FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended .................. September 30, 2001
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[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 0-26584
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BANNER CORPORATION
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(Exact name of registrant as specified in its charter)
WASHINGTON 91-1691604
-------------------------------- -------------------
(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)
(Former name, former address and former fiscal year, if changed since last
report.)
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.
(1) Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Title of class: As of October 31, 2001
--------------- -------------------
Common Stock, $.01 Par Value 11,838,570 shares *
* Includes 633,278 shares held by employee stock ownership plan (ESOP)
that have not been released, committed to be released, or allocated to
participant accounts.
Banner Corporation and Subsidiaries
Table of Contents
PART I - FINANCIAL INFORMATION
ITEM 1 - Financial Statements. The Consolidated Financial Statements of
Banner Corporation and Subsidiaries filed as a part of the report are as
follows:
Consolidated Statements of Financial Condition
as of September 30, 2001 and December 31, 2000.......................... 2
Consolidated Statements of Income
for the Quarters and Nine Months Ended September 30, 2001 and 2000...... 3
Consolidated Statements of Comprehensive Income
for the Quarters and Nine Months Ended September 30, 2001 and 2000...... 4
Consolidated Statements of Changes in Stockholders' Equity
for the Nine months Ended September 30, 2001 and 2000................... 5
Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 2001 and 2000................... 7
Selected Notes to Consolidated Financial Statements..................... 9
ITEM 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operation
General................................................................. 15
Recent Developments and Significant Events.............................. 16
Comparison of Financial Condition at September 30, 2001
and December 31, 2000................................................... 16
Comparison of Results of Operations for the Quarters and
Nine Months Ended September 30, 2001 and 2000........................... 16
Asset Quality........................................................... 24
Market Risk and Asset/Liability Management.............................. 25
Liquidity and Capital Resources......................................... 28
Capital Requirements.................................................... 29
PART II - OTHER INFORMATION
Item 1. Legal Proceedings............................................... 30
Item 2. Changes in Securities........................................... 30
Item 3. Defaults upon Senior Securities................................. 30
Item 4. Submission of Matters to a Vote of Stockholders................. 30
Item 5. Other Information............................................... 30
Item 6. Exhibits and Reports on Form 8-K................................ 30
SIGNATURES................................................................ 31
1
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (in thousands, except shares)
September 30, 2001 and December 31, 2000
(Unaudited)
September 30 December 31
ASSETS 2001 2000
----------- -----------
Cash and due from banks $ 56,093 $ 67,356
Securities available for sale, cost $309,275
and $310,539
Encumbered 64,462 66,405
Unencumbered 248,996 242,393
----------- -----------
313,458 308,798
Securities held to maturity, fair value $15,663
and $18,269 15,546 17,717
Federal Home Loan Bank stock 30,305 28,807
Loans receivable:
Held for sale, fair value $22,631 and $8,011 22,150 7,934
Held for portfolio 1,579,502 1,479,149
Allowance for loan losses (18,593) (15,314)
----------- -----------
1,583,059 1,471,769
Accrued interest receivable 14,832 12,963
Real estate owned, held for sale, net 2,871 3,287
Property and equipment, net 17,919 17,746
Costs in excess of net assets acquired
(goodwill), net 32,232 34,617
Deferred income tax asset, net 1,209 2,337
Bank owned life insurance 19,968 14,190
Other assets 7,341 3,244
----------- -----------
$ 2,094,833 $ 1,982,831
=========== ===========
LIABILITIES
Deposits:
Non-interest-bearing $ 173,061 $ 140,779
Interest-bearing 1,125,653 1,051,936
----------- -----------
1,298,714 1,192,715
Advances from Federal Home Loan Bank 513,783 507,098
Other borrowings 73,370 74,538
Accrued expenses and other liabilities 13,307 10,857
Deferred compensation 2,595 2,293
Income taxes payable -- 1,535
----------- -----------
1,901,769 1,789,036
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, 13,201,418 shares issued:
11,838,570 shares and 12,005,302 shares
outstanding at September 30, 2001 and
December 31, 2000, respectively. 129,987 133,839
Retained earnings 65,724 66,893
Accumulated other comprehensive income:
Unrealized gain (loss) on securities
available for sale 2,698 (1,125)
Unearned shares of common stock issued to
Employee Stock Ownership Plan (ESOP) trust:
633,278 and 633,278 restricted shares out-
standing at September 30, 2001 and December
31, 2000, respectively, at cost (5,234) (5,234)
Carrying value of shares held in trust for
stock related compensation plans (2,713) (3,130)
Liability for common stock issued to deferred,
stock related, compensation plan 2,602 2,552
----------- -----------
(111) (578)
----------- -----------
193,064 193,795
----------- -----------
$ 2,094,833 $ 1,982,831
=========== ===========
See notes to consolidated financial statements
2
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited) (in thousands except for per share amounts)
Quarters Ended Nine Months Ended
September 30 September 30
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
INTEREST INCOME:
Loans receivable $ 34,468 $ 34,060 $103,387 $ 96,206
Mortgage-backed securities 2,940 3,826 9,217 11,732
Securities and deposits 2,450 3,037 7,571 8,723
-------- -------- -------- --------
39,858 40,923 120,175 116,661
INTEREST EXPENSE:
Deposits 13,342 13,986 41,553 38,676
Federal Home Loan Bank advances 7,463 8,412 22,969 23,142
Other borrowings 739 1,292 2,674 3,634
-------- -------- -------- --------
21,544 23,690 67,196 65,452
-------- -------- -------- --------
Net interest income before
provision for loan losses 18,314 17,233 52,979 51,209
PROVISION FOR LOAN LOSSES 5,959 651 9,859 2,015
-------- -------- -------- --------
Net interest income 12,355 16,582 43,120 49,194
OTHER OPERATING INCOME:
Loan servicing fees 308 264 903 744
Other fees and service charges 1,228 1,297 4,159 3,676
Gain on sale of loans 1,327 558 3,410 1,027
Gain (loss) on sale of securities -- 44 360 59
Miscellaneous 451 62 982 172
-------- -------- -------- --------
Total other operating income 3,314 2,225 9,814 5,678
OTHER OPERATING EXPENSES:
Salary and employee benefits 7,817 6,822 22,821 19,604
Less capitalized loan
origination costs (1,146) (874) (3,582) (2,566)
Occupancy and equipment 2,026 1,764 5,770 5,208
Information/computer data services 1,718 623 3,220 1,824
Advertising 269 220 687 549
Check kiting loss 1,900 -- 8,100 --
Amortization of goodwill 795 793 2,385 2,377
Miscellaneous 2,222 2,338 7,112 6,785
-------- -------- -------- --------
Total other operating expenses 15,601 11,686 46,513 33,781
-------- -------- -------- --------
Income before provision for
income taxes 68 7,121 6,421 21,091
PROVISION FOR INCOME TAXES 212 2,515 2,637 7,517
-------- -------- -------- --------
NET INCOME (LOSS) $ (144) $ 4,606 $ 3,784 $ 13,574
======== ======== ======== ========
Net income (loss) per common
share, see Note 5:
Basic $ (.01) $ .41 $ .34 $ 1.20
Diluted $ (.01) $ .40 $ .32 $ 1.18
Cumulative dividends declared
per common share: $ .14 $ .13 $ .42 $ .38
See notes to consolidated financial statements
3
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited) (in thousands)
Quarters Ended Nine Months Ended
September 30 September 30
2001 2000 2001 2000
-------- -------- -------- --------
NET INCOME: $ (144) $ 4,606 $ 3,784 $ 13,574
OTHER COMPREHENSIVE INCOME (LOSS),
NET OF INCOME TAXES:
Unrealized holding gain (loss)
during the period, net of
deferred income tax (benefit)
of $945, $706 1,740 1,267 4,057 1,170
$2,227 and $639; respectively.
