UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
---------
(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, 2003.
------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________ to _________ :
Commission File Number 0-26584
BANNER CORPORATION
(Exact name of registrant as specified in its charter)
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Washington 91-1691604
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification Number)
10 South First Avenue, Walla Walla, Washington 99362
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (509) 527-3636
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). 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, 2003
--------------- ----------------------
Common Stock, $.01 par value per share 11,421,719 shares*
* Includes 515,960 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, 2003 and December 31, 2002 . . . . . . . . . . . . . . 2
Consolidated Statements of Income
for the Quarters and Nine Months Ended September 30, 2003 and 2002 . . . . 3
Consolidated Statements of Comprehensive Income
for the Quarters and Nine Months Ended September 30, 2003 and 2002 . . . . 4
Consolidated Statements of Changes in Stockholders' Equity
for the Nine Months Ended September 30, 2003 and 2002. . . . . . . . . . . 5
Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 2003 and 2002. . . . . . . . . . . 7
Selected Notes to Consolidated Financial Statements. . . . . . . . . . . . 9
Item 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operation
Special Note Regarding Forward-Looking Statements. . . . . . . . . . . . . 13
General. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Recent Developments and Significant Events . . . . . . . . . . . . . . . . 13
Comparison of Financial Condition at September 30, 2003 and December
31, 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Comparison of Results of Operations for the Quarters and Nine Months Ended
September 30, 2003 and 2002. . . . . . . . . . . . . . . . . . . . . . . . 14
Asset Quality. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Liquidity and Capital Resources. . . . . . . . . . . . . . . . . . . . . . 21
Capital Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
Market Risk and Asset/Liability Management . . . . . . . . . . . . . . . . 23
Sensitivity Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Item 4 - Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . 27
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . 28
Item 2 - Changes in Securities and Use of Proceeds . . . . . . . . . . . . . 28
Item 3 - Defaults upon Senior Securities . . . . . . . . . . . . . . . . . . 28
Item 4 - Submission of Matters to a Vote of Stockholders . . . . . . . . . . 28
Item 5 - Other Information . . . . . . . . . . . . . . . . . . . . . . . . . 28
Item 6 - Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . . 28
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
1
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (in thousands, except shares)
September 30, 2003 (Unaudited) and December 31, 2002
(Unaudited)
September 30 December 31
ASSETS 2003 2002
------- -------
Cash and due from banks $ 72,320 $ 132,910
Securities available for sale, cost $588,123
and $415,855
Encumbered 37,994 32,955
Unencumbered 554,836 388,267
--------- ---------
592,830 421,222
Securities held to maturity, fair value $13,719
and $13,414
Encumbered 216 --
Unencumbered 12,312 13,253
--------- ---------
12,528 13,253
Federal Home Loan Bank stock 34,262 32,831
Loans receivable:
Held for sale, fair value $23,925 and $39,984 23,593 39,366
Held for portfolio 1,668,392 1,534,100
Allowance for loan losses (26,161) (26,539)
--------- ---------
1,665,824 1,546,927
Accrued interest receivable 13,944 13,689
Real estate owned, held for sale, net 6,849 6,062
Property and equipment, net 22,074 20,745
Goodwill and other intangibles, net 36,563 36,714
Deferred income tax asset, net 1,391 2,786
Bank-owned life insurance 33,218 31,809
Other assets 10,563 4,224
--------- ---------
$ 2,502,366 $ 2,263,172
LIABILITIES ========= =========
Deposits:
Non-interest-bearing $ 203,596 $ 200,500
Interest-bearing 1,502,124 1,297,278
--------- ---------
1,705,720 1,497,778
Advances from Federal Home Loan Bank 461,552 465,743
Trust preferred securities 55,000 40,000
Other borrowings 58,764 41,202
Accrued expenses and other liabilities 19,139 24,700
Deferred compensation 4,006 3,372
Income taxes payable -- --
--------- ---------
2,304,181 2,072,795
COMMITMENTS AND CONTINGENCIES -- --
STOCKHOLDERS' EQUITY
Preferred stock - $0.01 par value per share, 500,000
shares authorized, no shares issued -- --
Common stock - $0.01 par value per share, 27,500,000
shares authorized, 13,201,418 shares issued:
11,415,636 shares and 11,306,977 shares outstanding
at September 30, 2003 and December 31, 2002,
respectively. 121,383 120,554
Retained earnings 77,411 70,813
Accumulated other comprehensive income:
Unrealized gain on securities available for sale 4,166 3,488
Unearned shares of common stock issued to Employee
Stock Ownership Plan (ESOP) trust:
515,960 and 515,707 restricted shares outstanding at
September 30, 2003 and December 31, 2002,
respectively, at cost (4,264) (4,262)
Carrying value of shares held in trust for stock
related compensation plans (3,602) (3,190)
Liability for common stock issued to deferred,
stock related, compensation plans 3,091 2,974
--------- ---------
198,185 190,377
--------- ---------
$ 2,502,366 $ 2,263,172
========= =========
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
-------------- -----------------
2003 2002 2003 2002
------ ------ ------ ------
INTEREST INCOME:
Loans receivable $ 29,260 $ 30,907 $ 87,500 $ 92,860
Mortgage-backed securities 2,227 2,770 8,462 8,212
Securities and cash equivalents 3,035 2,672 8,690 7,571
------ ------ ------ ------
34,522 36,349 104,652 108,643
INTEREST EXPENSE:
Deposits 8,889 9,733 26,611 29,751
Federal Home Loan Bank advances 5,339 5,791 16,786 18,490
Trust preferred securities 446 380 1,559 718
Other borrowings 188 366 563 1,258
------ ------ ------ ------
14,862 16,270 45,519 50,217
------ ------ ------ ------
Net interest income before provision for
loan losses 19,660 20,079 59,133 58,426
PROVISION FOR LOAN LOSSES 1,400 4,000 5,900 11,000
------ ------ ------ ------
Net interest income 18,260 16,079 53,233 47,426
OTHER OPERATING INCOME:
Loan servicing fees 241 239 688 996
Other fees and service charges 1,895 1,525 5,392 4,331
Mortgage banking revenues 2,924 1,602 8,230 4,021
Gain (loss) on sale of securities 15 10 18 27
Miscellaneous 464 555 1,412 1,323
------ ------ ------ ------
Total other operating income 5,539 3,931 15,740 10,698
OTHER OPERATING EXPENSES:
Salary and employee benefits 12,495 9,973 35,295 27,757
Less capitalized loan origination costs (2,028) (1,438) (5,578) (4,043)
Occupancy and equipment 2,447 2,141 7,168 6,263
Information/computer data services 930 925 2,636 2,262
Miscellaneous 4,024 3,699 12,679 10,227
------ ------ ------ ------
Total other operating expenses 17,868 15,300 52,200 42,466
------ ------ ------ ------
Income before provision for income taxes 5,931 4,710 16,773 15,658
PROVISION FOR INCOME TAXES 1,778 1,329 5,070 4,841
------ ------ ------ ------
NET INCOME $ 4,153 $ 3,381 $ 11,703 $ 10,817
Net income per common share (see ====== ====== ====== ======
(see Note 5):
Basic $ .38 $ .31 $ 1.08 $ .98
Diluted $ .37 $ .30 $ 1.05 $ .95
Cumulative dividends declared per common
share: $ .15 $ .15 $ .45 $ .45
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
