits and other
activities. During the nine months ended December 31, 1999 investments and
securities decreased by $2.1 million (including $12.2 million obtained in the
acquisition of SCB). Holdings of mortgage-backed securities decreased $12.8
million and U.S. Treasury and agency obligations increased $2.4 million.
Ownership of corporate and other securities increased $7.4 million. Municipal
bonds increased $962,000.
Mortgage-Backed and Mortgage-Related Securities: The Company purchases
mortgage-backed securities in order to: (i) generate positive interest rate
spreads on large principal balances with minimal administrative expense; (ii)
lower the credit risk of the Company as a result of the guarantees provided by
FHLMC, FMNA, and GNMA or credit enhancements provided by other entities or the
structure of the securities; (iii) enable the Company to use mortgage-backed
securities as collateral for financing; and (iv) increase liquidity. The
Company invests primarily in federal agency issued or guaranteed mortgage-
backed and mortgage-related securities, principally FNMA, FHLMC and GNMA. The
Company also invests in privately issued collateralized mortgage obligations
(CMOs) including real estate mortgage investment conduits (REMICs). At
December 31, 1999, net mortgage-backed securities totaled $230.0 million, or
12.6% of total assets. At December 31, 1999, 42..5% of the mortgage-backed
securities were adjustable-rate and 57.5% were fixed-rate. The estimated fair
value of the Company's mortgage-backed securities at December 31, 1999, was
$230.0 million, which is $8.1 million less than the amortized cost of $238..1
million. At December 31, 1999, the Company's portfolio of mortgage-backed
securities had a weighted average coupon rate of 6.72%. The estimated
weighted average remaining life of the portfolio was 5.5 years based on the
last 3 months' "constant prepayment rate" (CPR) or the most recent CPR if less
than 3 months history is available.
Mortgage-backed securities known as PC's or mortgage pass-through certificates
generally represent a participation interest in a pool of single-family
mortgage loans. The principal and interest payments on these loans are passed
from the mortgage originators, through intermediaries (generally U.S.
Government agencies and government sponsored enterprises) that pool and resell
the participation interests in the form of securities, to investors such as
the Company. Mortgage participation certificates generally yield less than
the loans that underlie such securities because of the cost of payment
guarantees and credit enhancements. In addition, PC's are usually more liquid
than individual mortgage loans and may be used to collateralize certain
liabilities and obligations of the Company. These types of securities also
permit the Company to optimize its regulatory capital because of their low
risk weighting.
19
<PAGE>
CMOs and REMICs are mortgage-related obligations and may be considered as
derivative financial instruments because they are created by redirecting the
cash flows from the pool of mortgage loans or mortgage-backed securities
underlying these securities into two or more classes (or tranches) with
different maturity or risk characteristics. Management believes these
securities may represent attractive alternatives relative to other investments
due to the wide variety of maturity, repayment and interest rate options
available; however, the complex structure of certain CMOs increases the
difficulty in assessing the portfolio's risk and its fair value. Yields on
privately issued CMOs generally exceed the yield on similarly structured
agency CMOs because they expose the Company to certain risks not inherent in
agency CMOs, such as credit risk and liquidity risk. Neither the U.S.
government nor any of its agencies guarantees these assets generally because
the loan size, credit underwriting or underlying collateral do not meet
certain industry standards. Consequently, the potential for loss of principal
is higher for privately issued securities. In addition, because the universe
of potential investors for privately issued CMOs is smaller, these securities
are somewhat less liquid than are agency issued or guaranteed securities. At
December 31, 1999 the Company held CMOs and REMICs with a net carrying value
of $201.7 million, including $60.4 million of privately issued CMOs.
Of the Company's $230.0 million mortgage-backed securities portfolio at
December 31, 1999, $105.0 million with a weighted average yield of 6.53% had
contractual maturities or period to repricing within ten years and $125.0
million with a weighted average yield of 5.71% had contractual maturities or
period to repricing over ten years. However, the actual maturity of a
mortgage-backed security is usually less than its stated maturity due to
prepayments of the underlying mortgages. Prepayments that are faster than
anticipated may shorten the life of the security and may result in rapid
amortization of premiums or discounts and thereby affect the net yield on such
securities. Although prepayments of underlying mortgages depend on many
factors, including the type of mortgages, the coupon rate, the age of
mortgages, the geographical location of the underlying real estate
collateralizing the mortgages and general levels of market interest rates, the
difference between the interest rates on the underlying mortgages and the
prevailing mortgage interest rates generally is the most significant
determinant of the rate of prepayments. During periods of declining mortgage
interest rates, if the coupon rate of the underlying mortgage loans exceeds
the prevailing market interest rates offered for mortgage loans, refinancing
generally increases and accelerates the prepayment of the underlying mortgage
loans and the related security. Under such circumstances, the Company may be
subject to reinvestment risk because, to the extent that the Company's
mortgage-backed securities amortize or prepay faster than anticipated, the
Company may not be able to reinvest the proceeds of such repayments and
prepayments at a comparable rate. In contrast to mortgage-backed securities
in which cash flow is received (and hence, prepayment risk is shared) pro rata
by all securities holders, the cash flow from the mortgage loans or mortgage-
backed securities underlying REMICs or CMOs is segmented and paid in
accordance with a predetermined priority to investors holding various tranches
of such securities or obligations. A particular tranche of REMICs and CMOs
may therefore carry prepayment risk that differs from that of both the
underlying collateral and other tranches.
Municipal Bonds: The Company's tax exempt municipal bond portfolio, which at
December 31, 1999, totaled $32.2 million at estimated fair value ($32.1
million at amortized cost), was comprised of general obligation bonds (i.e.,
backed by the general credit of the issuer) and revenue bonds (i.e., backed by
revenues from the specific project being financed) issued by various
authorities, hospitals, water and sanitation districts located in the states
of Washington, Oregon and Idaho. At December 31, 1999, general obligation
bonds and revenue bonds had total estimated fair values of $21.4 million and
$8.5 million, respectively. The Company also has taxable revenue bonds as of
December 31, 1999 totaling $5.8 million at estimated fair value ($6.0 million
at amortized cost). Many bank qualifying municipal bonds are not rated by a
nationally recognized credit rating agency (e.g., Moody's or Standard and
Poor's) due to their smaller size. At December 31, 1999, the Company's
municipal bond portfolio had a weighted average maturity of approximately 9.4
years and an average coupon rate of 6.24%. The largest security in the
portfolio was an industrial revenue bond issued by the City of Kent,
Washington, with an amortized cost of $3.5 million and a fair value of $3.5
million.
Corporate Bonds: The Company's corporate bond portfolio, which totaled $25.6
million at fair value ($26.7 million at amortized cost) at December 31, 1999,
was composed of short and long-term fixed-rate and adjustable-rate securities.
At December 31, 1999, the portfolio had a weighted average maturity of 21.2
years and a weighted average coupon rate of 7.37%. The longest term security
has an amortized cost of $4.0 million and a term to maturity of 29.9 years.
20
<PAGE>
U.S. Government and Agency Obligations: The Company's portfolio of U.S.
Government and agency obligations had a fair value of $58.9 million ($60.2
million at amortized cost) at December 31, 1999. The Company's subsidiary,
FSBW, has invested a small portion of its securities portfolio in structured
notes. The structured notes in which FSBW has invested provide for periodic
adjustments in coupon rates or prepayments based on various indices and
formulae. At December 31, 1999, structured notes, which totaled $5.2 million
at fair value ($5.4 million at amortized cost), consisted of a U.S. Government
agency obligation with a fair value of $2.3 million which matures in 2004 and
2005 and a privately issued obligation with a fair value of $2.9 million which
matures in 2005. In addition, most of the U.S. Government agency obligations
owned by the Company include call features which allow the issuing agency the
right to call the securities at various dates prior to the final maturity.
Asset-backed Securities: The Company's subsidiary, FSBW, has invested a small
portion of its investment portfolio in asset-backed securities collateralized
by equipment lease contracts. At December 31, 1999 the investment totaled
$5.8 million at fair value ($5.9 at amortized cost), was yielding 8.66%, and
matures in 2004.
Off Balance Sheet Derivatives: Derivatives include "off balance sheet"
financial products whose value is dependent on the value of an underlying
financial asset, such as a stock, bond, foreign currency, or a reference rate
or index. Such derivatives include "forwards," "futures," "options" or
"swaps." The Company generally has not invested in "off balance sheet"
derivative instruments, although investment policies authorize such
investments. On December 31, 1999 the Company had no off balance sheet
derivatives and no outstanding commitments to purchase or sell securities.
21
<PAGE>
<TABLE>
The following tables sets forth certain information regarding carrying values and percentage of total
carrying values, which is estimated market value, of the Company's consolidated portfolio of securities
classified as available for sale and held to maturity (in thousands).
At December 31 At March 31
------------------- ----------------------------------------------------------
Available for Sale: 1999 1999 1998 1997
- ------------------ ------------------- ------------------ ------------------ -------------------
Percent Percent Percent Percent
Carrying of Carrying of Carrying of Carrying of
value Total value Total value Total value Total
----- ----- ----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Government
Treasury and
agency obligations $ 58,868 16.90% $ 56,518 15.61% $ 65,594 21.69% $ 67,417 23.45%
Municipal bonds:
Tax exempt 30,585 8.78 32,259 8.91 32,093 10.61 33,969 11.81
Taxable 4,751 1.36 2,833 0.78 -- -- -- --
Corporate bonds 21,564 6.19 24,335 6.72 4,304 1.42 7,997 2.78
Other 3,769 1.08 3,441 0.95 3,298 1.09 3,758 1.31
Mortgage-backed or
related securities
Mortgage-backed
securities:
GNMA 18,306 5.26 22,508 6.22 16,862 5.58 20,273 7.05
FHLMC 3,324 .95 3,502 0.97 3,361 1.11 3,868 1.35
FNMA 5,452 1.57 6,841 1.89 6,048 2.00 7,281 2.53
Total mortgage-backed -------- ------ -------- ------ -------- ------ -------- ------
securities 27,082 7.78 32,851 9.08 26,271 8.693 1,422 10.93
Mortgage-related securities
CMOs-agency backed 141,333 40.57 150,438 41.56 146,300 48.38 117,212 40.77
CMOs-Non-agency 60,395 17.34 59,346 16.39 24,559 8.12 25,741 8.95
Total mortgage-related -------- ------ -------- ------ -------- ------ -------- ------
securities 201,728 57.91 209,784 57.95 170,859 56.50 142,953 49.72
-------- ------ -------- ------ -------- ------ -------- ------
Total 228,810 65.69 242,635 67.03 197,130 65.19 174,375 60.65
-------- ------ -------- ------ -------- ------ -------- ------
Total securities
available for sale $348,347 100.00% $362,021 100.00% $302,419 100.00% $287,516 100.00%
======== ====== ======== ====== ======== ====== ======== ======
Held to Maturity:
- ----------------
Mortgage-backed
securities-FHLMC
certificates $ 1,196 8.69% $ -- --% $ -- --% $ -- --%
Municipal bonds:
Tax exempt 1,613 11.71 1,991 92.39 -- -- -- --
Taxable 1,096 7.96 -- -- -- -- -- --
Corporate bonds 4,000 29.05 -- -- -- -- -- --
Asset-backed securities 5,865 42.59 -- -- -- -- -- --
CMOs agency backed -- -- 164 7.61 -- -- -- --
Certificates of deposit -- -- -- -- $ 194 100.00% $ 987 100.00%
-------- ------ -------- ------ -------- ------ -------- ------
Total $ 13,770 100.00% $ 2,155 100.00% $ 194 100.00% $ 987 100.00%
======== ====== ======== ====== ======== ====== ======== ======
Estimated market value $ 13,716 $ 2,235 $ 194 $ 987
======== ======== ======== ========
22
</TABLE>
<PAGE>
<TABLE>
The following table shows the maturity or period to repricing of the Company's consolidated portfolio of
securities available for sale (dollars in thousands):
Available for sale at December 31 1999
------------------------------------------------------------------------------------------------
Over One to Over Five to Over Ten to Over
One Year or Less Five Years Ten Years Twenty Years Twenty Years Total
---------------- ---------------- --------------- -------------- ---------------- ------------
Weigh- Weigh- Weigh- Weigh- Weigh- Weigh-
Carry- ted Carry- ted Carry- ted Carry- ted ted Carry- ted
ing Average ing Average ing Average ing Average Average ing Average
Value Yield Value Yield Value Yield Value Yield Value Yield Value Yield
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S.
Government
Treasury
and agency
obligations
Fixed-
rate $ 4,491 5.59% $47,366 6.04% $ 2,853 6.14% $ -- --% $ -- --% $ 54,710 6.04%
Adjust-
able-
rate 4,158 5.69 -- -- -- -- -- -- -- -- 4,158 5.69
-------- ------- ------- ------- ------- --------
8,649 5.64 47,366 6.04 2,853 6.14 -- -- -- -- 58,868 6.02
Municipal
bonds:
Taxable -- -- 481 6.82 2,609 6.95 1,412 8.08 249 5.05 4,751 7.20
Tax Exempt 2,350 4.19 6,262 5.32 11,281 6.39 7,663 7.01 3,029 5.52 30,585 6.06
-------- ------- ------- ------- ------- --------
2,350 4.19 6,743 5.43 13,890 6.50 9,075 7.18 3,278 5.48 35,336 6.21
Corporate
bonds
Fixed-
rate 10,399 6.69 2,950 5.98 2,893 6.49 -- -- 5,322 7.26 21,564 6.71
Mortgage-
backed
obligations:
Fixed-
rate 310 5.62 34 8.71 546 9.01 1,300 9.31 19,383 7.26 21,573 7.40
Adjustable-
rate 4,953 6.51 556 6.06 -- -- -- -- -- -- 5,509 6.53
-------- ------- ------- ------- ------- --------
5,263 6.46 590 6.21 546 9.01 1,300 9.31 19,383 7.26 27,082 7.22
Mortgage-
related
obligations:
Fixed-
rate 405 10.51 -- -- 5,816 6.27 1,047 6.22 102,108 6.78 109,376 6.76
Adjustable-
rate 92,352 6.52 -- -- -- -- -- -- -- -- 92,352 6.52
-------- ------- ------- ------- ------- --------
92,757 6.54 -- -- 5,816 6.27 1,047 6.22 102,108 6.78 201,728 6.65
-------- ------- ------- ------- ------- --------
Total
mortgage-
backed
or
related
obliga-
tions 98,020 6.53 590 6.21 6,362 6.51 2,347 7.93 121,491 6.86 228,810 6.72
Other
stock 3,769 6.53 -- .-- -- -- -- -- -- -- 3,769 6.53
-------- ------- ------- ------- ------- --------
Total
securities
available
for sale
carrying
value $123,187 6.45% $57,649 5.91% $25,998 5.76% $11,422 6.33% $130,091 6.83% $348,347 6.45%
======== ======= ======= ======= ======== ========
Total
securities
available
for sale
amortized
cost $122,882 $58,938 $26,526 $11,270 $137,001 $356,617
======== ======= ======= ======= ======== ========
23
</TABLE>
<PAGE>
<TABLE>
The following table shows the maturity or period to repricing of the Company's consolidated portfolio of
securities held to maturity (dollars in thousands):
Held to Maturity at December 31 1999
------------------------------------------------------------------------------------------------
Over One to Over Five to Over Ten to Over
One Year or Less Five Years Ten Years Twenty Years Twenty Years Total
---------------- ---------------- --------------- -------------- ---------------- ------------
Weigh- Weigh- Weigh- Weigh- Weigh- Weigh-
Carry- ted Carry- ted Carry- ted Carry- ted ted Carry- ted
ing Average ing Average ing Average ing Average Average ing Average
Value Yield Value Yield Value Yield Value Yield Value Yield Value Yield
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Municipal
bonds:
Taxable $ -- --% $ 995 6.54% $ --% $ 101 10.00% $ -- --% $ 1,096 6.86%
Tax
exempt 125 6.97 1,049 7.51 439 7.80 -- -- -- -- 1,613 7.55
-------- ------- ------- ------- ------- --------
125 6.97 2,044 14.05 439 7.80 101 10.00 -- -- 2,709 14.41
Corporate
bonds
Fixed
rate -- -- -- -- -- -- -- -- 4,000 9.88 4,000 9.88
Mortgage-
backed
obligations:
Fixed-
rate -- -- -- -- -- -- -- -- 1,196 6.94 1,196 6.94
Other
asset-
backed
securities:
Fixed
rate -- -- 5,865 8.66 -- -- -- -- -- -- 5,865 8.66
-------- ------- ------- ------- ------- --------
Total
securities
held to
maturity:
Carrying
value $ 125 6.97% $ 7,909 7.04% $ 439 7.80% $ 101 10.00% $ 5,196 9.20% $ 13,770 8.59%
======== ======= ======= ======= ======== ========
Total
securities
held to
maturity:
Fair
market
value $ 126 $ 7,880 $ 436 $ 101 $ 5,173 $ 13,716
======== ======= ======= ======= ======== ========
24
</TABLE>
<PAGE>
Deposit Activities and Other Sources of Funds
General: Deposits, FHLB advances (or borrowings) and loan repayments are the
major sources of the Banks' funds for lending and other investment purposes.
Scheduled loan repayments are a relatively stable source of funds, while
deposit inflows and outflows and loan prepayments are influenced significantly
by general interest rates and money market conditions. Borrowings may be used
on a short-term basis to compensate for reductions in the availability of
funds from other sources. They may also be used on a longer-term basis for
general business purposes. The Banks do not currently solicit brokered
deposits.
Deposit Accounts: Deposits are attracted from within the Banks' primary
market areas through the offering of a broad selection of deposit instruments,
including demand checking accounts, NOW accounts, money market deposit
accounts, regular savings accounts, certificates of deposit and retirement
savings plans. Deposit account terms vary according to the minimum balance
required, the time periods the funds must remain on deposit and the interest
rate, among other factors. In determining the terms of their deposit
accounts, the Banks consider current market interest rates, profitability to
the Banks, matching deposit and loan products and their customer preferences
and concerns. The Banks generally review their deposit mix and pricing
weekly.
The Banks compete with other financial institutions and financial
intermediaries in attracting deposits. Competition from mutual funds has been
particularly strong in recent years due to the performance of the stock
market. In addition, there is strong competition for savings dollars from
commercial banks, credit unions, and nonbank corporations, such as securities
brokerage companies and other diversified companies, some of which have
nationwide networks of offices.
The Banks, especially FSBW, have been most successful in attracting a broad
range of retail time deposits and, at December 31, 1999, the Banks had a total
of $682.3 million in retail time deposits, of which $422.6 million had
original maturities of one year or longer.
As illustrated in the following table, certificates of deposit have accounted
for a larger percentage of the deposit portfolio than have transaction
accounts. However, as reflected in the balances and percentages for December
31, 1999 and March 31, 1999 and 1998, the acquisitions of IEB, TB, WSB and SCB
have added significantly to demand, NOW and Money Market accounts for the
Company.
25
<PAGE>
<TABLE>
The following table sets forth the balances of deposits in the various types of accounts offered by the
Banks at the dates indicated (in thousands).
At December 31 At March 31
------------------------------ ----------------------------------------------
1999 1999 1998
------------------------------ ---------------------------- -----------------
% of Increase % of Increase % of
Amount Total (Decrease) Amount Total (Decrease) Amount Total
------ ----- ---------- ------ ----- ---------- ------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Demand and NOW checking $ 197,649 18.34% $ 18,040 $179,609 18.89% $ 67,420 $112,189 18.62%
Regular savings accounts 53,305 4.94 (5,828) 59,133 6.22 17,049 42,084 6.99
Money market accounts 144,943 13.44 12,866 132,077 13.89 55,435 76,642 12.72
Certificates which mature:
Within 1 year 477,112 44.26 71,806 405,306 42.63 165,232 240,074 39.84
After 1 year, but
within 2 years 99,422 9.22 6,079 93,343 9.82 18,824 74,519 12.37
After 2 years, but
within 5 years 96,838 8.98 25,006 71,832 7.55 28,327 43,505 7.22
Certificates maturing
thereafter 8,883 0.82 (665) 9,548 1.00 (3,961) 13,509 2.24
---------- ------ -------- -------- ------ -------- -------- ------
Total $1,078,152 100.00% 127,304 $950,848 100.00% $348,326 $602,522 100.00%
========== ====== ======== ======== ====== ======== ======== ======
</TABLE>
<TABLE>
The following table sets forth the deposit activities of the Banks for the periods indicated (in thousands).
Nine Months Ended December 31, Year Ended March 31,
------------------------------ ------------------------
1999 1999 1998
---- ---- ----
<S> <C> <C> <C>
Beginning balance $ 950,848 $602,522 $ 555,706
Acquisitions 40,645 218,368 --
Net increase (decrease)
before interest credited 55,184 95,939 21,527
Interest credited 31,475 34,019 25,289
---------- -------- ---------
Net increase in savings deposits 127,304 348,326 46,816
---------- -------- ---------
Ending balance $1,078,152 $950,848 $ 602,522
========== ======== =========
</TABLE>
<TABLE>
The following table indicates the amount of the Banks' jumbo certificates of deposit by time remaining until
maturity as of December 31, 1999. Jumbo certificates of deposit require a minimum deposit of $100,000 and
rates paid on such accounts are negotiable (in thousands).
Jumbo
Maturity Period Certificates
- --------------- of deposits
---------
<S> <C>
Due in three months or less $ 97,078
Due after three months through six months 43,406
Due after six months through twelve months 58,505
Due after twelve months 49,140
---------
Total $ 248,129
=========
26
</TABLE>
<PAGE>
Borrowings: Deposits are the primary source of funds for the Banks' lending
and investment activities and for their general business purposes. The Banks
also use borrowings to supplement their supply of lendable funds, to meet
deposit withdrawal requirements and to more effectively leverage their capital
position. The FHLB-Seattle serves as the Banks' primary borrowing source. At
December 31, 1999, the Banks had $466.5 million of combined borrowings from
FHLB-Seattle at a weighted average rate of 5.86%. At December 31, 1999 the
Banks, on a combined basis, have been authorized by the FHLB-Seattle to borrow
up to $542.4 million under a blanket floating lien security agreement.
Additional short-term funds are also obtained through commercial banking
credit lines and at December 31, 1999 totaled $6.5 million with interest at
4.67%.
The FHLB-Seattle functions as a central reserve bank providing credit for
member financial institutions. As a member, the Banks are required to own
capital stock in the FHLB-Seattle and are authorized to apply for advances on
the security of such stock and certain of its mortgage loans and other assets
(principally securities which are obligations of, or guaranteed by, the U.S.
Government) provided certain creditworthiness standards have been met.
Advances are made pursuant to several different credit and underwriting
programs. Each program has its own interest rate, maturity and collateral
requirements. Depending on the program, limitations on the amount of advances
are based on the financial condition of the member institution and the
adequacy of collateral pledged to secure the credit.
FSBW also uses retail repurchase agreements due generally within 90 days as a
source of funds. At December 31, 1999, retail repurchase agreements totaling
$8.5 million with interest rates from 5.28% to 7.18% were secured by a pledge
of certain FNMA, GNMA and FHLMC mortgage-backed securities with a market value
of $12.6 million.
FSBW also borrows funds through the use of secured wholesale repurchase
agreements with securities brokers. The broker holds FSBW's securities while
FSBW continues to receive the principal and interest payments from the
security. FSBW's outstanding borrowings at December 31, 1999, under wholesale
repurchase agreements totaled $66.7 million and were collateralized by
mortgage-backed securities with a fair value of $70.3 million.
(See "Management's Discussion and Analysis of Financial Position and Results
of Operations - Liquidity and Capital Resources" and Notes 11 and 12 of the
Consolidated Financial Statements).
Personnel
As of December 31, 1999, the Company had 473 full-time and 77 part-time
employees. The employees are not represented by a collective bargaining unit.
The Company believes its relationship with its employees is good.
Taxation
Federal Taxation
General. For tax reporting purposes, the Company and the Banks report their
income on a calendar year basis using the accrual method of accounting. The
Company and the Banks are subject to federal income taxation in the same
manner as other corporations with some exceptions including particularly the
reserve for bad debts discussed below. The following discussion of tax
matters is intended only as a summary and does not purport to be a
comprehensive description of the tax rules applicable to the Company and the
Banks.
Bad Debt Reserve. Historically, savings institutions such as FSBW which met
certain definitional tests primarily related to their assets and the nature of
their business ("qualifying thrift") were permitted to establish a reserve for
bad debts and to make annual additions thereto, which may have been deducted
in arriving at their taxable income. FSBW's deductions with respect to
"qualifying real property loans," which are generally loans secured by certain
interests in real property, were computed using an amount based on FSBW's
actual loss experience, or a percentage equal to 8% of FSBW's taxable income,
computed with certain modifications and reduced by the amount of any permitted
additions to the non-qualifying reserve. Due to FSBW's loss experience, it
generally recognized a bad debt deduction equal to 8% of taxable income.
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In August 1996, provisions repealing the current thrift bad debt rules were
enacted by Congress as part of "The Small Business Job Protection Act of
1996." The new rules eliminated the 8% of taxable income method for deducting
additions to the tax bad debt reserves for all thrifts for tax years beginning
after December 31, 1995. These rules also require that all institutions
recapture all or a portion of their bad debt reserves added since the base
year (last taxable year beginning before January 1, 1988). The Company's
subsidiary, FSBW had previously recorded a deferred tax liability equal to
the bad debt recapture and as such the new rules will have no effect on the
net income or federal income tax expense. For taxable years beginning after
December 31, 1995, because the Company is a "large" bank (i.e., assets in
excess of $500 million), the Company's bad debt deduction will be determined
on the basis of net charge-offs during the taxable year. Tax law requires that
the Company recapture, for federal income tax purposes, certain of its tax
basis bad debt reserves. Such recaptured amounts are being taken into ordinary
income ratably over a four- to six-year period beginning in fiscal 1998. The
Company is recapturing its post-1987 additions to its tax basis bad debt
reserves, which totaled $1.9 million at December 31, 1999, ratably over a
four- to six-taxable-year period, resulting in approximately $169,000 in
federal income tax payments for the nine months ended December 31, 1999 (based
upon current federal income tax rates). This will not result in a charge to
earnings as these amounts have been previously provided for in the deferred
tax liability at December 31, 1999. The Company is a "large" bank (i.e.,
assets in excess of $500 million) and the Company's bad debt deduction will be
determined on the basis of net charge-offs during the taxable year. The
Company is required to recapture the bad debt reserve of any "small" bank
(i.e., assets less than $500 million), that is acquired and becomes a part of
the Company's consolidated tax group, that has used any method other than the
specific charge-off method to compute their bad debt deduction. Any required
bad debt reserve recapture of an acquired bank due to the conversion from a
"small" bank to a "large" bank will be taken into ordinary income over a
four-year period. The Company's retained earnings at December 31, 1999
includes $5,318,000 of earnings which represent pre-1987 federal income tax
basis bad debt reserve deductions taken by its subsidiary FSBW, for which no
provisions for federal income taxes have been made. If the accumulated amount
that qualified as deductions for federal income taxes is later used for
purposes other than to absorb bad debt losses or FSBW no longer qualifies as a
bank, the accumulated reserve will be subject to federal income tax at the
then current tax rates which would equate to approximately $1,861,000 of
additional taxes.
Distributions. To the extent that FSBW makes "nondividend distributions" to
the Company, such distributions will be considered to result in distributions
from the balance of their bad debt reserves as of December 31, 1987 (or a
lesser amount if FSBW's loan portfolio decreased since December 31, 1987) and
then from the supplemental reserve for losses on loans ("Excess
Distributions"), and an amount based on the Excess Distributions will be
included in FSBW's taxable income. Nondividend distributions include
distributions in excess of FSBW's current and accumulated earnings and
profits, distributions in redemption of stock and distributions in partial or
complete liquidation. However, dividends paid out of FSBW's current or
accumulated earnings and profits, as calculated for federal income tax
purposes, will not be considered to result in a distribution from FSBW's bad
debt reserves.
The amount of additional taxable income created from an Excess Distribution is
an amount that, when reduced by the tax attributable to the income, is equal
to the amount of the distribution. Thus, approximately one and one-half times
the Excess Distribution would be includable in gross income for federal income
tax purposes, assuming a 34% federal corporate income tax rate. FSBW does not
intend to pay dividends that would result in a recapture of any portion of its
tax bad debt reserve.
Corporate Alternative Minimum Tax. The Code imposes a tax on alternative
minimum taxable income ("AMTI") at a rate of 20%. AMTI is increased by an
amount equal to 75% of the amount by which the corporation's adjusted current
earnings exceeds its AMTI (determined without regard to this preference and
prior to reduction for net operating losses). For taxable years beginning
after December 31, 1986, and before January 1, 1996, an environmental tax of
.12% of the excess of AMTI (with certain modification) over $2.0 million is
imposed on corporations, including the Banks, whether or not an Alternative
minimum Tax ("AMT") is paid.
Dividends-Received Deduction and Other Matters. The Company may exclude from
its income 100% of dividends received from the Banks 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 Banks will not file a consolidated
tax return, except that if the Company or the Banks own more than 20% of the
stock of a corporation distributing a dividend, then 80% of any dividends
received may be deducted.
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There have not been any IRS audits of the Company's or the Banks' federal
income tax returns during the past five years.
Environmental Regulation
The business of the Company is affected from time to time by federal and state
laws and regulations relating to hazardous substances. Under the federal
Comprehensive Environmental Response, Compensation and Liability Act (CERCLA),
owners and operators of properties containing hazardous substances may be
liable for the costs of cleaning up the substances. CERCLA and similar state
laws can affect the Company both as an owner of branches and other properties
used in its business and as a lender holding a security interest in property
which is found to contain hazardous substances. While CERCLA contains an
exemption for holders of security interests, the exemption is not available if
the holder participates in the management of a property, and some courts have
broadly defined what constitutes participation in management of property.
Moreover, CERCLA and similar state statutes can affect the Company's decision
of whether or not to foreclose on a property. Before foreclosing on
commercial real estate, it is the Company's general policy to obtain an
environmental report, thereby increasing the costs of foreclosure. In
addition, the existence of hazardous substances on a property securing a
troubled loan may cause the Company to elect not to foreclose on the property,
thereby reducing the Company's flexibility in handling the loan.
Competition
The Banks encounter significant competition both in attracting deposits and in
originating real estate loans. Their most direct competition for deposits has
come historically from other commercial and savings banks, savings
associations and credit unions in their market areas. More recently, the
Banks have experienced an increased level of competition from securities
firms, insurance companies, money market and mutual funds, and other
investment vehicles. The Banks expect continued strong competition from such
financial institutions and investment vehicles in the foreseeable future. The
ability of the Banks to attract and retain deposits depends on their ability
to provide investment opportunities that satisfy the requirements of investors
as to rate of return, liquidity, risk of loss of principal, convenience of
locations and other factors. The Banks compete for deposits by offering
depositors a variety of deposit accounts and financial services at competitive
rates, convenient business hours, and a high level of personal service and
expertise.
The competition for loans comes principally from commercial banks, loan
brokers, mortgage banking companies, other savings banks and credit unions.
The competition for loans has increased substantially in recent years as a
result of the large number of institutions competing in the Banks' market
areas as well as the increased efforts by commercial banks and credit unions
to expand mortgage loan originations.
The Banks compete for loans primarily through offering competitive rates and
fees and providing excellent services to borrowers and home builders. Factors
that affect competition include general and local economic conditions, current
interest rate levels and the volatility of the mortgage markets.