Less adjustment for (gains)/
losses included in net income,
net of income tax (benefit)
of $-0-, $15, $284 and $126;
respectively. -- (29) (234) (39)
-------- -------- -------- --------
Other comprehensive income (loss) 1,740 1,238 3,823 1,131
-------- -------- -------- --------
COMPREHENSIVE INCOME $ 1,596 $ 5,844 $ 7,607 $ 14,705
======== ======== ======== ========
See notes to consolidated financial statements
4
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited) (in thousands)
For the Nine Months Ended September 30, 2001 and 2000
2001 2000
--------- ---------
Common stock and Additional paid-in capital:
Balance, beginning of period $ 133,839 $ 123,204
Adjustment of and/or issuance of stock in
connection with acquisitions -- 53
Recognition of tax benefit due to vesting
of MRP shares 259 2
Issuance of shares to MRP 52 62
Purchase of forfeited shares from MRP (3) (25)
Net proceeds (cost) of treasury stock reissued
for exercised stock options 1,380 139
Purchase and retirement of treasury stock (5,540) (2,780)
--------- ---------
Balance, end of period 129,987 120,655
Retained earnings:
Balance, beginning of period 66,893 69,170
Net income 3,784 13,574
Cash dividends (4,953) (4,591)
Adjustment of stock issued and related
stock dividend in connection with acquisitions -- (7)
--------- ---------
Balance, end of period 65,724 78,146
ACCUMULATED OTHER COMPREHENSIVE INCOME:
Balance, beginning of period (1,125) (5,331)
Other comprehensive income (loss), net of
related income taxes 3,823 1,131
--------- ---------
Balance, end of period 2,698 (4,200)
UNEARNED, RESTRICTED ESOP SHARES AT COST:
Balance, beginning of period (5,234) (6,162)
Release of earned ESOP shares -- --
--------- ---------
Balance, end of period (5,234) (6,162)
CARRYING VALUE OF SHARES HELD IN TRUST FOR
STOCK-RELATED COMPENSATION PLANS:
Balance, beginning of period (578) (1,708)
Issuance of treasury stock for MRP grant (52) (62)
Net change in number and/or valuation of shares
held in trust 3 25
Amortization of compensation related to MRP 516 844
--------- ---------
Balance, end of period (111) (901)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY $ 193,064 $ 187,538
========= =========
See notes to consolidated financial statements
5
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited) (continued) (in thousands)
For the Nine Months Ended September 30, 2001 and 2000
2001 2000*
--------- ---------
COMMON STOCK , SHARES ISSUED:
Number of shares, beginning of period 13,201 13,201
--------- ---------
Number of shares, end of period 13,201 13,201
--------- ---------
LESS Treasury stock PURCHASED AND RETIRED:
Number of shares, beginning of period (1,196) (864)
Purchase of shares forfeited from MRP -- (2)
Reissuance of treasury stock to deferred
compensation plan and/or exercised
stock options 127 31
Shares reissued in connection with acquisitions 2
Purchase and retirement of treasury stock (293) (212)
--------- ---------
Number of shares retired/repurchased, end of period (1,362) (1,045)
--------- ---------
Shares issued and outstanding, end of period 11,839 12,156
========= =========
UNEARNED, RESTRICTED ESOP SHARES:
Number of shares, beginning of period (633) (746)
Release of earned shares -- --
--------- ---------
Number of shares, end of period (633) (746)
========= =========
*Adjusted for stock dividend, see note 2
See notes to consolidated financial statements
6
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (in thousands)
For the Nine Months Ended September 30, 2001 and 2000
2001 2000
--------- ---------
OPERATING ACTIVITIES
Net income $ 3,784 $ 13,574
Adjustments to reconcile net income to net cash
provided by operating activities:
Deferred taxes (714) 678
Depreciation 2,181 2,013
Loss (gain) on sale of securities (360) (59)
Net amortization of premiums and discounts
on investments 14 72
Increase in cash surrender value of bank
owned life insurance (778) (188)
Amortization of costs in excess of net
assets acquired 2,385 2,377
Amortization of MRP compensation liability 516 844
Loss (gain) on sale of loans (3,318) (990)
Net changes in deferred loan fees, premiums
and discounts (418) 961
Loss (gain) on disposal of real estate held for sale 31 52
Loss (gain) on disposal of property and equipment 167 8
Amortization of mortgage servicing rights 365 186
Capitalization of mortgage servicing rights
from sale of mortgages with servicing retained (92) (37)
Provision for losses on loans and real estate
held for sale 9,950 2,036
FHLB stock dividend (1,498) (1,247)
Net change in:
Loans held for sale (14,216) (758)
Accrued interest receivable (1,869) (2,475)
Other assets (4,323) (63)
Deferred compensation 313 192
Accrued expenses and other liabilities 2,476 6,325
Income taxes payable (1,535) (616)
--------- ---------
Net cash provided (used) by operating activities (6,939) 22,885
--------- ---------
INVESTING ACTIVITIES:
Purchases of securities available for sale (100,985) (11,351)
Principal repayments and maturities of
securities available for sale 101,219 32,908
Proceeds from sales of securities available for sale 1,372 4,131
Purchases of securities held to maturity -- (4,662)
Principal repayments and maturities of
securities held to maturity 2,175 188
Net sales (purchases) of FHLB stock -- (2,257)
Origination of loans, net of principal repayments (307,498) (220,467)
Purchases of loans and participating
interest in loans (2,736) (10,382)
Proceeds from sales of loans and participating
interest in loans 204,389 71,402
Purchases of property and equipment (2,544) (2,731)
Proceeds from sale of property and equipment 23 10
Additional capitalized costs of real estate
held for sale, net of insurance proceeds (257) (62)
Proceeds from sale of real estate held for sale 3,302 1,301
Funds transferred to deferred compensation plan trusts (58) (101)
Investment in bank owned life insurance (5,000) (6)
--------- ---------
Net cash used by investing activities (106,598) (142,079)
--------- ---------
(Continued on next page)
7
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (in thousands)
For the Nine Months Ended September 30, 2001 and 2000
(Continued from prior page)
2001 2000
--------- ---------
FINANCING ACTIVITIES
Increase (decrease) in deposits $ 105,999 $ 93,988
Proceeds from FHLB advances 180,965 724,479
Repayment of FHLB advances (174,280) (660,705)
Proceeds from repurchase agreement borrowings 9,430 935
Repayments of repurchase agreement borrowings (11,893) (2,929)
Increase (decrease) in other borrowings 1,192 (2,265)
Cash dividends paid (4,979) (4,398)
Net (cost) proceeds of exercised stock options 1,380 139
Repurchases of stock, net of forfeitures (5,540) (2,781)
--------- ---------
Net cash provided by financing activities 102,274 146,463
--------- ---------
NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS (11,263) 27,269
CASH AND DUE FROM BANKS, BEGINNING OF PERIOD 67,356 44,769
--------- ---------
CASH AND DUE FROM BANKS, END OF PERIOD $ 56,093 $ 72,038
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $ 67,063 $ 64,848
Taxes paid $ 7,678 $ 7,455
Non-cash transactions:
Loans, net of discounts, specific loss
allowances and unearned income, transferred
to real estate owned $ 2,751 $ 1,439
Net change in accrued dividends payable $ 26 $ 195
Net change in unrealized gain (loss) in deferred
compensation trust and related liability $ 39 $ 47
Treasury stock forfeited by MRP $ 3 $ 35
Treasury stock issued to MRP $ 52 $ 62
Tax benefit of vested MRP shares $ 259 $ 2
Fair value of stock issued and options
assumed in connection with acquisitions $ -- $ 48
See notes to consolidated financial statements
8
BANNER CORPORATION AND SUBSIDIARIES
SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: BASIS OF PRESENTATION
Banner Corporation (BANR or the Company) is a bank holding company
incorporated in the State of Washington. The Company is primarily engaged in
the business of planning, directing and coordinating the business activities
of its wholly-owned subsidiary, Banner Bank (BB or the Bank). BB is a
Washington-chartered commercial bank the deposits of which are insured by the
Federal Deposit Insurance Corporation (FDIC) under both the Bank Insurance
Fund (BIF) and the Savings Association Insurance Fund (SAIF). BB conducts
business from its main office in Walla Walla, Washington, and its 38 branch
offices and six loan production offices located in Washington, Oregon and
Idaho.
The Company is subject to regulation by the Federal Reserve Board (FRB). The
Bank is subject to regulation by the State of Washington Department of
Financial Institutions Division of Banks and the Federal Deposit Insurance
Corporation (FDIC).
In the opinion of management, the accompanying consolidated statements of
financial condition and related interim consolidated statements of income,
comprehensive income, changes in stockholders' equity and cash flows reflect
all adjustments (which include reclassifications and normal recurring
adjustments) that are necessary for a fair presentation in conformity with
generally accepted accounting principles ("GAAP"). The preparation of
financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect amounts reported in the financial
statements. Actual results could differ from these estimates and may have a
material impact on the financial statements.
Certain reclassifications have been made to the 2000 financial statements
and/or schedules to conform to the 2001 presentation. These reclassifications
may have affected certain ratios for the prior periods. The effect of such
reclassifications is considered immaterial. All significant intercompany
transactions and balances have been eliminated.
The information included in this Form 10-Q should be read in conjunction with
Banner Corporation's 2000 Annual Report on Form 10-K filed with the Securities
and Exchange Commission. Interim results are not necessarily indicative of
results for a full year.
Note 2: RECENT DEVELOPMENTS AND SIGNIFICANT EVENTS
Restatement of Financial Statements: As explained in Note 6, on September 17,
2001, Banner Corporation announced that it had become aware of irregularities
associated with a former senior lending officer. The irregularities included
a check kiting scheme of a single commercial loan customer of Banner Bank, as
well as activities designed to conceal credit weaknesses of several loan
customers. Upon further review, the Company determined that it would be
necessary to file amended quarterly reports on Form 10-Q/A for each of the
quarters ended March 31, 2001 and June 30, 2001, to recognize charges in those
periods which appropriately reflect the timing of losses incurred as a result
of the check kiting and credit manipulation activities. The Company also
recorded charges in the quarter ended September 30, 2001, as a result of these
irregularities. (See Note 6 for additional details.)