-------------- -----------------
2003 2002 2003 2002
------ ------ ------ ------
NET INCOME: $ 4,153 $ 3,381 $ 11,703 $ 10,817
OTHER COMPREHENSIVE INCOME (LOSS),
NET OF INCOME TAXES:
Unrealized holding gain (loss) during the
period, net of deferred income tax
(benefit) of $449, $576, $371 and
$727 respectively. 836 1,067 690 1,348
Less adjustment for (gains)/losses
included in net income, net of income
tax (benefit) of $5, $4, $6 and $10;
respectively (10) (6) (12) (17)
------ ------ ------ ------
Other comprehensive income (loss) 826 1,061 678 1,331
------ ------ ------ ------
COMPREHENSIVE INCOME $ 4,979 $ 4,442 $ 12,381 $ 12,148
====== ====== ====== ======
See notes to consolidated financial statements
4
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited) (In thousands, except per share amounts)
For the Nine Months Ended September 30, 2003 and 2002
Carrying Value
Of Shares Held
in Trust for
Common Stock Accumulated Unearned Stock-Related
And Additional Other Restricted Compensation Total
Paid-in Retained Comprehensive ESOP Plans Stockholders'
Capital Earnings Income Shares Net of Liability Equity
--------- -------- ------------- -------- ---------------- ------------
<s> <c> <c> <c> <c> <c> <c>
BALANCE, January 1, 2002 $126,844 $ 68,104 $ 2,264 $ (4,769) $ (103) $ 192,340
Net income 10,817 10,817
Change in valuation of
securities available for
sale, net of income taxes 1,331 1,331
Cash dividend on common stock
($ .45/share cumulative) (5,188) (5,188)
Purchase and retirement of
common stock (7,285) (7,285)
Proceeds from issuance of
common stock for exercise of
stock options 1,138 1,138
Recognition of tax benefit
related to release or MRP
shares 4 4
Release of treasury stock
from MRP grant 135 (135) --
Amortization of compensation
related to MRP 27 27
--------- -------- ------------- -------- ---------------- ------------
BALANCE, September 30, 2002 $ 120,836 $ 73,733 $ 3,595 $ (4,769) $ (211) $ 193,184
========= ======== ============= ======== ================ ============
BALANCE, January 1, 2003 $ 120,554 $ 70,813 $ 3,488 $ (4,262) $ (216) $ 190,377
Net income 11,703 11,703
Change in valuation of
securities available for
sale, net of income taxes 678 678
Cash dividend on common stock
($ .45/share cumulative) (5,105) (5,105)
Proceeds from reissued common
stock for exercise of stock
options 437 437
Adjust prior year release of
earned ESOP shares (3) (2) (5)
Release of stock for MRP grant 443 (443) --
Amortization of compensation
related to MRP 100 100
Forfeiture or net change in the
number and/or carrying value of
shares held in trust for
compensation plans (48) 48 --
--------- -------- ------------- -------- ---------------- ------------
BALANCE, September 30, 2003 $ 121,383 $ 77,411 $ 4,166 $ (4,264) $ (511) $ 198,185
========= ======== ============= ======== ================ ============
See selected 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, 2003 and 2002
2003 2002
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 COMMON stock RETIRED:
Number of shares, beginning of period (1,894) (1,567)
Purchase and retirement of common stock (9) (364)
Issuance of common stock to deferred compensation
plan and/or exercised stock options 117 89
------ ------
Number of shares retired, end of period (1,786) (1,842)
------ ------
Shares issued and outstanding, end of period 11,415 11,359
====== ======
UNEARNED, RESTRICTED ESOP SHARES:
Number of shares, beginning of period (516) (577)
Release of earned shares -- --
------ ------
Number of shares, end of period (516) (577)
====== ======
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, 2003 and 2002
2003 2002
OPERATING ACTIVITIES ------ ------
Net income $ 11,703 $ 10,817
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 5,304 2,802
Loss (gain) on sale of securities (18) (27)
Increase in cash surrender value of bank owned
life insurance (1,409) (1,052)
Gain on sale of loans, excluding capitalized
servicing rights (6,872) (3,405)
Loss (gain) on disposal of real estate held for
sale and property and equipment (170) 454
Provision for losses on loans and real estate held for sale 6,405 11,000
Federal Home Loan Bank stock dividend (1,431) (1,408)
Net change in:
Loans held for sale 15,773 14,191
Other assets (5,163) 3,641
Other liabilities (4,759) (2,810)
------- -------
Net cash provided (used) by operating activities 19,363 34,203
------- -------
INVESTING ACTIVITIES:
Purchases of securities (600,642) (208,012)
Principal repayments and maturities of securities 382,747 135,017
Proceeds from sales of securities 44,298 4,670
Origination of loans, net of principal repayments (596,528) (213,239)
Purchases of loans and participating interest in loans (29,030) (22,650)
Proceeds from sales of loans and participating interest
in loans 486,013 245,311
Purchases of property and equipment-net (3,844) (3,002)
Proceeds from sale of real estate held for sale-net 5,422 1,679
Investment in bank-owned life insurance -- (10,000)
Cash (used for) provided by acquisitions -- (6,519)
Other (46) (134)
------- -------
Net cash used by investing activities (311,610) (76,879)
------- -------
FINANCING ACTIVITIES
Increase in deposits 207,942 156,372
Proceeds from FHLB advances 567,850 255,231
Repayment of FHLB advances (572,041) (312,970)
Proceeds from issuance of trust preferred securities 15,000 25,000
Increase (decrease) in repurchase agreement borrowings 5,058 (13,958)
Increase (decrease) in other borrowings 12,504 1,556
Cash dividends paid (5,088) (5,118)
Repurchases of stock, net of forfeitures -- (7,285)
ESOP shares earned (5) --
Exercise of Stock Options 437 1,138
------- -------
Net cash provided by financing activities 231,657 99,966
------- -------
NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS (60,590) 57,290
CASH AND DUE FROM BANKS, BEGINNING OF PERIOD 132,910 67,728
------- -------
CASH AND DUE FROM BANKS, END OF PERIOD $ 72,320 $125,018
======= =======
(Continued on next page)
7
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (in thousands)
For the Nine Months Ended September 30, 2003 and 2002
(Continued from prior page)
2003 2002
------ ------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid in cash $ 45,781 $ 50,110
Taxes paid in cash $ 5,000 $ 4,900
Non-cash transactions:
Loans, net of discounts, specific loss allowances and
unearned income, transferred to real estate owned
and other repossessed assets $ 6,859 $ 4,470
Net change in accrued dividends payable $ 17 $ 70
Stock issued to Rabbi Trust/MRP $ 395 $ 135
Recognize tax benefit of vested MRP shares $ -- $ 4
Fair value of derivatives issued on loan rate lock
commitments and offsetting commitments to sell $ 193 $ 600
Other assets/liabilities $ 68 $ 64
The following summarizes the non-cash activities
relating to acquisitions:
Fair value of assets and intangibles acquired $ -- $(44,544)
Fair value of liabilities assumed -- 34,453
Fair value of stock issued and
options assumed to acquisitions' shareholders -- --
------- -------
Cash paid out in acquisition (10,091)
Less cash acquired -- 3,572
------- -------
Net cash acquired (used) $ -- $ (6,519)
======= =======
See notes to consolidated financial statements
8
BANNER CORPORATION AND SUBSIDIARIES
SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Basis of Presentation and Critical Accounting Policies
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). The Bank is a Washington-chartered
commercial bank that conducts business from its main office in Walla Walla,
Washington, and its 42 branch offices and nine 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.