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Regulation
The Banks
General: As state-chartered, federally insured financial institutions, the
Banks are subject to extensive regulation. Lending activities and other
investments must comply with various statutory and regulatory requirements,
including prescribed minimum capital standards. The Banks are regularly
examined by the FDIC and their state banking regulators and file periodic
reports concerning their activities and financial condition with their
regulators. The Banks' relationship with depositors and borrowers also is
regulated to a great extent by both federal and state law, especially in such
matters as the ownership of savings accounts and the form and content of
mortgage documents.
Federal and state banking laws and regulations govern all areas of the
operation of the Banks, including reserves, loans, mortgages, capital,
issuance of securities, payment of dividends and establishment of branches.
Federal and state bank regulatory agencies also have the general authority to
limit the dividends paid by insured banks and bank holding companies if such
payments should be deemed to constitute an unsafe and unsound practice. The
respective primary federal regulators of the Company and the Banks have
authority to impose penalties, initiate civil and administrative actions and
take other steps intended to prevent banks from engaging in unsafe or unsound
practices.
State Regulation and Supervision: As a state-chartered savings bank, FSBW is
subject to applicable provisions of Washington law and regulations. As a
state chartered commercial Bank, TB is subject to applicable provisions of
Washington law and regulations. As a state-chartered commercial bank, IEB is
subject to applicable provisions of Oregon law and regulations. State law and
regulations govern the Banks' ability to take deposits and pay interest
thereon, to make loans on or invest in residential and other real estate, to
make consumer loans, to invest in securities, to offer various banking
services to its customers, and to establish branch offices. Under state law,
savings banks in Washington also generally have all of the powers that federal
mutual savings banks have under federal laws and regulations. The Banks are
subject to periodic examination and reporting requirements by and of their
state banking regulators.
Deposit Insurance: The FDIC is an independent federal agency that insures the
deposits, up to prescribed statutory limits, of depository institutions. The
FDIC currently maintains two separate insurance funds: the BIF and the SAIF.
As insurer of the Banks' deposits, the FDIC has examination, supervisory and
enforcement authority over the Banks.
FSBW's accounts are insured by the SAIF and IEB's and TB's accounts are
insured by the BIF to the maximum extent permitted by law. The Banks pay
deposit insurance premiums based on a risk-based assessment system established
by the FDIC. Under applicable regulations, institutions are assigned to one
of three capital groups that are based solely on the level of an institution's
capital "well capitalized," "adequately capitalized," and "undercapitalized"
which are defined in the same manner as the regulations establishing the
prompt corrective action system, as discussed below. These three groups are
then divided into three subgroups which reflect varying levels of supervisory
concern, from those which are considered to be healthy to those which are
considered to be of substantial supervisory concern. The matrix so created
results in nine assessment risk classifications.
Pursuant to the Deposit Insurance Funds Act of 1996 (the "DIF Act"), which was
enacted on September 30, 1996, the FDIC imposed a special assessment on each
depository institution with SAIF-assessable deposits which resulted in the
SAIF achieving its designated reserve ratio. In connection therewith, the
FDIC reduced the assessment schedule for SAIF members, effective January 1,
1997, to a range of 0% to 0.27%, with most institutions, including FSBW,
paying 0%. This assessment schedule is the same as that for the BIF, which
reached its designated reserve ratio in 1995. In addition, since January 1,
1997, SAIF members are charged an assessment of .065% of SAIF-assessable
deposits for the purpose of paying interest on the obligations issued by the
Financing Corporation ("FICO") in the 1980s to help fund the thrift industry
cleanup. BIF-assessable deposits will be charged an assessment to help pay
interest on the FICO bonds at a rate of approximately .013% until the earlier
of December 31, 1999 or the date upon which the last savings association
ceases to exist, after which time the assessment will be the same for all
insured deposits. The DIF Act provides for the merger of the BIF and the SAIF
into the Deposit Insurance Fund on January 1, 1999, but only if no insured
depository institution is a savings association on that date.
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The FDIC may terminate the deposit insurance of any insured depository
institution if it determines after a hearing that the institution has engaged
or is engaging in unsafe or unsound practices, is in an unsafe or unsound
condition to continue operations, or has violated any applicable law,
regulation, order or any condition imposed by an agreement with the FDIC. It
also may suspend deposit insurance temporarily during the hearing process for
the permanent termination of insurance, if the institution has no tangible
capital. If insurance of accounts is terminated, the accounts at the
institution at the time of termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined
by the FDIC. Management is aware of no existing circumstances that could
result in termination of the deposit insurance of the Banks.
Prompt Corrective Action: Under Federal Deposit Insurance Corporation
Improvement Act of 1991 (FDICIA), each federal banking agency is required to
implement a system of prompt corrective action for institutions which it
regulates. The federal banking agencies have promulgated substantially
similar regulations to implement this system of prompt corrective action.
Under the regulations, an institution shall be deemed to be: (i) "well
capitalized" if it has a total risk-based capital ratio of 10.0% or more, has
a Tier I risk-based capital ratio of 6.0% or more, has a Tier I leverage
capital ratio of 5.0% or more and is not subject to specified requirements to
meet and maintain a specific capital level for any capital measure; (ii)
"adequately capitalized" if it has a total risk-based capital ratio of 8.0% or
more, has a Tier I risk-based capital ratio of 4.0% or more, has a Tier I
leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and
does not meet the definition of "well capitalized;" (iii) "undercapitalized"
if it has a total risk-based capital ratio that is less than 8.0%, has a Tier
I risk-based capital ratio that is less than 4.0% or has a Tier I leverage
capital ratio that is less than 4.0% (3.0% under certain circumstances); (iv)
"significantly undercapitalized" if it has a total risk-based capital ratio
that is less than 6.0%, has a Tier I risk-based capital ratio that is less
than 3.0% or has a Tier I leverage capital ratio that is less than 3.0%; and
(v) "critically undercapitalized" if it has a ratio of tangible equity to
total assets that is equal to or less than 2.0%.
A federal banking agency may, after notice and an opportunity for a hearing,
reclassify a well capitalized institution as adequately capitalized and may
require an adequately capitalized institution or an undercapitalized
institution to comply with supervisory actions as if it were in the next lower
category if the institution is in an unsafe or unsound condition or engaging
in an unsafe or unsound practice. (The FDIC may not, however, reclassify a
significantly undercapitalized institution as critically undercapitalized.)
An institution generally must file a written capital restoration plan which
meets specified requirements, as well as a performance guaranty by each
company that controls the institution, with the appropriate federal banking
agency within 45 days of the date that the institution receives notice or is
deemed to have notice that it is undercapitalized, significantly
undercapitalized or critically undercapitalized. Immediately upon becoming
undercapitalized, an institution shall become subject to various mandatory and
discretionary restrictions on its operations.
At December 31, 1999, all the Banks except TB were categorized as "well
capitalized" under the prompt corrective action regulations of the FDIC. TB
was categorized as "adequately capitalized" under FDIC regulation.
Standards for Safety and Soundness: The federal banking regulatory agencies
have prescribed, by regulation, standards for all insured depository
institutions relating to: (i) internal controls, information systems and
internal audit systems; (ii) loan documentation; (iii) credit underwriting;
(iv) interest rate risk exposure; (v) asset growth; (vi) asset quality; (vii)
earnings and (viii) compensation, fees and benefits (Guidelines). The
Guidelines set forth the safety and soundness standards that the federal
banking agencies use to identify and address problems at insured depository
institutions before capital becomes impaired. If the FDIC determines that
either Bank fails to meet any standard prescribed by the Guidelines, the
agency may require the Bank to submit to the agency an acceptable plan to
achieve compliance with the standard. FDIC regulations establish deadlines
for the submission and review of such safety and soundness compliance plans.
Capital Requirements: The FDIC's minimum capital standards applicable to
FDIC-regulated banks and savings banks require the most highly-rated
institutions to meet a "Tier 1" leverage capital ratio of at least 3% of total
assets. Tier 1 (or "core capital") consists of common stockholders' equity,
noncumulative perpetual preferred stock and minority interests in consolidated
subsidiaries minus all intangible assets other than limited amounts of
purchased mortgage servicing rights and certain other accounting adjustments.
All other banks must have a Tier 1 leverage ratio of at least 100-200 basis
points above the 3% minimum. The FDIC capital regulations establish a minimum
leverage ratio of not less than 4% for banks that are not highly rated or are
anticipating or experiencing significant growth.
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Any insured bank with a Tier 1 capital to total assets ratio of less than 2%
is deemed to be operating in an unsafe and unsound condition unless the
insured bank enters into a written agreement, to which the FDIC is a party, to
correct its capital deficiency. Insured banks operating with Tier 1 capital
levels below 2% (and which have not entered into a written agreement) are
subject to an insurance removal action. Insured banks operating with lower
than the prescribed minimum capital levels generally will not receive approval
of applications submitted to the FDIC. Also, inadequately capitalized state
nonmember banks will be subject to such administrative action as the FDIC
deems necessary.
FDIC regulations also require that banks meet a risk-based capital standard.
The risk-based capital standard requires the maintenance of total capital
(which is defined as Tier 1 capital and Tier 2 or supplementary capital) to
risk weighted assets of 8% and Tier 1 capital to risk-weighted assets of 4%.
In determining the amount of risk-weighted assets, all assets, plus certain
off balance sheet items, are multiplied by a risk-weight of 0% to 100%, based
on the risks the FDIC believes are inherent in the type of asset or item. The
components of Tier 1 capital are equivalent to those discussed above under the
3% leverage requirement. The components of supplementary capital currently
include cumulative perpetual preferred stock, adjustable-rate perpetual
preferred stock, mandatory convertible securities, term subordinated debt,
intermediate-term preferred stock and allowance for possible loan and lease
losses. Allowance for possible loan and lease losses includable in
supplementary capital is limited to a maximum of 1.25% of risk-weighted
assets. Overall, the amount of capital counted toward supplementary capital
cannot exceed 100% of Tier 1 capital.
FDIC capital requirements are designated as the minimum acceptable standards
for banks whose overall financial condition is fundamentally sound, which are
well-managed and have no material or significant financial weaknesses. The
FDIC capital regulations state that, where the FDIC determines that the
financial history or condition, including off-balance sheet risk, managerial
resources and/or the future earnings prospects of a bank are not adequate and/
or a bank has a significant volume of assets classified substandard, doubtful
or loss or otherwise criticized, the FDIC may determine that the minimum
adequate amount of capital for that bank is greater than the minimum standards
established in the regulation.
The Company believes that, under the current regulations, the Banks will
continue to meet their minimum capital requirements in the foreseeable future.
However, events beyond the control of the Banks, such as a downturn in the
economy in areas where the Banks have most of their loans, could adversely
affect future earnings and, consequently, the ability of the Banks to meet
their capital requirements.
Activities and Investments of Insured State-Chartered Banks: Federal law
generally limits the activities and equity investments of FDIC-insured, state-
chartered banks to those that are permissible for national banks. Under
regulations dealing with equity investments, an insured state bank generally
may not directly or indirectly acquire or retain any equity investment of a
type, or in an amount, that is not permissible for a national bank. An
insured state bank is not prohibited from, among other things, (i) acquiring
or retaining a majority interest in a subsidiary, (ii) investing as a limited
partner in a partnership the sole purpose of which is direct or indirect
investment in the acquisition, rehabilitation or new construction of a
qualified housing project, provided that such limited partnership investments
may not exceed 2% of the bank's total assets, (iii) acquiring up to 10% of the
voting stock of a company that solely provides or reinsures directors',
trustees' and officers' liability insurance coverage or bankers' blanket bond
group insurance coverage for insured depository institutions, and (iv)
acquiring or retaining the voting shares of a depository institution if
certain requirements are met.
Federal law provides that an insured state-chartered bank may not, directly or
indirectly through a subsidiary, engage as "principal" in any activity that is
not permissible for a national bank unless the FDIC has determined that such
activities would pose no risk to the insurance fund of which it is a member
and the bank is in compliance with applicable regulatory capital requirements.
Any insured state-chartered bank directly or indirectly engaged in any
activity that is not permitted for a national bank must cease the
impermissible activity.
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Federal Reserve System: In 1980, Congress enacted legislation which imposed
Federal Reserve requirements (under "Regulation D") on all depository
institutions that maintain transaction accounts or nonpersonal time deposits.
These reserves may be in the form of cash or non-interest-bearing deposits
with the regional Federal Reserve Bank. NOW accounts and other types of
accounts that permit payments or transfers to third parties fall within
thedefinition of transaction accounts and are subject to Regulation D reserve
requirements, as are any nonpersonal time deposits at a bank. Under
Regulation D, a bank must establish reserves equal to 3% of the first $47.8
million of transaction accounts, of which the first $4.4 million is exempt,
and 10% on the remainder. The reserve requirement on nonpersonal time deposits
with original maturities of less than 1-1/2 years is 0%. As of December 31,
1999, the Banks met their reserve requirements.
Affiliate Transactions: The Company and the Banks are legal entities separate
and distinct. Various legal limitations restrict the Banks from lending or
otherwise supplying funds to the Company (an "affiliate"), generally limiting
such transactions with the affiliate to 10% of the Bank's capital and surplus
and limiting all such transactions to 20% of the Bank's capital and surplus.
Such transactions, including extensions of credit, sales of securities or
assets and provision of services, also must be on terms and conditions
consistent with safe and sound banking practices, including credit standards,
that are substantially the same or at least as favorable to the Banks as those
prevailing at the time for transactions with unaffiliated companies.
Federally insured banks are subject, with certain exceptions, to certain
restrictions on extensions of credit to their parent holding companies or
other affiliates on investments in the stock or other securities of affiliates
and on the taking of such stock or securities as collateral from any borrower.
In addition, such banks are prohibited from engaging in certain tie-in
arrangements in connection with any extension of credit or the providing of
any property or service.
Community Reinvestment Act: Banks are also subject to the provisions of the
Community Reinvestment Act of 1977, which requires the appropriate federal
bank regulatory agency, in connection with its regular examination of a bank,
to assess the bank's record in meeting the credit needs of the community
serviced by the bank, including low and moderate income neighborhoods. The
regulatory agency's assessment of the bank's record is made available to the
public. Further, such assessment is required of any bank which has applied,
among other things, to establish a new branch office that will accept
deposits, relocate an existing office or merge or consolidate with, or acquire
the assets or assume the liabilities of, a federally regulated financial
institution.
Dividends: Dividends from the Banks will constitute the major source of funds
for dividends which may be paid by the Company. The amount of dividends
payable by the Banks to the Company will depend upon the Banks' earnings and
capital position, and is limited by federal and state laws, regulations and
policies.
Federal law further provides that no insured depository institution may make
any capital distribution (which would include a cash dividend) if, after
making the distribution, the institution would be "undercapitalized," as
defined in the prompt corrective action regulations. Moreover, the federal
bank regulatory agencies also have the general authority to limit the
dividends paid by insured banks if such payments should be deemed to
constitute an unsafe and unsound practice.
The Company
General: The Company is a bank holding company registered with the Federal
Reserve. Bank holding companies are subject to comprehensive regulation by
the Federal Reserve under the Bank Holding Company Act of 1956, as amended
(BHCA), and the regulations of the Federal Reserve. The Company is required
to file with the Federal Reserve annual reports and such additional
information as the Federal Reserve may require and is subject to regular
examinations by the Federal Reserve. The Federal Reserve also has extensive
enforcement authority over bank holding companies, including, among other
things, the ability to assess civil money penalties, to issue cease and desist
or removal orders and to require that a holding company divest subsidiaries
(including its bank subsidiaries). In general, enforcement actions may be
initiated for violations of law and regulations and unsafe or unsound
practices.
Under the BHCA, a bank holding company must obtain Federal Reserve approval
before: (1) acquiring, directly or indirectly, ownership or control of any
voting shares of another bank or bank holding company if, after such
acquisition, it would own or control more than 5% of such shares (unless it
already owns or controls the majority of such shares); (2) acquiring all or
substantially all of the assets of another bank or bank holding company; or
(3) merging or consolidating with another bank holding company.
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The BHCA also prohibits a bank holding company, with certain exceptions, from
acquiring direct or indirect ownership or control of more than 5% of the
voting shares of any company that is not a bank or bank holding company and
from engaging directly or indirectly in activities other than those of
banking, managing or controlling banks, or providing services for its
subsidiaries. The principal exceptions to these prohibitions involve certain
nonbank activities which, by statute or by Federal Reserve regulation or
order, have been identified as activities closely related to the business of
banking or managing or controlling banks. The list of activities permitted by
the Federal Reserve includes, among other things: operating a savings
institution, mortgage company, finance company, credit card company or
factoring company; performing certain data processing operations; providing
certain investment and financial advice; underwriting and acting as an
insurance agent for certain types of credit-related insurance; leasing
property on a full-payout, non-operating basis; selling money orders,
travelers' checks and U.S. Savings Bonds; real estate and personal property
appraising; providing tax planning and preparation services; and, subject to
certain limitations, providing securities brokerage services for customers.
Interstate Banking and Branching. The Federal Reserve must approve an
application of an adequately capitalized and adequately managed bank holding
company to acquire control of, or acquire all or substantially all of the
assets of, a bank located in a state other than such holding company's home
state, without regard to whether the transaction is prohibited by the laws of
any state. The Federal Reserve may not approve the acquisition of a bank that
has not been in existence for the minimum time period (not exceeding five
years) specified by the statutory law of the host state. Nor may the Federal
Reserve approve an application if the applicant (and its depository
institution affiliates) controls or would control more than 10% of the insured
deposits in the United States or 30% or more of the deposits in the target
bank's home state or in any state in which the target bank maintains a branch.
Federal law does not affect the authority of states to limit the percentage of
total insured deposits in the state which may be held or controlled by a bank
holding company to the extent such limitation does not discriminate against
out-of-state banks or bank holding companies. Individual states may also
waive the 30% state-wide concentration limit contained in the federal law.
The Federal banking agencies are authorized to approve interstate merger
transactions without regard to whether such transaction is prohibited by the
law of any state, unless the home state of one of the banks adopted a law
prior to June 1, 1997 which applies equally to all out-of-state banks and
expressly prohibits merger transactions involving out-of-state banks.
Interstate acquisitions of branches will be permitted only if the law of the
state in which the branch is located permits such acquisitions. Interstate
mergers and branch acquisitions will also be subject to the nationwide and
statewide insured deposit concentration amounts described above.
Dividends: The Federal Reserve has issued a policy statement on the payment
of cash dividends by bank holding companies, which expresses the Federal
Reserve's view that a bank holding company should pay cash dividends only to
the extent that the company's net income for the past year is sufficient to
cover both the cash dividends and a rate of earning retention that is
consistent with the company's capital needs, asset quality and overall
financial condition. The Federal Reserve also indicated that it would be
inappropriate for a company experiencing serious financial problems to borrow
funds to pay dividends.
Bank holding companies, except for certain "well-capitalized" bank holding
companies, are required to give the Federal Reserve prior written notice of
any purchase or redemption of its outstanding equity securities if the gross
consideration for the purchase or redemption, when combined with the net
consideration paid for all such purchases or redemptions during the preceding
12 months, is equal to 10% or more of their consolidated net worth. The
Federal Reserve may disapprove such a purchase or redemption of it determines
that the proposal would constitute an unsafe or unsound practice or would
violate any law, regulation, Federal Reserve order, or any condition imposed
by, or written agreement with, the Federal Reserve.
Capital Requirements: The Federal Reserve has established capital adequacy
guidelines for bank holding companies that generally parallel the capital
requirements of the FDIC for the Banks. The Federal Reserve regulations
provide that capital standards will be applied on a consolidated basis in the
case of a bank holding company with $150 million or more in total consolidated
assets.
The Company's total risk based capital must equal 8% of risk-weighted assets
and one half of the 8% (4%) must consist of Tier 1 (core) capital. As of
December 31, 1999 the Company's total risk based capital was 12.79% of
risk-weighted assets and its risk based capital of Tier 1 (core) capital was
11.71% of risk-weighted assets.
34
<PAGE>
MANAGEMENT PERSONNEL
Executive Officers
The following table sets forth information with respect to the executive
officers of the Company as of December 31, 1999.
Name Age (1) Position with Company Position with Banks
- ---- ------- --------------------- -------------------
Gary Sirmon 56 Chief Executive Officer, FSBW - Chief Executive
President and Director Officer, President and
Director, IEB, TB -
Director
D. Allan Roth 62 Secretary/Treasurer FSBW - Executive Vice
Executive Vice President President and Chief
Financial Officer
Michael K. Larsen 57 Executive Vice President FSBW - Executive Vice
President and Chief
Lending Officer
Jesse G. Foster 61 Director IEB-Chief Executive
Officer, President and
Director
Lloyd Baker 51 Senior Vice President FSBW-Senior Vice
President
S. Rick Meikle 52 Director TB-Chief Executive
Officer, President and
Director
- ----------------
(1) As of December 31, 1999.
Biographical Information
Set forth is certain information regarding the executive officers of the
Company, directors or executive officers. There are no family relationships
among or between the directors or executive officers.
Gary Sirmon is Chief Executive Officer, President and a Director of the
Company and FSBW; and a Director of IEB and TB. He joined FSBW in 1980 as an
Executive Vice President and assumed his current position in 1982.
D. Allan Roth is Executive Vice President and Chief Financial Officer of FSBW
and is Secretary/Treasurer and an Executive Vice President of the Company. He
joined FSBW in 1965.
Michael K. Larsen is Executive Vice President and Chief Lending Officer of
FSBW and is an Executive Vice President of the Company. He joined FSBW in
1981.
Jesse G. Foster is the Chief Executive Officer, President and a Director of
IEB and a Director of the Company. He joined IEB in 1962.
Lloyd Baker is a Senior Vice President with FSBW and is an Senior Vice
President of the Company. He joined FSBW in 1995 as a Vice President.
S. Rick Meikle is Chief Executive Officer, President and a Director of TB and
a Director of the Company. He helped form TB in 1991.
35
<PAGE>
Item 2 - Properties
The Company's home office, which is owned by the Company, is located in Walla
Walla, Washington. FSBW has, in total, 23 branch offices including five WSB
offices and two SCB offices, located in Washington and Idaho. These offices
are located in the cities of Walla Walla (4), Kennewick (2), Richland,
Clarkston, Sunnyside, Yakima (4), Selah, Wenatchee, Dayton, Bellingham,
Ferndale, Lynden, Blaine, Point Roberts and the two SCB offices which are
located in Lewiston, Idaho. Of these offices, 15 are owned by the Company and
are leased. The leases expire from 2000 through 2006. In addition to these,
FSBW has five leased loan production offices in Bellevue, Spokane, Puyallup,
Bellingham and Oak Harbor, Washington plus FSBW leases two administration
offices in Walla Walla, Washington. The leases expire from 2000 through 2002.
IEB's main office is located in Hermiston, Oregon and is owned by the Company.
IEB has, in total, six branch offices and a drive-up facility, all of which
are located in the State of Oregon. These offices, and the drive up
facility, which are owned by the Company, are located in Hermiston, Pendleton,
Umatilla, Boardman and Stanfield. IEB has two loan production offices, one in
Condon, which is on a month-to-month lease and one in La Grande, which is on a
lease which expires in 2003. IEB also leases a facility in Hermiston for its
information systems and it leases a grocery branch in Pendleton. These leases
expire in 2001 and 2004, respectively. Towne Bank operates from seven branch
locations, all of which are leased under agreements which expire from 2000 to
2006. TB offices are located in Woodinville, Bellevue, Redmond, Bothell,
Renton, Everett and Kirkland, Washington. The Company's net investment in its
offices, premises, equipment and leaseholds was $16.6 million at December 31,
1999.
Item 3 - Legal Proceedings
Periodically, there have been various claims and lawsuits involving the Banks,
mainly as a defendant, such as claims to enforce liens, condemnation
proceedings on properties in which the Banks hold security interests, claims
involving the making and servicing of real property loans and other issues
incident to the Banks' business. The Company and the Banks are not a party to
any pending legal proceedings that it believes would have a material adverse
effect on the financial condition or operations of the Company.
Item 4 - Submission of Matters to a Vote of Security Holders
None.
36
<PAGE>
Part II
Item 5 - Market for Registrant's Common Equity and Related Stockholder Matters
Stock Listing
First Washington Bancorp, Inc. common stock is traded over-the-counter on The
Nasdaq Stock Market under the symbol "FWWB." Newspaper stock tables list the
company as "FSBWA." Stockholders of record at December 31, 1999 totaled
1,170. This total does not reflect the number of persons or entitles who hold
stock in nominee or "street" name through various brokerage firms. The
following tables show the reported high and low sale prices of the Company's
common stock for the nine months ended December 31, 1999 and the four year
period ended March 31, 1999.
Cash
Nine Months Ended Dividends
December 31, 1999 High Low Declared
----------------- ---- ---- --------
First quarter $22 $18.06 $0.12
Second quarter 20 17.44 0.12
Third quarter 19.25 14.75 0.12
Cash
Year Ended Dividends
March 31, 1999 High Low Declared
----------------- ---- ---- --------
First quarter(1) $25.34 $21.81 $0.082
Second quarter 23.64 19.38 0.090
Third quarter 24.00 19.88 0.090
Fourth quarter 24.00 18.38 0.120
Cash
Year Ended Dividends
March 31, 1998(1) High Low Declared
----------------- ---- ---- --------
First quarter $20.23 $17.05 $0.064
Second quarter 22.62 19.66 0.064
Third quarter 25.96 21.14 0.064
Fourth quarter 25.12 21.36 0.082
Cash
Year Ended Dividends
March 31, 1997(1) High Low Declared
----------------- ---- ---- --------
First quarter $14.21 $12.16 $0.045
Second quarter 15.68 13.18 0.045
Third quarter 17.27 15.05 0.045
Fourth quarter 20.12 16.36 0.064
Cash
Year Ended Dividends
March 31, 1996*(1) High Low Declared
----------------- ---- ---- --------
Third quarter $12.05 $11.31 $0.045
Fourth quarter 12.27 11.25 0.045
* Year of Conversion
(1) Restated to reflect 10% stock dividend granted in August 1998, see
Note 1.
37
<PAGE>
Item 6 - Selected Consolidated Financial and Other Data
During May of 1999 the Company announced its decision to change its fiscal
year end from March 31 to December 31 beginning with the current period ended
on December 31, 1999. The information presented for the nine months ended
December 31, 1998 is for comparative purposes only and has not been subjected
to a financial audit. These tables set forth selected consolidated financial
and other data of the Company at the dates and for the periods indicated.
This information is derived from and is qualified in its entirety by reference
to the detailed information and Consolidated Financial Statements and Notes
thereto presented elsewhere in this or prior filings.
<TABLE>
FINANCIAL CONDITION DATA: At December 31 At March 31 (2)
------------------------- ------------------------------------------------
(In thousands) 1999 1998 1999 1998 1997 1996
---- ---- ---- ---- ---- ----
Unaudited
<S> <C> <C> <C> <C> <C> <C>
Total assets $1,820,110 $1,469,457 $1,631,900 $1,154,072 $1,007,633 $743,176
Loans receivable, net 1,308,164 976,131 1,102,669 756,917 645,881 415,295
Cash and securities (1) 406,886 412,420 436,679 345,142 312,991 302,772
Deposits 1,078,152 809,521 950,848 602,522 555,706 383,070
Borrowings 548,179 478,228 486,719 389,272 293,700 199,071
Stockholders equity 179,173 170,883 183,608 150,184 148,636 154,142
Shares outstanding excluding
unearned, restricted shares
held in ESOP 10,538 10,556 10,902 10,160 10,718 11,085
</TABLE>
<TABLE>
For the Nine Months
Ended December 31 For the Years Ended March 31 (2)
OPERATING DATA: ------------------------- -------------------------------------------------
(In thousands, except per 1999 1998 1999 1998 1997 1996
share data) ---- ---- ---- ---- ---- ----
Unaudited
<S> <C> <C> <C> <C> <C> <C>
Interest income $ 101,032 $ 81,822 $ 112,292 $ 85,147 $ 67,292 $ 41,409
Interest expense 53,201 44,283 60,442 46,651 36,372 23,287
---------- ---------- ---------- ---------- --------- ---------
Net interest income 47,831 37,539 51,850 38,496 30,920 18,122
Provision for loan losses 1,885 2,210 2,841 1,628 1,423 524
Net interest income after ---------- ---------- ---------- ---------- --------- ---------
provision for loan losses 45,946 35,329 49,009 36,868 29,497 17,598
Gains from sale of loans
and securities 1,159 2,059 2,895 1,379 686 387
Other operating income 4,356 3,297 4,558 3,341 2,384 1,216
Other operating expenses 30,522 22,394 31,745 21,020 19,330 10,318
Income before provision for ---------- ---------- ---------- ---------- --------- ---------
income taxes 20,939 18,291 24,717 20,568 13,237 8,883
Provision for income taxes 8,070 6,880 9,277 7,446 3,923 2,631
---------- ---------- ---------- ---------- --------- ---------
Net income $ 12,869 $ 11,411 $ 15,440 $ 13,122 $ 9,314 $ 6,252
========== ========== ========== ========== ========= =========
PER SHARE DATA:(3)
Net income: Basic $ 1.23 $ 1.09 $ 1.46 $ 1.30 $ 0.88 $ 0.56
Diluted 1.19 1.04 1.40 1.25 0.87 0.56
Stockholders' equity (4) 17.00 16.19 16.84 14.78 13.87 13.91
Cash dividends 0.36 0.26 0.38 0.27 0.20 0.09
Dividend payout ratio (diluted) 30.25% 25.00% 27.14% 21.60% 22.99% 16.07%
(footnotes on following page)
38
<PAGE>
</TABLE>
KEY FINANCIAL RATIOS: (5)
<TABLE>
At or for the Nine Months
Ended December 31 At or for the Years Ended March 31 (2)
------------------------- -------------------------------------------------
1999 1998 1999 1998 1997 1996
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Performance Ratios:
Return on average assets (6) 0.99% 1.09% 1.08% 1.21% 1.04% 1.11%
Return on average equity (7) 9.49 8.86 8.91 8.70 6.30 6.62
Average equity to average assets 10.44 12.35 12.07 13.86 16.58 16.75
Interest rate spread (8) 3.64 3.42 3.45 3.13 2.88 2.49
Net interest margin (9) 3.91 3.81 3.83 3.68 3.59 3.33
Non-interest income to average
assets 0.42 0.51 0.52 0.43 0.34 0.28
Non-interest expense to average
assets 2.35 2.15 2.21 1.93 2.17 1.83
Efficiency ratio (10) 57.22 52.21 53.53 48.64 56.87 52.31
Average interest-earning
assets to interest-bearing
liabilities 106.01 108.76 108.30 112.53 116.97 119.80
Asset Quality Ratios:
Allowance for loan losses as
a percent of net loans at end
of period 1.02 1.09 1.10 1.03 0.94 0.97
Net charge-offs as a percent
of average outstanding loans
during the period 0.09 0.10 0.14 0.08 0.04 0.01
Non-performing assets as
a percent of total assets 0.48 0.37 0.57 0.20 0.31 0.17
Ratio of allowance for loan
losses as a percent of non-
performing loans (11) 2.67 3.30 1.60 5.53 3.20 7.53
Consolidated Capital Ratio:
Tier 1 leverage capital ratio 8.39 9.82 9.44 12.17 13.68 20.78
</TABLE>
- ---------------
(1) Includes securities available for sale and held to maturity.
(2) Certain amounts in the prior periods' financial statements have been
reclassified to conform to the current period's presentation. These
reclassifications have affected certain ratios for the prior periods.
The effect of such reclassifications is immaterial.
(3) FSBW converted from mutual to stock ownership on October 31, 1995. Per
share data for fiscal 1996 represent proforma calculations. Per share
data have been adjusted for the 10% stock dividend paid in August 1998.
(4) Calculated using shares outstanding excluding unearned restricted shares
held in ESOP.