Mergers and Acquisitions: The Company recently signed a definite agreement to
acquire Oregon Business Bank of Lake Oswego, Oregon, in an all cash
transaction valued at approximately $10.0 million. Opened in October 1999,
Oregon Business Bank is an Oregon state-chartered commercial community bank
with $41.5 million in assets, $32.5 million in gross loans, $35.8 million in
deposits and shareholders equity of $4.7 million at August 31, 2001. The
acquisition, which has been approved by the Board of Directors of each
company, is subject to, among other contingencies, approval by regulators and
Oregon Business Bank's shareholders. The transaction is expected to close in
the first quarter of 2002.
Name Change/Consolidation of Banking Operations: On October 30, 2000 First
Washington Bancorp, Inc. (FWWB) changed its name to Banner Corporation in
conjunction with a consolidation of banking operations affecting its banking
subsidiaries. Towne Bank (TB) merged with First Savings Bank of Washington
(FSBW), FSBW converted from a Washington state-chartered savings bank to a
Washington state-chartered commercial bank and changed its name, along with
the names of its divisions, Whatcom State Bank and Seaport Citizens Bank, to
Banner Bank. At the same time, Inland Empire Bank (IEB) changed its name to
Banner Bank of Oregon (BBO).
9
The combination was designed to strengthen the Company by more effectively
sharing the resources of the existing subsidiaries, improving operating
efficiency and developing a broader regional brand identity. The banks used
one name, Banner Bank, and were united under the leadership of an experienced
management team. The same ten individuals became members of the Board of
Directors of the Company and each of the banks. Final integration of all data
processing into a common system is scheduled for completion by December 31,
2001.
In light of the Gramm-Leach-Bliley financial modernization legislation, the
Company chose to retain a separate charter for Banner Bank of Oregon (formerly
IEB) and to operate two banking subsidiaries. That legislation enacted
Federal Home Loan Bank System reforms that affected community financial
institutions. The intent was for Banner Bank of Oregon to qualify as a
community financial institution allowing it to obtain long-term Federal Home
Loan Bank advances to fund small business and small agribusiness loans and to
offer those loans as collateral for such borrowings. A community financial
institution is defined as a "member of the Federal Home Loan Bank (FHLB)
System, the deposits of which are insured by the FDIC and that has average
total assets (over the preceding three years) of less than $500 million."
However, with release of the FHLB's implementing procedures, including rules
expanding eligible collateral for members not qualifying as community
financial institutions, the Company determined that the potential benefits of
additional borrowing capacity were not as substantial as the efficiencies it
may derive by operating under a single bank charter. Therefore, on June 29,
2001, the Company announced its plans to merge the two subsidiary banks. The
merger of BB and BBO was completed on September 1, 2001, with the surviving
entity operating as a Washington state-chartered commercial bank.
Declaration of 10% Stock Dividend: On October 19, 2000 BANR's Board of
Directors declared a 10% stock dividend payable November 10, 2000 to
shareholders of record on October 31, 2000. All earnings per share and share
data have been adjusted to reflect the 10% stock dividend.
Mortgage Lending Subsidiary: On April 1, 2000 BB opened a new mortgage
lending subsidiary, Community Financial Corporation (CFC), located in the Lake
Oswego area of Portland, Oregon, with John Satterberg as President. Primary
lending activities for CFC are in the area of construction and permanent
financing for one- to four-family residential dwellings. CFC, an Oregon
corporation, functions as a wholly-owned subsidiary of BB. BB has capitalized
CFC with $2 million of equity capital and provides funding support for CFC's
lending operations.
Accounting Standards Recently Adopted: In June 1998 the Financial Accounting
Standards Board (FASB) issued Statements of Financial Accounting Standards
(SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities.
In June 2000, the FASB issued SFAS No. 138, which amends certain provisions of
SFAS No. 133 to clarify specific areas causing difficulties in implementation.
The Company has not historically engaged in any hedging activities, and does
not anticipate that it will enter into any transactions that will qualify for
hedge accounting as defined by SFAS No. 133. The Company adopted SFAS No. 133
and the corresponding amendments under SFAS No. 138 effective on January 1,
2001. The adoption of SFAS No. 133, as amended by SFAS No. 138, did not have
a material impact on the Company's consolidated results of operations,
financial position or cash flows.
In September 2000, the FASB issued SFAS No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, which
revises the standards for accounting for securitizations and other transfers
of financial assets and collateral and requires certain disclosures, but
carries over most of the provisions of SFAS No. 125 without reconsideration.
SFAS No. 140 is effective for transfers and servicing of financial assets and
extinguishments of liabilities occurring after March 31, 2001. The provisions
of this statement did not have a material effect on the Company's financial
position or results of operations.
Recent Accounting Standards Not Yet Adopted: In July 2001, the FASB issued
SFAS No. 141, Business Combinations, which applies to all business
combinations initiated after June 30, 2001. This statement requires that all
business combinations be accounted for using the purchase method of
accounting; the use of the pooling-of-interests method is no longer permitted.
The purchase method of accounting requires goodwill to be measured as the
excess of the cost of an acquired entity over the estimated fair value of net
amounts assigned to assets acquired and liabilities assumed. This statement
also addressees the disclosures required in the financial statements
pertaining to business combinations. The adoption of this statement is not
expected to have a material impact on the Company's financial condition or
results of operations.
In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets, which applies to all acquired intangible assets whether acquired
singly, as part of a group, or in a business combination. This statement
requires that goodwill not be amortized; however, goodwill for each reporting
unit must be evaluated for impairment on at least an annual basis using a
two-step
10
approach. The first step used to identify potential impairment compares the
estimated fair value of a reporting unit to its carrying amount, including
goodwill. If the fair value of a reporting unit is less than its carrying
amount, the second step of the impairment evaluation which compares the
implied fair value of goodwill to its carrying amount must be performed to
determine the amount of the impairment loss, if any. This statement also
provides standards for financial statement disclosures of goodwill and other
intangible assets and related impairment losses. The Company will be required
to adopt this statement on January 1, 2002. The adoption of this statement is
expected to have a material impact on the Company's results of operation.
Goodwill will no longer be amortized, which will reduce other operating
expenses by an estimated $793,000 per quarter, or $3.2 million a year, with a
corresponding increase in net income.
Note 3: BUSINESS SEGMENTS
The Company has been managed by legal entity or bank, not by lines of
business. Each bank has been managed by its management team that was
responsible for its own lending, deposit operations, information systems and
administration. Marketing support, sales training assistance, and human
resource services were provided from a central source at BB, and costs were
allocated to the individual banks using appropriate methods based on usage.
In addition, corporate overhead and centralized administrative costs were
allocated to each bank. In prior periods, business segment reporting included
results for each subsidiary bank; however, over the past year all of the
subsidiary banks have been merged into a single legal entity, BB, with a
consolidated management team. For comparative purposes prior period segment
information has been regrouped to match current business segments/grouping
after merger of the bank subsidiaries. All of the executive officers of BANR
are members of the BB management team.
BB is a community oriented commercial bank chartered in the State of
Washington. As explained above under Consolidation of Banking Operations in
Note 2, BB includes the operations of the former First Savings Bank of
Washington and its divisions, Whatcom State Bank and Seaport Citizens Bank,
the former Towne Bank and BBO (formerly IEB). BB offers a wide variety of
deposit products to its consumer and commercial customers. Lending activities
include the origination of real estate, commercial/agriculture business and
consumer loans. BB's primary business is that of a traditional banking
institution, gathering deposits and originating loans for portfolio in its
primary market area. BB is also an active participant in the secondary
market, originating residential loans for sale on both a servicing released
and servicing retained basis. In addition to interest income on loans and
investment securities, BB receives other income from deposit servicing
charges, loan servicing fees and from the sale of loans and investments. BB
also has a mortgage lending subsidiary, CFC, located in the Lake Oswego area
of Portland, Oregon, that was established in fiscal 2000. CFC's primary
lending activities are in the area of construction and permanent financing for
one- to four-family residential dwellings.
BBO (formerly IEB) was a community oriented commercial bank chartered in the
State of Oregon which historically offered a wide variety of deposit and loan
products to its consumer and commercial customers. Lending activities
included origination of consumer, commercial, agribusiness and real estate
loans. BBO also engaged in mortgage banking activity with respect to
residential lending within its local markets and originating loans for sale
generally on a servicing released basis. BBO operated a division, Inland
Financial Services, which offered insurance and brokerage services to its
customers. BBO was merged into BB on September 1, 2001.
The performance of the Bank is reviewed by the Company's executive management
team and the Board of Directors on a monthly basis.
11
Note 3: BUSINESS SEGMENTS (continued)
Financial highlights by legal entity were as follows:
Quarter Ended September 30, 2001
---------------------------------------
(dollars in thousands)
Condensed Income Statement BBO
(now merged
BB into BB) Other* Total
------ ------ ------ ------
Net interest income $ 18,259 $ -- $ 55 $ 18,314
Provision for loan losses 5,959 -- -- 5,959
Other operating income 3,345 -- (31) 3,314
Other operating expenses 14,959 -- (642) 15,601
------ ------ ------ ------
Income (loss) before income taxes 686 -- (618) 68
Income taxes (benefit) 363 -- (151) 212
------ ------ ------ ------
Net income (loss) $ 323 $ -- $(467) $ (144)
====== ====== ====== ======
Quarter Ended September 30, 2000 (1)
---------------------------------------------
(dollars in thousands)
Condensed Income Statement
BBO TB
(Now merged (Now merged
BB into BB) into BB) Other* Total
------ ------ ------ ------ ------
Net interest income $ 17,222 $ -- $ -- $ 11 $ 17,233
Provision for loan losses 651 -- -- - 651
Other operating income 2,243 -- -- (18) 2,225
Other operating expenses 11,191 -- -- 495 11,686
------ ----- ------ ------ ------
Income (loss) before income
taxes 7,623 -- -- (502) 7,121
Income taxes (benefit) 2,691 - -- (176) 2,515
------ ------ ------ ------ ------
Net income (loss) $ 4,932 $ -- $ -- $(326) $ 4,606
====== ====== ====== ====== ======
* Includes intercompany eliminations and holding company amounts.