Various elements of the Company's accounting policies, by their nature, are
inherently subject to estimation techniques, valuation assumptions and other
subjective assessments. In particular, management has identified several
accounting policies that, due to the judgments, estimates and assumptions
inherent in those policies, are critical to an understanding of the financial
statements. These policies relate to the methodology for the determination of
the provision and allowance for loan and lease losses, the valuation of
goodwill, estimation of deferred taxes, valuation and amortization of deferred
loan fees and mortgage servicing rights, and valuation of real estate held for
sale. These policies and the judgments, estimates and assumptions are described
in greater detail in Management's Discussion and Analysis of Financial Condition
and Results of Operations and in Note 1 of the Notes to the Consolidated
Financial Statements in the Company's Annual Report on Form 10-K for the year
ended December 31, 2002 filed with the Securities and Exchange Commission.
Management believes that the judgments, estimates and assumptions used in the
preparation of the Company's financial statements are appropriate given the
factual circumstances at the time. However, given the sensitivity of the
financial statements to these critical accounting policies, the use of other
judgments, estimates and assumptions could result in material differences in the
Company's results of operations or financial condition.
Stock Compensation Plans: The Company measures its employee stock-based
compensation arrangements under the provisions outlined in Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees.
Accordingly, no compensation cost has been recognized for its stock option
plans. If the compensation cost for the Company's compensation plans had been
determined consistent with Statement of Financial Accounting Standards (SFAS)
No. 123, Accounting for Stock-Based Compensation, the Company's net income
available to common stockholders on a diluted basis and diluted earnings per
common share would have been reduced to the pro forma amounts indicated below
(in thousands except per share amounts):
Quarters Ended Nine Months Ended
September 30 September 30
-------------- -----------------
2003 2002 2003 2002
---- ---- ---- ----
Net income available to common stockholders:
Basic:
As reported $ 4,153 $ 3,381 $11,703 $10,817
Pro forma 3,873 3,063 10,875 10,235
Diluted:
As reported $ 4,153 $ 3,381 $11,703 $10,817
Pro forma 3,873 3,063 10,875 10,235
Net income per common share:
Basic:
As reported $ 0.38 $ 0.31 $ 1.08 $ 0.98
Pro forma 0.36 0.28 1.01 0.93
Diluted:
As reported $ 0.37 $ 0.30 $ 1.05 $ 0.95
Pro forma 0.34 0.27 0.98 0.89
The compensation expense included in the pro forma net income available to
common stockholders on a diluted basis and diluted earnings per common share is
not likely to be representative of the effect on reported net income for future
years because options vest over several years and additional awards generally
are made each year.
9
The fair value of options granted under the Company's stock option plans (SOPs)
is estimated on the date of grant using the Black-Scholes option-pricing model
with the following weighted average assumptions used for grants:
2003 2002
------------- -------------
Annual dividend yield 2.79 to 3.76% 2.58 to 3.56%
Expected volatility 29.5 to 49.6% 40.2 to 64.8%
Risk free interest rate 2.94 to 4.44% 2.63 to 5.21%
Expected lives 5 to 9 yrs 5 to 9 yrs
Certain reclassifications have been made to the 2002 financial statements and/or
schedules to conform to the 2003 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 2002 Annual Report on Form 10-K for the year ended December
31, 2002 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
Sale of $55 Million of Trust Preferred Securities: During fiscal 2002, the
Company completed the issuance of $40 million of trust preferred securities
(TPS) in private placements of $25 million in April 2002 and $15 million in
December 2002. On September 25, 2003, the Company completed the issuance of an
additional $15 million of TPS, also in a private placement. The TPS were issued
by special purpose business trusts owned by the Company and sold to pooled
investment vehicles sponsored and marketed by investment banking firms. The TPS
have been recorded as a liability on the statement of financial condition but,
under current Federal Reserve guidelines, qualify as Tier 1 capital for
regulatory capital purposes. A portion of the proceeds from these offerings was
used to augment the Bank's capital with the remainder expected to be used
primarily to fund growth, including acquisitions. Remaining proceeds may also
be used to fund the Company's stock repurchase program and for other general
corporate purposes as necessary.
Under the terms of the transactions, the TPS have a maturity of 30 years and are
redeemable after five years with certain exceptions. The holders of the TPS are
entitled to receive cumulative cash distributions at a variable annual rate.
The initial issue, of $25 million, has a current interest rate of 4.92% (4.99%
at the most recent quarter end), which is reset semi-annually to equal six-month
LIBOR plus 3.70%. The second issue, of $15 million, has a current rate of 4.50%
(4.64% at the most recent quarter end), which is reset quarterly to equal
three-month LIBOR plus 3.35%. The third issue, of $15 million, has a current
rate of 4.04% (4.04% at the most recent quarter end), which is reset quarterly
to equal three-month LIBOR plus 2.90%.
Accounting Standards Recently Adopted or Issued: On May 31, 2003, the Financial
Accounting Standards Board (FASB) issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity. This
statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). Many of
those instruments were previously classified as equity. Some of the provisions
of this statement are consistent with the current definition of liabilities in
FASB Concepts Statement No. 6, Elements of Financial Statements. The remaining
provisions of this statement are consistent with FASB's proposal to revise the
definition to encompass certain obligations that a reporting entity can or must
settle by issuing its own equity shares, depending on the nature of the
relationship established between the holder and the issuer. This statement was
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise was effective at the beginning of the first interim period
beginning after June 15, 2003, except for mandatorily redeemable financial
instruments of nonpublic entities. The adoption of SFAS No. 150 has not had a
material impact on the Company's financial statements.
On April 30, 2003, FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. The new guidance amends SFAS No. 133 for decisions made as part of the
Derivatives Implementation Group "DIG" process that effectively required
amendments to SFAS No. 133, and decisions made in connection with other FASB
projects dealing with financial instruments and in connection with
implementation issues raised in relation to the application of the definition of
a derivative and characteristics of a derivative that contains financing
components. In addition, it clarifies when a derivative contains a financing
component that warrants special reporting in the statement of cash flows. SFAS
No. 149 was effective for contracts entered into or modified after June 30, 2003
and for hedging relationships designated after June 30, 2003. The Bank's
adoption of SFAS No. 149 did not result in a material impact on the Company's
financial statements.