(5) Ratios are annualized.
(6) Net income divided by average assets.
(7) Net income divided by average equity.
(8) Difference between the average yield on interest-earning assets and the
average cost of interest-bearing liabilities.
(9) Net interest income before provision for loan losses as a percent of
average interest-earning assets.
(10) Other operating expenses divided by the total of net interest income
before loan losses and other operating income (non-interest income).
(11) Non-performing loans consist of nonaccrual and 90 days past due loans.
39
<PAGE>
ITEM 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations
Special Note Regarding Forward-Looking Statements
Management's Discussion and Analysis (MD&A) and other portions of this report
contain certain "forward-looking statements" concerning the future operations
of First Washington Bancorp, Inc. Management desires to take advantage of the
"safe harbor" provisions of the Private Securities Litigation Reform Act of
1995 and is including this statement for the express purpose of availing the
Company of the protections of such safe harbor with respect to all "forward-
looking statements" contained in our Annual Report. We have used "forward-
looking statements" to describe future plans and strategies, including our
expectations of the Company's future financial results. Management's ability
to predict results or the effect of future plans or strategies is inherently
uncertain. Factors which could affect actual results include interest rate
trends, the general economic climate in the Company's market area and the
country as a whole, the ability of the Company to control costs and expenses,
the ability of the Company to efficiently incorporate acquisitions into its
operations, competitive products and pricing, loan delinquency rates, and
changes in federal and state regulation. These factors should be considered
in evaluating the "forward-looking statements," and undue reliance should not
be placed on such statements.
General
First Washington Bancorp, Inc. (the Company or FWWB), a Washington
corporation, is primarily engaged in the business of planning, directing and
coordinating the business activities of its wholly owned subsidiaries, First
Savings Bank of Washington (FSBW), Inland Empire Bank (IEB) and Towne Bank
(TB) (together, the Banks). FSBW is a Washington-chartered savings bank the
deposits of which are insured by the Federal Deposit Insurance Corporation
(FDIC) under the Savings Association Insurance Fund (SAIF). FSBW conducts
business from its main office in Walla Walla, Washington and its 23 branch
offices and four loan production offices located in Washington and Idaho.
Effective April 1, 1999 FSBW completed the acquisition of Seaport Citizens
Bank (SCB). SCB was merged with FSBW and its two branches in Lewiston, Idaho,
together with FSBW's Clarkston, Washington, branch operate as a division of
FSBW. Effective January 1, 1999, FWWB completed the acquisition of Whatcom
State Bancorp whose wholly-owned subsidiary, Whatcom State Bank (WSB), was
merged with FSBW and operates as Whatcom State Bank, a Division of First
Savings Bank of Washington. WSB, which is based in Bellingham, operates five
full service branches and a loan office in northwest Washington. IEB is an
Oregon-chartered commercial bank whose deposits are insured by the FDIC under
the Bank Insurance Fund (BIF). IEB conducts business from its main office in
Hermiston, Oregon and its six branch offices and two loan production offices
located in northeast Oregon. TB is a Washington-chartered commercial bank
whose deposits are insured by the FDIC under BIF. TB conducts business from
seven full service branches in the Seattle, Washington, metropolitan area.
During May 1999, the Company announced its decision to change its fiscal year
from April 1 through March 31 to January 1 through December 31. The current
fiscal period is for the transition period April 1, 1999 through December 31,
1999. For discussion and analysis purposes, the nine months ended December
31, 1999 are compared to the unaudited nine months ended December 31, 1998.
The operating results of FWWB depend primarily on its net interest income,
which is the difference between interest income on interest-earning assets,
consisting of loans and investment securities, and interest expense on
interest-bearing liabilities, composed primarily of savings deposits and
Federal Home Loan Bank (FHLB) advances. Net interest income is primarily a
function of FWWB's interest rate spread, which is the difference between the
yield earned on interest-earning assets and the rate paid on interest-bearing
liabilities, as well as a function of the average balance of interest-earning
assets as compared to the average balance of interest-bearing liabilities. As
more fully explained below, FWWB's net interest income significantly increased
for the nine months ended December 31, 1999, when compared to the same period
for the prior year. This increase in net interest income was due in part to
the substantial growth in average asset and liability balances from the
acquisitions of WSB on January 1, 1999 and SCB on April 1, 1999, although
significant asset and liability growth also occurred at FSBW, IEB and TB. The
increase in net interest income also reflects expansion of the interest rate
spread and net interest margin resulting from changes in the mix of assets and
liabilities and changes in the levels of various market interest rates.
FWWB's
40
<PAGE>
net income also is affected by provisions for loan losses and the level of its
other income, including deposit service charges, loan origination and
servicing fees, and gains and losses on the sale of loans and securities, as
well as its non-interest operating expenses and income tax provisions.
Management's discussion and analysis of results of operations is intended to
assist in understanding the financial condition and results of operations of
the Company. The information contained in this section should be read in
conjunction with the Consolidated Financial Statements and accompanying
Selected Notes to Consolidated Financial Statements.
Recent Developments and Significant Events since March 31, 1999
Consolidation of Banking Operations:
- -----------------------------------
On July 22, 1999 the Company announced its plans to combine its three separate
banking subsidiaries into a single community banking franchise. The
combination was designed to strengthen the Company's commitment to community
banking by more effectively sharing the resources of the existing
subsidiaries, improving operating efficiency and developing a broader regional
brand identity. The consolidation was intended to be done in stages. The
first phase, which was expected to be completed by January 1, 2000, included
the merger of TB and FSBW and the selection of a single name and charter to be
used by TB, FSBW, WSB and SCB. Final integration of all data processing into
a common system and the merger of Inland Empire Bank was scheduled for
completion by December 31, 2000.
On December 23, 1999, the Company announced its decision to temporarily
postpone the previously announced consolidation of its subsidiaries, TB and
IEB, into FSBW in light of the new Gramm-Leach-Bliley financial modernization
legislation. The recent legislation enacts Federal Home Loan Bank System
reforms that impact community financial institutions. A community financial
institution (CFI) is defined as a "member of the Federal Home Loan Bank
System, the deposits of which are insured by the FDIC and that has average
total assets (over the preceding 3 years) of less than $500 million." One
provision of the reforms provides community financial institutions with the
ability to obtain long-term FHLB advances to fund small business, small farm
and small agribusiness loans. In addition, community financial institutions
will be able to offer these loans as collateral for such borrowings. This
provision, which represents a change in policy from the previous requirement
that these funds be securitized primarily by residential mortgage loans, will
be available only to community financial institutions. As independent
subsidiaries, TB and IEB currently qualify as community financial
institutions. Merging either of these two subsidiaries into FSBW could
disqualify them and remove this favorable status. Based on the information
available at this time, the Company believes that TB and IEB could derive
significant benefits from this legislation. Rather than complete the proposed
bank mergers as previously announced, the Company has chosen to allow adequate
time for an in-depth review and interpretation of the regulations as they
pertain to future plans. Consolidation of support operations continues on
schedule and budget and First Washington expects to receive long-term benefits
from the proposed efficiencies. Postponement of the mergers will have minimal
impact on the operational changes. The previously announced name and charter
changes scheduled for spring 2000 are expected to proceed for FSBW, including
its WSB and SCB divisions.
Acquisition of Seaport Citizens Bank:
- ------------------------------------
On April 1, 1999, FWWB and FSBW completed the acquisition of Seaport Citizens
Bank (SCB). FSBW paid $10.1 million in cash for all the outstanding common
shares of SCB, which was headquartered in Lewiston, Idaho. As a result of the
merger of SCB into FSBW, SCB became a division of FSBW. The acquisition was
accounted for as a purchase in the current period and resulted in the
recording of $6.1 million of costs in excess of the fair value of SCB's net
assets acquired (goodwill). Goodwill assets are being amortized over a 14-
year period and resulted in a current charge to earnings of $108,100 per
quarter, beginning in the first quarter of the current period, or $433,000 per
year. Founded in 1979, SCB is a commercial bank which had, before recording of
purchase accounting adjustments, approximately $45 million in total assets,
$41 million in deposits, $27 million in loans, and $4.1 million in
shareholders' equity at March 31, 1999. SCB operates two full service
branches in Lewiston, Idaho. SCB's results of operations are included in the
Company's consolidated results of operations (or financial statements) for the
nine months ended December 31, 1999.
Acquisition of Whatcom State Bancorp, Inc.:
- -------------------------------------------
On January 1, 1999 FWWB completed the acquisition of Whatcom State Bancorp,
Inc. FWWB paid $12.1 million in common stock for all the outstanding common
shares and stock options of Whatcom State Bancorp, Inc., which was the
41
<PAGE>
holding company for Whatcom State Bank (WSB), headquartered in Bellingham,
Washington. As a result of the merger of Whatcom State Bancorp, Inc. into
FWWB, WSB became a division of FSBW. The acquisition was accounted for as a
purchase and resulted in the recording of approximately $6.0 million of costs
in excess of the fair value of Whatcom State Bancorp, Inc. net assets acquired
(goodwill). Goodwill assets are being amortized over a 14-year period
resulting in a current charge to earnings of approximately $105,200 per
quarter or $421,000 per year. Founded in 1980, WSB is a community commercial
bank which had, before recording of purchase accounting adjustments,
approximately $99 million in total assets, $85 million in deposits, $79
million in loans, and $5.4 million in shareholders' equity at December 31,
1998. WSB operates five full service branches in the Bellingham, Washington,
area Bellingham, Ferndale, Lynden, Blaine and Point Roberts. WSB's results of
operations are included in the Company's consolidated results of operations
(or financial statements) for the nine months ended December 31, 1999.
Year 2000 Compliance
The "Year 2000" (Y2K) issue is the result of older computer programs being
written using two digits rather than four to define the applicable year. A
computer program that has date sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a
system failure or miscalculations causing disruption of operations, including,
among other things, a temporary inability to process transactions, send
statements, or engage in similar normal business activities. All of FWWB's
and its subsidiary Banks' operations have continued uninterrupted since
January 1, 2000 and the Company has not experienced any computer system
failures as a result of the year 2000 issue.
Based on an assessment of computer hardware, software and other equipment
operated by FWWB and its subsidiary Banks, FWWB presently believes that all
equipment and programs are Y2K compliant. A program for addressing the Y2K
issue through awareness, assessment, renovation and testing was developed and
implemented. The testing phase was completed on all internal operations and
mission critical outside vendors. The results of the testing disclosed only
insignificant items that needed to be resolved, all of which were corrected.
The program also provided for awareness and assessment of customer Y2K issues.
The Banks adopted business contingency plans for the computer systems and
facilities that they determined were most critical. These plans conformed to
guidance from the Federal Financial Institutions Examinations Council (FFIEC)
on business contingency planning for Year 2000 readiness.
The three Bank subsidiaries budgeted approximately $988,000, including
$638,000 to cover soft and hard costs such as upgrading ATMs, contacting and
monitoring vendors, contacting customers, providing information regarding
preparations and testing the systems identified as critical and non-critical,
and $350,000 for unidentified contingencies. FWWB and its Bank subsidiaries
have incurred and expensed approximately $577,000 of Y2K-related costs in the
21-month period ended December 31, 1999. Costs incurred and expensed in
fiscal years ending prior to March 31, 1998 were not significant. The Company
does not expect to expense additional costs with respect to Y2K issues.
FWWB and its subsidiary Banks contacted and monitored all significant
suppliers to determine the extent to which they were vulnerable to those third
parties' failures to remedy their own Y2K impact issues. Third party
responses indicated satisfactory progress in addressing any needs for
equipment or software renovation. The Banks contacted their large loan and
deposit customers to build Y2K awareness and encourage early development of
contingency plans and solutions in an effort to prevent potential business
disruption due to Y2K processing failures. Loan and deposit customers were
updated regularly about the Banks' preparations and information was provided
to create a much greater awareness of the issue with some ideas about how to
assess and prepare for their own Y2K vulnerability.
There could be no guarantee that the systems of other companies on which the
Banks' systems rely would be fully functional, or timely converted, or that a
failure to convert by another company, or a conversion that is incompatible
with the Banks' systems would not have a material adverse effect on the Banks.
However, the Banks tested for the Y2K preparedness of all internal functions
and external functions provided by third parties whenever possible and have
not and do not expect to experience any significant failures. In addition,
contingency or alternate sources of support were identified for each critical
function and many non-critical functions. In the event that the Banks' data
processing providers' systems prove not
42
<PAGE>
to be Y2K compliant and FWWB is not able to switch to an alternative provider
or an in-house system in a timely manner, resulting computer malfunctions
could interrupt the operations of the Banks and have a significant adverse
effect on FWWB's financial condition and results of operations. However, the
century change date has occurred and no such malfunctions or interruptions
have been experienced through the date of filing of this report.
Comparison of Financial Condition at December 31, 1999 and March 31, 1999
Total assets increased $188.2 million, or 11.5%, from $1.632 billion at March
31, 1999, to $1.820 billion at December 31, 1999. A large portion of the
increase, $51.1 million, was from the acquisition of SCB, including $6.1
million of goodwill resulting from the use of purchase accounting. The
remaining growth of $137.1 million was spread among all three subsidiary Banks
and was funded primarily with deposit growth and advances from the FHLB. This
growth represented a continuation of management's plans to further leverage
FWWB's capital and reflects the solid economic conditions in the markets where
FWWB operates. Loans receivable (gross loans less loans in process, deferred
fees and discounts, and allowance for loan losses) grew $205.0 million, or
18.6%, from $1.103 billion at March 31, 1999, to $1.308 billion at December
31, 1999. The increase in gross loans of $221.0 million from $1.191 billion at
March 31, 1999, to $1.412 billion at December 31, 1999, consisted of $29.0
million of residential mortgages, $75.1 million of mortgages secured by
commercial and multifamily real estate, $46.0 million of construction and land
loans and $70.9 million of non-mortgage loans such as commercial, agricultural
and consumer loans. These balances reflect the acquisition of SCB on April 1,
1999, which provided $27.4 million of gross loans consisting of $5.7 million
of commercial and multifamily mortgages, $1.6 million of construction and land
loans, $3.6 million of residential mortgages and $16.5 million of commercial
and consumer loans. These balances also reflect the Company's continuing
effort to increase the portion of its assets invested in loans and more
specifically the portion of loans invested in commercial real estate and non-
mortgage loans. The majority of the increase in loans was funded by a net
increase of $185.6 million in deposits and FHLB advances. Asset growth was
also funded by net income from operations. Deposits grew $127.2 million, or
13.4%, from $950.8 million at March 31, 1999, to $1.078 billion at December
31, 1999. The SCB acquisition provided $41.0 million of deposits. FHLB
advances increased $58.2 million from $408.3 million at March 31, 1999, to
$466.5 million at December 31, 1999. Other borrowings, primarily reverse
repurchase agreements with securities dealers, increased $3.2 million, from
$78.5 million at March 31, 1999, to $81.7 million at December 31, 1999.
Securities available for sale and held to maturity decreased $2.1 million, or
0.6%, from $364.2 million at March 31, 1999, to $362.1 million at December 31,
1999. FHLB stock increased $1.4 million, as FWWB was required to purchase
more stock as a result of its increased use of FHLB advances. Real estate
held for sale increased $1.9 million.
Comparison of Results of Operations for the Nine Months Ended December 31,
1999 and December 31, 1998
General. Net income for the nine-month period ended December 31, 1999 was
$12.9 million, or $1.19 per share (diluted), compared to net income of $11.4
million, or $1.04 per share (diluted), for the nine months ended December 31,
1998. Net income for the nine months ended December 31, 1999 increased $1.5
million from the comparable nine-month period ended December 31, 1998. FWWB's
improved operating results reflect the significant growth of assets and
liabilities as well as improvements in net interest margin and non-interest
revenues which were offset somewhat by increased operating expenses and
amortization of goodwill. Compared to levels a year ago, total assets
increased 23.9% to $1.820 billion at December 31, 1999, total loans rose 34.0%
to $1.308 billion, deposits grew 33.2% to $1.078 billion and borrowings
increased 14.6% to $548.2 million. Net interest margin improved, despite the
adverse effects of prepayment of certain higher yielding seasoned loans in
late 1998 and early 1999 and rising market rates throughout most of 1999,
reflecting the acquisitions of WSB and SCB, continuing changes in the asset
and liability mix and the lagging impact of rising rates on deposit costs.
Interest Income. Interest income for the nine-month period ended December 31,
1999 was $101.0 million compared to $81.8 million for the nine months ended
December 31, 1998, an increase of $19.2 million, or 23.5%. The increase in
interest income was a result of a $317.6 million, or 24.3%, growth in average
balances of interest-earning assets, moderated by a 6 basis point decrease in
the average yield on those assets. The yield on average assets declined to
8.25% for the nine months ended December 31, 1999 compared to 8.31% for the
same period a year earlier. Average loans receivable for the nine months ended
December 31, 1999 increased by $284.6 million, or 30.1%, when compared to the
nine months ended December 31, 1998, reflecting the previously discussed
acquisition and internal growth. Interest income on loans increased by $16.9
million, or 25.8%, compared to the prior year, reflecting the impact of the
increase in average loan balances and
43
<PAGE>
despite a 30 basis point decrease in the average yield. The decline in
average loan yield largely resulted from the significant decline in market
interest rates, including a 75 basis point decline in the prime rate, in the
third and fourth calendar quarters of 1998, and the subsequent prepayment and
refinancing of many higher yielding loans in a lower interest rate
environment. Loans yielded 8.85% for the nine months ended December 31, 1999
compared to 9.15% for the nine months ended December 31, 1998. The average
balance of mortgage-backed securities, investment securities, daily interest-
bearing deposits and FHLB stock increased by $33.0 million for the nine months
ended December 31, 1999, causing the interest and dividend income from those
investments to increase $2.4 million for the nine months ended December 31,
1999 compared to the nine months ended December 31, 1998. The average yield
on mortgage-backed securities increased from 6.00% for the nine months ended
December 31, 1998, to 6.38% for the comparable period in 1999. Yields on
mortgage-backed securities were particularly low in the 1998 period reflecting
the adverse impact of accelerated prepayments on the amortization of purchase
premiums on those securities as well as the impact of low market rates on the
interest rates paid on the significant portion of those securities that have
adjustable interest rates. In the nine-month period ended December 31, 1999
the accelerated prepayments diminished and market rates increased reversing
both of those effects on mortgage-backed securities yields. The average yield
on investment securities and short term cash investments increased from 6.03%
for the nine months ended December 31, 1998 to 6.21% for the comparable nine
months in 1999, also reflecting the rise in interest rates during 1999.
Earnings on FHLB stock increased by $176,000, reflecting an increase of $4.4
million in the average balance of FHLB stock for the nine months ended
December 31, 1999, which was partially offset by a 44 basis point decrease in
the dividend yield on that stock.
Interest Expense. Interest expense for the nine months ended December 31,
1999 was $53.2 million compared to $44.3 million for the comparable period in
1998, an increase of $8.9 million, or 20.1%. The increase in interest expense
was due to the $330.8 million growth in average interest-bearing liabilities
which was offset somewhat by the average cost of all interest-bearing
liabilities declining to 4.61% from 4.89%. The $268.5 million increase in
average interest-bearing deposits for the nine months ended December 31,
reflects the $125.4 million of deposits acquired in the acquisitions of WSB
and SCB as well as solid deposit growth throughout the Company. Deposit
interest expense increased $6.8 million for the nine months ended December 31,
1999. Average deposit balances increased from $761.2 million for the nine
months ended December 31, 1998, to $1.030 billion for the nine months ended
December 31, 1999, while, at the same time, the average rate paid on deposit
balances decreased 25 basis points. The decline in the rate paid on deposits
reflects the $10.8 million growth in non-interest bearing deposits, as well as
generally lower rates paid on interest-bearing accounts resulting from
declining market rates in the second half of 1998. While market rates
subsequently rose throughout much of 1999, the lagging impact of changing
market rates on deposit costs helped to keep the cost of deposits low when
compared to the prior period. Average FHLB advances totaled $425.3 million
during the nine months ended December 31, 1999, as compared to $348.8 million
during the nine months ended December 31, 1998, resulting in a $2.9 million
increase in related interest expense. The average rate paid on those advances
decreased to 5.78% for the nine months ended December 31, 1999 from 5.96% for
the nine months ended December 31, 1998. Other borrowings consist of retail
repurchase agreements with customers and repurchase agreements with investment
banking firms secured by certain investment securities. The average balance
for other borrowings decreased $14.2 million from $91.9 million for the nine
months ended December 31, 1998, to $77.7 million for the same period in 1999,
and the related interest expense decreased $718,000 from $3.9 million to $3.2
million for the respective periods. The average rate paid on other borrowings
was 5.50% in the December 1999 nine-month period compared to 5.69% for the
same nine-month period in 1998.
Provision for Loan Losses. During the nine months ended December 31, 1999,
the provision for loan losses was $1.9 million, compared to $2.2 million for
the nine months ended December 31, 1998, a decrease of $325,000. The decrease
in the provision for losses reflects the amount required to maintain the
allowance for losses at an appropriate level based upon management's
evaluation of the adequacy of general and specific loss reserves as more fully
explained in the following paragraphs. The higher provision in the prior
period reflected more significant changes in the portfolio mix and
non-performing loans and a higher level of net charge-offs during that period
than occurred in the most recent nine months. A comparison of the allowance
for loan losses at December 31, 1999 and 1998 shows an increase of $2.8
million from $10.7 million at December 31, 1998 to $13.5 million at December
31, 1999. The allowance for loan losses increased by $1.2 million, to $13.5
million at December 31, 1999, compared to $12.3 million at March 31, 1999.
The allowance for loan losses as a percentage of net loans (loans receivable
excluding allowance for losses) was 1.02% and 1.09% at December 31, 1999
44
<PAGE>
and December 31, 1998, respectively. The allowance for loan losses equaled
267% of non-performing loans at December 31, 1999 compared to 330% of
non-performing loans at December 31, 1998.
The allowance for losses on loans is maintained at a level sufficient to
provide for estimated losses based on evaluating known and inherent risks in
the loan portfolio and upon management's continuing analysis of the factors
underlying the quality of the loan portfolio. These factors include changes
in the size and composition of the loan portfolio, actual loan loss
experience, current and anticipated economic conditions, detailed analysis of
individual loans for which full collectibility may not be assured, and
determination of the existence and realizable value of the collateral and
guarantees securing the loans. Additions to these allowances are charged to
earnings. Provisions for losses that are related to specific assets are
usually applied as a reduction of the carrying value of the assets and charged
immediately against the allowance for loan loss reserve. Recoveries on
previously charged off loans are credited to the allowance. The reserve is
based upon factors and trends identified by management at the time financial
statements are prepared. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the Banks'
allowance for loan losses. Such agencies may require the Banks to provide
additions to the allowance based upon judgments different from management.
Although management uses the best information available, future adjustments to
the allowance may be necessary due to economic, operating, regulatory and
other conditions beyond the Banks' control. The adequacy of general and
specific reserves is based on management's continuing evaluation of the
pertinent factors underlying the quality of the loan portfolio, including
changes in the size and composition of the loan portfolio, delinquency rates,
actual loan loss experience and current economic conditions. Large groups of
smaller-balance homogeneous loans are collectively evaluated for impairment.
Loans that are collectively evaluated for impairment by the Banks include
residential real estate and consumer loans. Smaller balance non-homogeneous
loans also may be evaluated collectively for impairment. Larger balance
non-homogeneous residential construction and land, commercial real estate,
commercial business loans and unsecured loans are individually evaluated for
impairment. Loans are considered impaired when, based on current information
and events, management determines that it is probable that the Bank will be
unable to collect all amounts due according to the contractual terms of the
loan agreement. Factors involved in determining impairment include, but are
not limited to, the financial condition of the borrower, value of the
underlying collateral and current status of the economy. Impaired loans are
measured based on the present value of expected future cash flows discounted
at the loan's effective interest rate or, as a practical expedient, at the
loan's observable market price or the fair value of collateral if the loan is
collateral dependent. Subsequent changes in the value of impaired loans are
included within the provision for loan losses in the same manner in which
impairment initially was recognized or as a reduction in the provision that
would otherwise be reported.
The Company's methodology for assessing the appropriateness of the allowance
consists of several key elements, which include specific allowances, an
allocated formula allowance, and an unallocated allowance. Losses on specific
loans are provided for when the losses are probable and estimable. General
loan loss reserves are established to provide for inherent loan portfolio
risks not specifically provided for. The level of general reserves is based
on analysis of potential exposures existing in the Banks' loan portfolios
including evaluation of historical trends, current market conditions and other
relevant factors identified by management at the time the financial statements
are prepared. The formula allowance is calculated by applying loss factors to
outstanding loans, excluding loans with specific allowances. Loss factors are
based on the Company's historical loss experience adjusted for significant
factors including the experience of other banking organizations that, in
management's judgment, affect the collectibility of the portfolio as of the
evaluation date. The unallocated allowance is based upon management's
evaluation of various factors that are not directly measured in the
determination of the formula and specific allowances. This methodology may
result in losses or recoveries differing significantly from those provided in
the financial statements.
Other Operating Income. Other operating income increased $159,000 from $5.4
million for the nine-month period ended December 31, 1998, to $5.5 million for
the nine months ended December 31, 1999. The increase included an $824,000
increase in other fees and service charges due in part to the addition of WSB
and SCB operations. Fee and service charge income also increased at FSBW, TB
and IEB, reflecting deposit growth and pricing adjustments. There also was an
$895,000 decrease in net gains on loans sold in the nine-month period ended
December 31, 1999, as compared to the same period in 1998. This decrease
primarily reflected decreased sales of loans by FSBW and IEB and the adverse
impact of rising interest rates on the profitability of loan sales when
compared to the comparable period in the prior year. The volume of loan sales
and related net gain on sale of loans decreased from $117.4 million and $2.1
million, respectively, for the nine months ended December 31, 1998, to $99.3
million and $1.0 million, respectively, for the nine months ended December 31,
45
<PAGE>
1999. The $80,000 increase in miscellaneous other income reflects a gain on
the sale of IEB real property sold in the second quarter of the nine months
ended December 31, 1999.
Other Operating Expenses. Other operating expenses increased $8.1 million
from $22.4 million for the nine-month period ended December 31, 1998, compared
to $30.5 million for the nine months ended December 31, 1999. The increase in
expenses was largely due to the inclusion of WSB and SCB's operating expenses
in the nine months ended December 31, 1999 that were not present in the nine
months ended December 31, 1998 and the additional expenses of two new branches
opened in the nine months ended December 31, 1999. The increase in other
operating expenses was partially offset by a $573,000 increase in capitalized
loan origination costs resulting from an increased volume in loan
originations. In addition to the acquisitions of WSB and SCB, increases in
other operating expenses reflect the overall growth in assets and liabilities,
customer relationships and complexity of operations as FWWB continues to
expand. The higher operating expenses associated with FWWB's transition to
more of a commercial bank profile caused FWWB's efficiency ratio, excluding
the amortization of goodwill, to increase 4.55 percentage points, to 52.78%
(57.22% including goodwill), for the nine-month period ended December 31,
1999, from 48.23% (52.21% including goodwill) for the comparable period ended
December 31, 1998. Other operating expenses as a percentage of average assets
were 2.35% (2.17% excluding the amortization of goodwill) for the nine months
ended December 31, 1999, compared to 2.15% (1.98% excluding the amortization
of goodwill) for the nine months ended December 31, 1998.
Income Taxes. Income tax expense was $8.1 million for the nine months ended
December 31, 1999, compared to $6.9 million for the comparable period in 1998.
The $1.2 million increase in the provision for income taxes reflects the
higher level of income being taxed at higher effective rates due to the phase
out of the 34% surtax exemption; the net effect of IEB paying Oregon state
income taxes; and the fact that the expenses from the amortization of goodwill
acquired in purchasing IEB, TB, WSB and SCB and part of the expense recorded
in the release of the Employee Stock Ownership Plan (ESOP) shares are not
deductible for tax purposes. The Company's effective tax rates for the nine
months ended December 31, 1999 and 1998, were 39% and 38%, respectively.
Comparison of Results of Operations for the Years Ended March 31, 1999 and
March 31, 1998
General. Net income for the fiscal year ended March 31, 1999 was $15.4
million, or $1.40 per share (diluted), compared to net income of $13.1
million, or $1.25 per share (diluted), recorded in fiscal 1998. Net income for
the fiscal year ended March 31, 1999 increased $2.3 million from the
comparable period in fiscal 1998. FWWB's improved operating results reflect
the significant growth of assets and liabilities as well as improvements in
net interest margin and non-interest revenues which were offset somewhat by
increased operating expenses and amortization of goodwill. Compared to the
prior year's levels, total assets increased 41.4% to $1.632 billion at March
31, 1999, total loans rose 45.7% to $1.103 billion, deposits grew 57.8% to
$950.8 million and borrowings increased 25.0% to $486.7 million. The net
interest margin improved, despite the adverse effects of a flattening yield
curve and declining market rates and loan pricing spreads, reflecting the
acquisitions of TB and WSB and continuing changes in the asset and liability
mix.
Interest Income. Interest income for the year ended March 31, 1999 was $112.3
million compared to $85.1 million for the year ended March 31, 1998, an
increase of $27.1 million, or 31.9%. The increase in interest income was a
result of a $310.2 million, or 29.7%, growth in average balances of interest-
earning assets combined with a 13 basis point increase in the average yield on
those assets. The yield on average assets rose to 8.28% in the fiscal year
ended March 31, 1999 compared to 8.15% in fiscal 1998. Average loans
receivable for the fiscal year ended March 31, 1999 increased by $252.3
million, or 34.5%, when compared to fiscal 1998, reflecting the acquisitions
of WSB on January 1, 1999 and TB on April 1, 1998. Interest income on loans
increased by $24.9 million, or 38.5%, compared to the prior year, reflecting
the impact of the increase in average loan balances and a 26 basis point
increase in the average yield, largely resulting from the addition of higher
yielding loans held by TB and WSB, but also reflecting higher yields on the
expanding balances of commercial and multifamily real estate, construction and
land, and non-mortgage loans at FSBW. Loans yielded 9.12% for the fiscal year
ended March 31, 1999 compared to 8.86% for fiscal 1998. The average balance
of mortgage-backed securities, investment securities, daily interest-bearing
deposits and FHLB stock increased by $57.9 million in the fiscal year ended
March 31, 1999, causing the interest and dividend income from those
investments to increase $2.2 million for the fiscal year ended March 31, 1999
compared to fiscal 1998 despite a 42 basis point decline in the average yield
on those investments. The average yield on mortgage-backed securities
decreased from 6.61% for the year ended March 31, 1998, to 5.96% in 1999,
46
<PAGE>
reflecting both paydowns in certain higher yielding securities and lower
yields on most adjustable-rate securities as market rates declined. The
average yield on investment securities and short term cash investments
decreased from 6.13% for fiscal 1998 to 6.05% in 1999. Earnings on FHLB stock
increased by $398,000, reflecting an increase of $5.4 million in the average
balance of FHLB stock for the year ended March 31, 1999, offset by a 12 basis
point decrease in the dividend yield on that stock.