(1) For comparative purposes prior period segment information has been
regrouped to match current business segments/grouping after merger of
subsidiaries.
12
Note 3: BUSINESS SEGMENTS, CONTINUED:
Nine Months Ended September 30, 2001
---------------------------------------
(dollars in thousands)
Condensed Income Statement BBO
(now merged
BB into BB) Other* Total
------ ------ ------ ------
Net interest income (loss) $ 52,925 $ -- $ 54 $ 52,979
Provision for loan losses 9,859 -- - 9,859
Other operating income 9,814 - -- 9,814
Other operating expenses 45,046 -- 1,467 46,513
------ ------ ------ ------
Income (loss) before income taxes 7,834 -- (1,413) 6,421
Income taxes (benefit) 3,130 -- (493) 2,637
------ ------ ------ ------
Net income (loss) $ 4,704 $ -- $(920) $ 3,784
====== ====== ====== ======
Nine Months Ended September 30, 2000(1)
---------------------------------------------
(dollars in thousands)
Condensed Income Statement
BBO TB
(Now merged (Now merged
BB into BB) into BB) Other* Total
------ ------ ------ ------ ------
Net interest income (loss) $ 51,171 $ -- $ -- $ 38 $ 51,209
Provision for loan losses 2,015 -- - -- 2,015
Other operating income 5,730 -- -- (52) 5,678
Other operating expenses 32,320 -- - 1,461 33,781
------ ------ ------ ------ ------
Income (loss) before income
taxes 22,566 -- - (1,475) 21,091
Income taxes (benefit) 8,028 -- -- (511) 7,517
------ ------ ------ ------ ------
Net income (loss) $ 14,538 $ -- $ - $(964) $ 13,574
====== ====== ====== ====== ======
Condensed Income Statement
BBO TB
(Now merged (Now merged
BB into BB) into BB) Other* Total
---------- ------- ------ ------ ------
September 30, 2000
----------------------------------------------------
Total Assets $2,093,970 $ -- $ 863 $2,094,833
========== ======= ====== ==========
September 30, 2000 (1)
----------------------------------------------------
Total Assets $ 1,986,929 $ -- $ -- $ 865 $1,987,794
========== ======= ======= ====== ==========
*Includes intercompany eliminations and holding company amounts.
(1) For comparative purposes prior period segment information has been
regrouped to match current business segments/grouping after merger of
subsidiaries.
13
Note 4: ADDITIONAL INFORMATION REGARDING INTEREST-BEARING DEPOSITS AND
SECURITIES
The following table sets forth additional detail on BANR's interest-bearing
deposits and securities at the dates indicated (at carrying
value) (in thousands):
September 30 December 31
2001 2000
--------- ---------
Interest-bearing deposits included
in cash and due from banks $ 2,400 $ 15,661
Mortgage-backed securities 221,181 194,073
Other securities-taxable 77,034 100,261
Other securities-tax exempt 27,239 28,212
Other stocks with dividends 3,550 3,969
--------- ---------
Total securities 329,004 326,515
Federal Home Loan Bank (FHLB) stock 30,305 28,807
--------- ---------
$ 361,709 $ 370,983
========= =========
The following table provides additional detail on income from deposits and
securities for the periods indicated (in thousands):
Quarters Ended Nine Months Ended
September 30 September 30
------------------ ------------------
2001 2000 2001 2000
-------- -------- -------- --------
Mortgage-backed securities $ 2,940 $ 3,826 $ 9,217 $ 11,732
-------- -------- -------- --------
Taxable interest and dividends 1,515 2,134 4,836 6,043
Tax-exempt interest 410 458 1,237 1,411
Federal Home Loan Bank stock-dividends 525 445 1,498 1,269
-------- -------- -------- --------
2,450 3,037 7,571 8,723
-------- -------- -------- --------
$ 5,390 $ 6,863 $ 16,788 $ 20,455
======== ======== ======== ========
Note 5: CALCULATION OF WEIGHTED AVERAGE SHARES OUTSTANDING FOR EARNINGS PER
SHARE (EPS) (IN THOUSANDS)
Quarters Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2001 2000 2001 2000
------- ------- ------- -------
Total shares originally issued 13,201 13,201 13,201 13,201
Less retired shares and treasury
stock plus unvested shares
allocated to MRP (1,393) (1,142) (1,363) (1,127)
Less unallocated shares held by
the ESOP (633) (746) (633) (746)
------- ------- ------- -------
Basic weighted average shares
outstanding 11,175 11,313 11,205 11,328
Plus unvested MRP and stock option
incremental shares considered
outstanding for diluted
EPS calculations 488 147 451 181
------- ------- ------- -------
Diluted weighted average shares
outstanding 11,663 11,460 11,656 11,509
======= ======= ======= =======
14
Note 6: RESTATEMENT OF FINANCIAL STATEMENTS
On September 17, 2001, the Company announced that it had become aware of
irregularities associated with a former senior lending officer. The
irregularities included a check kiting scheme of a single commercial loan
customer of BB, as well as activities designed to conceal credit weaknesses of
several loan customers. Upon further review, the Company determined that it
would be necessary to file amended quarterly reports on Form 10-Q/A for each
of the quarters ended March 31, 2001 and June 30, 2001, to recognize charges
in those periods which appropriately reflect the timing of losses incurred as
a result of the check kiting and credit manipulation activities. For the
restated quarter ended March 31, 2001, the Company has recorded an expense of
$3.6 million ($2.3 million after tax) as a result of the check kiting scheme.
During the restated quarter ended June 30, 2001, the Company recorded $2.6
million ($1.7 after tax) of expense related to the check kiting scheme and an
additional $2.0 million ($1.3 million after tax) was added to the provision
for loan losses. The Company recorded an additional expense of $1.9 million
in the quarter ended September 30, 2001, with respect to the check kiting
scheme and also recognized $4.2 million of additional provision for loan
losses associated with the credit manipulation. The changes in the financial
statements resulted in restated net income of $1.6 million for the quarter
ended June 30, 2001, compared to $4.6 million as previously reported. For the
six months ended June 30, 2001, restated net income was $3.9 million compared
to $9.2 million as previously reported.
ITEM 2 - 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 Banner Corporation. 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 this report and 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, the Company's ability to successfully
complete consolidation and conversion activities, successfully resolve
outstanding credit issues and/or recover check kiting losses, 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
Banner Corporation (the Company or BANR), a Washington corporation, is
primarily engaged in the business of planning, directing and coordinating the
business activities of its wholly owned subsidiary, Banner Bank (BB). Prior
to the consolidation and name change, which occurred on October 30, 2000, the
Company's subsidiaries included First Savings Bank of Washington (FSBW),
Inland Empire Bank (IEB) and Towne Bank (TB) (together, the Banks). As of
September 30, 2001, BB is a Washington-chartered commercial bank the deposits
of which are insured by the FDIC under both the BIF and the SAIF. BB conducts
business from its main office in Walla Walla, Washington, and its 38 branch
offices and six loan production offices located in Washington, Idaho and
Oregon. Prior to merging with FSBW on October 30, 2000, TB was a
Washington-chartered commercial bank and its deposits were insured by the FDIC
under BIF. As of October 30, 2000, TB conducted business from seven full
service branches in the Seattle, Washington, metropolitan area. An eighth
Seattle area office opened in November 2000. Prior to merging with BB on
September 1, 2001, Banner Bank of Oregon (BBO) was an Oregon-chartered
commercial bank whose deposits were insured by the FDIC under BIF. BBO
conducted business from its main office in Hermiston, Oregon, and its six
branch offices and one loan production office located in northeast Oregon.
The Company completed its merger of BBO with and into BB as of September 1,
2001.