In June 2002, FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. This statement requires recording costs associated
with exit or disposal activities at their fair values when a liability has been
incurred. Under previous guidance, certain exit costs were accrued upon
management's commitment to an exit plan, which is generally before an actual
liability has been incurred. The Company adopted SFAS No. 146 as of January 1,
2003. The adoption of SFAS No. 146 has not had a material impact on the
Company's consolidated results of operations, financial position or cash flows.
10
In January 2003, FASB issued Financial Accounting Standards Board Interpretation
Number (FIN) 46, Consolidation of Certain Variable Interest Entities An
Interpretation of ARB No. 51, to clarify when an entity should consolidate
another entity known as a Variable Interest Entity (VIE), more commonly referred
to as a special purpose entity or SPE. A VIE is an entity in which equity
investors do not have characteristics of a controlling financial interest or do
not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties, and may
include many types of SPEs. FIN 46 requires that an entity consolidate a VIE if
that entity has a variable interest that will absorb a majority of the VIE's
expected losses if they occur, receive a majority of the VIE's expected residual
returns if they occur, or both. FIN 46 was effective for newly created VIEs
beginning February 1, 2003. The effective date for existing VIEs was deferred
by FASB until the fourth quarter of 2003. The Company is currently evaluating
the impact of the interpretation on its financial statements and, except for the
possible effect related to its trust preferred obligation, and possible related
regulatory effects, does not currently believe the interpretation will have
significant effects.
In November 2002, FASB issued FIN 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others, which requires the guarantor to recognize as a liability the fair value
of the obligation at the inception of the guarantee. The disclosure
requirements in FIN 45 were effective for financial statements of interim or
annual periods ending after December 15, 2002. Management believes that the
Company has no material guarantees that are required to be disclosed in the
financial statements. The recognition provisions are to be applied on a
prospective basis to guarantees issued after December 31, 2002. The adoption of
the recognition provisions of FIN 45 did not have a material impact on the
Company's financial statements.
Note 3: Business Segments
The Company is managed by legal entity and not by lines of business. The Bank
is a community oriented commercial bank chartered in the State of Washington.
The Bank's primary business is that of a traditional banking institution,
gathering deposits and originating loans for portfolio in its primary market
area. The Bank 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. The Bank 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, the Bank receives other
income from deposit service charges, loan servicing fees and from the sale of
loans and investments. The performance of the Bank is reviewed by the Company's
executive management and Board of Directors on a monthly basis. All of the
executive officers of the Company are members of the Bank's management team.
Generally accepted accounting principles establish standards to report
information about operating segments in annual financial statements and
require reporting of selected information about operating segments in interim
reports to stockholders. The Company has determined that its current
business and operations consist of a single business segment.
11
Note 4: Additional Information Regarding Interest-Bearing Deposits and
Securities
Encumbered Securities: Securities labeled "Encumbered" are pledged securities
that are subject to certain agreements which may allow the secured party to
either sell and replace them with similar but not the exact same security or
otherwise pledge the securities. In accordance with SFAS No. 140, the amounts
have been separately identified in the Consolidated Statements of Financial
Condition as "Encumbered."
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 September 30
2003 2002 2002
Interest-bearing deposits included -------- -------- --------
in cash and due from banks $ 128 $ 42,921 $ 51,736
-------- -------- --------
Mortgage-backed securities 331,485 269,153 225,872
Other securities--taxable 240,968 141,404 138,257
Other securities--tax exempt 29,342 21,107 21,000
Equity securities with dividends 3,563 2,811 2,702
-------- -------- --------
Total securities 605,358 434,475 387,831
Federal Home Loan Bank (FHLB) stock 34,262 32,831 32,282
-------- -------- --------
$639,748 $510,227 $471,849
======== ======== ========
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
-------------- -----------------
2003 2002 2003 2002
------ ------ ------ ------
Mortgage-backed securities interest $ 2,227 $ 2,770 $ 8,462 $ 8,212
------ ------ ------ ------
Taxable interest and dividends 2,292 1,877 6,400 5,187
Tax-exempt interest 296 310 859 973
FHLB stock dividends 447 485 1,431 1,411
------ ------ ------ ------
3,035 2,672 8,690 7,571
------ ------ ------ ------
$ 5,262 $5,442 $17,152 $15,783
====== ====== ====== ======
Note 5: Calculation of Weighted Average Shares Outstanding for Earnings Per
Share (EPS)
The following table reconciles total shares originally issued to weighted shares
outstanding used to calculate earnings per share data (in thousands):
Quarters Ended Nine Months Ended
September 30 September 30
-------------- -----------------
2003 2002 2003 2002
------ ------ ------ ------
Total shares originally issued 13,201 13,201 13,201 13,201
Less retired weighted average shares plus
unvested weighted average shares allocated
to MRP (1,842) (1,732) (1,873) (1,626)
Less unallocated shares held by the ESOP (516) (577) (516) (577)
------ ------ ------ ------
Basic weighted average shares outstanding 10,843 10,892 10,812 10,998
Plus unvested MRP and stock option
incremental shares considered outstanding
for diluted EPS calculations 426 395 335 440
------ ------ ------ ------
Diluted weighted average shares outstanding 11,269 11,287 11,147 11,438
====== ====== ====== ======
12
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
the Company. 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 cause actual results to differ materially include, but
are not limited to, regional and general economic conditions, management's
ability to generate continued improvement in asset quality and profitability,
changes in interest rates, deposit flows, demand for mortgages and other loans,
real estate values, competition, loan delinquency rates, changes in accounting
principles, practices, policies or guidelines, changes in legislation or
regulation, other economic, competitive, governmental, regulatory and
technological factors affecting operations, pricing, products and services and
the Company's ability to successfully resolve the outstanding credit issues.
Accordingly, these factors should be considered in evaluating the
"forward-looking statements," and undue reliance should not be placed on such
statements. The Company undertakes no responsibility to update or revise any
"forward-looking statements."
General
Banner Corporation, a Washington corporation, is primarily engaged in the
business of planning, directing and coordinating the business activities of its
wholly owned subsidiary, Banner Bank. The Bank is a Washington-chartered
commercial bank the deposits of which are insured by the Federal Deposit
Insurance Corporation (FDIC). The Bank is a regional bank which offers a wide
variety of commercial banking services and financial products to both businesses
and individuals in its primary market areas. The Bank conducts business from
its main office in Walla Walla, Washington, and its 42 branch offices and nine
loan production offices located in 20 counties in Washington, Oregon and
Idaho.