Interest Expense. Interest expense for the year ended March 31, 1999 was
$60.4 million compared to $46.7 million for the comparable period in 1998, an
increase of $13.8 million, or 29.6%. The increase in interest expense was due
to the $322.6 million growth in average interest-bearing liabilities which was
offset somewhat by the average cost of all interest-bearing liabilities
declining to 4.83% from 5.02%. The increase in average interest-bearing
liabilities in the fiscal year ended March 31, 1999 was largely due to $218.4
million ($158.5 million average balance) of deposits acquired in the
acquisitions of TB and WSB along with $9.0 million ($3.7 million average
balance) of FHLB borrowings. Deposit interest expense increased $8.7 million
for the year ended March 31, 1999. Average deposit balances increased from
$573.5 million for the year ended March 31, 1998, to $799.4 million for the
year ended March 31, 1999, while, at the same time, the average rate paid on
deposit balances decreased 15 basis points. The decline in the rate paid on
deposits primarily reflects the acquisition of TB and WSB's $42.1 million of
non-interest-bearing deposits as well as generally lower rates paid on
interest-bearing accounts resulting from declining market rates. Average FHLB
advances totaled $363.3 million during the year ended March 31, 1999, as
compared to $276.3 million during the year ended March 31, 1998, resulting in
a $4.6 million increase in related interest expense. The average rate paid on
those advances decreased to 5.90% for the fiscal year ended March 31, 1999
from 6.07% for fiscal 1998. Other borrowings consist of retail repurchase
agreements with customers and repurchase agreements with investment banking
firms secured by certain investment securities. The average balance for other
borrowings increased $9.8 million from $79.2 million for the year ended March
31, 1998, to $89.0 million for the same period in 1999, and the related
interest expense increased $413,000 from $4.6 million to $5.0 million for the
respective periods.
Provision for Loan Losses. The provision for loan losses for the year ended
March 31, 1999 increased by $1.2 million to $2.8 million compared to $1.6
million for fiscal 1998. This increase is reflective of the growth in loans
receivable which, excluding loans acquired through business combination,
increased by $165.7 million for the fiscal year ended March 31, 1999 compared
to an increase of $111.0 million in the 1998 period. The increase also is
reflective of changes in the portfolio mix which resulted in the need for a
higher level of loss allowance as well as the impact of a greater amount of
non-performing loans and net charge- offs for the year. Specifically,
excluding loans acquired through acquisitions, changes in the loan mix
included increases of $119.8 million in commercial and multifamily real estate
loans, $59.3 million in construction and land loans, and $27.9 million in
commercial and agricultural loans, while one- to four-family loans declined by
$40.3 million and consumer loans declined by $1.0 million. Income producing
real estate loans, construction and land loans, commercial and agricultural
loans are generally riskier than one- to four-family residential loans
resulting in a higher provision for losses. Adding to the need for the
increased provision for loan losses for the year ended March 31, 1999 was an
increase in the amount of non-performing loans which grew to $7.7 million
compared to $1.4 million a year earlier. Further adding to the increase in
the provision for loan losses was an increase in the level of net charge-offs
which increased from $519,000 for the year ended March 31, 1998, to $1.1
million for the year ended March 31, 1999 (see Notes 7 and 8 to the
Consolidated Financial Statements for further analysis of the loan portfolio
mix and allowance for loan losses). The allowance for loan losses equaled
1.10% of gross loans and 160% of non-performing loans at March 31, 1999,
compared to 1.03% and 553%, respectively, at March 31, 1998.
Other Operating Income. Other operating income increased $2.7 million from
$4.7 million for the year ended March 31, 1998, to $7.5 million for the year
ended March 31, 1999. The increase included a $1.1 million increase in other
fees and service charges due largely to the addition of TB operations. Fee
and service charge income also increased at FSBW and IEB, reflecting deposit
growth, pricing adjustments, and the fourth quarter acquisition of WSB. There
also was a $1.5 million increase in net gains on loans sold in the fiscal year
ended March 31, 1999, as compared to the same period in 1998. This increase
primarily reflects increased sales of loans by FSBW, with servicing retained,
and by IEB which increased the volume of loans sold in the secondary market
over the comparable period in the prior year. In addition, gains on loans
sold for the fiscal year ended March 31, 1999 include $250,000 of gains on the
sale of SBA guaranteed loans originated by TB. The volume of loan sales and
related net gain on sale of loans increased from $81.6 million and $933,000,
respectively, for the year ended March 31, 1998, to $127.5 million and $1.9
million, respectively, for the year ended March 31, 1999. Increased sales of
loans at FSBW were designed to curtail the rate of growth in relatively low
yielding fixed-rate residential
47
<PAGE>
mortgages during this period of low market rates and to reduce the Banks
exposure to the risk of rising interest rates. The $96,000 increase in
miscellaneous other income reflects a gain on the sale of IEB real property in
the second quarter of the fiscal year ended March 31, 1999.
Other Operating Expenses. Other operating expenses increased $10.7 million
from $21.0 million for the year ended March 31, 1998, to $31.7 million for the
year ended March 31, 1999. The increase in expenses was largely due to the
inclusion of $7.2 million of TB's operating expenses in the fiscal year ended
March 31, 1999 were not present in fiscal 1998 and the additional expenses of
five branches from WSB's acquisition in the last quarter of the fiscal year
ended March 31, 1999. The increase in other operating expenses was partially
offset by a $620,000 increase in capitalized loan origination costs resulting
from an increased volume in loan originations. In addition to the
acquisitions of TB and WSB, increases in other operating expenses reflect the
overall growth in assets and liabilities, customer relationships and
complexity of operations as FWWB continued to expand. Despite the higher
operating expenses associated with FWWB's transition to more of a commercial
bank profile, FWWB's efficiency ratio, excluding the amortization of goodwill,
increased only 2.94 percentage points, to 49.50% (53.53% including goodwill),
for the fiscal year ended March 31, 1999, from 46.56% (48.64% including
goodwill) in fiscal 1998. Other operating expenses as a percentage of average
assets were 2.21% (2.04% excluding the amortization of goodwill) for the year
ended March 31, 1999, compared to 1.93% (1.85% excluding the amortization of
goodwill) for the year ended March 31, 1998.
Income Taxes. Income tax expense was $9.3 million for the year ended March
31, 1999, compared to $7.4 million for the comparable period in 1998. The
$1.8 million increase in the provision for income taxes reflects the higher
level of income being taxed at higher effective rates due to the phase out of
the 34% surtax exemption; the net effect of IEB paying Oregon state income
taxes; and the fact that the expenses from the amortization of goodwill
acquired in purchasing IEB, TB and WSB and part of the expense recorded in the
release of the Employee Stock Ownership Plan (ESOP) shares are not deductible
for tax purposes. The Company's effective tax rates for the years ended March
31, 1999 and 1998, were 38% and 36%, respectively.
Yields Earned and Rates Paid
The earnings of the Company depend largely on the spread between the yield on
interest-earning assets (primarily loans and investment securities) and the
cost of interest-bearing liabilities (primarily deposit accounts and FHLB
advances), as well as the relative size of the Company's interest-earning
assets and interest-bearing liability portfolio.
Table I, Analysis of Net Interest Spread, sets forth, for the periods
indicated, information regarding average balances of assets and liabilities as
well as the total dollar amounts of interest income from average interest-
earning assets and interest expense on average interest-bearing liabilities,
resultant yields, interest rate spread, net interest margin, and ratio of
average interest-earning assets to average interest-bearing liabilities.
Average balances for a period have been calculated using the daily average
during such period.
Changes in the economic and interest rate environment, competition in the
marketplace and changes in asset and liability mix can cause the Company's
average interest rate spread to increase or decrease. While strong competition
and a generally unstable and often unfavorable interest rate environment (a
relatively flat yield curve brought about largely by declining intermediate
and long term interest rates in 1998 and significantly rising rates in 1999)
have had negative effects on the Company's interest rate spread in recent
periods, for the past two years the most significant impact on the Company's
interest rate spread has come from changes in its asset and liability mix. On
balance, those changes in mix have resulted in an expanding interest rate
spread which has increased from 3.13% in the fiscal year ended March 31, 1998
to 3.45% in March 1999, and again to 3.64% for the nine- month period ended
December 31, 1999. Contributing to this increased spread has been a decline
in the relative portion of the Company's assets invested in securities which
was 30.1% of average earning assets at March 31, 1998, 27.5% at March 31, 1999
and 24.2% for the nine months ended December 31, 1999. In addition to the
relative decline in investment securities and commensurate increase in loans,
the mix of the loan portfolio has changed to include more higher yielding
loans. Changes in the portfolio mix are evident in the higher yields on
mortgage loans which increased from 8.69% in the fiscal year ended March 31,
1998 to 8.95% in the fiscal year ended March 31, 1999. The decline in
mortgage loan yields to 8.66% for the nine months ended December 31, 1999
reflects the significant decline of market rates in the second half of
calendar year 1998. Changes in the portfolio mix are also reflected in the
increased portion
48
<PAGE>
of non-mortgage loans which increased from 8.1% of earning assets at March 31,
1998 to 14.6% of earning assets at March 31, 1999, and to 17.7% for the nine
months ended December 31, 1999. Also contributing to an improved interest
rate spread has been a decline in the cost of deposits primarily brought about
by the substantial increase in the amount of non-interest bearing checking and
NOW account balances. Deposit costs declined from 4.41% in 1998 to 4.26% in
1999, and to 4.06% for the nine months ended December 31, 1999. The cost of
total interest-bearing liabilities decreased from 5.02% for the fiscal year
ended March 31, 1998, to 4.83% for the fiscal year ended March 31, 1999 and
the cost of interest bearing liabilities declined further to 4.61% for the
nine months ended December 31, 1999. The acquisitions of IEB, TB, WSB and SCB
significantly contributed to the changes in loan and deposit portfolio mix.
Improvement in the Company's net interest margin over this same period mostly
reflects the same changes associated with the increased net interest rate
spread. However, counterbalancing to a degree this increased spread is the
somewhat adverse impact on net interest margin resulting from the increased
use of leverage which can be seen in the declining ratio of average
interest-earning assets to average interest-bearing liabilities. Nonetheless,
net interest margin increased from 3.68% in the year ended March 31, 1998, to
3.83% in the year ended March 31, 1999, and to 3.91% for the nine months ended
December 31, 1999. Management believes that in the future increased net
interest income will come primarily from increased volumes, although continued
changes in asset and liability mix and a slightly more favorable interest rate
environment may also add to net interest income.
49
<PAGE>
<TABLE>
Table I: Analysis of Net Interest Spread (dollars in thousands)
Nine Months Ended Year Ended Year Ended
December 31, 1999 (4) March 31, 1999 (1) March 31, 1998 (1)
-------------------------- -------------------------- -----------------------
Average Interest & Yield/ Average Interest & Yield/ Average Interest & Yield/
Balance Dividends Cost Balance Dividends Cost Balance Dividends Cost
------- ---------- ---- ------- ---------- ---- ------- ---------- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning
assets:
Mortgage loans $ 943,498 $ 61,589 8.66% $ 784,534 $ 70,193 8.95% $ 645,576 $ 56,111 8.69%
Commercial/agri-
cultural loans 230,067 16,230 9.36 153,706 15,047 9.79 57,516 5,587 9.71
Consumer and
other loans 57,600 4,288 9.88 44,568 4,375 9.82 27,412 2,997 10.93
---------- -------- ---- ---------- -------- ---- ---------- ---------- ----
Total loans (2) 1,231,165 82,107 8.85 982,808 89,615 9.12 730,505 64,695 8.86
Mortgage-backed
securities 241,760 11,630 6.38 218,648 13,025 5.96 189,572 12,522 6.61
Securities and
deposits 128,330 6,009 6.21 134,014 8,107 6.05 110,625 6,783 6.13
FHLB stock 23,565 1,286 7.24 20,066 1,545 7.70 14,661 1,147 7.82
Total investment ---------- -------- ---- ---------- -------- ---- ---------- ---------- ----
securities 393,655 18,925 6.38 372,728 22,671 6.08 314,858 20,452 6.50
---------- -------- ---- ---------- -------- ---- ---------- ---------- ----
Total interest-
earning assets 1,624,820 101,032 8.25 1,355,536 112,292 8.28 1,045,362 85,147 8.15
Non-interest-earning -------- ---- -------- ---- ---------- ----
assets 99,356 80,038 43,256
---------- ---------- ----------
Total assets $1,724,176 $1,435,574 $1,088,618
========== ========== ==========
Interest-bearing
liabilities:
Savings accounts $ 58,942 1,336 3.01 $ 47,487 1,356 2.86 $ 42,937 1,248 2.91
Checking and NOW
accounts(3) 191,705 896 0.62 154,108 1,110 0.72 103,426 899 0.87
Money market
accounts 149,269 4,152 3.69 109,379 4,154 3.80 76,048 3,073 4.04
Certificates of
deposit 629,856 25,091 5.29 488,377 27,399 5.61 351,042 20,069 5.72
---------- -------- ---- ---------- -------- ---- ---------- ---------- ----
Total deposits 1,029,772 31,475 4.06 799,351 34,019 4.26 573,453 25,289 4.41
Other interest-
bearing liabilities:
FHLB advances 425,293 18,505 5.78 363,279 21,430 5.90 276,328 16,782 6.07
Other borrowings 77,680 3,221 5.50 88,967 4,993 5.61 79,210 4,580 5.78
---------- -------- ---- ---------- -------- ---- ---------- ---------- ----
Total interest-
bearing
liabilities 1,532,745 53,201 4.61 1,251,597 60,442 4.83 928,991 46,651 5.02
Non-interest-bearing -------- ---- -------- ---- ---------- ----
liabilities 11,422 10,682 8,783
---------- ---------- ----------
Total liabilities 1,544,167 1,262,279 937,774
---------- ---------- ----------
Stockholders equity 180,009 173,295 150,844
---------- ---------- ----------
Total liabilities
and stockholders
equity $1,724,176 $1,435,574 $1,088,618
========== ========== ==========
Net interest income/
rate spread $ 47,831 3.64% $ 51,850 3.45% $ 38,496 3.13%
======== ==== ======== ==== ========== ====
Net interest margin 3.91% 3.83% 3.68%
==== ==== ====
Ratio of average
interest-earning
assets to average
interest-bearing
liabilities 106.01% 108.30% 112.53%
====== ====== ======
(1) Restated to be comparable to current year's presentation.
(2) Average balances include loans accounted for on a nonaccrual basis and loans 90 days or more past
due. Amortized net deferred loan fees are included with interest and dividends on loans.
(3) Average balances include non-interest-bearing deposits.
(3) Yield/cost rates are annualized.
50
</TABLE>
<PAGE>
<TABLE>
Table II, Rate/Volume Analysis, sets forth the effects of changing rates and volumes on net interest income
of the Company. Information is provided with respect to (i) effects on interest income attributable to
changes in volume (changes in volume multiplied by prior rate) and (ii) effects on interest income
attributable to changes in rate (changes in rate multiplied by prior volume). Effects on interest income
attributable to changes in rate and volume (changes in rate multiplied by changes in volume) have been
allocated between changes in rate and changes in volume.
Table II: Rate/Volume Analysis
Year Ended December 31, 1999 Year Ended March 31, 1999
Compared to December 31, 1998 Compared to March 31, 1998
Increase (Decrease) Due to Increase (Decrease) Due to (1)
------------------------------- -------------------------------
(dollars in thousands)
Rate Volume Net Rate Volume Net
---- ------ --- ---- ------ ---
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Mortgage loans $ (1,889) $ 11,985 $ 10,096 $ 1,718 $ 12,364 $ 14,082
Commercial/agricultural loans (559) 6,263 5,704 46 9,414 9,460
Consumer and other loans 44 1,009 1,053 (331) 1,709 1,378
-------- -------- -------- -------- -------- --------
Total loans(1) (2,404) 19,257 16,853 1,433 23,487 24,920
Mortgage-backed securities 646 1,282 1,928 (1,305) 1,808 503
Securities and deposits 178 75 253 (90) 1,414 1,324
FHLB stock (67) 243 176 (18) 416 398
-------- -------- -------- -------- -------- --------
Total net change in interest income
on interest-earning assets (1,647) 20,857 19,210 20 27,125 27,145
-------- -------- -------- -------- -------- --------
Interest-bearing liabilities:
Deposits (1,505) 8,287 6,782 (890) 9,620 8,730
FHLB advances (486) 3,340 2,854 (483) 5,131 4,648
Other borrowings (358) (360) (718) (385) 798 413
-------- -------- -------- -------- -------- --------
Total net change in interest expense
on interest-bearing liabilities (2,349) 11,267 8,918 (1,758) 15,549 13,791
-------- -------- -------- -------- -------- --------
Net change in net interest income $ 702 $ 9,590 $ 10,292 $ 1,778 $ 11,576 $ 13,354
======== ======== ======== ======== ======== ========
(1) Does not include interest on loans 90 days or more past due.
51
</TABLE>
<PAGE>
Market Risk and Asset/Liability Management
The financial condition and operations of the Company are influenced
significantly by general economic conditions, including the absolute level of
interest rates as well as changes in interest rates and the slope of the yield
curve. The Company's profitability is dependent to a large extent on its net
interest income, which is the difference between the interest received from
its interest-earning assets and the interest expense incurred on its
interest-bearing liabilities.
The activities of the Company, like all financial institutions, inherently
involve the assumption of interest rate risk. Interest rate risk is the risk
that changes in market interest rates will have an adverse impact on the
institution's earnings and underlying economic value. Interest rate risk is
determined by the maturity and repricing characteristics of an institution's
assets, liabilities, and off-balance-sheet contracts. Interest rate risk is
measured by the variability of financial performance and economic value
resulting from changes in interest rates. Interest rate risk is the primary
market risk impacting the Company's financial performance.
The greatest source of interest rate risk to the Company results from the
mismatch of maturities or repricing intervals for rate sensitive assets,
liabilities and off-balance-sheet contracts. This mismatch or gap is
generally characterized by a substantially shorter maturity structure for
interest-bearing liabilities than interest-earning assets. Additional
interest rate risk results from mismatched repricing indices and formulae
(basis risk and yield curve risk), and product caps and floors and early
repayment or withdrawal provisions (option risk), which may be contractual or
market driven, that are generally more favorable to customers than to the
Company.
The principal objectives of asset/liability management are to evaluate the
interest rate risk exposure of the Company; to determine the level of risk
appropriate given the Company's operating environment, business plan
strategies, performance objectives, capital and liquidity constraints, and
asset and liability allocation alternatives; and to manage the Company's
interest rate risk consistent with regulatory guidelines and approved policies
of the Board of Directors. Through such management the Company seeks to
reduce the vulnerability of its earnings and capital position to changes in
the level of interest rates. The Company's actions in this regard are taken
under the guidance of the Asset/Liability Management Committee, which is
comprised of members of the Company's senior management. The committee
closely monitors the Company's interest sensitivity exposure, asset and
liability allocation decisions, liquidity and capital positions, and local and
national economic conditions and attempts to structure the loan and investment
portfolios and funding sources of the Company to maximize earnings within
acceptable risk tolerances.
Sensitivity Analysis
The Company's primary monitoring tool for assessing interest rate risk is
asset/liability simulation modeling which is designed to capture the dynamics
of balance sheet, interest rate and spread movements and to quantify
variations in net interest income resulting from those movements under
different rate environments. The sensitivity of net interest income to changes
in the modeled interest rate environments provides a measurement of interest
rate risk. The Company also utilizes market value analysis, which addresses
changes in estimated net market value of equity arising from changes in the
level of interest rates. The net market value of equity is estimated by
separately valuing the Company's assets and liabilities under varying interest
rate environments. The extent to which assets gain or lose value in relation
to the gains or losses of liability values under the various interest rate
assumptions determines the sensitivity of net equity value to changes in
interest rates and provides an additional measure of interest rate risk.
The interest rate sensitivity analysis performed by the Company incorporates
beginning-of-the-period rate, balance and maturity data, using various levels
of aggregation of that data, as well as certain assumptions concerning the
maturity, repricing, amortization and prepayment characteristics of loans and
other interest-earning assets and the repricing and withdrawal of deposits and
other interest-bearing liabilities into an asset/liability computer simulation
model. The Company updates and prepares simulation modeling at least
quarterly for review by senior management and the directors. The Company
believes the data and assumptions are realistic representations of its
portfolio and possible outcomes under the various interest rate scenarios.
Nonetheless, the interest rate sensitivity of the Company's net interest
income and net market value of equity could vary substantially if different
assumptions were used or if actual experience differs from the assumptions
used.
52
<PAGE>
Tables III and III (a), Interest Rate Risk Indicators, set forth as of
December 31, 1999 and March 31, 1999, the estimated changes in the Company's
net interest income over a one-year time horizon and the estimated changes in
market value of equity based on the indicated interest rate environments.
Table III: Interest Rate Risk Indicators
As of December 31, 1999
Estimated Change in
-----------------------------------------
Change (in Basis Points) Net Interest Income
in Interest Rates (1) Next 12 Months Net Market Value
------------------------ ------------------- --------------------
(dollars in thousands)
+400 $ (2,795) (4.4%) $ (82,602) (44.8%)
+300 (1,816) (2.8%) (65,753) (35.7%)
+200 (922) (1.4%) (45,856) (24.9%)
+100 (320) (0.5%) (23,055) (12.5%)
0 0 0 0 0
-100 (493) (0.8%) 22,190 12.0%
-200 (2,203) (3.5%) 20,208 11.0%
-300 (4,794) (7.5%) 8,663 4.7%
-400 (8,308) (13.0%) (10,992) (6.0%)
Table III (a): Interest Rate Risk Indicators
As of March 31, 1999
Estimated Change in
-----------------------------------------
Change (in Basis Points) Net Interest Income
in Interest Rates (1) Next 12 Months Net Market Value
------------------------ ------------------- --------------------
(dollars in thousands)
+400 $ (1,677) (3.0%) $ (72,990) (37.4%)
+300 (649) (1.2%) (55,433) (28.4%)
+200 (81) (0.1%) (34,919) (17.9%)
+100 194 0.3% (14,526) (7.4%)
0 0 0 0 0
-100 (1,440) (2.6%) 83 0.0%
-200 (3,582) (6.4%) (7,140) (3.7%)
-300 (6,568) (11.6%) (20,441) (10.5%)
-400 (9,495) (16.8%) (31,427) (16.1%)
- --------------
(1) Assumes an instantaneous and sustained uniform change in market interest
rates at all maturities.
53
<PAGE>
Another although less reliable monitoring tool for assessing interest rate
risk is "gap analysis." The matching of the repricing characteristics of
assets and liabilities may be analyzed by examining the extent to which such
assets and liabilities are "interest sensitive" and by monitoring an
institution's interest sensitivity "gap." An asset or liability is said to be
interest sensitive within a specific time period if it will mature or reprice
within that time period. The interest rate sensitivity gap is defined as the
difference between the amount of interest-earning assets anticipated, based
upon certain assumptions, to mature or reprice within a specific time period
and the amount of interest-bearing liabilities anticipated to mature or
reprice, based upon certain assumptions, within that same time period. A gap
is considered positive when the amount of interest-sensitive assets exceeds
the amount of interest-sensitive liabilities. A gap is considered negative
when the amount of interest-sensitive liabilities exceeds the amount of
interest-sensitive assets. Generally, during a period of rising rates, a
negative gap would tend to adversely affect net interest income while a
positive gap would tend to result in an increase in net interest income.
During a period of falling interest rates, a negative gap would tend to result
in an increase in net interest income while a positive gap would tend to
adversely affect net interest income.
Certain shortcomings are inherent in gap analysis. For example, although
certain assets and liabilities may have similar maturities or periods of
repricing, they may react in different degrees to changes in market rates.
Also, the interest rates on certain types of assets and liabilities may
fluctuate in advance of changes in market rates, while interest rates on other
types may lag behind changes in market rates. Additionally, certain assets,
such as ARM loans, have features that restrict changes in interest rates on a
short-term basis and over the life of the asset. Further, in the event of a
change in interest rates, prepayment and early withdrawal levels would likely
deviate significantly from those assumed in calculating the table. Finally,
the ability of some borrowers to service their debt may decrease in the event
of a severe interest rate increase.
Tables IV and IV (a), Interest Sensitivity Gap, present the Company's interest
sensitivity gap between interest-earning assets and interest-bearing
liabilities at December 31, 1999 and March 31, 1999. The tables set forth the
amounts of interest-earning assets and interest-bearing liabilities which are
anticipated by the Company, based upon certain assumptions, to reprice or
mature in each of the future periods shown. At December 31, 1999, total
interest-bearing liabilities maturing or repricing within one year exceeded
total interest-earning assets maturing or repricing in the same time period by
$183.1 million, representing a one-year gap to total assets ratio of (10.06%).
Management is aware of the sources of interest rate risk and in its opinion
actively monitors and manages it to the extent possible. The interest rate
risk indicators and interest sensitivity gaps for the Company as of December
31, 1999 and March 31, 1999 are within policy guidelines. Management
considers that the Company's current level of interest rate risk is
reasonable.
54
<PAGE>
<TABLE>
Table IV: Interest Sensitivity Gap
as of December 31, 1999
> 3 > 5
> 6 Years Years
Months > 1 Year < 5 < 10 > 10
< 6 Months < 1 Year < 3 Years Years Years Years Total
---------- -------- -------- ----- ----- ----- -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:(1)
Construction loans $114,922 $ 35,643 $ 1,555 $ 845 $ -- $ -- $ 152,965
Fixed-rate mortgage loans 41,335 33,540 131,896 112,044 168,146 123,336 610,297
Adjustable-rate mortgage
loans 113,209 56,289 42,017 40,167 -- -- 251,682
Fixed-rate mortgage-backed
securities 11,371 11,010 59,314 35,089 22,622 5,169 144,575
Adjustable-rate mortgage-
backed securities 97,185 2,084 -- -- -- -- 99,269
Fixed-rate commercial/
agricultural loans 13,009 6,067 14,781 23,397 10,355 3,454 71,063
Adjustable-rate commercial/
agricultural loans 179,967 -- -- -- -- -- 179,967
Consumer and other loans 17,880 3,564 13,881 11,811 1,037 11,376 59,549
Investment securities and
interest-earning deposits 20,794 4,385 22,485 37,896 17,269 53,540 156,369
-------- --------- -------- -------- -------- -------- ----------
Total rate sensitive assets 609,672 152,582 285,929 261,249 219,429 196,875 1,725,736
-------- --------- -------- -------- -------- -------- ----------
Interest-bearing liabilities:(2)
Regular savings and NOW
accounts 20,492 20,493 47,817 47,817 -- -- 136,619
Money market deposit accounts 72,516 43,510 29,006 -- -- -- 145,032
Certificates of deposit 313,118 207,127 130,052 23,080 8,856 21 682,254
FHLB advances 128,505 59,000 102,280 145,290 22,500 8,949 466,524
Other borrowings 73,198 -- -- -- -- -- 73,198
Retail repurchase agreements 6,938 419 -- 1,101 -- -- 8,458
-------- --------- -------- -------- -------- -------- ----------
Total rate sensitive
liabilities 614,767 330,549 309,155 217,288 31,356 8,970 1,512,085
-------- --------- -------- -------- -------- -------- ----------
Excess (deficiency) of
interest-sensitive assets
over interest-sensitive
liabilities $ (5,095) $(177,967) $(23,226) $ 43,961 $188,073 $187,905 $ 213,651
======== ========= ======== ======== ======== ======== ==========
Cumulative excess (deficiency)
of interest-sensitive assets $ (5,095) $(183,062) $(206,288) $(162,327)$ 25,746 $213,651 $ 213,651
======== ========= ======== ======== ======== ======== ==========
Cumulative ratio of interest-
earning assets to interest-
bearing liabilities 99.17% 80.63% 83.56% 88.97% 101.71% 114.13% 114.13%
======== ========= ======== ======== ======== ======== ==========
Interest sensitivity gap to
total assets (0.28%) (9.78%) (1.28%) 2.42% 10.33% 10.32% 11.74%
======== ========= ======== ======== ======== ======== ==========
Ratio of cumulative gap to
total assets (0.28%) (10.06%) (11.33%) (8.92%) 1.41% 11.74% 11.74%
======== ========= ======== ======== ======== ======== ==========
(footnotes follow tables)
55
</TABLE>
<PAGE>
<TABLE>
Table IV:(d) Interest Sensitivity Gap
as of March 31, 1999
> 3 > 5
> 6 Years Years
Months > 1 Year < 5 < 10 > 10
< 6 Months < 1 Year < 3 Years Years Years Years Total
---------- -------- -------- ----- ----- ----- -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:(1)
Construction loans $ 98,302 $ 33,841 $ 813 $ 588 $ -- $ -- $ 133,544
Fixed-rate mortgage loans 45,106 41,823 144,842 113,687 130,154 61,775 537,387
Adjustable-rate mortgage loans 103,894 50,506 27,494 25,518 -- -- 207,412
Fixed-rate mortgage-backed
securities 13,554 14,674 62,831 24,087 10,968 1,182 127,296
Adjustable-rate mortgage-
backed securities 108,001 6,880 -- -- -- -- 114,881
Fixed-rate commercial/
agricultural loans 9,431 7,484 12,599 15,482 11,528 701 57,225
Adjustable-rate commercial/
agricultural loans 139,292 -- -- -- -- -- 139,292
Consumer and other loans 12,400 3,485 10,330 6,140 1,468 10,235 44,058
Investment securities and
interest-earning deposits 60,360 8,250 23,062 26,410 15,295 30,166 163,543
-------- --------- -------- -------- -------- -------- ----------
Total rate sensitive assets 590,340 166,943 281,971 211,912 169,413 104,059 1,524,638
-------- --------- -------- -------- -------- -------- ----------
Interest-bearing liabilities:(2)
Regular savings and NOW
accounts 22,620 22,620 52,780 52,780 -- -- 150,800
Money market deposit accounts 66,039 39,623 26,415 -- -- -- 132,077
Certificates of deposit 272,316 134,609 130,451 33,105 9,527 21 580,029
FHLB advances 105,000 34,414 109,499 102,990 55,500 849 408,252
Other borrowings 47,690 -- 25,000 -- -- -- 72,690
Retail repurchase agreements 2,993 237 1,455 1,092 -- -- 5,777
-------- --------- -------- -------- -------- -------- ----------
Total rate sensitive
liabilities 516,658 231,503 345,600 189,967 65,027 870 1,349,625
-------- --------- -------- -------- -------- -------- ----------
Excess (deficiency) of
interest-sensitive assets
over interest-sensitive
liabilities $ 73,683 $ (64,560) $(63,629) $ 21,945 $104,386 $103,189 $ 175,013
======== ========= ======== ======== ======== ======== ==========
Cumulative excess
(deficiency) of
interest-sensitive assets $ 73,683 $ 9,122 $(54,507) $(32,562) $ 71,824 $175,013 $ 175,013
======== ========= ======== ======== ======== ======== ==========
Cumulative ratio of interest-
earning assets to interest-
bearing liabilities 114.26% 101.22% 95.02% 97.46% 105.33% 112.97% 112.97%
======== ========= ======== ======== ======== ======== ==========
Interest sensitivity gap to
total assets 4.52% (3.96%) (3.90%) 1.34% 6.40% 6.32% 10.72%
======== ========= ======== ======== ======== ======== ==========
Ratio of cumulative gap to
total assets 4.52% 0.56% (3.34%) (2.00%) 4.40% 10.72% 10.72%
======== ========= ======== ======== ======== ======== ==========
(footnotes follow tables)
56
</TABLE>
<PAGE>
Footnotes for Tables IV and IV (a): Interest Sensitivity Gap
- -------------------------------------------------------------
(1) Adjustable-rate assets are included in the period in which interest rates
are next scheduled to adjust rather than in the period in which they are due
to mature, and fixed-rate assets are included in the period in which they are
scheduled to be repaid based upon scheduled amortization, in each case
adjusted to take into account estimated prepayments. Mortgage loans and other
loans are not reduced for allowances for loan losses and non-performing loans.
Mortgage loans, mortgage-backed securities, other loans, and investment
securities are not adjusted for deferred fees and unamortized acquisition
premiums and discounts.