The operating results of BANR 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 BANR'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, BANR's net interest income increased for the
quarter ended September 30, 2001 compared to the same period a year earlier,
reflecting a 12 basis point increase in the interest rate spread and growth in
interest bearing assets and liabilities. The net interest margin also
increased, expanding four basis points for the quarter ended September 30,
2001, when compared to the same period one year prior, reflecting the improved
interest rate spread which was somewhat offset by the increased use of
interest-bearing liabilities relative to interest-earning assets. While the
Company's interest rate spread declined four basis points for the nine months
ended September 30, 2001, net interest income for the first nine
15
months increased from the year earlier period as a result of the significant
asset and liability growth that occurred at BANR. Net interest margin
declined by seven basis points for the nine months ended September 30, 2001,
compared to the same period a year earlier. BANR's 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. The provision for loan
losses increased sharply for both the quarter and nine months ended September
30, 2001, compared to the same periods ended September 30, 2000. As explained
more fully below and in Notes 2 and 6 of the Selected Notes to the
Consolidated Financial Statements, much of this increase reflects impaired
loans associated with a former senior commercial loan officer that had been
manipulated to conceal credit weaknesses. Other operating income increased
significantly for both the quarter and nine months ended September 30, 2001,
largely as a result of increased gain on the sale of loans, although other
non-interest revenues also increased. Other operating expenses also increased
significantly for the quarter and nine months ended September 30, 2001,
compared to the same periods ended September 30, 2000. As explained below and
in Notes 2 and 6 of the Selected Notes to the Consolidated Financial
Statements, non-interest expenses for the quarter and nine months ended
September 30, 2001, included check kiting losses of $1.9 million and $8.1
million, respectively. Other operating expenses (excluding the check kiting
losses) also increased compared to the year earlier amounts, reflecting the
continued growth of the Company and costs associated with conversion of the
company's core data processing system.
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 Notes
to the Consolidated Financial Statements.
16
RECENT DEVELOPMENTS AND SIGNIFICANT EVENTS
See Notes 2 and 6 to Consolidated Financial Statements
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2001 AND DECEMBER 31, 2000
Total assets increased $112.0 million, or 5.6%, from $1.983 billion at
December 31, 2000, to $2.095 billion at September 30, 2001. The growth of
$112.0 million occurred substantially at BB and was funded primarily with
deposit growth. This growth reflects the economic conditions in the markets
where BANR operates. Net loans receivable (gross loans less loans in process,
deferred fees and discounts, and allowance for loan losses) grew $111.0
million, or 7.6%, from $1.472 billion at December 31, 2000, to $1.583 billion
at September 30, 2001. This loan growth included an increase of $14.2 million
in loans held for sale which increased to $22.2 million at September 30, 2001,
reflecting increased mortgage banking activity in the current low interest
rate environment. Loans held for sale are generally sold in the secondary
market within sixty days following the loan closing date. The increase in net
loans included growth of $30.5 million of mortgages secured by commercial real
estate, $69.6 million of construction and land loans, and $28.6 million of
non-mortgage commercial and agricultural loans. Partially offsetting these
increases were declines of $8.0 million of one to four-family and $3.0 million
of multi-family real estate loans and a decline of $3.2 million in
non-mortgage consumer loans. These balances 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,
construction and land development, and non-mortgage loans. While these loans
are of inherently higher risk than residential mortgages, management believes
they can produce higher credit-adjusted returns to the Company and provide
better opportunities to develop comprehensive banking relationships with the
borrowers than most residential mortgages. The majority of the increase in
loans was funded by a net increase of $106.0 million in deposits. Increased
borrowings and net income from operations also helped to fund asset growth.
Deposits grew $106.0 million, or 8.9%, from $1.193 billion at December 31,
2000, to $1.299 billion at September 30, 2001. FHLB advances increased $6.7
million from $507.1 million at December 31, 2000, to $513.8 million at
September 30, 2001. Other borrowings, primarily reverse repurchase agreements
with securities dealers, decreased $1.1 million, from $74.5 million at
December 31, 2000, to $73.4 million at September 30, 2001. Securities
available for sale and held to maturity increased $2.5 million, or 0.8%, from
$326.5 million at December 31, 2000, to $329.0 million at September 30, 2001.
FHLB stock increased $1.5 million as a result of the regular quarterly stock
dividends paid by the FHLB. The Company's investment in bank owned life
insurance increased by $5.8 million reflecting $800,000 of accumulated
earnings from increased cash surrender value and an initial premium of $5.0
million for the purchase of additional insurance.
COMPARISON OF RESULTS OF OPERATIONS FOR THE QUARTERS AND NINE MONTHS ENDED
SEPTEMBER 30, 2001 AND 2000
GENERAL. For the quarter ended September 30, 2001, the Company had a net loss
of $144,000, or $.01 per share (diluted), compared to net income of $4.6
million, or $.40 per share (diluted), for the quarter ended September 30,
2000, a decrease of $4.8 million. Net income for the first nine months of the
current year was $3.8 million, a decrease of $9.8 million from the nine months
ended September 30, 2000. The decreases in net income resulted from the
expenses associated with the check kiting scheme and additional loan loss
provision described in Notes 2 and 6. Excluding those charges and the related
tax effect, net income for the quarter and nine months ended September 30,
2001, would have decreased $135,000 and increased $340,000, respectively,
compared to the same periods a year earlier. BANR's operating results
(excluding the check kiting and credit manipulation charges) reflect
significant growth of assets and liabilities which was offset by a higher
level of loan loss provision and other operating expenses. As explained
below, provision for loan losses increased for reasons other than the credit
manipulation activities and other operating expense included certain unusual
data processing conversion and related technology expenses. Net interest
margin increased four basis points for the quarter yet decreased by seven
basis points for the nine-month period reflecting changes in the level of
market rates and the increased use of interest-bearing liabilities relative to
interest-earning assets. The Company's operating results also reflect a
significant increase in other operating revenues, particularly gain on sale of
loans, and other operating expenses including costs associated with the
conversion of its data processing systems and expenses incurred as a result of
increased mortgage lending. Compared to levels a year ago, total assets
increased 5.4%, to $2.095 billion, at September 30, 2001, net loans rose 8.1%,
to $1.583 billion, deposits grew 10.8%, to $1.299 billion, and borrowings
decreased 3.4%, to $587.2 million. Average equity was 9.49% of average
assets for the quarter ended September 30, 2001, compared to 9.43% of average
assets for the quarter ended September 30, 2000. The modest changes in net
interest spread and net interest margin are notable in light of the
significant volatility and changes in the level of market interest rates over
the past twelve months.
17
INTEREST INCOME. Interest income for the quarter ended September 30, 2001,
was $39.9 million compared to $40.9 million for the quarter ended September
30, 2000, a decrease of $1.0 million, or 2.6%. The decrease in interest
income occurred despite an $88.8 million, or 4.8%, growth in average balances
of interest-earning assets as a result of a 64 basis point decrease in the
average yield on those assets. The yield on average interest-earning assets
decreased to 8.08% for the quarter ended September 30, 2001, compared to 8.72%
for the same period a year earlier. Average loans receivable for the quarter
ended September 30, 2001, increased by $144.3 million, or 9.9%, when compared
to the quarter ended September 30, 2000, reflecting the Banks' significant
internal growth. Interest income on loans increased by $408,000, or 1.2%,
compared to the prior year, as the impact of the increase in average loan
balances was substantially offset by a 76 basis point decrease in the average
yield. The decrease in average loan yield reflects the significant decline in
the level of market interest rates, particularly the prime rate, compared to
prior year levels, which offset continued changes in the mix of the loan
portfolio. The loan mix continued to change as the portion of the portfolio
invested in lower yielding one- to four-family residential loans declined,
while the portion invested in higher yielding construction, land development
and commercial loans increased. Loans yielded 8.51% for the quarter ended
September 30, 2001, compared to 9.27% for the quarter ended September 30,
2000. While the level of market interest rates continued a steep decline
during the quarter, loan yields were supported to a degree by certain loans
with rate floors and by changes in the portfolio mix. The average balance of
mortgage-backed securities, investment securities, daily interest-bearing
deposits and FHLB stock decreased by $55.5 million for the quarter ended
September 30, 2001, and the interest and dividend income from those
investments decreased $1.5 million, compared to the quarter ended September
30, 2000. The average yield on mortgage-backed securities decreased from
6.80% for the quarter ended September 30, 2000, to 5.86% for the comparable
period in 2001. Yields on mortgage-backed securities were lower in the 2001
period reflecting the affect of lower market rates on the interest rates paid
on the significant portion of those securities that have adjustable rates and
more rapid prepayments on certain higher-yielding portions of the portfolio.
The average yield on investment securities and short term cash investments
decreased from 6.67% for the quarter ended September 30, 2000, to 6.30% for
the comparable quarter in 2001, also reflecting the lower level of market
rates. Earnings on FHLB stock increased by $81,000, resulting from an increase
of $2.6 million in the average balance of FHLB stock for the quarter ended
September 30, 2001, and a higher dividend yield. The dividend yield on FHLB
stock was 6.99% for the quarter ended September 30, 2001, compared to 6.49%
for the quarter ended September 30, 2000. Dividends on FHLB stock are
established on a quarterly basis by vote of the Directors of the FHLB.
Interest income for the nine months ended September 30, 2001, increased $3.5
million, or 3.0%, from the comparable period in 2000. Interest income from
loans increased $7.2 million, or 7.5%, from the comparable period in 2000.
The increase in loan interest income reflected the effect of a $155.6 million
growth in average loans receivable balances and occurred despite a 29 basis
point decrease in the yield on the loan balances. Interest income from
mortgage-backed and investment securities and FHLB stock for the nine months
ended September 30, 2001, decreased $1.1 million, from $8.7 million in 2000,
to $7.6 million in the current period, reflecting a $22.2 million decrease in
average balances along with a four basis point decrease in yield. The yield
on average earning assets decreased from 8.62% for the nine months ended
September 30, 2000, to 8.42% for the nine months ended September 30, 2001, as
a result of declines in the level of market interest rates, which more than
offset changes in the relative amount of loans and investments.