The operating results of the Company depend primarily on its net interest
income, which is the difference between interest income on interest-
earning assets, consisting of loans and investment securities, and interest
expense on interest-bearing liabilities, composed primarily of customer deposits
and FHLB advances. Net interest income is primarily a function of the Company's
interest rate spread, which is the difference between the yield earned on
interest-earning assets and the rate paid on interest-bearing liabilities, as
well as a function of the average balance of interest-earning assets as compared
to the average balance of interest-bearing liabilities. As more fully explained
below, the Company's net interest income decreased for the quarter ended
September 30, 2003, compared to the same period a year earlier, as a result of a
decrease of 59 basis points in the interest rate spread and despite growth in
interest-bearing assets and liabilities. By contrast, for the nine months ended
September 30, 2003, the Company's net interest income increased, despite a
decrease of 35 basis points in the interest rate spread, as a result of growth
in interest-bearing assets and liabilities. The net interest margin also
decreased 63 and 41 basis points, respectively, for the quarter and nine months
ended September 30, 2003, compared to the same periods one year ago. The
Company's net income also is affected by provisions for loan losses and the
level of its other income, including deposit service charges, loan 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 decreased $2.6 million to $1.4 million for the quarter
ended September 30, 2003, compared to $4.0 million for the quarter ended
September 30, 2002. For the nine months ended September 30, 2003, the provision
for loan losses was $5.9 million, compared to $11.0 million for the same period
a year earlier. Other operating income increased significantly for the quarter
and nine months ended September 30, 2003, largely as a result of increased
mortgage banking activity and resulting gain on the sale of loans, although
other non-interest revenues also increased significantly. Other operating
expenses also increased for the quarter and nine months ended September 30,
2003, compared to the same periods ended September 30, 2002, reflecting the
continued growth of the Company as detailed below in the Comparison of Financial
Condition and Operating Results sections of this report.
Management's discussion and analysis of results of operations is intended to
assist in understanding the financial condition and results of operations of the
Company. The information contained in this section should be read in
conjunction with the Consolidated Financial Statements and accompanying Selected
Notes to the Consolidated Financial Statements.
Recent Developments and Significant Events
See Note 2 to the Consolidated Financial Statements.
Comparison of Financial Condition at September 30, 2003 and December 31, 2002
General: Total assets increased $239.2 million, or 10.6%, from $2.263 billion
at December 31, 2002, to $2.502 billion at September 30, 2003. The growth
largely resulted from an increase in securities, and growth in the loan
portfolio, and was funded primarily by deposit growth. Net loans receivable
(gross loans less loans in process, deferred fees and discounts, and allowance
for loan losses) increased $118.9 million, or 7.7%, from $1.547 billion at
December 31, 2002, to $1.666 billion at September 30, 2003. Despite decreases
of $52.5 million in one- to four-family residential mortgages and $2.4 million
in consumer loans as a result of accelerated prepayments in the current low
interest rate environment, the balance of the loan portfolio experienced net
growth, including an increase of $54.7 million in mortgages secured by
commercial real estate loans, an increase of $4.1 million in multifamily real
estate loans, an increase of $53.3 million in construction and land loans and an
increase of $61.4 million in non-mortgage commercial and agricultural loans.
These increased balances reflect the Company's continuing effort to increase the
portion of its loans invested in commercial real estate, construction, land
development, and commercial
13
business and agricultural loans. While these loans are inherently of 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 borrowers than most residential
mortgages. Securities available for sale and held to maturity increased $170.9
million, or 39.3%, from $434.5 million at December 31, 2002, to $605.4 million
at September 30, 2003, as a result of additional investing. FHLB stock
increased $1.4 million as a result of dividends paid by the FHLB in the form of
additional shares of stock. The Company also had an increase of $1.4 million in
bank-owned life insurance from the growth of cash surrender values on existing
policies. Other assets increased $6.3 million, largely as a result of the
Company recording a $5 million commitment to invest in limited partnerships
focused on providing affordable housing for low and moderate income families.
The majority of the increase in assets was funded by a growth in deposits.
Asset growth was also funded by additional borrowings, the issuance of trust
preferred securities and net income from operations. Deposits grew $207.9
million, or 13.9%, from $1.498 billion at December 31, 2002, to $1.706 billion
at September 30, 2003. Non-interest-bearing deposits increased $3.1 million, or
1.5%, and interest-bearing deposits increased by $204.8 million, or 15.8%, from
the prior year-end amounts. While FHLB advances decreased $4.2 million from
$465.7 million at December 31, 2002, to $461.6 million at September 30, 2003,
trust preferred securities increased $15.0 million to $55.0 million and other
borrowings increased $17.6 million to $58.8 million at September 30, 2003.
Comparison of Results of Operations for the Quarters and Nine Months Ended
September 30, 2003 and 2002
General. For the quarter ended September 30, 2003, the Company had net income
of $4.2 million, or $.37 per share (diluted), compared to net income of $3.4
million, or $.30 per share (diluted), for the quarter ended September 30, 2002,
an increase of $772,000. The Company's operating results reflect the
significant growth of assets and liabilities, which was generally offset by a
narrower net interest margin. The Company's operating results also reflect
significant increases in other operating income and other operating expenses.
Compared to levels a year ago, total assets increased 12.2%, to $2.502 billion
at September 30, 2003, net loans increased 5.9%, to $1.666 billion, deposits
grew 14.8%, to $1.706 billion, and borrowings, including trust preferred
securities, increased 7.7%, to $575.3 million. Average interest earning assets
were $2.327 billion for the quarter ended September 30, 2003, an increase of
$326.8 million, or 16.3%, compared to the same period a year earlier. Average
equity was 7.87% of average assets for the quarter ended September 30, 2003,
compared to 9.14% of average assets for the quarter ended September 30, 2002.
Net Interest Income. Net interest income before provision for loan losses
decreased to $19.7 million for the quarter ended September 30, 2003, compared to
$20.1 million for the quarter ended September 30, 2002. Net interest margin
decreased 63 basis points for the quarter, reflecting a 59 basis point decrease
in net interest rate spread and an increased use of interest-bearing liabilities
relative to interest-earning assets. Net interest income before provision for
loan losses increased to $59.1 million for the nine months ended September 30,
2003, compared to $58.4 million for the same period ended September 30, 2002.
For the nine-month period, the net interest margin decreased 41 basis points,
reflecting a 35 basis point decrease in net interest rate spread and a similar
increased use of interest-bearing liabilities relative to interest-earning
assets. The changes in net interest spread and net interest margin reflect the
impact of the current very low level of market interest rates as well the
effects of changes in the asset and liability mix.