(2) Adjustable-rate liabilities are included in the period in which interest
rates are next scheduled to adjust rather than in the period they are due to
mature. Although the Banks' regular savings, demand, NOW, and money market
deposit accounts are subject to immediate withdrawal, management considers a
substantial amount of such accounts to be core deposits having significantly
longer maturities. For the purpose of the gap analysis, these accounts have
been assigned decay rates to reflect their longer effective maturities. If
all of these accounts had been assumed to be short-term, the one-year
cumulative gap of interest-sensitive assets would have been $(307.7) million,
or (16.91%) of total assets at December 31, 1999 and $(122.9) million, or
(7.53%) at March 31, 1999. Interest-bearing liabilities for this table
exclude certain non-interest bearing deposits which are included in the
average balance calculations in the earlier Table I, Analysis of Net Interest
Spread.
Liquidity and Capital Resources
The Company's primary sources of funds are deposits, borrowings, proceeds from
loan principal and interest payments and sales of loans, and the maturity of
and interest income on mortgage-backed and investment securities. 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.
The primary investing activity of the Company, through its subsidiaries, is
the origination and purchase of loans. During the nine months ended December
31, 1999 and the fiscal years ended March 31, 1999 and 1998, the Company
closed or purchased loans in the amounts of $772.8 million, $803.1 million and
$562.4 million, respectively. This activity was funded primarily by principal
repayments on loans and securities, sales of loans, increases in FHLB
advances, other borrowings, and deposit growth. For the nine months ended
December 31, 1999 and the fiscal years ended March 31, 1999 and 1998,
principal repayments on loans totaled $486.9 million, $522.0 million and
$375.9 million, respectively. During the nine-month period ended December 31,
1999 and the fiscal years ended March 31, 1999 and 1998, the Company sold
$99.3 million, $127.5 million and $81.6 million, respectively, of loans. FHLB
advances increased $58.3 million, $101.7 million and $66.0 million,
respectively, for the nine-month period ended December 31, 1999 and the fiscal
years ended March 31, 1999 and 1998. Other borrowings increased $3.2 million
for the nine months ended December 31, 1999 and decreased $13.3 million, and
increased $29.5 million for the fiscal years ended March 31, 1999 and 1998,
respectively. Net deposit growth was $86.7 million (excluding $40.6 million of
deposits acquired with SCB) for the nine months ended December 31, 1999,
$130.0 million (excluding $218.4 million of deposits acquired with TB and
WSB), and $46.6 million, for the fiscal years ended March 31, 1999 and 1998,
respectively.
The Banks must maintain an adequate level of liquidity to ensure the
availability of sufficient funds to accommodate deposit withdrawals, to
support loan growth, to satisfy financial commitments and to take advantage of
investment opportunities. During the nine months ended December 31, 1999 and
fiscal years ended March 31, 1999 and 1998, the Banks used their sources of
funds primarily to fund loan commitments, to purchase securities, and to pay
maturing savings certificates and deposit withdrawals. At December 31, 1999,
the Banks had outstanding loan commitments totaling $166.9 million and
undisbursed loans in process totaling $84.9 million. The Banks generally
maintain sufficient cash and readily marketable securities to meet short-term
liquidity needs. FSBW maintains a credit facility with the FHLB-Seattle, which
provides for advances which in aggregate may equal up to 45% of FSBW's assets,
which as of December 31, 1999 could give a total credit line of $586.0
million. Advances under this credit facility totaled $456.0 million, or 35.0%
of FSBW's assets at December 31, 1999. IEB and TB also maintain credit lines
with various institutions, including the FHLB-Seattle, that would allow them
to borrow up to $23.8 million.
At December 31, 1999, savings certificates amounted to $682.2 million, or
63.3%, of the Banks' total deposits, including $518.6 million, which were
scheduled to mature by December 31, 2000. Historically, the Banks have been
able to retain a significant amount of their deposits as they mature.
Management believes it has adequate resources to fund all loan commitments
from savings deposits and FHLB-Seattle advances and sale of mortgage loans and
that it can adjust the offering rates of savings certificates to retain
deposits in changing interest rate environments.
57
<PAGE>
Capital Requirements
The Company is a bank holding company registered with the Federal Reserve.
Bank holding companies are subject to capital adequacy requirements of the
Federal Reserve under the Bank Holding Company Act of 1956, as amended (BHCA),
and the regulations of the Federal Reserve. Each of the Banks, as
state-chartered, federally insured institutions, is subject to the capital
requirements established by the FDIC.
The capital adequacy requirements are quantitative measures established by
regulation that require the Company and its subsidiary Banks to maintain
minimum amounts and ratios of capital. The Federal Reserve requires the
Company to maintain capital adequacy that generally parallels the FDIC
requirements. The FDIC requires the Banks to maintain minimum ratios of Tier
1 total capital to risk-weighted assets as well as Tier 1 leverage capital to
average assets (see further discussion in Note 17 to the Consolidated
Financial Statements).
At December 31, 1999 the Company and its banking subsidiaries, FSBW, IEB and
TB, exceeded all current regulatory capital requirements.
The most recent notifications from the FDIC as of December 31, 1999,
individually categorized the Banks as "well capitalized" under the regulatory
framework for prompt corrective action.
Table V, Regulatory Capital Ratios, shows the regulatory capital ratios of the
Company, FSBW, IEB and TB and minimum regulatory requirements for the Banks to
be categorized as "well-capitalized."
Table V: Regulatory Capital Ratios
"Well-
capitalized"
The Minimum
Capital Ratios Company FSBW IEB TB Ratio
-------------- ------- ---- --- -- -----
Total capital to risk-
weighted assets 12.79% 13.27% 13.16% 9.86% 10.00%
Tier 1 capital to risk-
weighted assets 11.71 12.17 12.13 8.78 6.00
Tier 1 leverage capital
to average assets 8.39 7.74 9.96 8.91 5.00
Effect of Inflation and Changing Prices
The Consolidated Financial Statements and related financial data 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
relative purchasing power of money over time due to inflation. The primary
impact of inflation on operations of the Company is reflected in increased
operating costs. Unlike most industrial companies, virtually all the assets
and liabilities of a financial institution are monetary in nature. As a
result, interest rates generally have a more significant impact on a financial
institution's performance than do general levels of inflation. Interest rates
do not necessarily move in the same direction or to the same extent as the
prices of goods and services.
Recent Accounting Standard Not Yet Adopted
Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for
Derivative Instruments and Hedging Activities, was issued in June 1998 and
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. FWWB will implement this statement on January 1, 2001.
The impact of the adoption of the provisions of this statement on the results
of operations or financial condition of FWWB has not yet been determined.
58
<PAGE>
ITEM 7A - Quantitative and Qualitative Disclosures about Market Risk
See pages 52-57 of Management's Discussion and Analysis of Financial Condition
and Results of Operations.
ITEM 8 - Financial Statements and Supplementary Data
For financial statements, see index on page 63.
ITEM 9 - Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
Not Applicable
59
<PAGE>
Part III
ITEM 10 - Directors and Executive Officers of the Registrant
The information contained under the section captioned "Proposal I - Election
of Directors" in the Registrant's Proxy Statement is incorporated herein by
reference.
Information regarding the executive officers of the Registrant is provided
herein in Part I, Item 1 hereof.
Reference is made to the cover page of this Annual Report and the section
captioned "Compliance with Section 16(a) of the Exchange Act" of the Proxy
Statement for the Annual Meeting of the Stockholders regarding compliance with
Section 16(a) of the Securities Exchange Act of 1934.
ITEM 11- Executive Compensation
Information regarding management compensation and transactions with management
and others is incorporated by reference to the section captioned "Proposal I -
Election of Directors" in the Proxy Statement for the Annual Meeting of
Stockholders.
ITEM 12 - Security Ownership of Certain Beneficial Owners and Management
{a} Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by reference to the
section captioned "Securities Ownership of Certain Beneficial Owners and
Management" in the Proxy Statement for the Annual Meeting of Stockholders.
{b} Security Ownership of Management
Information required by this item is incorporated herein by reference to the
section captioned "Securities Ownership of Certain Beneficial Owners and
Management" in the Proxy Statement for the Annual Meeting of Stockholders.
{c} Changes in Control
The Company is not aware of any arrangements, including any pledge by any
person of securities of the Company, the operation of which may at a
subsequent date result in a change in control of the Company.
ITEM 13 - Certain Relationships and Related Transactions
The information contained under the sections captioned "Transactions with
Management" in the Proxy Statement for the Annual Meeting of Stockholders is
incorporated herein by reference.
60
<PAGE>
Part IV
ITEM 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K
{a} {1} Financial Statements
See Index to Consolidated Financial Statements on page 63.
{2} Financial Statement Schedules
All financial statement schedules are omitted because they are not
applicable or not required, or because the required information
is included in the Consolidated Financial Statements or the Notes
thereto or in Part 1, Item 1.
{b} Reports on 8-K:
Reports on Form 8-K filed during the quarter ended December 31,
1999 are as follows:
Date Filed Purpose
---------- -------
None
{c} Exhibits
See Index of Exhibits on page 108.
61
<PAGE>
Signatures of Registrant
Pursuant to the requirements of the Section 13 of the Securities Exchange Act
of 1934, the Company has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized on March 29, 2000.
FIRST WASHINGTON BANCORP, INC.
/s/ Gary Sirmon
-------------------------------------
Gary Sirmon
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the Company
and in the capacities indicated on March 29, 2000.
/s/ Gary Sirmon /s/ D. Allan Roth
Gary Sirmon D. Allan Roth
- ----------------------------- -------------------------------------
President and Chief Executive Executive Vice President and Chief
Officer; Director Financial Officer
(Principal Executive Officer) (Principal Financial and Accounting
Officer)
/s/ Marvin Sundquist /s/ Robert D. Adams
- ----------------------------- -------------------------------------
Marvin Sundquist Robert D. Adams
Chairman of the Board Director
/s/ David Casper /s/Jesse G. Foster
- ----------------------------- -------------------------------------
David Casper Jesse G. Foster
Director Director
/s/ S. Rick Meikle /s/ Dean W. Mitchell
- ----------------------------- -------------------------------------
S. Rick Meikle Dean W. Mitchell
Director Director
/s/ Brent A. Orrico /s/ Wilber Pribilsky
- ----------------------------- -------------------------------------
Brent A. Orrico Wilber Pribilsky
Director Director
62
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
FIRST WASHINGTON BANCORP, INC. AND SUBSIDIARIES
(Item 8 and Item 14 (a) (1))
Report of Management.................................................... 64
Report of Audit Committee............................................... 64
Independent Auditors' Report............................................ 65
Consolidated Statements of Financial Condition as of December 31, 1999
and 1998............................................................... 66
Consolidated Statements of Income for the Nine Months Ended December 31,
1999 and 1998, and the Years Ended March 31, 1999 and 1998............. 67
Consolidated Statements of Comprehensive Income for the Nine Months
Ended December 31, 1999 and 1998, and the Years ended March 31, 1999
and 1998............................................................... 68
Consolidated Statements of Changes in Stockholders' Equity for the
Nine Months Ended December 31, 1999 and 1998, and the Years Ended
March 31, 1999 and 1998................................................ 69
Consolidated Statements of Cash Flows for the Nine Months Ended December
31, 1999 and 1998, and the Years Ended March 31, 1999 and 1998......... 71
Notes to the Consolidated Financial Statements.......................... 73
63
<PAGE>
March 5, 2000
Report of Management:
To the Stockholders:
The management of First Washington Bancorp, Inc. (the Company) is responsible
for the preparation, integrity, and fair presentation of its published
financial statements and all other information presented in this annual
report. The financial statements have been prepared in accordance with
generally accepted accounting principles and, as such, include amounts based
on informed judgments and estimates made by management. In the opinion of
management, the financial statements and other information herein present
fairly the financial condition and operations of the Company at the dates
indicated in conformity with generally accepted accounting principles.
Management is responsible for establishing and maintaining an effective system
of internal control over financial reporting. The internal control system is
augmented by written policies and procedures and by audits performed by an
internal audit staff which reports to the Audit Committee of the Board of
Directors. Internal auditors monitor the operation of the internal control
system and report findings to management and the Audit Committee. When
appropriate, corrective actions are taken to address identified control
deficiencies and other opportunities for improving the system. The Audit
Committee provides oversight to the financial reporting process. There are
inherent limitations in the effectiveness of any system of internal control,
including the possibility of human error and circumvention or overriding of
controls. Accordingly, even an effective internal control system can provide
only reasonable assurance with respect to financial statement preparation.
Further, because of changes in conditions, the effectiveness of an internal
control system may vary over time.
The Audit Committee of the Board of Directors is comprised entirely of outside
directors who are independent of the Company's management. The Audit
Committee is responsible for recommending to the Board of Directors the
selection of independent auditors. It meets periodically with management, the
independent auditors and the internal auditors to ensure that they are
carrying out their responsibilities. The Committee is also responsible for
performing an oversight role by reviewing and monitoring the financial,
accounting, and auditing procedures of the Company in addition to reviewing
the Company's financial reports. The independent auditors and the internal
auditors have full and free access to the Audit Committee, with or without the
presence of management, to discuss the adequacy of the internal control
structure for financial reporting and any other matters which they believe
should be brought to the attention of the Committee.
Gary Sirmon, Chief Executive Officer D. Allan Roth, Chief Financial Officer
/s/ Gary Sirmon /s/ D. Allan Roth
March 5, 2000
Report of the Audit Committee of the Board of Directors
The Audit Committee of the Board of Directors is comprised of all directors
who are not employees of the Company. The Audit Committee has reviewed the
audited financial statements of First Washington Bancorp, Inc. with management
of the Company, including a discussion of the quality of the accounting
principles applied and significant judgments and estimates affecting the
financial statements. The Audit Committee has also discussed with the outside
auditors the auditors' opinion of the quality of those principles and
significant judgments as applied by management in preparation of the financial
statements. In addition, the members of the Audit Committee have discussed
among themselves, without management or the outside auditors present, the
information disclosed to the committee by management and the outside auditors
and have met regularly with the internal audit staff, without management
present, to review compliance with approved policies and procedures. In
reliance on these reviews and discussions, the Audit Committee believes that
the financial statements of First Washington Bancorp, Inc. are fairly
presented in conformity with generally accepted accounting principles in all
material respects.
/s/ Robert D. Adams
Robert D. Adams
Audit Committee Chairman
64
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors
First Washington Bancorp, Inc. and Subsidiaries
Walla Walla, Washington
We have audited the accompanying consolidated statements of financial
condition of First Washington Bancorp, Inc. and subsidiaries (the Company) as
of December 31, 1999 and March 31, 1999, and the related consolidated
statements of income, comprehensive income, changes in stockholders' equity,
and cash flows for the nine-month period ended December 31, 1999 and for each
of the two years in the period ended March 31, 1999. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial condition of First Washington Bancorp, Inc.
and subsidiaries as of December 31, 1999 and March 31, 1999, and the results
of their operations and their cash flows for the nine-month period ended
December 31, 1999 and for each of the two years in the period ended March 31,
1999 in conformity with generally accepted accounting principles.
/s/Deloitte and Touche LLP
DELOITTE & TOUCHE LLP
March 5, 2000
Seattle, Washington
65
<PAGE>
FIRST WASHINGTON BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(in thousands, except shares)
December 31, 1999 and March 31, 1999
December 31, 1999 March 31, 1999
----------------- --------------
ASSETS
Cash and due from banks $ 44,769 $ 72,503
Securities available for sale,
cost $356,617 and $358,540 348,347 362,021
Securities held to maturity, fair
value $13,716 and $2,235 13,770 2,155
Federal Home Loan Bank stock 24,543 23,137
Loans receivable:
Held for sale, fair value $9,519 and
$11,256 9,519 11,256
Held for portfolio 1,312,186 1,103,674
Allowance for loan losses (13,541) (12,261)
-------------- --------------
1,308,164 1,102,669
Accrued interest receivable 10,732 9,898
Real estate held for sale, net 3,293 1,439
Property and equipment, net 16,637 15,960
Costs in excess of net assets acquired
(goodwill), net 37,733 34,182
Deferred income tax asset, net 5,338 758
Other assets 6,784 7,178
-------------- --------------
$ 1,820,110 $ 1,631,900
============== ==============
LIABILITIES
Deposits:
Non-interest-bearing $ 114,252 $ 97,062
Interest-bearing 963,900 853,786
-------------- --------------
1,078,152 950,848
Advances from Federal Home Loan Bank 466,524 408,252
Other borrowings 81,655 78,467
Accrued expenses and other liabilities 10,524 7,928
Deferred compensation 1,944 1,691
Income taxes payable 2,138 1,106
-------------- --------------
1,640,937 1,448,292
STOCKHOLDERS' EQUITY
Preferred stock - $0.01 par value, 500,000
shares authorized, no shares issued -- --
Common stock - $0.01 par value, 27,500,000
shares authorized, 12,001,562 shares issued:
11,215,756 shares and 11,647,615 shares
outstanding at December 31, 1999 and
March 31, 1999, respectively 123,204 130,770
Retained earnings 69,170 59,958
Accumulated other comprehensive income:
Unrealized gain (loss) on securities
available for sale (5,331) 2,296
Unearned shares of common stock issued to
Employee Stock Ownership Plan (ESOP) trust:
677,846 and 745,918 restricted shares
outstanding at December 31, 1999 and
March 31,1999, respectively, at cost (6,162) (6,781)
Carrying value of shares held in trust
for stock related compensation plans (4,041) (4,785)
Liability for common stock issued to
deferred, stock related, compensation plan 2,333 2,150
-------------- --------------
(1,708) (2,635)
-------------- --------------
179,173 183,608
-------------- --------------
$ 1,820,110 $ 1,631,900
============== ==============
See notes to consolidated financial statements
66
<PAGE>
FIRST WASHINGTON BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except for per share data)
For the Nine Months Ended December 31, 1999 and 1998
and the Years Ended March 31, 1999 and 1998
December 31 March 31
--------------------- -------------------
1999 1998 1999 1998
---- ---- ---- ----
INTEREST INCOME: (Unaudited)
Loans receivable $ 82,107 $ 65,254 $ 89,615 $ 64,695
Mortgage-backed securities 11,630 9,702 13,025 12,522
Securities and cash
equivalents 7,295 6,866 9,652 7,930
--------- -------- --------- --------
101,032 81,822 112,292 85,147
--------- -------- --------- --------
INTEREST EXPENSE:
Deposits 31,475 24,693 34,019 25,289
Federal Home Loan Bank
advances 18,505 15,651 21,430 16,782
Other borrowings 3,221 3,939 4,993 4,580
--------- -------- --------- --------
53,201 44,283 60,442 46,651
--------- -------- --------- --------
Net interest income before
provision for loan losses 47,831 37,539 51,850 38,496
PROVISION FOR LOAN LOSSES 1,885 2,210 2,841 1,628
--------- -------- --------- --------
Net interest income 45,946 35,329 49,009 36,868
OTHER OPERATING INCOME:
Loan servicing fees 741 586 798 815
Other fees and service
charges 3,367 2,543 3,574 2,436
Gain on sale of loans 1,157 2,052 2,884 1,377
Gain on sale of securities 2 7 11 2
Miscellaneous 248 168 186 90
--------- -------- --------- --------
Total other operating
income 5,515 5,356 7,453 4,720
OTHER OPERATING EXPENSES:
Salary and employee
benefits 17,503 13,026 18,644 13,117
Less capitalized loan
origination costs (2,572) (1,999) (2,689) (2,069)
Occupancy and equipment 4,660 3,425 4,816 2,983
Information/computer data
services 1,751 1,130 1,603 1,169
Advertising 514 416 590 450
Deposit insurance 257 258 338 280
Amortization of goodwill 2,364 1,706 2,389 899
Miscellaneous 6,045 4,432 6,054 4,191
--------- -------- --------- --------
Total other operating
expenses 30,522 22,394 31,745 21,020
--------- -------- --------- --------
Income before provision
for income taxes 20,939 18,291 24,717 20,568
PROVISION FOR INCOME TAXES 8,070 6,880 9,277 7,446
--------- -------- --------- --------
NET INCOME $ 12,869 $ 11,411 $ 15,440 $ 13,122
========= ======== ========= ========
Earnings per common share:
see Notes 2 and 24
Basic $ 1.23 $ 1.09 $ 1.46 $ 1.30
Diluted $ 1.19 $ 1.04 $ 1.40 $ 1.25
Cumulative dividends
declared per common share $ 0.36 $ 0.26 $ 0.38 $ 0.27
See notes to consolidated financial statements
67
<PAGE>
FIRST WASHINGTON BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
For the Nine Months Ended December 31, 1999 and 1998
and the Years Ended March 31, 1999 and 1998
December 31 March 31
--------------------- -------------------
1999 1998 1999 1998
---- ---- ---- ----
(Unaudited)
NET INCOME $ 12,869 $ 11,411 $ 15,440 $ 13,122
OTHER COMPREHENSIVE INCOME
(LOSS), NET OF INCOME TAXES:
Unrealized holding gain
(loss) during the period,
net of deferred income
tax (benefit) of $(4,123),
$(126), $(194) and $1,588 (7,626) (236) (377) 3,082
Less adjustment for gains
included in net income,
net of income tax of $1,
$4, $4 and $1 (1) (4) (7) (1)
--------- -------- --------- --------
Other comprehensive income
(loss) (7,627) (240) (384) 3,081
--------- -------- --------- --------
COMPREHENSIVE INCOME $ 5,242 $ 11,171 $ 15,056 $ 16,203
========= ======== ========= ========
See notes to consolidated financial statements
68
<PAGE>
FIRST WASHINGTON BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the Nine Months Ended December 31, 1999 and 1998
and the Years Ended March 31, 1999 and 1998 (in thousands)
December 31 March 31
--------------------- -------------------
1999 1998 1999 1998
---- ---- ---- ----
COMMON STOCK: (Unaudited)
Balance, beginning of year $ 130,770 $ 108,994 $ 108,994 $ 107,953
Issuance of stock in
connection with
acquisitions -- 1,260 12,776 --
Assumption of options in
connection with acquisitions -- 2,018 2,546 --
Excess (deficiency) of
proceeds over basis of stock
reissued for exercised stock
options 80 (285) (265) (29)
Record 10% stock dividend:
see Note 2 -- 24,371 24,371 --
Repurchase and retirement of
stock subsequent to reincor-
poration (8,572) (4,012) (7,955) --
Retirement of treasury stock
resulting from reincorporation
in State of Washington: see
Note 1 -- (11,116) (11,116) --
Net issuance of stock through
employees' stock plans,
including tax benefit 926 819 1,419 1,070
--------- --------- --------- ---------
Balance, end of year 123,204 122,049 130,770 108,994
RETAINED EARNINGS:
Balance, beginning of year 59,958 72,962 72,962 62,572
Net income 12,869 11,411 15,440 13,122
Record 10% stock dividend -- (24,371) (24,371) --
Cash dividends (3,657) (2,729) (4,073) (2,732)
--------- --------- --------- ---------
Balance, end of year 69,170 57,273 59,958 72,962
ACCUMULATED OTHER COMPREHENSIVE
INCOME:
Balance, beginning of year 2,296 2,680 2,680 (401)
Other comprehensive income
(loss), net of related
income taxes (7,627) (240) (384) 3,081
--------- --------- --------- ---------
Balance, end of year (5,331) 2,440 2,296 2,680
TREASURY STOCK:
Balance, beginning of year -- (20,979) (20,979) (6,954)
Issuance of stock in
connection with acquisitions 17,206 17,206 --
Purchases of treasury stock,
prior to reincorporation (7,340) (7,340) (13,993)
Purchases of treasury stock
for exercised stock options (409) (409) (74)
Issuance of treasury stock for
MRP and/or exercised stock
options 409 409 74
Repurchase of forfeited shares
from MRP (3) (3) (32)
Retirement of treasury shares
resulting from reincorporation
in State of Washington: see
Note 1 11,116 11,116 --
--------- --------- --------- ---------
Balance, end of year -- -- -- (20,979)
UNEARNED, RESTRICTED ESOP
SHARES AT COST:
Balance, beginning of year (6,781) (7,163) (7,163) (7,751)
Release of earned ESOP shares 619 382 382 588
--------- --------- --------- ---------
Balance, end of year (6,162) (6,781) (6,781) (7,163)
continued on next page
69
<PAGE>
FIRST WASHINGTON BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the Nine Months Ended December 31, 1999 and 1998
and the Years Ended March 31, 1999 and 1998 (in thousands)
(Continued from prior page)
December 31 March 31
--------------------- -------------------
1999 1998 1999 1998
---- ---- ---- ----
(Unaudited)
CARRYING VALUE OF SHARES HELD
IN TRUST FOR STOCK RELATED
COMPENSATION PLANS:
Balance, beginning of year $ (2,635) $ (6,310) $ (6,310) $ (6,783)
Cumulative effect of change
in accounting for Rabbi
Trust: see Note 1 -- 1,354 1,095 --
Stock issued to fund Rabbi
Trust plans -- -- (601) --
Net change in number and/or
valuation of shares held
in trust 5 (35) 1,987 (740)
Issuance of treasury stock
for MRP (52) -- -- --
Amortization of compensation
related to MRP 974 893 1,194 1,213
--------- --------- --------- --------
Balance, end of year (1,708) (4,098) (2,635) (6,310)
--------- --------- --------- --------
TOTAL STOCKHOLDERS' EQUITY $ 179,173 $ 170,883 $ 183,608 $150,184
========= ========= ========= ========
COMMON STOCK, SHARES ISSUED .*
Number of shares, beginning
of year 12,002 12,002 12,002 12,002
--------- --------- --------- --------
Number of shares, end of year 12,002 12,002 12,002 12,002
--------- --------- --------- --------
LESS TREASURY STOCK RETIRED/
REPURCHASED:* see Note 1
Number of shares, beginning
of year (354) (1,054) (1,054) (431)
Repurchase stock (443) (505) (675) (621)
Repurchase stock for
exercised stock options -- (18) (18) (3)
Issuance of stock to deferred
compensation plan and/or
exercised stock options 12 24 34 3
Stock issued in acquisitions -- 853 1,361 --
Repurchase of stock forfeited
from MRP (1) -- (2) (2)
Shares of stock retired/ --------- --------- --------- --------
repurchased, end of year (786) (700) (354) (1,054)
--------- --------- --------- --------
SHARES OUTSTANDING, END OF YEAR 11,216 11,302 11,648 10,948
========= ========= ========= ========
UNEARNED, RESTRICTED ESOP SHARES:*
Number of shares, beginning
of year (746) (788) (788) (853)
Release of earned shares 68 42 42 65
--------- --------- --------- --------
Number of shares, end of year (678) (746) (746) (788)
========= ========= ========= ========
* Adjusted for stock dividend: see Note 2.
See notes to consolidated financial statements
70
<PAGE>
FIRST WASHINGTON BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
For the Nine Months Ended December 31, 1999 and 1998
and the Years Ended March 31, 1999 and 1998
December 31 March 31
--------------------- -------------------
1999 1998 1999 1998
---- ---- ---- ----
OPERATING ACTIVITIES: (Unaudited)
Net income $ 12,869 $ 11,411 $ 15,440 $ 13,122
Adjustments to reconcile net
income to net cash provided
by operating activities:
Deferred taxes (302) (143) (144) 374
Depreciation 1,764 1,296 1,901 1,135
Loss (gain) on sale of
securities (2) (7) (11) (2)
Net amortization of premiums
and discounts on investments 325 687 1,017 287
Amortization of costs in
excess of net assets acquired 2,364 1,707 2,389 899
Amortization of MRP
compensation liability 974 893 1,194 1,213
Loss (gain) on disposal of
equipment (7) (95) (95) (7)
Loss (gain) on sale of loans (1,029) (2,052) (1,903) (933)
Net change in deferred loan
fees, premiums and discounts 1,934 49 46 523
Loss (gain) on disposal of real
estate held for sale (61) 24 35 30
Amortization of mortgage
servicing rights 215 196 277 100
Capitalization of mortgage
servicing rights from sale of
mortgages with servicing
retained (128) (739) (981) (442)
Provision for loan losses 1,885 2,210 2,841 1,628
FHLB stock dividend (1,287) (1,110) (1,545) (1,146)
Cash provided (used) in
operating assets and
liabilities:
Loans held for sale 1,737 (144) 3,306 (9,496)
Accrued interest receivable (454) (220) (1,111) (619)
Other assets 276 (42) 865 (482)
Deferred compensation 382 242 380 288
Accrued expenses and other
liabilities 2,512 1,083 170 1,038
Income taxes payable 1,092 (1,878) (1,709) (38)
--------- --------- --------- ----------
Net cash provided by
operating activities 25,059 13,368 22,362 7,472
--------- --------- --------- ----------
INVESTING ACTIVITIES:
Purchases of securities
available for sale (45,021) (282,350) (353,354) (233,660)
Principal repayments and
maturities of securities
available for sale 53,120 248,129 301,393 221,766
Sales of securities available
for sale 5,829 2,206 2,637 1,405
Purchases of securities held
to maturity (12,058) -- -- --
Principal repayments and
maturities of securities
held to maturity 449 510 647 793
Loans originated and closed,
net (759,640) (512,138) (716,952) (511,398)
Purchases of loans and
participating interest
in loans (13,171) (59,100) (86,165) (51,049)
Sales of loans and
participating interest
in loans 99,316 117,422 127,452 81,575
Principal repayments on loans 486,948 351,642 521,958 375,868
Purchases of FHLB stock (119) (3,825) (3,437) (2,097)
Proceeds from sale of
property and equipment 10 373 373 13
Purchases of property and
equipment (1,866) (2,394) (3,067) (1,986)
Additional investment in real
estate held for sale, net
of insurance proceeds (346) (85) (165) (26)
Proceeds from sale of real
estate held for sale 2,407 1,673 2,661 2,417
Funds transferred to deferred
compensation plans (99) (104) (494) (91)
Acquisitions, net of cash
acquired (5,423) 9,328 13,877 --
--------- --------- --------- ----------
Net cash used by
investing activities $(189,664) $(128,713) $(192,636) $ (116,470)
--------- --------- --------- ----------
71
<PAGE>
FIRST WASHINGTON BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
For the Nine Months Ended December 31, 1999 and 1998
and the Years Ended March 31, 1999 and 1998
(Continued from prior page)
December 31 March 31
--------------------- -------------------
1999 1998 1999 1998
---- ---- ---- ----
FINANCING ACTIVITIES: (Unaudited)
Increase (decrease) in
deposits $ 86,302 $ 73,415 $ 129,998 $ 46,645
Proceeds from FHLB advances 420,900 244,554 300,807 640,025
Repayment of FHLB advances (362,628) (150,247) (199,099) (573,991)
Proceeds from repurchase
agreement borrowings 4,500 268 268 33,687
Repayment of repurchase
agreement borrowings (10,492) (11,254) (13,008) (431)
Increase (decrease) in other
borrowings 9,180 3,635 (516) (3,718)
Compensation expense
recognized for shares
released for allocation
to participants of the ESOP:
Original basis of shares 619 382 382 588
Excess of fair value of
released shares over basis 686 543 542 839
Cash dividends paid (3,709) (2,610) (3,595) (2,583)
Net (cost) gain of exercised
stock options 80 (285) (265) (29)
Repurchases of stock, net of
forfeitures (8,567) (11,352) (15,266) (13,993)
--------- --------- --------- ----------
Net cash provided by
financing activities 136,871 147,049 200,248 127,039
--------- --------- --------- ----------
NET INCREASE (DECREASE) IN CASH
AND DUE FROM BANKS (27,734) 31,704 29,974 18,041
CASH AND DUE FROM BANKS,
BEGINNING OF PERIOD 72,503 42,529 42,529 24,488
--------- --------- --------- ----------
CASH AND DUE FROM BANKS, END
OF PERIOD $ 44,769 $ 74,233 $ 72,503 $ 42,529
========= ========== ========= ==========
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION:
Interest paid $ 54,792 $ 43,480 $ 59,407 $ 46,311
Taxes paid $ 7,298 $ 8,880 $ 10,619 $ 7,108
Non-cash transactions:
Loans, net of discounts,
specific loss allowances
and unearned income
transferred to real
estate held for sale $ 3,854 $ 2,971 $ 3,007 $ 2,246
Net change in accrued
dividends payable $ 52 $ 119 $ 477 $ 149
Net change in unrealized
gain (loss) in deferred
compensation trust and
related liability $ 66 $ 1,387 $ 3,498 $ 707
Stock issued to Rabbi
Trust/MRP $ 52 $ -- $ 601 $ --
Stock forfeited by MRP $ 5 $ 3 $ 32 $ 32
Recognize tax benefit of
vested MRP shares $ 188 $ 276 $ 276 $ 231
Non-cash portion of 10%
stock dividend $ -- $ 24,371 $ 24,360 $ --
The following summarizes the non-cash activities relating to acquisitions:
Fair value of assets
acquired $ (51,374) $ (164,532) $(270,436) $ --
Fair value of liabilities
assumed 41,201 136,296 230,012 --
Fair value of stock issued
and Options assumed to
acquisitions' shareholders -- 20,484 32,527 --
--------- ---------- --------- ---------
Cash paid out in acquisition (10,173) (7,752) (7,897) --
Less cash acquired 4,750 17,080 21,774 --
--------- ---------- --------- ---------
Net cash acquired (used) $ (5,423) $ 9,328 $ 13,877 $ --
========= ========== ========= =========
See notes to consolidated financial statements
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FIRST WASHINGTON BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: BASIS OF PRESENTATION AND SUMMARY OF ACCOUNTING POLICIES
Basis for Presentation: First Washington Bancorp, Inc. ("FWWB" and together
with its subsidiaries, "The Company") is a bank holding company incorporated
in the State of Washington. The Company was originally organized for the
purpose of acquiring all of the capital stock of First Savings Bank of
Washington (FSBW) upon its reorganization from the mutual holding company form
of organization to the stock holding company form of organization.