INTEREST EXPENSE. Interest expense for the quarter ended September 30, 2001,
was $21.5 million compared to $23.7 million for the comparable period in 2000,
a decrease of $2.2 million, or 9.1%. The decrease in interest expense was due
to a decrease in the average cost of all interest-bearing liabilities from
5.33% to 4.57%. The $127.3 million increase in average interest-bearing
deposits for the quarter ended September 30, 2001, compared to September 30,
2000, reflects the solid deposit growth throughout the Company over the past
twelve months. Deposit interest expense decreased $644,000 for the quarter
ended September 30, 2001, compared to the same quarter a year ago. Average
deposit balances increased from $1.161 billion for the quarter ended September
30, 2000, to $1.288 billion for the quarter ended September 30, 2001, while,
at the same time, the average rate paid on deposit balances decreased 68 basis
points. To a significant degree, deposit costs for a quarter reflect market
interest rates and pricing decisions made three to twelve months prior to the
end of that quarter. Generally, market interest rates for deposits were
declining and lower for the nine months preceding the quarter ended September
30, 2001, than for the same period preceding the September 30, 2000, quarter.
The reduction in deposit costs, which tends to lag declines in market rates,
accelerated during the most recent quarter as a result of the cumulative
effect of declining rates in the two preceding quarters as well as sharply
lower rates in the current quarter. Average FHLB advances totaled $509.3
million during the quarter ended September 30, 2001, compared to $530.9
million during the quarter ended September 30, 2000, a decrease of $21.6
million that, combined with a 49 basis point decrease in the average cost of
advances, resulted in a $949,000 decrease in related interest expense. The
average rate paid on those advances decreased to 5.81% for the quarter ended
September 30, 2001, from 6.30% for the quarter ended September 30, 2000. 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
$3.1 million from $76.4 million for
18
the quarter ended September 30, 2000, to $73.3 million for the same period in
2001, while the related interest expense decreased $553,000 from $1.3 million
to $739,000 for the respective periods. The average rate paid on other
borrowings was 4.00% in the quarter ended September 30, 2001 compared to 6.73%
for the same quarter in 2000. Similar to deposits, the cost of FHLB advances
reflects to a degree a lagged effect from prior period market interest rate
levels, while the Company's other borrowings generally have relatively short
terms and therefore reprice to current market levels more quickly.
Total interest expense for the nine months ended September 30, 2001, increased
$1.7 million, or 2.7%, from the comparable period in September 2000. The
increase in interest expense reflects an increase in average deposits of
$105.1 million combined with a $566,000 decrease in FHLB advances and other
borrowings. The effect on interest expense of the $104.5 million increase in
average interest-bearing liabilities was offset by a 16 basis point decrease
in the interest rate paid on those liabilities.
19
The following tables provide additional comparative data on the Company's
operating performance:
Quarters Ended Nine Months Ended
AVERAGE BALANCES September 30 September 30
---------------- ---------------------- ----------------------
(in thousands) 2001 2000 2001 2000
---------- ---------- ---------- ----------
Investment securities
and deposits $ 121,191 $ 154,646 $ 124,521 $ 149,979
Mortgage-backed obligations 199,083 223,699 196,743 230,159
Loans 1,606,375 1,462,106 1,558,183 1,402,539
FHLB stock 29,796 27,231 29,298 26,063
---------- ---------- ---------- ----------
Total average interest-
earning asset 1,956,445 1,867,682 1,908,745 1,808,740
Non-interest-earning assets 127,244 96,998 119,582 95,665
---------- ---------- ---------- ----------
Total average assets $2,083,689 $1,964,680 $2,028,327 $1,904,405
========== ========== ========== ==========
Deposits 1,288,163 1,160,889 $1,235,583 1,130,528
Advances from FHLB 509,331 530,906 507,577 504,415
Other borrowings 73,328 76,365 72,372 76,100
---------- ---------- ---------- ----------
Total average interest-
bearing liabilities 1,870,822 1,768,160 1,815,532 1,711,043
Non-interest-bearing
liabilities 15,079 11,184 15,153 10,970
---------- ---------- ---------- ----------
Total average liabilities 1,885,901 1,779,344 1,830,685 1,722,013
Equity 197,788 185,336 197,642 182,392
---------- ---------- ---------- ----------
Total average liabilities
and equity $2,083,689 $1,964,680 $2,028,327 $1,904,405
========== ========== ========== ==========
INTEREST RATE YIELD/EXPENSE (RATES ARE ANNUALIZED)
--------------------------------------------------
Interest Rate Yield:
Investment securities and
deposits 6.30% 6.67% 6.52% 6.64%
Mortgage-backed obligations 5.86% 6.80% 6.26% 6.81%
Loans 8.51% 9.27% 8.87% 9.16%
FHLB stock 6.99% 6.49% 6.84% 6.50%
---------- --------- --------- ---------
Total interest rate yield on
interest-earning assets 8.08% 8.72% 8.42% 8.62%
---------- --------- --------- ---------
Interest Rate Expense:
Deposits 4.11% 4.79% 4.50% 4.57%
Advances from FHLB 5.81% 6.30% 6.05% 6.13%
Other borrowings 4.00% 6.73% 4.94% 6.38%
---------- --------- --------- ---------
Total interest rate expense
on interest-bearing
liabilities 4.57% 5.33% 4.95% 5.11%
---------- --------- --------- ---------
Interest spread 3.51% 3.39% 3.47% 3.51%
========== ========= ========= =========
Net interest margin on interest
earning assets 3.71% 3.67% 3.71% 3.78%
---------- --------- --------- ---------
ADDITIONAL KEY FINANCIAL RATIOS (RATIOS ARE ANNUALIZED)
-------------------------------------------------------
Return on average assets (0.03%) 0.93% 0.25% 0.95%
Return on average equity (0.29%) 9.89% 2.56% 9.94%
Average equity / average assets 9.49% 9.43% 9.74% 9.58%
Average interest-earning assets /
interest-bearing liabilities 104.58% 105.63% 105.13% 105.71%
Non-interest [other operating]
expenses / average assets
Excluding amortization of costs
in excess of net assets
acquired (goodwill) 2.86% 2.25% 2.96% 2.25%
Including amortization of costs
in excess of net assets
acquired (goodwill) 2.97% 2.37% 3.07% 2.37%
Efficiency ratio [non-interest
(other operating) expenses /
revenues]
Excluding amortization of costs
in excess of net assets
acquired (goodwill) 68.46% 55.98% 70.28% 55.20%
Including amortization of costs
in excess of net assets
acquired (goodwill) 72.13% 60.06% 74.07% 59.38%
20
PROVISION FOR LOAN LOSSES. During the quarter ended September 30, 2001, the
provision for loan losses was $6.0 million, compared to $651,000 for the
quarter ended September 30, 2000, an increase of $5.3 million. A comparison
of the provision for loan losses for the nine-month periods ended September
30, 2001, and 2000, shows an increase of $7.9 million from $2.0 million to
$9.9 million. The increase 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
provisions in the current periods reflect changes in the portfolio mix, higher
levels of non-performing loans and net charge offs, and concerns about the
current economic environment. The provision for loan losses for the quarter
and nine months ended September 30, 2001, includes $4.2 million and $6.2
million, respectively, of charges associated with credit manipulation
activities of a former senior commercial loan officer which were designed to
conceal weaknesses of several loan customers. Non-performing loans increased
to $13.4 million at September 30, 2001, compared to $11.9 million at September
30, 2000. Non-performing loans at September 30, 2001, include $6.3 million of
non-accrual loans associated with the credit manipulation activities. Net
charge offs were $4.1 million for the current quarter compared to $118,000 for
the same quarter a year earlier. Net charge offs for the nine months ended
September 30, 2001, were $6.6 million compared to $532,000 for the nine months
ended September 30, 2000. Net charge offs for the quarter and nine months
ended September 30, 2001, included $3.4 million and $4.9 million associated
with the credit manipulation activities. A comparison of the allowance for
loan losses at September 30, 2001, and 2000, shows an increase of $3.6 million
from $15.0 million at September 30, 2000, to $18.6 million at September 30,
2001. The allowance for loan losses as a percentage of net loans (loans
receivable excluding allowance for losses) was 1.16% and 1.02% at September
30, 2001, and September 30, 2000, respectively. The allowance for loan losses
equaled 138% of non-performing loans at September 30, 2001, compared to 127%
of non-performing loans at September 30, 2000.
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 the allowance are charged to
earnings. 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.
21
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.