Interest Income. Interest income for the quarter ended September 30, 2003 was
$34.5 million, compared to $36.3 million for the quarter ended September 30,
2002, a decrease of $1.8 million, or 5.0%. The decrease in interest income
occurred despite a $326.8 million, or 16.3%, growth in average balances of
interest-earning assets as a result of a 132 basis point decrease in the average
yield on those assets. The yield on average interest-earning assets decreased to
5.89% for the quarter ended September 30, 2003, compared to 7.21% for the same
period a year earlier. Average loans receivable for the quarter ended September
30, 2003 increased by $125.9 million, or 8.0%, when compared to the quarter
ended September 30, 2002. Nonetheless, interest income on loans for the quarter
decreased by $1.6 million, or 5.3%, compared to the prior year, as the impact of
the increase in average loan balances was more than offset by a 97 basis point
decrease in the average yield. The decrease in average loan yield reflects the
significant decline in the level of market interest rates compared to prior year
levels, particularly the prime rate, which affects a large portion of
construction, commercial and agricultural loans, and lower mortgage rates, which
have led to a significant amount of prepayments of real estate loans. The loan
mix continued to change as the portion of the portfolio invested in one- to
four-family residential loans declined, while the portion invested in
construction, land development and commercial loans increased. Loans yielded
6.83% for the quarter ended September 30, 2003, compared to 7.80% for the
quarter ended September 30, 2002. While the level of market interest rates was
significantly lower than a year earlier, loan yields were supported to a degree
by certain loans with rate floors and by changes in the portfolio mix. The
combined average balance of mortgage-backed securities, investment securities,
daily interest-bearing deposits and FHLB stock increased by $200.8 million for
the quarter ended September 30, 2003, while the interest and dividend income
from those investments decreased $180,000 compared to the quarter ended
September 30, 2002. The average yield on mortgage-backed securities decreased
to 2.73% for the quarter ended September 30, 2003, from 5.31% for the comparable
period in 2002, reflecting significantly accelerated amortization of purchase
premiums on certain portions of the portfolio as a result of the rapid
prepayments as well as the effect of lower market rates on the interest rates
paid on the portion of those securities that have adjustable rates, prepayments
on certain higher-yielding portions of the portfolio, and reinvestment and
growth at current market rates. The average yield on investment securities and
short-term cash investments decreased to 3.78% for the quarter ended September
30, 2003, from 4.60% for the comparable quarter in 2002, also reflecting the
lower level of market rates. Earnings on FHLB stock decreased by $37,000, to
$448,000, in the quarter ended September 30, 2003, from $485,000 in the
comparable quarter in 2002, despite a $2.0 million increase in the average
balance held, as a result of a 79 basis point decrease in the yield received.
The dividend yield on FHLB stock was 5.26% for the quarter ended September 30,
2003, compared to 6.05% for the quarter ended September 30, 2002. 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, 2003 decreased by $4.0
million, or 3.7%, to $104.7 million from $108.6 million for the comparable
period in 2002. Interest income from loans decreased $5.4 million, or 5.8%,
from the comparable period in 2002. The decrease in loan interest income
reflects the impact of a 67 basis point decrease in the yield on the loan
balances and occurred despite a $49.7 million growth in the average balance of
loans receivable. Interest income from mortgage-backed and investment
securities and FHLB stock for the
14
nine months ended September 30, 2003 increased $1.4 million, from $15.8 million
in 2002 to $17.2 million in the current period, reflecting a substantial $206.1
million increase in average balances, offset by a 149 basis point decrease in
yield. Similar to the quarter just ended, yields for the nine months ended
September 30, 2003 reflect the significant effect of the low level of market
interest rates and rapid prepayments on loans and securities.
Interest Expense. Interest expense for the quarter ended September 30, 2003 was
$14.9 million, compared to $16.3 million for the comparable period in 2002, a
decrease of $1.4 million, or 8.7%. The decrease in interest expense was the
result of a decrease in the average cost of all interest-bearing liabilities to
2.59% from 3.32%, primarily reflecting the lower levels of market interest
rates. Deposit interest expense decreased $844,000 for the quarter ended
September 30, 2003, compared to the same quarter a year ago, despite the solid
deposit growth throughout the Company over the past twelve months, as a result
of a continuing decline in the cost of deposits. Average deposit balances
increased $279.4 million, or 19.8%, to $1.691 billion for the quarter ended
September 30, 2003, from $1.412 billion for the quarter ended September 30,
2002, while, at the same time, the average rate paid on deposit balances
decreased 65 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. Despite some modest upward movement during
the current quarter, market interest rates for deposits generally were declining
and lower for the nine months preceding the quarter ended September 30, 2003,
than for the same period preceding the quarter ended September 30, 2002. The
reduction in deposit costs, which tends to lag declines in market rates,
continued in the most recent quarter as a result of the cumulative effect of
declining rates in preceding quarters as well as very low rates in the current
quarter. Average FHLB advances totaled $495.0 million during the quarter ended
September 30, 2003, compared to $444.6 million during the quarter ended
September 30, 2002, an increase of $50.4 million that, combined with a 89 basis
point decrease in the average cost of advances, resulted in a $452,000 decrease
in related interest expense. The average rate paid on those advances decreased
to 4.28% for the quarter ended September 30, 2003, from 5.17% for the quarter
ended September 30, 2002. FHLB advances are generally fixed-rate, fixed-term
borrowings with rates on many of those advances having been established in
periods when market rates were considerably higher than are currently available.
Funding was also provided in the third quarter of 2003 by trust preferred
securities (TPS) which had an average balance of $40.2 million and an average
cost of 4.41% (including amortization of prepaid underwriting costs) for the
quarter ended September 30, 2003. TPS outstanding in the third quarter of the
prior year had an average balance of $25.0 million and an average rate of 6.03%.
Other borrowings consist of retail repurchase agreements with customers and
reverse repurchase agreements with investment banking firms secured by certain
investment securities. The average balance for other borrowings decreased $13.2
million, to $51.8 million for the quarter ended September 30, 2003, from $65.0
million for the same period in 2002, while the related interest expense
decreased $178,000, to $188,000, from $366,000 for the respective periods. The
average rate paid on other borrowings was 1.44% in the quarter ended September
30, 2003, compared to 2.24% for the same quarter in 2002. The Company's other
borrowings generally have relatively short terms and therefore reprice to
current market levels more quickly than FHLB advances, which generally lag
current market rates.
15
A comparison of total interest expense for the nine months ended September 30,
2003, shows a decrease of $4.7 million, or 9.4%, from the comparable period in
September 2002. The interest expense reflects an increase in average deposits
of $221.1 million combined with a $50.6 million increase in FHLB advances, trust
preferred securities and other borrowings. The effect on interest expense of
the $271.1 million increase in average interest-bearing liabilities was offset
by a 72 basis point decrease in the interest rate paid on those liabilities.