The Company is primarily engaged in the business of planning, directing and
coordinating the business activities of its wholly owned subsidiaries, FSBW,
Inland Empire Bank (IEB), and Towne Bank (TB) (together, the Banks). FSBW is
a Washington-chartered savings bank the deposits of which are insured by the
Federal Deposit Insurance Corporation (FDIC) under the Savings Association
Insurance Fund (SAIF). FSBW conducts business from its main office in Walla
Walla, Washington and its sixteen branch offices and three loan production
offices located in southeast, central, north central and western Washington.
FSBW also conducts business through its two divisions, Whatcom State Bank
(WSB), which has five branch offices and one loan production office located in
northwest Washington in Bellingham, Washington, and Whatcom and Island
counties; and Seaport Citizens Bank (SCB) which has two offices located in
Lewiston, Idaho. IEB is an Oregon-chartered commercial bank whose deposits
are insured by the FDIC under the Bank Insurance Fund (BIF). IEB conducts
business from its main office in Hermiston, Oregon, and its six branch offices
and two loan production offices located in northeast Oregon. TB operates seven
full service branches in the Seattle, Washington, metropolitan area--in
Woodinville, Redmond, Bellevue, Renton, Kirkland, Bothell and Everett. The
Company's only significant assets are the capital stock of its subsidiaries,
its loan to the Company's Employee Stock Ownership Plan (ESOP) (see Note 15)
and the portion of the net proceeds retained from the offering. The Company
has no significant liabilities.
The Company and its Bank subsidiaries are subject to regulation by the Federal
Reserve Board (FRB) and the FDIC. In addition FSBW, IEB and TB are subject
to the state banking regulations applicable to their state charters.
Changes in Fiscal Year End: During May of 1999, the Company announced its
decision to change its fiscal year from April 1 through March 31 to January 1
through December 31. The current fiscal period is for the transition period
April 1, 1999 through December 31, 1999. For discussion and analysis
purposes, the nine months ended December 31, 1999 are compared to the
unaudited nine months ended December 31, 1998.
Reincorporation: The stockholders of First Savings Bank of Washington
Bancorp, Inc., a Delaware corporation and herein referred to as "FSBWB,"
approved the reincorporation of FSBWB from Delaware to Washington on July 24,
1998. The purpose of the reincorporation was to save higher costs incurred as
a result of being a Delaware corporation. The reincorporation was effected
July 24, 1998 by merging FSBWB into a wholly-owned subsidiary which had been
recently formed solely for the purpose of effecting the reincorporation. The
surviving corporation is known as First Washington Bancorp, Inc., a Washington
corporation, and is hereafter referred to as "FWWB" or "the Company." Upon
consummation of the merger, each share of Common Stock of FSBWB, par value
$.01 per share, was automatically converted into one share of Common Stock of
FWWB, par value $.01 per share.
The merger was consummated under the terms and conditions of a Plan of Merger
pursuant to which FSBWB ceased to exist as a Delaware corporation, the
stockholders of FSBWB became shareholders of FWWB, FWWB succeeded to all the
assets, liabilities, subsidiaries and other properties of FSBWB to the full
extent provided by law, and the rights of the shareholders and internal
affairs of FWWB are to be governed by the articles of incorporation and bylaws
of FWWB and the Washington Business Corporation Act, as amended. As a result
of the merger, similar to a pooling of interest, FWWB has the same recorded
basis, business, management, benefit plans, location, assets, liabilities and
net worth as did FSBWB. However, because the State of Washington treats all
treasury stock as retired upon purchase, all purchases of treasury stock
reduce stock issued and the cost of treasury stock acquired is charged to par
value and paid-in capital.
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Nature of Business: The operating results of the Company depend primarily on
its net interest income, which is the difference between interest income on
interest-earning assets, consisting of loans and securities, and interest
expense on interest-bearing liabilities, composed primarily of savings
deposits, Federal Home Loan Bank (FHLB) advances and repurchase agreements.
Net interest income is a function of the Company's interest rate spread, which
is the difference between the yield earned on interest-earning assets and the
rate paid on interest-bearing liabilities, as well as a function of the
average balance of interest-earning assets as compared to the average balance
of interest-bearing liabilities.
In addition to interest income on loans and securities, the Banks receive
other income from deposit service charges, loan origination and servicing fees
and from the sale of loans and investments.
Principles of Consolidation: The consolidated financial statements include
the accounts of FWWB and its wholly owned subsidiaries, FSBW, IEB and TB. All
material intercompany transactions, profits and balances have been eliminated.
Use of Estimates: The preparation of the financial statements in conformity
with generally accepted accounting principles (GAAP) requires management to
make estimates and assumptions that affect amounts reported in the financial
statements. Changes in these estimates and assumptions are considered
reasonably possible and may have a material impact on the financial
statements. The Company has used significant estimates in determining
reported reserves and allowances for loan losses, mortgage servicing rights,
goodwill, tax liabilities and other contingencies.
Securities: Securities are classified as held to maturity when the Company has
the ability and positive intent to hold them to maturity. Securities
classified as available for sale are available for future liquidity
requirements and may be sold prior to maturity.
Securities held to maturity are carried at cost, adjusted for amortization of
premiums and accretion of discounts to maturity. Unrealized losses on
securities held to maturity due to decreases in fair value are recognized when
it is determined that an other than temporary decline in value has occurred.
Securities available for sale are carried at fair value. Unrealized gains and
losses on securities available for sale are excluded from earnings and are
reported net of tax as accumulated other comprehensive income, a component of
stockholders' equity, until realized. Realized gains and losses on sale are
computed on the specific identification method and are included in operations
on the trade date sold.
Loans Receivable: The Banks originate mortgage loans for both portfolio
investment and sale in the secondary market. At the time of origination,
mortgage loans are designated as held for sale or held for investment. Loans
held for sale are stated at lower of cost or estimated fair value determined
on an aggregate basis. The Banks also originate commercial, financial,
agribusiness and installment credit loans for portfolio investment. Loans
receivable not designated as held for sale are recorded at the principal
amount outstanding, net of allowance for loan losses, deferred fees,
discounts, and premiums. Premiums, discounts and deferred loan fees are
amortized to maturity using the level-yield methodology.
Interest is accrued as earned unless management doubts the collectibility of
the loan or the unpaid interest. Interest accruals are generally discontinued
when loans become 90 days past due for interest. All previously accrued but
uncollected interest is deducted from interest income upon transfer to
nonaccrual status. Future collection of interest is included in interest
income based upon an assessment of the likelihood that the loans will be
repaid or recovered. A loan may be put in nonaccrual status sooner than this
policy would dictate if, in management's judgment, the loan may be
uncollectible. Such interest is then recognized as income only if it is
ultimately collected.
Allowances for Loan Losses: The adequacy of general and specific reserves is
based on management's continuing evaluation of the pertinent factors
underlying the quality of the loan portfolio, including changes in the size
and composition of the loan portfolio, delinquency rates, actual loan loss
experience and current economic conditions. Large groups of smaller-balance
homogeneous loans are collectively evaluated for impairment. Loans that are
collectively evaluated for impairment by the Banks include residential real
estate and consumer loans. Smaller balance non-homogeneous loans also may be
evaluated collectively for impairment. Larger balance non-homogeneous
residential construction and land, commercial real estate, commercial business
loans and unsecured loans are individually evaluated for impairment. Loans
are considered impaired when, based on current information and events,
management determines that it is probable that the Bank will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. Factors involved in determining impairment include, but
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<PAGE>
are not limited to, the financial condition of the borrower, value of the
underlying collateral and current status of the economy. Impaired loans are
measured based on the present value of expected future cash flows discounted
at the loan's effective interest rate or, as a practical expedient, at the
loan's observable market price or the fair value of collateral if the loan is
collateral dependent. Subsequent changes in the value of impaired loans shall
be included within the provision for loan losses in the same manner in which
impairment initially was recognized or as a reduction in the provision that
would otherwise be reported.
The Company's methodology for assessing the appropriateness of the allowance
consists of several key elements, which include specific allowances, an
allocated formula allowance, and an unallocated allowance. Losses on specific
loans are provided for when the losses are probable and estimable. General
loan loss reserves are established to provide for inherent loan portfolio
risks not specifically provided for. The level of general reserves is based
on analysis of potential exposures existing in the Banks' loan portfolios
including evaluation of historical trends, current market conditions and other
relevant factors identified by management at the time the financial statements
are prepared. The formula allowance is calculated by applying loss factors to
outstanding loans, excluding loans with specific allowances. Loss factors are
based on the Company's historical loss experience adjusted for significant
factors including the experience of other banking organizations that, in
management's judgment, affect the collectibility of the portfolio as of the
evaluation date. The unallocated allowance is based upon management's
evaluation of various factors that are not directly measured in the
determination of the formula and specific allowances. This methodology may
result in losses or recoveries differing significantly from those provided in
the financial statements.
When available information confirms that specific loans or portions thereof
are uncollectible, these amounts are charged off against the reserve for loan
losses. The existence of some or all of the following criteria will generally
confirm that a loss has been incurred: the loan is significantly delinquent
and the borrower has not evidenced the ability or intent to bring the loan
current; the Company has no recourse to the borrower, or if it does, the
borrower has insufficient assets to pay the debt; or the fair value of the
loan collateral is significantly below the current loan balance and there is
little or no near-term prospect for improvement.
Loan Origination and Commitment Fees: Loan origination fees, net of certain
specifically defined direct loan origination costs, are deferred and
recognized as an adjustment of the loans' interest yield using the level-yield
method over the contractual term of each loan adjusted for actual loan
prepayment experience. Net deferred fees or costs related to loans held for
sale are recognized in income at the time the loans are sold. Loan commitment
fees are deferred until the expiration of the commitment period unless
management believes there is a remote likelihood that the underlying
commitment will be exercised, in which case the fees are amortized to fee
income using the straight-line method over the commitment period. If a loan
commitment is exercised, the deferred commitment fee is accounted for in the
same manner as a loan origination fee. Deferred commitment fees associated
with expired commitments are recognized as fee income.
Real Estate Held for Sale: Property acquired by foreclosure or deed in lieu of
foreclosure is recorded at the lower of estimated fair value, less cost to
sell, or the principal balance of the defaulted loan. Development,
improvement, and direct holding costs relating to the property are
capitalized. The carrying value of such property is periodically evaluated by
management and, if necessary, allowances are established to reduce the
carrying value to net realizable value. Gains or losses at the time the
property is sold are charged or credited to operations in the period in which
they are realized. The amounts the Banks will ultimately recover from real
estate held for sale may differ substantially from the carrying value of the
assets because of future market factors beyond the Banks' control or because
of changes in the Banks' strategy for recovering the investment.
Property and Equipment: The provision for depreciation is based upon the
straight-line method applied to individual assets and groups of assets
acquired in the same year at rates adequate to charge off the related costs
over their estimated useful lives.
Buildings and improvements................................. 10-30 years
Furniture and equipment.................................... 3-10 years
Routine maintenance, repairs, and replacement costs are expensed as incurred.
Expenditures which materially increase values or extend useful lives are
capitalized. The Company reviews buildings, leasehold improvements, and
equipment for impairment whenever events or changes in circumstances indicate
that the undiscounted cash flows for the property are less than its carrying
value. If identified, an impairment loss is recognized through a charge to
earnings based on the fair value of the property.
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Costs in Excess of Net Assets Acquired: Costs in excess of net assets
acquired (goodwill) is an intangible asset arising from the purchase of IEB,
TB, WSB and SCB. It is being amortized on a straight-line basis over the
14-year period of expected benefit. The Company periodically evaluates
goodwill for impairment.
Mortgage Servicing Rights: Purchased servicing rights represent the cost of
acquiring the right to service mortgage loans. Originated servicing rights are
recorded when mortgage loans are originated and subsequently sold or
securitized with the servicing rights retained. The total cost of mortgage
loans sold is allocated to the servicing rights and the loans (without the
servicing rights) based on relative fair values. The cost relating to
purchased and originated servicing is capitalized and amortized in proportion
to, and over the period of, estimated future net servicing income.
The Banks assess the fair value of unamortized servicing rights for impairment
on a stratum by stratum basis every quarter by using secondary market quotes
for comparable packages of serviced loans and a valuation model that
calculates the present value of future cash flows using market discount rates
and market based assumptions for prepayment speeds, servicing costs and
ancillary income for those pools of serviced mortgages for which secondary
market quotes are not readily available. For purposes of measuring impairment,
the servicing rights are stratified based on their interest rate, original and
remaining terms to maturity and balances outstanding.
Income Taxes: The Company files a consolidated income tax return including all
of its wholly owned subsidiaries on a calendar year basis. Income taxes are
accounted for using the asset and liability method. Under this method, a
deferred tax asset or liability is determined based on the enacted tax rates
which will be in effect when the differences between the financial statement
carrying amounts and tax bases of existing assets and liabilities are expected
to be reported in the Company's income tax returns. The effect on deferred
taxes of a change in tax rates is recognized in income in the period of
change. Where state income tax laws do not permit consolidated income tax
returns, applicable state income tax returns are filed.
Stock Compensation Plans: The Company sponsors an ESOP. The ESOP purchased 8%
of the shares of common stock issued in the reorganization and initial public
stock offering pursuant to the subscription rights granted under the ESOP
plan. The ESOP borrowed $8,728,500 from the Company in order to fund the
purchase of common stock. The loan to the ESOP will be repaid principally
from the Company's contribution to the ESOP, and the collateral for the loan
is the Company's common stock purchased by the ESOP. As the debt is repaid,
shares are released from collateral based on the proportion of debt service
paid in the year and allocated to participants' accounts. As shares are
released from collateral, compensation expense is recorded equal to the
average current market price of the shares, and the shares become outstanding
for earnings-per-share calculations. Stock and cash dividends on allocated
shares are recorded as a reduction of retained earnings and paid or
distributed directly to participants' accounts. Stock and cash dividends on
unallocated shares are recorded as a reduction of debt and accrued interest
(see additional discussion in Note 15).
In July 1998, the Emerging Issues Task Force (EITF) of the Financial
Accounting Standards Board (FASB) reached a consensus on the accounting
treatment for deferred compensation arrangements where amounts earned are held
in a Rabbi Trust and invested. The consensus position (EITF 97-14) was
applied as of September 30, 1998 for all awards granted, and existing plans
were required to be amended prior to September 30, 1998. Application of the
consensus is reflected as a change in accounting principle under which the
Company stock purchased for a Rabbi Trust obligation and the related liability
for deferred compensation are recorded at acquisition cost. Prior to this
change the stock was recorded at fair market value. The effect of this change
in accounting increased equity by $1.1 million and reduced the related
liability for deferred compensation by the same amount.
Average Balances: Average balances are obtained from the best available
daily, weekly or monthly data, which FWWB's management believes approximate
the average balances calculated on a daily basis.
Recent Accounting Standard Not Yet Adopted: Statement of Financial Accounting
Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging
Activities, was issued in June 1998 and establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. FWWB will implement
this statement on January 1, 2001. The impact of the adoption of the
provisions of this statement on the results of operations or financial
condition of FWWB has not yet been determined.
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Reclassification: Certain amounts in the prior years' financial statements
have been reclassified to conform to the current year's presentation.
Note 2: RECENT DEVELOPMENTS AND ACQUISITIONS
Consolidation of Banking Operations:
On July 22, 1999 the Company announced its plans to combine its three separate
banking subsidiaries into a single community banking franchise. The
combination was designed to strengthen the Company's commitment to community
banking by more effectively sharing the resources of the existing
subsidiaries, improving operating efficiency and developing a broader regional
brand identity. The consolidation was intended to be done in stages. The
first phase, which was expected to be completed by January 1, 2000, included
the merger of TB and FSBW and the selection of a single name and charter to be
used by TB, FSBW, WSB and SCB. Final integration of all data processing into
a common system and the merger of IEB was scheduled for completion by December
31, 2000.
On December 23, 1999, the Company announced its decision to temporarily
postpone the pending consolidation of its subsidiaries, TB and IEB, into FSBW
in light of the new Gramm-Leach-Bliley financial modernization legislation.
The recent legislation enacts Federal Home Loan Bank System reforms that
impact community financial institutions. A community financial institution
(CFI) is defined as a "member of the FHL Bank System, the deposits of which
are insured by the FDIC and that has average total assets (over the preceding
3 years) of less than $500 million." One provision of the reforms provides
community financial institutions with the ability to obtain long-term FHLB
advances to fund small business, small farm and small agribusiness loans. In
addition, community financial institutions will be able to offer these loans
as collateral for such borrowings. This provision, which represents a change
in policy from the previous requirement that these funds be securitized
primarily by residential mortgage loans, will be available only to community
financial institutions. As independent subsidiaries, TB and IEB currently
qualify as community financial institutions. Merging either of these two
subsidiaries into FSBW could disqualify them and remove this favorable status.
Based on the information available at this time, the Company believes that TB
and IEB could derive significant benefits from this legislation. Rather than
complete the proposed bank mergers as previously announced, the Company has
chosen to allow adequate time for an in-depth review and interpretation of the
regulations as they pertain to future plans. Consolidation of support
operations continues on schedule and budget and First Washington expects to
receive long-term benefits from the proposed efficiencies. The postponement
of our mergers will have minimal impact on the operational changes. The
previously announced name and charter changes scheduled for Spring 2000 are
expected to proceed for the FSBW subsidiary, including its WSB and SCB
divisions.
Acquisition of Seaport Citizens Bank:
On April 1, 1999, FWWB and FSBW completed the acquisition of Seaport Citizens
Bank (SCB). FSBW paid $10.1 million in cash for all the outstanding common
shares of SCB, which was headquartered in Lewiston, Idaho. As a result of the
merger of SCB into FSBW, SCB became a division of FSBW. The acquisition was
accounted for as a purchase in the current period and resulted in the
recording of $6.1 million of costs in excess of the fair value of SCB's net
assets acquired (goodwill). Goodwill assets are being amortized over a
14-year period and resulted in a current charge to earnings of $108,100 per
quarter, beginning in the first quarter of the current period, or $433,000 per
year. Founded in 1979, SCB is a commercial bank which had, before recording of
purchase accounting adjustments, approximately $45 million in total assets,
$41 million in deposits, $27 million in loans, and $4.1 million in
shareholders' equity at March 31, 1999. SCB operates two full service
branches in Lewiston, Idaho.
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Acquisition of Whatcom State Bancorp, Inc.:
On January 1, 1999 FWWB completed the acquisition of Whatcom State Bancorp,
Inc. FWWB paid $12.1 million in common stock for all the outstanding common
shares and stock options of Whatcom State Bancorp, Inc., which was the holding
company for Whatcom State Bank (WSB), headquartered in Bellingham, Washington.
As a result of the merger of Whatcom State Bancorp, Inc. into FWWB, WSB became
a division of FSBW. The acquisition was accounted for as a purchase and
resulted in the recording of approximately $6.0 million of costs in excess of
the fair value of Whatcom State Bancorp, Inc. net assets acquired (goodwill).
Goodwill assets are being amortized over a 14-year period resulting in a
current charge to earnings of approximately $105,200 per quarter or $421,000
per year. Founded in 1980, WSB is a community commercial bank which had,
before recording of purchase accounting adjustments, approximately $99 million
in total assets, $85 million in deposits, $79 million in loans, and $5.4
million in shareholders' equity at December 31, 1998. WSB operates five full
service branches in the Bellingham, Washington, area Bellingham, Ferndale,
Lynden, Blaine and Point Roberts.
Declaration of 10% Stock Dividend:
On July 24, 1998 FWWB's Board of Directors declared a 10% stock dividend
payable August 17, 1998 to shareholders of record on August 10, 1998. All
earnings per share and share data have been adjusted to reflect the 10% stock
dividend.
Acquisition of Towne Bancorp, Inc.:
On April 1, 1998 FWWB completed the acquisition of Towne Bancorp, Inc. FWWB
paid $28.2 million in cash and common stock for all of the outstanding common
shares and stock options of Towne Bancorp, Inc., which was the holding company
for Towne Bank (TB), headquartered in Woodinville, Washington, a Seattle
suburb. As a result of the merger of Towne Bancorp, Inc. into FWWB, TB became
a wholly owned subsidiary of FWWB. The acquisition was accounted for as a
purchase and resulted in the recording of $19.4 million of costs in excess of
the fair value of Towne Bancorp, Inc. net assets acquired (goodwill).
Goodwill assets are being amortized over a 14-year period resulting in a
current charge to earnings of $346,700 per quarter or $1,387,000 per year.
Founded in 1991, TB is a community business bank which had, before recording
of purchase accounting adjustments, approximately $146 million in total
assets, $134 million in deposits, $120 million in loans and $9.3 million in
shareholders' equity at March 31, 1998. TB operates seven full service
branches in the Seattle, Washington, metropolitan area in Woodinville,
Kirkland, Redmond, Bellevue, Renton, Bothell and Everett.
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Note 3: CASH AND DUE FROM BANKS
Cash and due from banks consisted of the following (in thousands):
December 31 March 31
1999 1999
----------- -----------
Cash on hand and demand deposits $ 41,810 $ 51,126
Cash equivalents:
Short-term cash investments 559 2,562
Federal funds sold 2,400 18,815
----------- -----------
$ 44,769 $ 72,503
=========== ===========
For the purpose of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks, overnight investments and short-term
deposits with original maturities less than 90 days.
FRB regulations require depository institutions to maintain certain minimum
reserve balances. Included in cash and demand deposits were reserves required
by the FRB of $9.1 million and $6.4 million at December 31, 1999 and March 31,
1999, respectively.
Note 4: SECURITIES AVAILABLE FOR SALE
The amortized cost and estimated fair value of securities available for sale
are summarized as follows (in thousands):
December 31, 1999
---------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
U.S. Government and agency
obligations $ 60,197 $ 62 $ (1,391) $ 58,868
Municipal bonds:
Taxable 4,947 33 (229) 4,751
Tax exempt 30,505 635 (555) 30,585
Corporate bonds 22,689 -- (1,125) 21,564
Mortgage-backed securities:
FHLMC certificates 3,372 20 (68) 3,324
FHLMC collateralized
mortgage obligations 56,935 48 (2,773) 54,210
-------- -------- -------- --------
Total FHLMC mortgage-
backed securities 60,307 68 (2,841) 57,534
GNMA certificates 18,982 34 (710) 18,306
GNMA collateralized
mortgage obligations 8,697 8 (201) 8,504
-------- -------- -------- --------
Total GNMA mortgage-
backed securities 27,679 42 (911) 26,810
FNMA certificates 5,518 17 (83) 5,452
FNMA collateralized
mortgage obligations 80,916 254 (2,551) 78,619
-------- -------- -------- --------
Total FNMA mortgage-
backed securities 86,434 271 (2,634) 84,071
Other collateralized
mortgage obligations 62,497 24 (2,126) 60,395
FHLMC stock 1,049 2,327 (20) 3,356
FNMA stock 303 72 (3) 372
FARMERMAC stock 10 27 -- 37
Miscellaneous equities -- 4 -- 4
-------- -------- -------- --------
$356,617 $ 3,565 $(11,835) $348,347
======== ======== ======== ========
Proceeds from sales of securities during the nine months ended December 31,
1999 were $5,829,000. Gross gains of $2,000 and gross losses of $0 were
realized on those sales.
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Note 4: SECURITIES AVAILABLE FOR SALE (continued)
March 31, 1999
---------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
U.S. Government and agency
obligations $ 56,477 $ 205 $ (164) $ 56,518
Municipal bonds:
Taxable 2,737 97 (1) 2,833
Tax exempt 30,994 1,338 (73) 32,259
Corporate bonds 24,729 117 (511) 24,335
Mortgage-backed securities:
FHLMC certificates 3,446 63 (7) 3,502
FHLMC collateralized
mortgage obligations 67,049 292 (269) 67,072
-------- -------- -------- --------
Total FHLMC mortgage-
backed securities 70,495 355 (276) 70,574
GNMA certificates 22,446 199 (137) 22,508
GNMA collateralized
mortgage obligations 1,507 -- (7) 1,500
-------- -------- -------- --------
Total GNMA mortgage-
backed securities 23,953 199 (144) 24,008
FNMA certificates 6,823 68 (50) 6,841
FNMA collateralized
mortgage obligations 82,339 139 (611) 81,867
-------- -------- -------- --------
Total FNMA mortgage-
backed securities 89,162 207 (661) 88,708
Other collateralized
mortgage obligations 59,631 188 (474) 59,345
FHLMC stock 49 2,971 -- 3,020
FNMA stock 303 81 -- 384
FARMERMAC stock 10 27 -- 37
-------- -------- -------- --------
$358,540 $ 5,785 $ (2,304) $362,021
======== ======== ======== ========
Proceeds from sales of securities during the year ended March 31, 1999 were
$2,637,000. Gross gains of $11,000 and gross losses of $0 were realized on
those sales.
At December 31, 1999 and March 31, 1999, the Company's investment portfolio
did not contain any securities of an issuer (other than the U.S. Government,
its agencies and U.S. Government sponsored enterprises) which had an aggregate
book value in excess of 10% of the Company's stockholders' equity at that
date.
The amortized cost and estimated fair value of securities available for sale
at December 31, 1999, by contractual maturity, are shown below (in thousands).
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties.
December 31, 1999
-----------------------
Amortized Estimated
cost fair value
---------- ----------
Due in one year or less $ 11,497 $ 11,491
Due after one year through five years 58,361 57,094
Due after five years through ten years 39,033 38,271
Due after ten years 246,364 237,722
-------- --------
355,255 344,578
Equity securities 1,362 3,769
-------- --------
$356,617 $348,347
======== ========
80
<PAGE>
Note 5: SECURITIES HELD TO MATURITY
The amortized cost and estimated fair value of securities held to maturity are
summarized as follows (in thousands):
December 31, 1999
---------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
Mortgage-backed securities
FHLMC certificates $ 1,196 $ -- $ (25) $ 1,171
Municipal bonds:
Tax exempt 1,613 11 (2) 1,622
Taxable 1,096 11 (10) 1,097
Corporate bonds 4,000 -- (10) 3,990
Asset-backed securities 5,865 -- (29) 5,836
-------- ------- -------- --------
$ 13,770 $ 22 $ (76) $ 13,716
======== ======= ======== ========
March 31, 1999
---------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
Municipal bonds tax exempt $ 1,991 $ 81 $ -- $ 2,072
Mortgage-backed securities-
FHLMC-REMICs 164 -- (1) 163
-------- ------- -------- --------
$ 2,155 $ 81 $ (1) $ 2,235
======== ======= ======== ========
The amortized cost and estimated fair value of securities held to maturity at
December 31, 1999, by contractual maturity, are shown below (in thousands):
December 31, 1999
-----------------------
Amortized Estimated
cost fair value
---------- ----------
Due in one year or less $ 125 $ 126
Due after one year through five years 7,909 7,880
Due after five years through ten years 439 436
Due after ten years 5,297 5,274
-------- --------
$ 13,770 $ 13,716
======== ========
Note 6: ADDITIONAL INFORMATION REGARDING COMPOSITION OF SECURITIES AND CASH
EQUIVALENT INTEREST INCOME
The following table sets forth the composition of income from securities and
deposits for the periods indicated (in thousands):
Nine Months
Ended December 31 Years Ended March 31
---------------------- ----------------------
1999 1998 1999 1998
-------- -------- -------- --------
(Unaudited)
Taxable interest income $ 4,409 $ 4,212 $ 6,069 $ 4,647
Tax-exempt interest income 1,517 1,491 1,967 2,031
Other stock dividend income 83 53 71 105
Federal Home Loan Bank stock
dividend income 1,286 1,110 1,545 1,147
-------- -------- -------- --------
Total securities and
cash equivalent
interest income $ 7,295 $ 6,866 $ 9,652 $ 7,930
======== ======== ======= ========
81
<PAGE>
Note 7: LOANS RECEIVABLE
Loans receivable at December 31 and March 31 are summarized as follows (in
thousands) (includes loans held for sale):
December 31 March 31
1999 1999
---------- ----------
One- to four-family real estate loans $ 436,679 $ 407,673
Commercial/multifamily real estate loans 399,992 324,858
Construction/land 263,093 217,094
Commercial business 195,566 149,943
Agricultural business 55,000 46,800
Consumer, credit card and other 61,580 44,346
---------- ----------
1,411,910 1,190,714
Loans in process (84,894) (71,638)
Deferred loan fees, discounts and premiums (5,311) (4,146)
---------- ----------
Net loans before allowance for loan losses 1,321,705 1,114,930
Allowance for loan losses (13,541) (12,261)
---------- ----------
Net loans $1,308,164 $1,102,669
========== ==========
Loans serviced for others totaled $273,926,000 and $268,756,000 at December
31, 1999 and March 31, 1999, respectively. Custodial accounts maintained in
connection with this servicing totaled $2,531,000 and $4,088,000 at December
31, 1999 and March 31, 1999, respectively.
The Banks' outstanding loan commitments totaled $166,921,000 and $147,122,000
at December 31, 1999 and March 31, 1999, respectively. In addition, the Banks
had outstanding commitments to sell loans of $2,647,000 at December 31, 1999.