22
The following tables are provided to disclose additional detail on the Banks'
loans and allowance for loan losses (in thousands):
September 30 December 31
2001 2000
----------- -----------
Loans (including loans held for sale):
Secured by real estate
One- to four-family $ 410,018 $ 408,613
Commercial 396,539 366,071
Multifamily 81,286 84,282
Construction and land 340,907 271,273
Commercial business 254,716 228,676
Agricultural business 70,444 67,809
Consumer 47,742 60,359
----------- -----------
Total Loans $ 1,601,652 $ 1,487,083
Less allowance for loan losses 18,593 15,314
----------- -----------
Total net loans at end of period $ 1,583,059 $ 1,471,769
=========== ===========
Allowance for loan losses as a percentage
of net loans outstanding 1.16% 1.03%
Quarters Ended Nine Months Ended
September 30 September 30
---------------------- ----------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
Balance, beginning of
the period $ 16,775 $ 14,491 $ 15,314 $ 13,541
Provision 5,959 651 9,859 2,015
Recoveries of loans
previously charged off:
Secured by real estate
One- to four-family -- -- 1 2
Commercial -- 1 -- 1
Multifamily -- -- -- --
Construction and land -- -- -- --
Commercial business 45 5 72 31
Agricultural business -- -- -- --
Consumer 16 26 21 127
--------- ---------- ---------- ----------
61 32 94 161
Loans charged off:
Secured by real estate
One- to four-family -- (4) (97) (65)
Commercial -- (16) -- (16)
Multifamily -- -- -- --
Construction and land -- -- (14) (12)
Commercial business (3,984) (75) (6,026) (248)
Agricultural business -- -- (100) --
Consumer (218) (55) (437) (352)
--------- ---------- ---------- ----------
(4,202) (150) (6,674) (693)
--------- ---------- ---------- ----------
Net charge offs (4,141) (118) (6,580) (532)
--------- ---------- ---------- ----------
Balance, end of period $ 18,593 $ 15,024 $ 18,593 $ 15,024
========= ========== ========== ==========
Net charge offs as a
percentage of average net
book value of loans
outstanding for the period 0.26% 0.01% 0.42% 0.04%
--------- ---------- ---------- ----------
23
The following is a schedule of the Company's allocation of the allowance for
loan losses:
September 30 December 31
2001 2000
---------- ----------
Specific or allocated loss allowances:
Secured by real estate:
One- to four-family $ 2,292 $ 2,256
Commercial 4,119 4,556
Multifamily 615 731
Construction and land 3,755 2,738
Commercial business 4,957 2,859
Agricultural business 979 851
Consumer 777 879
---------- ----------
Total allocated 17,494 14,870
Unallocated 1,099 444
---------- ----------
Total allowance for loan losses $ 18,593 $ 15,314
========== ==========
Ratio of allowance for loan losses to
non-performing loans 138% 183%
Allowance for loan losses as a percent
of net loans (loans receivable excluding
allowance for losses) 1.16% 1.03%
Other Operating Income. Other operating income was $3.3 million for the
quarter ended September 30, 2001, an increase of $1.1 million from the quarter
ended September 30, 2000. This included a $769,000 increase in the gain on
sale of loans for the current quarter. Loan sales for the quarter ended
September 30, 2001 totaled $70.0 million, including $12.9 million of loans
sold by CFC, compared to $32.7 million for the quarter ended September 30,
2000. Gain on sale of loans for BANR included $119,000 of fees on $11.7
million of loans brokered by CFC, which are not reflected in the volume of
loans sold. Other fee and service charge income for BANR decreased by $69,000
to $1.2 million for the quarter ended September 30, 2001, compared to $1.3
million for the quarter ended September 30, 2000. Miscellaneous income
increased by $389,000 in large part reflecting the Company's increased
investment in bank owned life insurance and the resulting increase in cash
surrender value.
Other operating income for the nine months ended September 30, 2001, increased
$4.1 million from the comparable period in 2000. This includes a $2.4 million
increase in the gain on sale of loans, $483,000 increase in other fee and
service charge income, $301,000 increase in gain on sale of securities and an
$810,000 increase in miscellaneous income. Loan sales increased from $71.4
million for the nine months ended September 30, 2000, to $204.4 million for
the nine months ended September 30, 2001. Miscellaneous income includes an
increase of $800,000 of cash surrender value for bank owned life insurance.
Other Operating Expenses. Other operating expenses increased $3.9 million
from $11.7 million for the quarter ended September 30, 2000, to $15.6 million
for the quarter ended September 30, 2001. As noted above, other operating
expense for the quarter ended September 30, 2001, includes a charge of $1.9
million associated with a check kiting scheme that had been concealed by a
former senior lending officer of BB. Excluding the check kiting charge, other
operating expense increased $2.0 million compared to the same quarter a year
earlier. Increases in other operating expenses, excluding the check kiting
charge, reflect the overall growth in assets and liabilities, customer
relationships and complexity of operations as BANR continues to expand. The
increase in expenses reflects the inclusion of two new bank branches opened
subsequent to September 30, 2000. The increase also reflects expenses
associated with the expanding operations at BB's lending subsidiary, CFC. The
increase in other operating expenses was partially offset by a $272,000
increase in capitalized loan origination costs reflecting a greater level of
loan origination activity. Additionally, during the quarter ended September
30, 2001, the Company incurred approximately $800,000 of expenses associated
with the conversion of the Company's core data processing system and an
additional $200,000 for other technology enhancements. The Company expects to
incur about $300,000 of conversion related expenses during the fourth quarter.
The higher operating expenses associated with BANR's transition to more of a
commercial bank profile, coupled with the recognition of the check kiting
loss, caused BANR's efficiency ratio, excluding the amortization of goodwill,
to increase to 68.46% (72.13% including goodwill), for the quarter ended
September 30, 2001, from 55.98% (60.06% including goodwill) for the comparable
period ended September 30, 2000. Other operating expenses as a percentage of
average assets increased to 2.97% (2.86% excluding the amortization of
goodwill) for the quarter ended September 30, 2001, compared to 2.37% (2.25%
excluding the amortization of goodwill) for the
24
quarter ended September 30, 2000. BANR's efficiency ratio adjusted to exclude
amortization of goodwill, the check kiting loss and the unusual conversion and
technology expenses, would have been 55.05% for the quarter and, excluding the
same items, adjusted operating expenses as a percentage of average assets
would have been 2.27%.
Other operating expenses for the nine months ended September 30, 2001,
increased $12.7 million from $33.8 million for the first nine months of 2000
to $46.5 million in the current period. As explained earlier, the increase is
largely due to the previously noted check kiting loss ($8.1 million) and
conversion and technology expenses ($1.3 million) as well as growth in BANR's
operations for the current nine month period.
Income Taxes. Income tax expense was $212,000 for the quarter ended September
30, 2001, compared to $2.5 million for the comparable period in 2000. The
Company's effective tax rates for the quarters ended September 30, 2001 and
2000 were 312% and 35%, respectively. The higher effective tax rate in the
current quarter is primarily a result of a larger relative effect of the
non-deductible goodwill amortization expense compared to the quarter one year
earlier.
Income tax expense for the nine months ended September 30, 2001 decreased to
$2.6 million, compared to $7.5 million in the comparable period in 2000. The
Company's effective tax rates for the nine months ended September 30, 2001 and
2000 were 41% and 36%, respectively. Similar to the quarterly results the
higher effective tax rate in the current period is primarily a result of a
larger relative effect of the non-deductible goodwill amortization expense
compared to the same period a year earlier.
25
Asset Quality
The following tables are provided to disclose additional details on asset
quality (in thousands):
September 30 December 31
2001 2000
---------- ----------
Non-performing assets at end of the period:
Nonaccrual Loans:
Secured by real estate
One- to four-family $ 1,021 $ 873
Multifamily real estate 750 1,741
Commercial real estate 52 --
Construction and land 2,370 2,937
Commercial business 7,977 1,734
Agricultural business 188 529
Consumer 314 18
---------- ----------
12,672 7,832
Loans more than 90 days delinquent, still on accrual:
Secured by real estate
One- to four-family 75 20
Multifamily real estate -- --
Commercial real estate 372 --
Construction and land -- --
Commercial business 49 1
Agricultural business 127 467
Consumer 151 54
---------- ----------
774 542
---------- ----------
Total non-performing loans 13,446 8,374
Real estate owned, held for sale, net (REO),
and other repossessed assets 2,871 3,287
---------- ----------
Total non-performing assets at the end of
the period $ 16,317 $ 11,661
========== ==========
Non-performing loans as a percentage of total
net loans before allowance for loan losses
at end of the period 0.84% 0.56%
Ratio of allowance for loan losses to
non-performing loans at end of the period 138% 183%
Non-performing assets as a percentage of total
assets at end of the period. 0.78% 0.59%
Troubled debt restructuring [TDRs]
at end of the period $ 302 $ 337
========== ==========
Troubled debt restructuring as a percentage of:
Total gross principal of loans outstanding
at end of the period 0.02% 0.02%
Total assets at end of the period 0.01% 0.02%
26
Market Risk and Asset/Liability Management
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 affecting 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.
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.
27
Sensitivity Analysis
The table of Interest Rate Risk Indicators sets forth, as of September 30,
2001, 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 of Interest Rate Risk Indicators
Estimated Change in
------------------------------------------------
Change (In Basis Points) Net Interest Income
in Interest Rates (1) Next 12 Months Net Market Value
- ------------------------ ------------------- ----------------------
(Dollars in thousands)
+400 $ 2,628 3.4% $ (59,536) (30.1%)
+300 2,777 3.6% (32,781) (16.6%)
+200 2,050 2.7% (13,625) (6.9%)
+100 719 0.9% (1,783) (0.9%)
0 0 0 0 0
-100 (848) (1.1%) (7,177) (3.6%)
-200 (2,766) (3.6%) (22,992) (11.6%)
-300 (7,909) (10.3%) (27,657) (14.0%)
-400 $ N/A N/A $ N/A N/A
- ----------
(1) Assumes an instantaneous and sustained uniform change in market interest
rates at all maturities.