The following tables provide additional comparative data on the Company's
operating performance:
Quarters Ended Nine Months Ended
September 30 September 30
---------------------- -----------------------
Average Balances 2003 2002 2003 2002
---------------- ------ ------ ------ ------
(in thousands)
Investment securities and
deposits $ 271,189 $ 188,744 $ 244,046 $ 163,318
Mortgage-backed obligations 323,477 207,117 328,178 204,848
Loans 1,698,796 1,572,856 1,638,508 1,588,842
FHLB stock 33,819 31,806 33,350 31,351
--------- --------- --------- ---------
Total average interest-earning
assets 2,327,281 2,000,523 2,244,082 1,988,359
Non-interest-earning assets 170,972 157,773 162,623 144,041
--------- --------- --------- ---------
Total average assets $2,498,253 $2,158,296 $2,406,705 $2,132,400
========= ========= ========= =========
Deposits $1,691,159 $1,411,767 $1,599,482 $1,378,411
Advances from FHLB 494,959 444,585 507,384 456,831
Trust preferred securities 40,163 25,000 40,055 15,842
Other borrowings 51,772 64,956 46,853 71,640
Total average interest-bearing --------- --------- --------- ---------
liabilities 2,278,053 1,946,308 2,193,774 1,922,724
Non-interest-bearing liabilities 23,470 14,687 17,840 12,719
--------- --------- --------- ---------
Total average liabilities 2,301,523 1,960,995 2,211,614 1,935,433
Equity 196,730 197,301 195,091 196,957
--------- --------- --------- ---------
Total average liabilities
and equity $2,498,253 $2,158,296 $2,406,705 $2,132,400
========= ========= ========= =========
Interest Rate Yield/Expense (rates are annualized)
-------------------------------------------------
Interest Rate Yield:
Investment securities
and deposits 3.78% 4.60% 3.98% 5.04%
Mortgage-backed obligations 2.73% 5.31% 3.45% 5.36%
Loans 6.83% 7.80% 7.14% 7.81%
FHLB stock 5.26% 6.05% 5.74% 6.02%
Total interest rate yield on ------ ------ ------ ------
interest-earning assets 5.89% 7.21% 6.24% 7.31%
------ ------ ------ ------
Interest Rate Expense:
Deposits 2.09% 2.74% 2.22% 2.89%
Advances from FHLB 4.28% 5.17% 4.42% 5.41%
Trust preferred securities 4.41% 6.03% 5.20% 6.06%
Other borrowings 1.44% 2.24% 1.61% 2.35%
Total interest rate expense on ------ ------ ------ ------
interest-bearing liabilities 2.59% 3.32% 2.77% 3.49%
------ ------ ------ ------
Interest spread 3.30% 3.89% 3.47% 3.82%
====== ====== ====== ======
Net interest margin on interest
earning assets 3.35% 3.98% 3.52% 3.93%
------ ------ ------ ------
Additional Key Financial Ratios
(ratios are annualized)
-------------------------------
Return on average assets 0.66% 0.62% 0.65% 0.68%
Return on average equity 8.38% 6.80% 8.02% 7.34%
Average equity / average assets 7.87% 9.14% 8.11% 9.24%
Average interest-earning assets /
interest-bearing liabilities 102.16% 102.79% 102.29% 103.41%
Non-interest(other operating)
expenses/ average assets 2.84% 2.81% 2.90% 2.66%
Efficiency ratio [non-interest
(other operating) expenses /
revenues] 70.91% 63.72% 69.72% 61.43%
16
Provision and Allowance for Loan Losses. During the quarter ended September 30,
2003, the provision for loan losses was $1.4 million, compared to $4.0 million
for the quarter ended September 30, 2002, a decrease of $2.6 million. For the
nine months ended September 30, 2003, the provision for loan losses was $5.9
million, compared to $11.0 million for the same period ended September 30, 2002.
As noted in Note 1 to the Consolidated Financial Statements, the provision and
allowance for loan losses is one of the most critical accounting estimates
included in the Company's financial statements. The decrease in the provision
for loan 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. Despite slightly higher levels of non-performing loans
than a year earlier and continued concerns about the current economic
environment, the provision in the current periods is lower largely as a result
of the recognition of the deterioration of the portfolio through the very large
provisions recorded in the fourth quarter of 2002, which significantly added to
the allowance for loan losses, and clear improvement in the Company's credit
quality ratios in recent periods. Non-performing loans increased to $24.4
million at September 30, 2003, compared to $22.7 million at September 30, 2002,
but declined from $28.1 million and $36.1 million, respectively, at June 30,
2003 and December 31, 2002. Non-performing loans are primarily concentrated in
the Puget Sound region where continued economic weakness has diminished certain
borrowers' ability to meet loan obligations. Net charge-offs were $1.3 million
for the current quarter, compared to $1.5 million for the same quarter a year
earlier. Net charge-offs declined to $6.3 million for the first nine months of
2003, compared to $9.9 million for the nine months ended September 30, 2002. A
comparison of the allowance for loan losses at September 30, 2003 and 2002,
shows an increase of $7.0 million, to $26.2 million at September 30, 2003, from
$19.2 million at September 30, 2002. The allowance for loan losses as a
percentage of total loans (loans receivable excluding allowance for losses) was
1.55% and 1.20% at September 30, 2003 and September 30, 2002, respectively.
In originating loans, the Company recognizes that losses will be experienced and
that the risk of loss will vary with, among other things, the type of loan being
made, the credit worthiness of the borrower over the term of the loan, general
economic conditions and, in the case of a secured loan, the quality of the
security for the loan. As a result, the Company maintains an allowance for loan
losses consistent with the GAAP guidelines outlined in SFAS No. 5, Accounting
for Contingencies. The Company has established systematic methodologies for the
determination of the adequacy of its allowance for loan losses. The
methodologies are set forth in a formal policy and take into consideration the
need for an overall general valuation allowance as well as specific allowances
that are tied to individual problem loans. The Company increases its allowance
for loan losses by charging provisions for probable loan losses against the
Company's income and values impaired loans consistent with the guidelines in
SFAS No. 114, Accounting by Creditors for Impairment of a Loan, and SFAS No.
118, Accounting by Creditors for Impairment of a Loan Income Recognition
and Disclosure.
The allowance for losses on loans is maintained at a level sufficient to provide
for estimated losses based on evaluating known and inherent risks in the loan
portfolio and upon management's continuing analysis of the factors underlying
the quality of the loan portfolio. These factors include changes in the size
and composition of the loan portfolio, delinquency rates, actual loan loss
experience, current 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. Realized losses related to specific assets are
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 allowance
for loan losses. These agencies may require changes 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 Company's
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, as well as individual review of certain large balance loans. Large
groups of smaller-balance homogeneous loans are collectively evaluated for
impairment. Loans that are collectively evaluated for impairment 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. As of September 30, 2003, the Company had
identified $23.2 million of impaired loans as defined by SFAS 114 and had
established $4.0 million of specific loss allowances for these loans.
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 Bank's loan portfolio 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.