The amount of impaired loans and the related allocated reserve for loan losses
were as follows (in thousands):
December 31 March 31
1999 1999
-------------------- --------------------
Loan Allocated Loan Allocated
amount reserves amount reserves
------ -------- ------ --------
Impaired loans:
Non-accrual $ 2,563 $ 117 $ 3,695 $ 739
Accrual 400 -- -- --
------- ------ ------- ------
$ 2,963 $ 117 $ 3,695 $ 739
======= ====== ======= ======
The average balance of impaired loans and the related interest income
recognized were as follows:
Nine Months Ended Years Ended March 31
December 31 --------------------
1999 1999 1998
---- ---- ----
Average balance of impaired loans $ 3,455 $ 622 $ --
Interest income recognized -- -- --
82
<PAGE>
The Banks originate both adjustable- and fixed-rate loans. At December 31,
1999, the maturity and repricing composition of those loans, less undisbursed
amounts and deferred fees, were as follows (in thousands):
Fixed-rate (term to maturity):
Due in one year or less $ 57,567
Due after one year through three years 73,114
Due after three years through five years 96,252
Due after five years through ten years 142,510
Due after ten years 357,699
----------
$ 727,142
==========
Adjustable-rate (term to rate adjustment):
Due in one year or less $ 465,029
Due after one year through three years 48,209
Due after three years through five years 69,150
Due after five years through ten years 10,723
Due after ten years 1,452
----------
$ 594,563
==========
The adjustable-rate loans have interest rate adjustment limitations and are
generally indexed to the Banks' internal cost of funds, the FHLB's National
Cost of Funds Index and 11th District Cost of Funds, One Year Constant
Maturity Treasury Index, or Prime Rate (The Wall Street Journal). Future
market factors may affect the correlation of the interest rate adjustment with
the rates the Banks pay on the short-term deposits that primarily have been
utilized to fund these loans.
Note 8: ALLOWANCE FOR LOAN LOSSES AND NON-PERFORMING LOANS
An analysis of the changes in the allowances for loan losses is as follows (in
thousands):
Nine Months
Ended December 31 Years Ended March 31
------------------- --------------------
1999 1998 1999 1998
---- ---- ---- ----
(Unaudited)
Balance, beginning of year $ 12,261 $ 7,857 $ 7,857 $ 6,748
Allowances added through business
combinations 477 1,616 2,693 --
Provision 1,885 2,210 2,841 1,628
Recoveries of loans previously
charged off:
Commercial/multifamily real
estate 1 60 60 6
Commercial business 450 134 143 27
Agricultural business 6 1 1 2
Consumer finance 8 8 15 14
Credit cards 3 3 6 2
-------- -------- -------- -------
468 206 225 51
Loans charged off:
One- to four-family real
estate loans (532) (25) (25) (359)
Commercial/multifamily real estate -- (5) (35) --
Construction/land (24) (59) (69) (11)
Commercial business (841) (897) (911) (19)
Agricultural business (19) (5) (5) --
Consumer finance (8) (50) (126) (89)
Credit cards (126) (130) (184) (92)
-------- -------- -------- -------
(1,550) (1,171) (1,355) (570)
-------- -------- -------- -------
Net charge offs (1,082) (965) (1,130) (519)
-------- -------- -------- -------
Balance, end of year $ 13,541 $ 10,718 $ 12,261 $ 7,857
======== ======== ======== =======
83
<PAGE>
The following is a schedule of the Company's allocation of the allowance for
loan losses (in thousands):
March 31
December 31 --------------------
1999 1999 1998
---- ---- ----
Specific or allocated loss allowances:
Secured by real estate:
One- to four-family real estate loans $ 2,334 $ 2,757 $ 1,059
Commercial/multifamily 4,273 3,567 849
Construction/land 1,638 1,597 856
Commercial/agricultural business 2,830 2,522 835
Consumer, credit card and other 1,023 841 307
--------- -------- --------
Total allocated 12,098 11,284 3,906
Unallocated 1,443 977 3,951
--------- -------- --------
Total allowance for loan losses $ 13,541 $ 12,261 $ 7,857
========= ======== ========
Ratio of allowance for loan losses to
non-performing loans 2.67 1.60 5.53
Allowance for loan losses as a percent
of net loans (loans receivable excluding
allowance for losses) 1.02% 1.10% 1.03%
The following is a schedule of the Company's non-performing loans (in
thousands):
March 31
December 31 --------------------
1999 1999 1998
---- ---- ----
Nonaccrual Loans:
One- to four-family real estate loans $ 623 $ 3,564 $ 448
Commercial/multifamily real estate 129 351 --
Construction/land 2,514 767 367
Commercial business 1,203 1,392 410
Agricultural business -- 47 4
Consumer, credit card and other 9 17 41
--------- -------- --------
4,478 6,138 1,270
Loans more than 90 days delinquent,
still on accrual:
One- to four-family real estate loans 155 20 52
Commercial/multifamily real estate -- 384 33
Construction/land -- -- 32
Commercial business 25 -- --
Agricultural business 334 1,052 --
Consumer, credit card and other 79 82 33
--------- -------- --------
593 1,538 150
--------- -------- --------
Total non-performing loans $ 5,071 $ 7,676 $ 1,420
========= ======== ========
Non-performing loans to net loans 0.38% 0.69% 0.19%
Loans are normally placed on nonaccrual status when interest is 90 days past
due; however, certain loans with third party guarantees from government
sponsored enterprises or readily accessible cash collateral may remain on an
accrual basis beyond 90 days past due.
84
<PAGE>
Note 9: PROPERTY AND EQUIPMENT
Land, buildings and equipment owned by the Company and its subsidiaries at
December 31, 1999 and March 31, 1999 are summarized as follows (in thousands):
December 31 March 31
1999 1999
----------- ---------
Buildings and leasehold improvements $ 16,524 $ 15,260
Furniture and equipment 13,709 12,249
----------- ---------
30,233 27,249
Less accumulated depreciation 15,927 13,820
----------- ---------
14,306 13,689
Land 2,331 2,271
----------- ---------
$ 16,637 $ 15,960
=========== =========
Note 10: DEPOSITS
Deposits consist of the following at December 31 and March 31, (in thousands):
December 31 March 31
1999 1999
----------- ---------
Demand, NOW and Money Market accounts, including
non-interest-bearing deposits in December 1999
and March 1999 of $114,252 and $97,062,
respectively, 0% to 6% $ 342,592 $ 311,686
Regular savings, 2% to 6% 53,305 59,133
Certificate accounts:
2.01% to 4% 2,339 6,292
4.01% to 6% 576,597 508,830
6.01% to 8% 102,625 63,617
8.01% to 10% 688 1,284
10.01% to 12% 6 6
----------- ---------
682,255 580,029
----------- ---------
$ 1,078,152 $ 950,848
=========== =========
Deposits at December 31 and March 31, 1999 include public funds of $72,943,000
and $48,383,000, respectively. Securities with a carrying value of
$13,711,000 and $9,956,000 were pledged as collateral on these deposits at
December 31 and March 31, 1999, respectively, which exceeds the minimum
collateral requirements established by state regulations.
85
<PAGE>
Scheduled maturities of certificate accounts at December 31 and March 31 are
as follows (in thousands):
December 31 March 31
1999 1999
---- ----
Due in one year or less $ 477,112 $ 405,306
Due after one year through two years 99,422 93,343
Due after two years through three years 69,956 38,721
Due after three years through four years 14,533 19,621
Due after four years through five years 12,349 13,490
Due after five years 8,883 9,548
--------- ---------
$ 682,255 $ 580,029
========= =========
Included in deposits are deposit accounts in excess of $100,000 of
$248,129,000 and $186,089,000 at December 31, 1999 and March 31, 1999,
respectively. Interest on deposit accounts in excess of $100,000 totaled
$8,786,000, for the nine months ended December 31, 1999 and $7,568,000 and
$3,901,000 for the years ended March 31, 1999 and 1998, respectively.
Deposit interest expense by type for the nine months ended December 31, 1999
and 1998 and the years ended March 31, 1999 and 1998 is as follows (in
thousands):
December 31 March 31
------------------ ------------------
1999 1998 1999 1998
---- ---- ---- ----
(Unaudited)
Certificates $ 25,105 $ 19,960 $ 27,407 $ 20,069
Demand, NOW and Money Market
accounts 5,034 3,793 5,256 3,972
Regular savings 1,336 940 1,356 1,248
-------- -------- -------- --------
$ 31,475 $ 24,693 $ 34,019 $ 25,289
======== ======== ======== ========
Note 11: ADVANCES FROM FEDERAL HOME LOAN BANK OF SEATTLE
The Banks have entered into borrowing arrangements with the FHLB to borrow
funds under a short-term cash management advance program and long-term loan
agreements. All borrowings are secured by stock of, and cash held by, the
FHLB. Additionally, mortgage loans receivable and securities issued, insured,
or guaranteed by the U.S. Government or agencies thereof are pledged as
security for the loans. At December 31, 1999, FHLB advances were scheduled to
mature as follows (in thousands):
Adjustable-rate Fixed-rate Total
advances advances advances
--------------- --------------- ----------------
Rate* Amount Rate* Amount Rate* Amount
----- ------ ----- ------ ----- ------
Due in one year or less 5.88% $ 15,100 5.68% $ 164,405 5.70% $ 179,505
Due after one year
through two years 6.56 1,000 5.99 102,280 5.99 103,280
Due after two years
through three years -- -- 5.96 102,470 5.96 102,470
Due after three years
through four years 6.12 7,000 5.64 42,820 5.70 49,820
Due after four years
through five years -- -- 6.58 10,000 6.58 10,000
Due after five years -- -- 6.12 21,449 6.12 21,449
-------- --------- ---------
5.98% $ 23,100 5.85% $ 443,424 5.86% $ 466,524
======== ========= =========
* Weighted average interest rate
The maximum and average outstanding balances and average interest rates on
advances from the FHLB were as follows for the nine months ended December 31,
1999 and the years ended March 31, 1999 and 1998 (in thousands):
December 31 March 31
----------- --------------------
1999 1999 1998
---- ---- ----
Maximum outstanding at any month end $ 466,524 $410,304 $299,377
Average outstanding 425,293 363,279 276,328
Weighted average interest rates:
Annual 5.78% 5.90% 6.07%
End of year 5.86 5.74 6.04
Interest expense during the year $ 18,505 $ 21,430 $ 16,782
86
<PAGE>
Note 12: OTHER BORROWINGS
Retail Repurchase Agreements and Other Short-Term Borrowings are included in
other borrowings. At December 31, 1999, retail repurchase agreements carry
interest rates ranging from 3.25% to 7.20%, payable at maturity, and are
secured by the pledge of certain FNMA, GNMA and FHLMC mortgage-backed
securities with a fair value of $12,561,000 as of December 31, 1999.
A summary of retail repurchase agreements and other short-term borrowings at
December 31, 1999 and March 31, 1999 by the period remaining to maturity is as
follows (in thousands):
December 31, 1999 March 31, 1999
----------------- -----------------
Weighted Weighted
average average
rate Balance rate Balance
---- ------- ---- -------
Retail repurchase agreements:
Due in one year or less 5.29% $ 7,356 4.90% $ 3,230
Due after two years through
three years -- -- 5.94 1,455
Due after three years through
four years 7.18 1,101 7.18 1,092
-------- --------
5.53% 8,457 5.59% 5,777
-------- --------
Other short-term borrowings:
Due in one year or less 4.67% 6,500 -- --
Total retail repurchase -------- --------
agreements and other
short-term borrowings $ 14,957 $ 5,777
======== ========
The maximum and average outstanding balances and average interest rates on
retail repurchase agreements were as follows for the nine months ended
December 31, 1999 and the years ended March 31, 1999 and 1998, respectively
(in thousands):
December 31 March 31
----------- --------------------
1999 1999 1998
---- ---- ----
Maximum outstanding at any month end $ 9,917 $ 17,300 $ 10,206
Average outstanding 8,698 10,404 6,934
Weighted average interest rates:
Annual 5.49% 5.61% 5.77%
End of year 5.53 5.59 5.78
Interest expense during the year $ 360 $ 584 $ 400
Wholesale Repurchase Agreements: The table below outlines the wholesale
repurchase agreements as of December 31, 1999 and March 31, 1999. The
agreements to repurchase are secured by mortgage-backed securities with a fair
value of $70,317,000 at December 31, 1999. The broker holds the security
while FSBW continues to receive the principal and interest payments from the
security. Upon maturity of the agreement the pledged securities will be
returned to FSBW.
A summary of wholesale repurchase agreements at December 31, 1999 and March
31, 1999 by the period remaining to maturity is as follows (in thousands):
December 31, 1999 March 31, 1999
----------------- -----------------
Weighted Weighted
average average
rate Balance rate Balance
---- ------- ---- -------
Due in one year or less 6.02% $ 66,698 5.20% $ 72,690
87
<PAGE>
The maximum and average outstanding balances and average interest rates on
wholesale repurchase agreements were as follows for the nine months ended
December 31, 1999 and the years ended March 31, 1999 and 1998 (in thousands):
March 31
December 31 --------------------
1999 1999 1998
---- ---- ----
Maximum outstanding at any month end $ 71,099 $ 85,430 $ 85,430
Average outstanding 68,982 78,563 72,276
Weighted average interest rates:
Annual 5.50% 5.61% 5.78%
End of year 6.02 5.20 5.65
Interest expense during the year $ 2,861 $ 4,409 $ 4,180
Note 13: INCOME TAXES
Tax law requires that the Company recapture, for federal income tax purposes,
certain of its tax basis bad debt reserves. Such recaptured amounts are being
taken into ordinary income ratably over a four- to six-year period beginning
in fiscal 1998. The Company is recapturing its post-1987 additions to its tax
basis bad debt reserves, which totaled $1.9 million at December 31, 1999,
ratably over a four- to six-taxable-year period, resulting in approximately
$169,000 a year in federal income taxes for the nine months ended December 31,
1999 (based upon current federal income tax rates). This will not result in a
charge to earnings as these amounts have been previously provided for in the
deferred tax liability at December 31, 1999.
Retained earnings at December 31, 1999 include $5,318,000 of earnings which
represent pre-1987 federal income tax basis bad debt reserve deductions taken
by FSBW, for which no provisions for federal income taxes have been made. If
the accumulated amount that qualified as deductions for federal income taxes
is later used for purposes other than to absorb bad debt losses or FSBW no
longer qualifies as a bank, the accumulated reserve will be subject to federal
income tax at the then current tax rates which would equate to approximately
$1,861,000 of additional taxes.
The provision for income taxes for the nine-month period ended December 31,
1999 and fiscal years ended March 31, 1999 and 1998 differs from that computed
at the statutory corporate tax rate as follows (in thousands):
March 31
December 31 --------------------
1999 1999 1998
---- ---- ----
Taxes at statutory rate $ 7,329 $ 8,651 $ 7,199
Increase (decrease) in taxes:
Tax-exempt interest (463) (597) (620)
Amortization of costs in
excess of net assets acquired 817 822 315
Difference in fair market value
versus basis of released ESOP
shares 32 34 328
State income taxes net of
federal tax benefit 229 279 271
Other 126 88 (47)
--------- -------- -------
$ 8,070 $ 9,277 $ 7,446
========= ======== =======
The provision for income tax expense for the nine months ended December 31,
1999 and the fiscal years ended March 31, 1999 and 1998 is composed of the
following (in thousands):
March 31
December 31 --------------------
1999 1999 1998
---- ---- ----
Current $ 8,346 $ 9,696 $ 7,303
Deferred (276) (296) 34
Change in valuation allowance -- (123) 109
--------- -------- --------
$ 8,070 $ 9,277 $ 7,446
========= ======== ========
88
<PAGE>
Income taxes are provided for the temporary differences between the tax basis
and financial statement carrying amounts of assets and liabilities.
Components of the Company's net deferred tax assets (liabilities) at December
31, 1999 and March 31, 1999 consisted of the following (in thousands):
December 31 March 31
1999 1999
---- ----
Deferred tax assets:
Loan loss reserves per books $ 4,835 $ 4,226
Deferred compensation and vacation 1,740 1,704
Other 119 221
--------- --------
6,694 6,151
--------- --------
Deferred tax liabilities:
Change in method of accounting for
amortization of premium and discount
on investments 84 116
Tax basis bad debt reserves to be recovered 659 606
FHLB stock dividends 2,418 2,342
Depreciation 762 695
Deferred loan fees and servicing rights 336 403
Other 23 34
--------- --------
1,619 1,167
4,282 4,196
--------- --------
2,412 1,955
Valuation allowance (13) (13)
--------- --------
2,399 1,942
Income (taxes) benefit related to unrealized
gain/loss on securities available for sale 2,939 (1,184)
--------- --------
Deferred tax asset (liability), net $ 5,338 $ 758
========= ========
89
<PAGE>
Note 14: EMPLOYEE BENEFIT PLANS
The Banks have their own profit sharing plans for all eligible employees. The
plans are funded annually at the discretion of the individual Banks' Boards of
Directors. Contributions charged to operations for the nine months ended
December 31, 1999 and the years ended March 31, 1999 and 1998 were none,
$5,500 and $269,000, respectively.
FSBW has entered into a salary continuation agreement with certain of its
senior management. This program was funded by purchasing single premium life
insurance contracts. The program provides for aggregate continued annual
compensation for all participants totaling $240,000 for life with a 15-year
guarantee. Participants vest ratably each plan year until retirement,
termination, death or disability. FSBW is recording the salary obligation
over the estimated remaining service lives of the participants. Expenses
related to this program for the nine months ended December 31, 1999 were
$162,300 and $139,000 and $129,000 for the years ended March 31, 1999 and
1998, respectively. The plan's projected benefit obligation is $2,031,000, of
which $756,000 was vested at December 31, 1999. The assumed discount rate was
7.00% for the nine months ended December 31, and 8.00% for the years ended
March 31, 1999 and 1998. At December 31, 1999, an obligation of $806,800 and
cash value of life insurance of $2,331,800 were recorded. At March 31, 1999,
an obligation of $643,400 and cash value of life insurance of $2,252,000 were
recorded. Increases in cash surrender value and related net earnings from the
life insurance contracts partially offset the expenses of this program
resulting in a net cost of $82,700 for the nine months ended December 31, 1999
and $31,000 and $21,000 for the years ended March 31, 1999 and 1998,
respectively.
IEB also has a non-qualified, non-contributory retirement compensation plan
for certain bank employees whose benefits are based upon a percentage of
defined participant compensation. Expenses related to this plan included in
the nine months ended December 31, 1999 and fiscal years ended March 31, 1999
and 1998 operations were $79,000, $54,000 and $27,000, respectively.
The Company and its subsidiaries also offer non-qualified deferred
compensation plans to members of their Boards of Directors and certain bank
employees. The plans permit each participant to defer a portion of director
fees, non-qualified retirement contributions, salary or bonuses until the
future. Compensation is charged to expense in the period earned. In order to
fund the plans' future obligations' the Company has purchased life insurance
polices, contributed to money market investments and purchased common stock of
the Company. As described in Note 1, during the year ended March 31, 1999,
the Company adopted the EITF consensus requiring the Company's stock held in
the Rabbi Trust and resulting obligation be recorded at acquisition cost (fair
value at time of purchase). In addition, the obligation relating to the
purchased shares was reclassified from liabilities to stockholders' equity.
As the Company is the owner of the investments and beneficiary of life
insurance contracts, and in order to reflect the Company's policy to pay
benefits equal to accumulations, the assets and liabilities under the plans
are reflected in the consolidated balance sheets of the Company. Common stock
of the Company held for such plans is reported as a contra-equity account and
was recorded at original cost of $2,333,000 at December 31, 1999 and
$2,150,000 at March 31, 1999. Prior to adoption of the EITF consensus, common
stock of the Company held for such plans was recorded at fair value of
$2,449,000 at March 31, 1998. The money market investments and cash surrender
value of the life insurance policies are included in other assets.
Note 15: EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST
The Company established for eligible employees an ESOP and related trust that
became effective upon the former mutual holding company's conversion to a
stock-based holding company. Eligible employees of FSBW as of January 1, 1995
and eligible employees of the Company employed after such date who have been
credited with at least 1,000 hours during a 12-month period will become
participants.
The ESOP borrowed $8,728,500 from the Company in order to purchase the common
stock. The loan will be repaid principally from the Company's contributions
to the ESOP over a period not to exceed twenty five years, and the collateral
for the loan will be the unreleased, restricted common stock purchased by the
ESOP. Contributions to the ESOP will be discretionary; however, the Company
intends to make annual contributions to the ESOP in an aggregate amount at
least equal to the principal and interest requirements of the debt. The
interest rate for the loan is 8.75%.
90
<PAGE>
Participants generally become 100% vested in their ESOP account after seven
years of credited service or if their service was terminated due to death,
early retirement, permanent disability or a change in control. Prior to the
completion of one year of credited service, a participant who terminates
employment for reasons other than death, retirement, disability, or change in
control of the Company will not receive any benefit. Forfeitures will be
reallocated among remaining participating employees in the same proportion as
contributions. Benefits are payable upon death, retirement, early retirement,
disability or separation from service. The contributions to the ESOP are not
fixed, so benefits payable under the ESOP cannot be estimated. ESOP
compensation expense for the nine months ended December 31, 1999 was $974,000,
and for the years ended March 31, 1999 and 1998 was $924,000 and $1,427,000,
respectively.
As of December 31, 1999, the Company has 677,846 unearned, restricted shares
remaining to be released to the ESOP. The fair value of unearned, restricted
shares held by the ESOP trust was $9,998,000 at December 31, 1999.
Note 16: STOCK BASED COMPENSATION PLANS AND STOCK OPTIONS
The Company operates the following stock based compensation plans as approved
by the shareholders: the 1996 Management Recognition and Development Plan
(MRP), the 1996 Stock Option Plan and 1998 Stock Option Plan (together, SOPs).
Under the MRP, the Company is authorized to grant up to 480,068 shares of
restricted stock to directors, officers and employees of FSBW. The initial
grant of 444,710 shares with a total cost of $6.0 million vests over a
five-year period starting from the July 26, 1996, MRP approval date. The
consolidated statements of income for the nine months ended December 31, 1999
and the years ended March 31, 1999 and 1998 reflect an accrual of $1,045,000,
$1,307,000 and $1,308,000, respectively, in compensation expense for the MRP
including $71,000, $113,900 and $95,800, respectively, of expense for
dividends on the allocated, restricted stock. A summary of the changes in the
granted, but not vested, MRP shares for the nine months ended December 31,
1999 and the years ended March 31, 1999 and 1998 follows:
Nine Months Ended Years Ended
December 31 March 31
----------------- -------------------
1999 1999* 1998*
---- ---- ----
Shares granted not vested, beginning
of period 261,594 352,228 444,270
Shares granted 2,750 -- --
Shares vested (97,072) (88,258) (89,666)
Shares forfeited (429) (2,376) (2,376)
------- ------- -------
Shares granted not vested, end of period 166,843 261,594 352,228
======= ======= =======
* Adjusted for stock dividend: see Note 2
Under the 1996 and 1998 SOPs, the Company has reserved 1,640,169 shares
(adjusted for 10% stock dividend) for issuance pursuant to the exercise of
stock options which may be granted to directors and employees. The exercise
price of the stock options is set at 100% of the fair market value of the
stock price at date of grant. Such options will vest ratably over a five-year
period and any unexercised options will expire ten years after vesting or 90
days after employment or service ends.
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Note 16: STOCK BASED COMPENSATION (continued)
Details of stock options granted, vested, exercised, forfeited or terminated
are as follows (adjusted for 10% stock dividend):
Weighted
average Weighted
fair value average Number of option shares
at date exercise ---------------------------------
of grant price Total Granted Exercisable
-------- ----- ----- ------- -----------
For the year ended
March 31, 1998: *
Beginning balance 1,004,789 1,004,789 --
Options granted $ 9.34 $ 21.43 19,800 19,800 --
Options vested -- (201,947) 201,947
Options forfeited 14.39 (5,170) (5,170) --
Options exercised 13.86 (3,295) -- (3,295)
Options terminated -- -- --
--------- --------- -------
Number of option shares
at March 31, 1998 $ 13.83 1,016,124 817,472 198,652
--------- --------- -------
For the year ended
March 31, 1999: *
Options granted $ 9.88 $ 23.89 277,112 277,112 --
Options assumed in
acquisitions 15.64 6.26 162,810 -- 162,810
Options vested -- (204,368) 204,368
Options forfeited 13.52 (2,817) (2,817) --
Options exercised 7.67 (25,855) -- (25,855)
Options terminated -- -- --
--------- --------- -------
Number of option shares
at March 31, 1999 $ 15.05 1,427,374 887,399 539,975
--------- --------- -------
For the nine months ended
December 31, 1999:
Options granted $ 5.83 $ 15.63 192,239 192,239 --
Options vested -- (262,172) 262,172
Options forfeited 18.96 (16,477) (16,477) --
Options exercised 9.26 (8,755) -- (8,755)
Options terminated -- -- --
--------- --------- -------
Number of option shares
at December 31, 1999 $ 15.13 1,594,381 800,989 793,392
========= ========= =======
* Adjusted for stock dividend: see Note 2
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Note 16: STOCK BASED COMPENSATION (continued)
Financial data pertaining to outstanding stock options granted at December 31,
1999 were as follows:
Weighted Weighted
average Number average
exercise Number of exercise
price of of option price Weighted
option option shares of option remaining
Exercise shares shares vested and shares contractual
price granted granted exercisable exercisable life
- ---------------- ------- -------- ----------- ----------- -----------
$ 1.30 to 4.68 $ 4.09 50,518 50,518 $ 4.09 8.4 yrs
5.66 to 8.83 6.04 53,761 53,761 6.04 8.3 yrs
11.56 to 13.97 13.51 962,055 604,997 13.47 8.4 yrs
15.06 to 19.75 15.55 240,159 31,680 15.73 8.7 yrs
22.10 to 24.25 23.82 287,888 52,436 23.66 9.4 yrs
--------- -------
1,594,381 793,392
========= =======
SFAS No. 123, Accounting for Stock-based Compensation. requires expanded
disclosures of stock-based compensation arrangements with employees and
encourages (but does not require) application of the fair value recognition
provisions in the statement. Companies may continue following those rules to
recognize and measure compensation as outlined in Accounting Principles Board
(APB) Opinion No. 25, Accounting for Stock Issued to Employees, but they are
now required to disclose the pro forma amounts of net income and earnings per
share that would have been reported had the company elected to follow the fair
value recognition provisions of SFAS No. 123. The Company continues to
measure its employee stock-based compensation arrangements under the
provisions of APB Opinion No. 25. Accordingly, no compensation cost has been
recognized for its stock option plans. If the compensation cost for the
Company's compensation plans been determined consistent with SFAS No. 123, the
Company's net income available to diluted common stock and diluted earnings
per share would have been reduced to the pro forma amounts indicated below:
Nine Months
Ended December 31 Years Ended March 31
----------------- --------------------
1999 1999 1998
---- ---- ----
(dollars in thousands,
except per share amounts)
Net income attributable to common stock:
Basic:
As reported $ 12,869 $ 15,440 $ 13,122
Pro forma 11,891 14,113 12,088
Diluted:
As reported $ 12,869 $ 15,440 $ 13,122
Pro forma 11,891 14,113 12,088
Net income per common share:
Basic:
As reported $ 1.23 $ 1.46 $ 1.30
Pro forma 1.14 1.34 1.19
Diluted:
As reported $ 1.19 $ 1.40 $ 1.25
Pro forma 1.10 1.28 1.15
The compensation expense included in the pro forma net income attributable to
diluted common stock and diluted earnings per share is not likely to be
representative of the effect on reported net income for future years because
options vest over several years and additional awards generally are made each
year.
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<PAGE>
The fair value of options granted under the Company's stock option plans is
estimated on the date of grant using the Black-Scholes options-pricing model
with the following weighted average assumptions used for grants in the nine
months ended December 31, 1999: annual dividend yield of 2.75%, expected
volatility of 30.8% to 38.5%, risk-free interest rates of 5.51% to 6.57% and
expected lives of 8.5 to 12.5 years.
Note 17: REGULATORY CAPITAL REQUIREMENTS
The Company is a bank holding company registered with the Federal Reserve.
Bank holding companies are subject to capital adequacy requirements of the
Federal Reserve under the Bank Holding Company Act of 1956, as amended (BHCA),
and the regulations of the Federal Reserve. Each of the Banks as
state-chartered federally insured institutions is subject to the capital
requirements established by the FDIC.
The capital adequacy requirements are quantitative measures established by
regulation that require the Company, FSBW, IEB and TB to maintain minimum
amounts and ratios of capital. The Federal Reserve requires the Company to
maintain capital adequacy that generally parallels the FDIC requirements. The
FDIC requires the Banks to maintain minimum ratios of total capital and Tier 1
capital to risk-weighted assets as well as Tier 1 leverage capital to average
assets.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)
created a statutory framework that increased the importance of meeting
applicable capital requirements. For FSBW, IEB and TB, FDICIA established
five capital categories: well-capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized. An institution's category depends upon where its capital
levels are in relation to relevant capital measures, which include a risk-
based capital measure, a leverage ratio capital measure, and certain other
factors. The federal banking agencies (including the FDIC) have adopted
regulations that implement this statutory framework. Under these regulations,
an institution is treated as well-capitalized if its ratio of total capital to
risk-weighted assets is 10.00% or more, its ratio of core capital to risk-
weighted assets is 6.00% or more, its ratio of core capital to adjusted total
assets is 5.00% or more and it is not subject to any federal supervisory order
or directive to meet a specific capital level. In order to be adequately
capitalized, an institution must have a total risk-based capital ratio of not
less than 8.00%, a Tier 1 risk-based capital ratio of not less than 4.00%, and
leverage ratio of not less that 4.00%. Any institution which is neither well-
capitalized nor adequately capitalized will be considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective action
requirements, regulatory controls and restrictions which become more extensive
as an institution becomes more severely undercapitalized. Failure by the
Banks, individually, to comply with applicable capital requirements would, if
unremedied, result in restrictions on their activities and lead to enforcement
actions against FSBW, IEB or TB by the FDIC, including, but not limited to,
the issuance of a capital directive to ensure the maintenance of required
capital levels. FDICIA requires the federal banking regulators to take
prompt corrective action with respect to depository institutions that do not
meet minimum capital requirements. Additionally, FDIC approval of any
regulatory application filed for its review may be dependent on compliance
with capital requirements.
Federal law requires that the federal banking agencies' risk-based capital
guidelines take into account various factors including interest rate risk,
concentration of credit risk, risks associated with nontraditional activities,
and the actual performance and expected risk of loss of multifamily mortgages.
In 1994, the federal banking agencies jointly revised their capital standards
to specify that concentration of credit and nontraditional activities are
among the factors that the agencies will consider in evaluating capital
adequacy. In that year, the FDIC amended its risk-based capital standards
with respect to the risk weighting of loans made to finance the purchase or
construction of multifamily residences. Management believes that the effect
of including such an interest rate risk component in the calculation of
risk-adjusted capital will not cause the Company and the Banks to cease to be
well-capitalized. In June 1996, the FDIC and certain other federal banking
agencies issued a joint policy statement providing guidance on prudent
interest rate risk management principles. The agencies stated that they would
determine banks' interest rate risk on a case-by-case basis, and would not
adopt a standardized measure or establish an explicit minimum capital charge
for interest rate risk.
The Company may not declare or pay cash dividends on, or repurchase, any of
its shares of common stock if the effect thereof would cause equity to be
reduced below applicable regulatory capital maintenance requirements or if
such declaration and payment would otherwise violate regulatory requirements.