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.
The table of Interest Sensitivity Gap presents the Company's interest
sensitivity gap between interest-earning assets and interest-bearing
liabilities at September 30, 2001. The table sets 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 September 30, 2001, total interest-bearing
liabilities maturing or repricing within one year exceeded total
interest-earning assets maturing or repricing in the same time period by $3.9
million, representing a one-year gap to total assets ratio of 0.18%.
28
6 Months
As of September 30, 2001 Within to 1-3 3-5 5-10 Over 10
6 Months One Year Years Years Years Years Total
-------- --------- -------- -------- -------- ------- ----------
(dollars in thousands)
<s> <c> <c> <c> <c> <c> <c> <c>
Interest-earning assets(1):
Construction loans $263,561 $ 5,771 $ 2,857 $ 1,308 $ -- $ -- $ 273,497
Fixed-rate mortgage loans 78,633 66,108 183,191 117,374 126,894 38,743 610,943
Adjustable-rate mortgage loans 186,910 57,556 72,700 4,824 -- -- 321,990
Fixed-rate mortgage-backed
securities 11,322 12,381 53,382 24,514 21,119 13,815 136,533
Adjustable-rate mortgage-backed
securities 80,620 4,875 -- -- -- -- 85,495
Fixed-rate commercial /
agriculture loans 28,921 10,102 32,457 25,552 5,639 1,611 104,282
Adjustable-rate commercial/
agriculture loans 233,290 -- -- -- -- -- 233,290
Consumer and other loans 23,322 7,416 18,064 9,970 1,966 2,325 63,063
Investment securities and
interest-bearing deposits 24,846 6,820 25,305 16,110 7,200 56,467 136,748
-------- --------- -------- -------- -------- -------- ----------
Total rate-sensitive assets 931,425 171,029 387,956 199,652 162,818 112,961 1,965,841
-------- --------- -------- -------- -------- -------- ----------
Interest-bearing liabilities(2):
Regular savings and NOW accounts 18,197 18,197 42,459 42,459 -- - 121,312
Money market deposit accounts 78,799 47,279 31,520 -- -- -- 157,598
Certificates of deposit 448,591 233,280 131,861 26,854 6,288 124 846,998
FHLB advances 106,900 76,370 106,984 97,600 125,079 849 513,782
Other borrowings 60,927 -- -- -- -- -- 60,927
Retail repurchase agreements 9,422 626 2,395 -- -- -- 12,443
-------- --------- -------- -------- -------- -------- ----------
Total rate-sensitive liabilities 722,836 375,752 315,219 166,913 131,367 973 1,713,060
-------- --------- -------- -------- -------- -------- ----------
Excess (deficiency) of interest-sensitive
assets over interest-sensitive
liabilities $208,589 $(204,723) $ 72,737 $ 32,739 $ 31,451 $111,988 $ 252,781
======== ========= ======== ======== ======== ======== ==========
Cumulative excess (deficiency) of
interest-sensitive assets $208,589 $ 3,866 $ 76,603 $109,342 $140,793 $252,781 $ 252,781
======== ========= ======== ======== ======== ======== ==========
Cumulative ratio of interest-earning
assets to interest-bearing
liabilities 128.86% 100.35% 105.42% 106.92% 108.22% 114.76% 114.76%
======== ========= ======== ======== ======== ======== ==========
Interest sensitivity gap to
total assets 9.96% (9.77%) 3.47% 1.56% 1.50% 5.35% 12.07%
======== ========= ======== ======== ======== ======== ==========
Ratio of cumulative gap to
total assets 9.96% 0.18% 3.66% 5.22% 6.72% 12.07% 12.07%
======== ========= ======== ======== ======== ======== ==========
(footnotes on following page)
29
Footnotes for Table of 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 periods 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- and variable-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, 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 negative
$112.6 million or (5.37%) of total assets. Interest-bearing liabilities for
this table exclude certain non-interest bearing deposits which are included in
the average balance calculations in the table included in the comparison of
Results of Operations section of this document.
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 September
30, 2001, the Company purchased loans in the amount of $2.7 million while loan
originations, net of repayments, totaled $307.5 million. This activity was
funded primarily by principal repayments on securities, sales of loans, and
deposit growth. During the nine months ended September 30, 2001, the Company
sold $204.4 million of loans. Net deposit growth was $106.0 million for the
nine months ended September 30, 2001. FHLB advances increased $6.7 million
for the nine months ended September 30, 2001. Other borrowings decreased $1.2
million for the nine months ended September 30, 2001.
The Bank 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 September 30, 2001,
the Banks used their sources of funds primarily to fund loan commitments, to
purchase securities, to repay FHLB advances and other borrowings, and to pay
maturing savings certificates and deposit withdrawals. At September 30, 2001,
BB had outstanding loan commitments totaling $243.3 million. BB generally
maintains sufficient cash and readily marketable securities to meet short-term
liquidity needs. BB maintains a credit facility with the FHLB-Seattle, which
provides for advances which, in aggregate, may equal the lesser of 45% of BB's
assets or unencumbered qualifying collateral, which as of September 30, 2001
could give a maximum total credit line of $942 million. Advances under this
credit facility totaled $513.8 million, or 25% of BB's assets at September 30,
2001.
At September 30, 2001, savings certificates amounted to $847.0 million, or
65%, of the Bank's total deposits, including $681.9 million which were
scheduled to mature within one year. Historically, the Bank has been able to
retain a significant amount of its deposits as they mature. Management
believes it has adequate resources to fund all loan commitments from savings
deposits, FHLB-Seattle advances, other borrowings and sale of mortgage loans
and that it can adjust the offering rates for savings certificates to retain
deposits in changing interest rate environments.
30
Capital Requirements
Federally-insured state-chartered banks are required to maintain minimum
levels of regulatory capital. Under current FDIC regulations, insured
state-chartered banks generally must maintain (i) a ratio of Tier 1 leverage
capital to total assets of at least 3.0% (4.0% to 5.0% for all but the most
highly rated banks), (ii) a ratio of Tier 1 capital to risk-weighted assets of
at least 4.0% and (iii) a ratio of total capital to risk-weighted assets of at
least 8.0%. At September 30, 2001, BANR's banking subsidiaries exceeded all
current regulatory capital requirements to be classified as well capitalized
institutions, the highest regulatory standard. In order to be categorized as
a well capitalized institution, the FDIC requires banks it regulates to
maintain a leverage ratio, defined as Tier 1 capital divided by total
regulatory assets, of at least 5.00%; Tier 1 (or core) capital of at least
6.00% of risk-weighted assets; and total capital of at least 10.00% of
risk-weighted assets.
BANR, as a bank holding company, is regulated by the Federal Reserve Board
(FRB). The FRB has established capital requirements for bank holding
companies that generally parallel the capital requirements of the FDIC for
banks with $150 million or more in total consolidated assets. BANR's total
regulatory capital must equal 8% of risk-weighted assets and one half of the
8% (4%) must consist of Tier 1 (core) capital.
The actual regulatory capital ratios calculated for BANR along with the
minimum capital amounts and ratios for capital adequacy purposes were as
follows (dollars in thousands):
Minimum for capital
Actual adequacy purposes
----------------- -------------------
Amount Ratio Amount Ratio
------ ----- ------ -----
September 30, 2001:
BANR consolidated
Total capital to risk-
weighted assets $177,574 11.60% $122,481 8.00%
Tier 1 capital to risk-
weighted assets 157,989 10.32 61,240 4.00
Tier 1 leverage capital
average assets 157,989 7.74 81,625 4.00
31
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
From time to time BANR or its subsidiaries are engaged in legal proceedings in
the ordinary course of business, none of which is considered to have a
material impact on the BANR's financial position or results of operations.
Item 2. Changes in Securities
Not Applicable
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Stockholders
Not Applicable
Item 5. Other Information
Not Applicable
Item 6. Exhibits and Reports on Form 8K
Report (s) on Form 8-K filed during the quarter ended September 30, 2001,
are as follows:
Date Filed Purpose
---------- -------
September 7, 2001 Announcement of consummation of merger
of the company's wholly owned
subsidiary banks, Banner Bank and
Banner Bank of Oregon.
September 18, 2001 Announcement of irregularities
associated with a former senior
lending officer. The irregularities
include a check kiting scheme and will
result in the recognition of a loss
and recording of additional loan loss
provision.
September 26, 2001 Announcement of entering into an
agreement and plan of merger between
wholly-owned subsidiary, Banner Bank,
and Oregon Business Bank.
32
SIGNATURES
- ----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Banner Corporation
November 14, 2001 /s/ Gary Sirmon
-------------------------------------
Gary Sirmon
President and Chief Executive Officer
November 14, 2001 /s/ Lloyd W. Baker
-------------------------------------
Lloyd W. Baker
Treasurer and Executive Vice President
33