94
<PAGE>
Note 17: REGULATORY CAPITAL REQUIREMENTS (continued)
The actual regulatory capital ratios calculated for the Company and the Banks,
along with the minimum capital amounts and ratios for capital adequacy
purposes and to be categorized as well-capitalized under the regulatory
framework for prompt corrective action were as follows:
Minimum to be
categorized
as "well-
Minimum capitalized"
for capital under prompt
adequacy corrective action
Actual purposes provisions
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(dollars in thousands)
December 31, 1999:
The Company consolidated
Total capital to risk-
weighted assets $ 160,152 12.79% $ 100,163 8.00% N/A N/A
Tier 1 capital to risk-
weighted assets 146,612 11.71 50,082 4.00 N/A N/A
Tier 1 leverage capital
to average assets 146,612 8.39 69,886 4.00 N/A N/A
FSBW
Total capital to risk-
weighted asset s 107,294 13.27 64,704 8.00 $ 80,879 10.00%
Tier 1 capital to risk-
weighted assets 98,465 12.17 32,352 4.00 48,528 6.00
Tier 1 leverage capital
to average assets 98,465 7.74 50,907 4.00 63,633 5.00
IEB
Total capital to risk-
weighted assets 22,237 13.16 13,516 8.00 16,895 10.00
Tier 1 capital to risk-
weighted assets 20,485 12.13 6,758 4.00 10,137 6.00
Tier 1 leverage capital
to average assets 20,485 9.96 8,228 4.00 10,285 5.00
TB
Total capital to risk-
weighted assets 27,034 9.86 21,941 8.00 27,426 10.00
Tier 1 capital to risk-
weighted assets 24,075 8.78 10,970 4.00 16,456 6.00
Tier 1 leverage capital
to average assets 24,075 8.91 10,812 4.00 13,515 5.00
95
<PAGE>
Note 17: REGULATORY CAPITAL REQUIREMENTS (continued)
Minimum to be
categorized
as "well-
Minimum capitalized"
for capital under prompt
adequacy corrective action
Actual purposes provisions
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(dollars in thousands)
March 31, 1999:
The Company consolidated
Total capital to risk-
weighted assets $ 159,221 15.15% $ 84,063 8.00% N/A N/A
Tier 1 capital to risk-
weighted assets 146,961 13.99 42,032 4.00 N/A N/A
Tier 1 leverage capital
to average assets 146,961 9.44 62,274 4.00 N/A N/A
FSBW
Total capital to risk-
weighted assets 118,576 17.01 55,773 8.00 $ 69,716 10.00%
Tier 1 capital to risk-
weighted assets 110,161 15.80 27,886 4.00 41,829 6.00
Tier 1 leverage capital
to average assets 110,161 9.41 46,817 4.00 58,521 5.00
IEB
Total capital to risk-
weighted assets 20,165 12.69 12,714 8.00 15,893 10.00
Tier 1 capital to risk-
weighted assets 18,521 11.65 6,357 4.00 9,536 6.00
Tier 1 leverage capital
to average assets 18,521 9.60 7,717 4.00 9,647 5.00
TB
Total capital to risk-
weighted assets 19,450 10.03 15,510 8.00 19,387 10.00
Tier 1 capital to risk-
weighted assets 17,249 8.90 7,755 4.00 11,632 6.00
Tier 1 leverage capital
to average assets 17,249 8.87 7,779 4.00 9,723 5.00
Company management believes that as of December 31, 1999, the Company, FSBW,
IEB and TB individually met all capital adequacy requirements to which they
were subject. There have been no conditions or events since the end of the
period that management believes have changed any Bank's individual category.
The most recent notifications from the FDIC as of December 31, 1999,
individually categorized the Banks as "well-capitalized" under the regulatory
framework for prompt corrective action. To be categorized as "well-
capitalized," a bank must maintain minimum total risk-based, Tier 1 risk-
based, and Tier 1 leverage ratios as set forth in the table above.
96
<PAGE>
Note 18: CONTINGENCIES
In the normal course of business, the Company and/or its subsidiaries have
various legal claims and other contingent matters outstanding. The Company
believes that any liability ultimately arising from these actions would not
have a material adverse effect on the results of operations or consolidated
financial position at December 31, 1999.
Note 19: INTEREST RATE RISK
The financial condition and operation of the Company are influenced
significantly by general economic conditions, including the absolute level of
interest rates as well as changes in interest rates and the slope of the yield
curve. The Company's profitability is dependent to a large extent on its net
interest income, which is the difference between the interest received from
its interest-earning assets and the interest expense incurred on its interest-
bearing liabilities.
The activities of the Company, like all financial institutions, inherently
involve the assumption of interest rate risk. Interest rate risk is the risk
that changes in market interest rates will have an adverse impact on the
institution's earnings and underlying economic value. Interest rate risk is
determined by the maturity and repricing characteristics of an institution's
assets, liabilities, and off-balance-sheet contracts. Interest rate risk is
measured by the variability of financial performance and economic value
resulting from changes in interest rates. Interest rate risk is the primary
market risk impacting the Company's financial performance.
The greatest source of interest rate risk to the Company results from the
mismatch of maturities or repricing intervals for rate-sensitive assets,
liabilities and off-balance-sheet contracts. This mismatch or gap is
generally characterized by a substantially shorter maturity structure for
interest-bearing liabilities than interest-earning assets. Additional
interest rate risk results from mismatched repricing indices and formulae
(basis risk and yield curve risk), product caps and floors, and early
repayment or withdrawal provisions (option risk), which may be contractual or
market driven, that are generally more favorable to customers than to the
Company.
The Company's primary monitoring tool for assessing interest rate risk is
"asset/liability simulation modeling," which is designed to capture the
dynamics of balance sheet, interest rate and spread movements, and to quantify
variations in net interest income and net market value resulting from those
movements under different rate environments. Another monitoring tool used by
the Company to assess interest rate risk is "gap analysis." The matching of
repricing characteristics of assets and liabilities may be analyzed by
examining the extent to which such assets and liabilities are "interest
sensitive" and by monitoring the Company's interest sensitivity "gap."
Management is aware of the sources of interest rate risk and in its opinion
actively monitors and manages it to the extent possible, and considers that
the Company's current level of interest rate risk is reasonable.
Note 20: GOODWILL
Costs in excess of net assets acquired (goodwill) consisted of the following
(in thousands):
December 31 March 31
1999 1999
----------- ---------
Acquisitions of IEB, TB, WSB and SCB, net
of accumulated amortization of $6,244,000
and $3,880,000, respectively $ 37,733 $ 34,182
=========== =========
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<PAGE>
Note 21: FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments
is made in accordance with the requirements of SFAS No. 107, Disclosures About
Fair Value of Financial Instruments. The estimated fair value amounts have
been determined by the Company using available market information and
appropriate valuation methodologies. However, considerable judgment is
necessary to interpret market data in the development of the estimates of fair
value. Accordingly, the estimates presented herein are not necessarily
indicative of the amounts the Company could realize in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
The estimated fair value of financial instruments is as follows (in
thousands):
December 31, 1999 March 31,1999
----------------------- -----------------------
Carrying Estimated Carrying Estimated
value fair value value fair value
----------- ---------- ---------- ----------
Assets:
Cash $ 44,769 $ 44,769 $ 72,503 $ 72,503
Securities available for
sale 348,347 348,347 362,021 362,021
Securities held to maturity 13,770 13,716 2,155 2,235
Loans receivable held for
sale 9,519 9,519 11,256 11,256
Loans receivable 1,298,645 1,274,360 1,091,413 1,098,161
FHLB stock 24,543 24,543 23,137 23,137
Mortgage servicing rights 1,584 1,776 1,671 1,853
Liabilities:
Demand, NOW and Money
Market accounts 342,952 342,952 311,686 311,686
Regular savings 53,305 53,305 59,133 59,133
Certificates of deposit 682,255 679,706 580,029 583,084
FHLB advances 466,524 455,868 408,252 407,553
Other borrowings 81,655 81,636 78,467 78,503
Off-balance-sheet financial
instruments:
Commitments to sell loans $ -- $ -- $ -- $ --
Commitments to originate
loans -- -- -- --
Commitments to purchase
securities -- -- -- --
Commitments to sell
securities -- -- -- --
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<PAGE>
Fair value estimates, methods, and assumptions are set forth below for the
Company's financial and off-balance-sheet instruments:
Cash: The carrying amount of these items is a reasonable estimate of their
fair value.
Securities: The estimated fair values of investment securities and mortgaged-
backed securities available for sale and held to maturity are based on quoted
market prices or dealer quotes.
Loans Receivable: Fair values are estimated for portfolios of loans with
similar financial characteristics. Loans are segregated by type such as
multifamily real estate, residential mortgage, nonresidential, commercial/
agricultural, consumer and other. Each loan category is further segmented
into fixed- and adjustable-rate interest terms and by performing and
non-performing categories.
The fair value of performing residential mortgages held for sale is estimated
based upon secondary market sources by type of loan and terms such as fixed or
variable interest rates. For performing loans held in portfolio, the fair
value is based on discounted cash flows using as a discount rate the current
rate offered on similar products.
Fair value for significant non-performing loans is based on recent appraisals
or estimated cash flows discounted using rates commensurate with risk
associated with the estimated cash flows. Assumptions regarding credit risk,
cash flows, and discount rates are judgmentally determined using available
market information and specific borrower information.
FHLB Stock: The fair value is based upon the redemption value of the stock
which equates to its carrying value.
Deposit Liabilities: The fair value of deposits with no stated maturity, such
as savings, checking and NOW accounts, is equal to the amount payable on
demand. The market value of certificates of deposit is based upon the
discounted value of contractual cash flows. The discount rate is determined
using the rates currently offered on comparable instruments.
FHLB Advances and Other Borrowings: The fair value of FHLB advances and other
borrowings is estimated based on discounting the estimated future cash flows
using rates currently available to the Company for debt with similar remaining
maturities.
Commitments: Commitments to sell loans with a notional balance of $2,647,000
and $3,791,000 at December 31, 1999 and March 31, 1999, respectively, have a
carrying value of zero, representing the cost of such commitments.
Commitments to originate loans, $166,921,000 and $147,122,000 at December 31,
1999 and March 31, 1999, respectively, also have a carrying value of zero.
There were no commitments to purchase or sell securities at December 31, 1999.
The fair value of such commitments is also estimated to be zero based upon
current market rates for similar loans and any fees received to enter into
similar agreements.
Limitations: The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 1999. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since that date and,
therefore, current estimates of fair value may differ significantly from the
amounts presented herein.
Fair value estimates are based on existing on- and off-balance-sheet financial
instruments without attempting to estimate the value of anticipated future
business. The fair value has not been estimated for assets and liabilities
that are not considered financial instruments. Significant assets and
liabilities that are not financial instruments include the deferred tax
assets/liabilities; land, buildings and equipment; costs in excess of net
assets acquired; and real estate held for sale.
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<PAGE>
Note 22: FIRST WASHINGTON BANCORP, INC. (FWWB)
(PARENT COMPANY ONLY)
Summary financial information as of December 31, 1999 and March 31, 1999 is as
follows (in thousands):
FWWB
Balance Sheets
December 31, 1999 and March 31, 1999 December 31 March 31
1999 1999
---- ----
ASSETS
Cash $ 2,446 $ 110
Investment in subsidiaries 175,586 182,578
Deferred tax asset 405 273
Other assets 2,556 2,376
---------- -----------
$ 180,993 $ 185,337
========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities $ 1,820 $ 1,730
Stockholders' equity 179,173 183,607
---------- -----------
$ 180,993 $ 185,337
========== ===========
FWWB
Statements of Income
For the nine months ended December 31, 1999 and 1998 and the years ended March
31, 1999 and 1998
Nine Months Years Ended
Ended December 31 March 31
-------------------- -------------------
1999 1998 1999 1998
---- ---- ---- ----
(Unaudited)
INTEREST INCOME:
Certificates and time deposits $ 81 $ 44 $ 56 $ 107
Investments -- 361 401 553
ESOP loan -- 325 325 678
-------- -------- -------- --------
81 730 782 1,338
OTHER INCOME:
Equity in undistributed income
of subsidiaries 13,679 11,742 16,010 13,201
Miscellaneous -- -- -- --
-------- -------- -------- --------
13,760 12,472 16,792 14,539
OTHER EXPENSE 1,331 1,233 1,653 1,460
-------- -------- -------- --------
12,429 11,239 15,139 13,079
PROVISION FOR (BENEFIT FROM)
INCOME TAXES (440) (172) (301) (43)
-------- -------- -------- --------
NET INCOME $ 12,869 $ 11,411 $ 15,440 $ 13,122
======== ======== ======== ========
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<PAGE>
FWWB
Statements of Cash Flows
For the nine months ended December 31, 1999 and 1998 and the years ended March
31, 1999 and 1998
Nine Months Years Ended
Ended December 31 March 31
-------------------- -------------------
1999 1998 1999 1998
---- ---- ---- ----
OPERATING ACTIVITIES: (Unaudited)
Net income $ 12,869 $ 11,411 $ 15,440 $ 13,122
Adjustments to reconcile net
income to net cash provided
by operating activities:
Equity in undistributed
earnings of subsidiaries (13,679) (11,742) (16,010) (13,201)
Net amortization of
investment discounts -- (354) (394) (553)
Amortization of MRP liability 339 254 339 339
(Increase) decrease in
deferred taxes (67) -- -- 101
(Increase) decrease in other
assets 52 (1) 44 (327)
Increase (decrease) in other
liabilities 147 414 (123) 22
Net cash provided (used) by -------- -------- -------- --------
operating activities (339) (18) (704) (497)
-------- -------- -------- --------
INVESTING ACTIVITIES:
Purchase of securities
available for sale -- (120,864) (136,831) (164,686)
Principal repayments and
maturities of securities
available for sale -- 128,200 149,200 167,290
Funds transferred to deferred
compensation trust (66) (60) (80) (80)
Acquisitions of subsidiaries -- (7,752) (7,824) --
Dividends received from
subsidiaries 18,041 5,209 6,914 26,545
Payments received on loan to
ESOP for release of shares 1,305 633 633 542
Additional investment in
subsidiaries (4,494) (2,658) (5,730) (216)
Net cash provided (used) by -------- -------- -------- --------
investing activities 14,786 2,708 6,282 29,395
-------- -------- -------- --------
FINANCING ACTIVITIES:
Repurchases of stock (8,568) (11,345) (15,266) (13,993)
Repurchase of forfeited MRP
shares -- (6) (32) (38)
Net proceeds from exercise of
stock options 166 129 250 --
Cash dividends paid (3,709) (2,611) (3,597) (2,583)
Net cash provided (used) by -------- -------- -------- --------
financing activities (12,111) (13,833) (18,645) (16,614)
-------- -------- -------- --------
NET INCREASE (DECREASE) IN CASH 2,336 (11,143) (13,067) 12,284
CASH, BEGINNING OF PERIOD 110 13,177 13,177 893
-------- -------- -------- --------
CASH, END OF PERIOD $ 2,446 $ 2,034 $ 110 $ 13,177
======== ======== ======== ========
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FWWB
Statements of Cash Flows
For the nine months ended December 31, 1999 and 1998 and the years ended March
31, 1999 and 1998 (continued)
Nine Months Years Ended
Ended December 31 March 31
-------------------- -------------------
1999 1998 1999 1998
---- ---- ---- ----
(Unaudited)
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Interest paid $ -- $ -- $ -- $ --
Taxes paid $ -- $ -- $ -- $ 16
Non-cash transactions:
Net change in accrued
dividends payable $ 52 $ 119 $ 477 $ 149
Increase of investment in
subsidiary for shares
released to ESOP
participants as
compensation $ -- $ 291 $ 291 $ 1,642
Net change in unrealized
gain (loss) in deferred
compensation trust and
related liability,
including subsidiaries $ 56 $ 1,387 $ 5,516 $ 1,536
Stock forfeited by MRP,
including subsidiaries $ -- $ -- $ -- $ 6
Recognize tax benefit of
vested MRP shares, including
subsidiaries $ 188 $ 276 $ 276 $ 231
Non-cash portion of 10%
stock dividend $ -- $ 24,371 $ 24,360 $ --
The following summarizes the non-cash activities relating to acquisitions:
Fair value of assets acquired $ -- $(164,532) $(270,436) $ --
Fair value of liabilities
assumed $ -- $ 136,296 $ 230,012 $ --
Fair value of stock issued to
acquisitions' shareholders -- 20,484 32,527 --
-------- --------- --------- --------
Cash paid out in acquisition $ -- $ (7,752) $ (7,897) $ --
Less cash acquired -- 17,080 21,774 --
-------- --------- --------- --------
Net cash acquired (used) $ -- $ 9,328 $ 13,877 $ --
======== ========= ========= ========
Note 23: STOCK REPURCHASE
On November 19, 1996, the Company completed its stock repurchase program
initiated in April 1996 which authorized the repurchase of 600,077 shares of
its outstanding common stock. On November 20, 1996, the Company's Board of
Directors approved continuance of the stock repurchase program authorizing the
purchase of up to 10% of total shares outstanding over the next 12 months.
Similar authorizations were approved by the Board of Directors in November
1997, October 1998 and November 1999. As of December 31, 1999, the Company
has repurchased a total of 2,631,133 shares at an average price of $19.28 per
share. The Company has reserved 480,067 shares for its MRP of which 441,839
shares were awarded as of December 31, 1999 (see Note 16 to financial
statements). The remaining 38,228 unallocated shares are held as authorized
but unissued shares reserved for the MRP. Management reissued 853,472 shares
in connection with the acquisition of TB, and 507,053 shares in connection
with the acquisition of WSB (see Note 2).
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Note 24: CALCULATION OF WEIGHTED AVERAGE SHARES OUTSTANDING USED TO CALCULATE
EARNINGS PER SHARE
(in thousands)
Nine Months Years Ended
Ended December 31 March 31
-------------------- -------------------
1999 1998* 1999* 1998*
---- ---- ---- ----
(Unaudited)
Total shares issued 12,002 12,002 12,002 12,002
Less stock repurchased/retired
including shares allocated to MRP (826) (900) (1,059) (537)
Less unallocated shares held by
the ESOP (746) (775) (824) (891)
-------- -------- -------- --------
Basic weighted average shares
outstanding 10,430 10,327 10,119 10,574
-------- -------- -------- --------
Plus MRP and stock option
incremental shares considered
outstanding for diluted EPS
calculations 344 447 411 139
-------- -------- -------- --------
Diluted weighted average
shares outstanding 10,774 10,774 10,530 10,713
======== ======== ======== ========
* Weighted average shares, restated for 10% stock dividend
Note 25: SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Results of operations on a quarterly basis were as follows (in thousands):
Nine Months Ended December 31, 1999
-----------------------------------
First Second Third
Quarter Quarter Quarter
------- ------- -------
Interest income $ 32,173 $ 33,595 $ 35,264
Interest expense 16,926 17,609 18,666
-------- -------- --------
Net interest income 15,247 15,986 16,598
Provision for loan losses 710 510 665
Net interest income after provision -------- -------- --------
for loan losses 14,537 15,476 15,933
Non-interest income 1,861 1,919 1,735
Non-interest expense 9,783 10,594 10,145
Income before provision for -------- -------- --------
income taxes 6,615 6,801 7,523
Provision for income taxes 2,558 2,594 2,918
-------- -------- --------
Net operating income $ 4,057 $ 4,207 $ 4,605
======== ======== ========
Basic earnings per share $ 0.39 $ 0.40 $ 0.44
Diluted earnings per share $ 0.37 $ 0.39 $ 0.43
Cash dividends declared $ 0.12 $ 0.12 $ 0.12
103
<PAGE>
Note 26: SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED), continued
Results of operations on a quarterly basis were as follows (in thousands):
Year Ended March 31, 1999
---------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest income $ 25,799 $ 27,676 $ 28,347 $ 30,470
Interest expense 13,940 14,919 15,424 16,159
-------- -------- -------- --------
Net interest income 11,859 12,757 12,923 14,311
Provision for loan losses 667 703 840 631
-------- -------- -------- --------
Net interest income
after provision
for loan losses 11,192 12,054 12,083 13,680
Non-interest income 1,593 1,792 1,971 2,097
Non-interest expense 7,073 7,487 7,834 9,351
Income before provision -------- -------- -------- --------
for income taxes 5,712 6,359 6,220 6,426
Provision for income
taxes 2,164 2,392 2,324 2,397
-------- -------- -------- --------
Net operating income $ 3,548 $ 3,967 $ 3,896 $ 4,029
======== ======== ======== ========
* Basic earnings per share $ 0.33 $ 0.38 $ 0.38 $ 0.37
* Diluted earnings per
share $ 0.32 $ 0.36 $ 0.36 $ 0.36
* Cash dividends declared $ 0.08 $ 0.09 $ 0.09 $ 0.12
Year Ended March 31, 1998
---------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest income $ 20,062 $ 21,311 $ 21,837 $ 21,937
Interest expense 10,721 11,754 12,038 12,138
-------- -------- -------- --------
Net interest income 9,341 9,557 9,799 9,799
Provision for loan losses 355 400 375 498
Net interest income -------- -------- -------- --------
after provision
for loan losses 8,986 9,157 9,424 9,301
Non-interest income 956 1,113 1,249 1,402
Non-interest expense 4,912 5,136 5,517 5,455
Income before provision -------- -------- -------- --------
for income taxes 5,030 5,134 5,156 5,248
Provision for income taxes 1,785 1,837 1,951 1,873
-------- -------- -------- --------
Net operating income $ 3,245 $ 3,297 $ 3,205 $ 3,375
======== ======== ======== ========
* Basic earnings per share $ 0.32 $ 0.32 $ 0.32 $ 0.34
* Diluted earnings per
share $ 0.30 $ 0.31 $ 0.30 $ 0.33
* Cash dividends declared $ 0.06 $ 0.06 $ 0.06 $ 0.08
* Restated to reflect 10% stock dividend declared to stockholders of record
as of August 10, 1998.
104
<PAGE>
Note 27: BUSINESS SEGMENTS
The Company is managed by legal entity or Bank, not by lines of business.
Each Bank is managed by its executive management team that is responsible for
its own lending, deposit operations, information systems and administration.
Marketing, sales training assistance, credit card administration and human
resources administration is provided from a central source at FSBW, and costs
are allocated to the individual Banks using appropriate methods based on
usage. In addition, corporate overhead and centralized administrative costs
are allocated to each Bank. The accounting policies followed by each Bank are
the same as those described in Note 1 to the Consolidated Financial
Statements.
FSBW is a community oriented savings bank which has traditionally offered a
wide variety of deposit products to its retail customers while concentrating
its lending activities on real estate loans. FSBW is increasing involvement in
non-mortgage commercial and agricultural lending while continuing to be
actively engaged in residential mortgage lending for the purchase of homes and
home construction. FSBW's primary business is originating loans for portfolio
in its primary market area, which consists of the states of Washington and
Idaho. FSBW's wholly owned subsidiary, Northwest Financial Corporation,
provides trustee services for FSBW, is engaged in real estate sales and
receives commissions from the sale of annuities. FSBW includes WSB and SCB
effective January 1, 1999 and April 1, 1999, respectively.
IEB is a community oriented commercial bank chartered in the State of Oregon.
IEB's lending activities consist of granting agribusiness, commercial and
consumer loans to customers throughout the northeastern Oregon region. IEB
has two wholly owned subsidiaries: Pioneer American Property Company, which
owns a building that is leased to IEB, and Inland Securities Corporation,
which previously made a market for IEB's stock but is currently inactive.
TB is a community oriented commercial bank chartered in the State of
Washington. TB's lending activities consist of granting commercial and
consumer loans to customers throughout the Seattle, Washington, metropolitan
area.
The performance of each Bank is reviewed by the Company's executive management
team and the Board of Directors on a monthly basis.
Financial highlights by legal entity were as follows:
Nine Months Ended December 31, 1999
-------------------------------------------------------
(dollars in thousands)
Condensed Income Statement
FSBW IEB TB Other * Total
---------- ------- -------- ------- ----------
Net interest income
(loss) $ 29,100 $ 8,316 $ 10,334 $ 81 $ 47,831
Provision for loan
losses 650 135 1,100 -- 1,885
Other income 2,997 1,631 934 (47) 5,515
Other expenses 17,181 5,143 6,913 1,285 30,522
Income (loss) before ---------- ------- -------- ------- ----------
income taxes 14,266 4,669 3,255 (1,251) 20,939
Income taxes (benefit) 4,906 2,090 1,515 (441) 8,070
---------- ------- -------- ------- ----------
Net income (loss) $ 9,360 $ 2,579 $ 1,740 $ (810) $ 12,869
========== ======= ======== ======= ==========
December 31, 1999
--------------------------------------------------------
Total Assets $1,302,054 $215,124 $302,487 $ 445 $1,820,110
========== ======== ======== ======= ==========
* Includes intercompany eliminations and holding company amounts.
105
<PAGE>
Note 27: BUSINESS SEGMENTS (continued)
Nine Months Ended December 31, 1998 (Unaudited)
-------------------------------------------------------
(dollars in thousands)
Condensed Income Statement
FSBW IEB TB Other * Total
---------- ------- -------- ------- ----------
Net interest income
(loss) $ 21,786 $ 7,620 $ 7,403 $ 730 $ 37,539
Provision for loan
losses 1,553 192 465 -- 2,210
Other income 2,634 1,944 778 -- 5,356
Other expenses 11,034 4,987 5,139 1,234 22,394
Income (loss) before ---------- ------- -------- ------- ----------
income taxes 11,833 4,385 2,577 (504) 18,291
Income taxes (benefit) 3,849 1,948 1,256 (173) 6,880
---------- ------- -------- ------- ----------
Net income (loss) $ 7,984 $ 2,437 $ 1,321 $ (331) $ 11,411
========== ======= ======== ======= ==========
December 31, 1998 (Unaudited)
-------------------------------------------------------
Total Assets $1,071,628 $207,499 $191,537 $(1,207) $1,469,457
========== ======== ======== ======= ==========
Year Ended March 31, 1999
-------------------------------------------------------
(dollars in thousands)
Condensed Income Statement
FSBW IEB TB Other * Total
---------- ------- -------- ------- ----------
Net interest income
(loss) $ 30,712 $10,114 $ 10,242 $ 782 $ 51,850
Provision for loan
losses 1,870 226 745 -- 2,841
Other income 3,875 2,528 1,071 (21) 7,453
Other expenses 16,049 6,841 7,223 1,632 31,745
Income (loss) before ---------- ------- -------- ------- ----------
income taxes 16,668 5,575 3,345 (871) 24,717
Income taxes (benefit) 5,442 2,490 1,646 (301) 9,277
---------- ------- -------- ------- ----------
Net income (loss) $ 11,226 $ 3,085 $ 1,699 $ (570) $ 15,440
========== ======= ======== ======= ==========
March 31, 1999
-------------------------------------------------------
Total Assets $1,193,269 $204,539 $233,485 $ 607 $1,631,900
========== ======== ======== ======= ==========
* Includes intercompany eliminations and holding company amounts.
106
<PAGE>
Note 27: BUSINESS SEGMENTS (continued)
Year Ended March 31, 1998
-------------------------------------------------------
(dollars in thousands)
Condensed Income Statement
FSBW IEB TB Other * Total
---------- ------- -------- ------- ----------
Net interest income
(loss) $ 27,417 $ 9,741 $ N/A $ 1,338 $ 38,496
Provision for loan
losses 1,559 69 N/A -- 1,628
Other income 2,556 2,164 N/A -- 4,720
Other expenses 13,163 6,397 N/A 1,460 21,020
Income (loss) before ---------- ------- -------- ------- ----------
income taxes 15,251 5,439 N/A (122) 20,568
Income taxes (benefit) 5,098 2,391 N/A (43) 7,446
---------- ------- -------- ------- ----------
Net income (loss) $ 10,153 $ 3,048 N/A $ (79) $ 13,122
========== ======= ======== ======= ==========
March 31, 1998
-------------------------------------------------------
Total Assets $ 952,644 $183,321 $ N/A $18,107 $1,154,072
========== ======== ======== ======= ==========
* Includes intercompany eliminations and holding company amounts.
107
<PAGE>
First Washington Bancorp, Inc.
Index of Exhibits
Exhibit
- ------------------------------------------------------------------------------
3{a} Certificate of Incorporation of Registrant [incorporated by reference
to Registration Statement on Form S-1, as amended (File No. 33-93386)].
3{b} Bylaws of Registrant [incorporated by reference to exhibits filed with
the Quarterly Report on Form 10-Q for the quarter ended December 31,
1997 (file No. 0-26584)].
10{a} Employment Agreement with Gary L. Sirmon [incorporated by reference to
exhibits filed with the Annual Report on Form 10-k dated March 31, 1996
(File No. 0-26584)].
10{b} Executive Salary Continuation Agreement with Gary L. Sirmon
[incorporated by reference to exhibits filed with the Annual Report on
Form 10-k dated March 31, 1996 (File No. 0-26584)].
10{c} Employment Agreement with D. Allan Roth [incorporated by reference to
exhibits filed with the Annual Report on Form 10-k dated March 31, 1996
(File No. 0-26584)].
10{d} Executive Salary Continuation Agreement with D. Allan Roth
[incorporated by reference to exhibits filed with the Annual Report on
Form 10-k dated March 31, 1996 (File No. 0-26584)].
10{e} Employment Agreement with Michael K. Larsen [incorporated by reference
to exhibits filed with the Annual Report on Form 10-k dated March 31,
1996 (File No. 0-26584)].
10{f} Executive Salary Continuation Agreement with Michael K. Larsen.
[incorporated by reference to exhibits filed with the Annual Report on
Form 10-k dated March 31, 1996 (File No. 0-26584)].
10{g} 1996 Stock Option Plan (incorporated by reference to Exhibit A to the
Proxy Statement for the Annual Meeting of Stockholders held on July 26,
1996).
10{h} 1996 Management Recognition and Development Plan (incorporated by
reference to Exhibit B to the Proxy Statement for the Annual Meeting of
Stockholders held on July 26, 1996).
10{i} Employment and Non-competition Agreement with Jesse G. Foster
[incorporated by reference to exhibits filed with the Annual Report on
Form 10-K dated March 31, 1997 (file No. 0-26584)].
10{j} Supplemental Retirement Plan as Amended with Jesse G. Foster
[incorporated by reference to exhibits filed with the Annual Report on
Form 10-K dated March 31, 1997 (file No. 0-26584)].
10{k} Towne Bank of Woodinville 1992 Stock Option Plan [incorporated by
reference to exhibits filed with the Registration Statement on Form S-8
dated April 2, 1999 (file No. 333-49193)].
10{l} 1998 Stock Option Plan (incorporated by reference to Exhibit A to the
Proxy Statement for the Annual Meeting of Stockholders held on July 24,
1998).
21 Subsidiaries of the Registrant.
23 Independent Auditors Consent.
27 Financial Data Schedule.
108
<PAGE>
Exhibit 21
Subsidiaries of the Registrant
Parent
- ------
First Washington Bancorp, Inc.
Percentage of Jurisdiction of
Subsidiaries ownership State of Incorporation
- ------------ ------------- ----------------------
First Savings Bank of
Washington (1) 100% Washington
Inland Empire Bank (1) 100% Oregon
Towne Bank of Woodinville (1) 100% Washington
Northwest Financial
Corporation (2) 100% Washington
Pioneer American Property
Company (3) 100% Oregon
Inland Securities Corporation (3) 100% Oregon
- ------------
(1) Wholly-owned by the First Washington Bancorp, Inc.
(2) Wholly-owned by the First Savings Bank of Washington.
(3) Wholly-owned by Inland Empire Bank.
<PAGE>
Exhibit 23
Independent Auditors' Consent
<PAGE>
INDEPENDENT AUDITORS' CONSENT
==============================================================================
We consent to the incorporation by reference in Registration Statement Nos.
333-10819, 333-49193 and 333-71625 of First Washington Bancorp, Inc. on Form
S-8 of our report dated March 5, 2000, appearing in the Annual Report on Form
10-K of First Washington Bancorp, Inc. for the nine-month period ended
December 31, 1999.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Seattle, Washington
March 5, 2000
<PAGE>
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