17
The following tables are provided to disclose additional detail on the Company's
loans and allowance for loan losses (in thousands):
September 30 December 31 September 30
2003 2002 2002
Loans (including loans held for sale): ------------ ----------- ------------
Secured by real estate:
One- to four-family $ 274,723 $ 329,314 $ 350,016
Consumer secured by one- to four-family 28,243 26,195 26,541
---------- ---------- ----------
Total one- to four-family 302,966 355,509 376,557
Commercial 433,800 379,099 379,416
Multifamily 76,397 72,333 81,919
Construction and land 392,819 339,516 335,411
Commercial business 326,368 285,231 278,713
Agricultural business 122,890 102,626 99,899
Consumer 36,745 39,152 40,918
---------- ---------- ----------
Total loans outstanding 1,691,985 1,573,466 1,592,833
Less allowance for loan losses 26,161 26,539 19,150
---------- ---------- ----------
Total net loans outstanding at end
of period $1,637,955 $1,546,927 $1,573,683
========== ========== ==========
Quarters Ended Nine Months Ended
September 30 September 30
---------------- ----------------
2003 2002 2003 2002
------ ------ ------ ------
Balance, beginning of the period $ 26,075 $ 16,646 $ 26,539 $ 17,552
Acquisitions -- -- -- 460
Provision for loan losses 1,400 4,000 5,900 11,000
Recoveries of loans previously charged off:
Secured by real estate:
One- to four-family -- -- -- --
Commercial -- -- -- --
Multifamily - -- -- --
Construction and land 78 -- 78 --
Commercial business 481 41 794 54
Agricultural business -- 1 12 3
Consumer 7 4 36 60
------ ------ ------ ------
566 46 920 117
Loans charged off:
Secured by real estate:
One- to four-family (346) -- (357) (11)
Commercial (368) -- (2,247) --
Multifamily -- -- -- --
Construction and land (1) (120) (530) (607)
Commercial business (1,067) (1,376) (3,708) (8,665)
Agricultural business -- -- -- (142)
Consumer (98) (46) (356) (554)
------ ------ ------ ------
(1,880) (1,542) (7,198) (9,979)
------ ------ ------ ------
Net charge-offs (1,314) (1,496) (6,278) (9,862)
------ ------ ------ ------
Balance, end of the period $ 26,161 $ 19,150 $ 26,161 $ 19,150
====== ====== ====== ======
Net charge-offs as a percentage of average
net book value of loans outstanding for
the period 0.08% 0.10% 0.38% 0.62%
18
The following is a schedule of the Company's allocation of the allowance for
loan losses:
September 30 December 31 September 30
2003 2002 2002
------------ ----------- ------------
Specific or allocated loss allowances:
Secured by real estate:
One- to four-family $ 676 $ 670 $ 711
Commercial 4,801 5,284 2,814
Multifamily 382 361 414
Construction and land 5,254 5,892 4,011
Commercial business 7,911 8,788 9,192
Agricultural business 2,942 2,164 945
Consumer 499 698 642
--------- -------- ---------
Total allocated 22,465 23,857 18,729
Estimated allowance for undisbursed commitments 240 36 34
Unallocated 3,456 2,646 387
--------- -------- ---------
Total allowance for loan losses $ 26,161 $ 26,539 $ 19,150
========= ======== =========
Allowance for loan losses as a percentage of
total loans outstanding(loans receivable
excluding allowance for losses) 1.55% 1.69% 1.20%
Other Operating Income. Other operating income was $5.5 million for the quarter
ended September 30, 2003, an increase of $1.6 million from the quarter ended
September 30, 2002. This included a $1.3 million increase in the gain on sale
of loans for the current quarter as lower interest rates led to increased
mortgage banking activity. Loan sales for the quarter ended September 30, 2003
totaled $190.8 million, compared to $84.9 million for the quarter ended
September 30, 2002. Gain on sale of loans for the Company included $179,000 of
fees on $13.2 million of loans which were brokered and are not reflected in the
volume of loans sold. Other fee and service charge income increased by
$370,000, to $1.9 million for the quarter ended September 30, 2003, compared to
$1.5 million for the quarter ended September 30, 2002, primarily reflecting
growth in customer transaction accounts, although increased fees also reflect
changes in the Company's overdraft protection program that have been implemented
in the current year.
Other operating income for the nine months ended September 30, 2003 increased
$5.0 million from the comparable period in 2002. This includes a $4.2 million
increase in the gain on sale of loans reflecting the current year's strong
mortgage banking activity and a $1.1 million increase in other fee and service
charge income primarily reflecting growth in customer transaction accounts, as
well as increased fees related to customer overdraft protection. Loan sales
increased from $245.6 million for the nine months ended September 30, 2002, to
$486.0 million for the nine months ended September 30, 2003. Loan servicing
fees declined by $308,000 compared to the same nine-month period a year earlier
largely as a result of accelerated loan prepayments in the current
low interest rate environment.
Other Operating Expenses. Other operating expenses increased $2.6 million, to
$17.9 million for the quarter ended September 30, 2003, from $15.3 million for
the quarter ended September 30, 2002. Other operating expenses reflect the
overall growth in assets and liabilities, customer relationships and complexity
of operations as the Company continues to expand. The higher level of operating
expenses in the current year includes significant increases in compensation for
credit examination and special assets personnel as well as additional executive
management and production staff hired to re-position the Company for future
growth. In addition, compensation was higher as a result of increased incentive
compensation and staffing caused by the elevated level of mortgage banking
activity in the current year. The higher level of mortgage banking activity is
also reflected in the increase in capitalized loan origination costs. The
Company also significantly increased its commitment to advertising and marketing
expenditures which were $195,000 greater in the quarter ended September 30, 2003
than in the same period in the prior year. The increase in expenses includes
operating costs associated with opening new branch offices in Spokane and Pasco,
Washington and new commercial lending centers in Portland, Oregon and Bellevue
(greater Seattle), Spokane and the Tri-Cities, Washington. The increase in
other operating expenses was partially offset by a $590,000 increase in
capitalized loan origination costs, reflecting a greater level of loan
origination activity. Higher operating expenses, as well as a reduction in the
net interest margin, caused the Company's efficiency ratio to increase to 70.91%
for the quarter ended September 30, 2003, from 63.72% for the comparable period
ended September 30, 2002. Other operating expenses as a percentage of average
assets increased slightly to 2.84% for the quarter ended September 30, 2003,
compared to 2.81% for the quarter ended September 30, 2002.
Other operating expenses for the nine months ended September 30, 2003 increased
$9.7 million, from $42.5 million for the first nine months of 2002 to $52.2
million in the current period. As explained earlier, the increase is largely
due to the increases in compensation, occupancy and advertising expenses as the
volume of activity has expanded and the Bank positions itself for future growth.
The increased expenses in the current period also reflect a higher level of cost
associated with the collection and disposition of non-performing assets.
Income Taxes. Income tax expense was $1.8 million for the quarter ended
September 30, 2003, compared to $1.3 million for the comparable period in 2002.
The Company's effective tax rates for the quarters ended September 30, 2003 and
2002 were 30% and 28%, respectively. The higher effective tax rate in the
quarter ended September 30, 2003 is primarily a result of an increase in the
relative amount of taxable income versus tax-exempt income compared to the third
quarter of 2002, largely as a result of the lower provision for loan losses in
the current quarter.
Income tax expense for the nine months ended September 30, 2003 increased to
$5.1 million, compared to $4.8 million in the comparable period
19
in 2002. The Company's effective tax rates for the nine months ended September
30, 2003 and 2002 were 30% and 31%, respectively. The lower effective tax rate
in the current period is primarily a result of an increase in the relative
effect of the tax-exempt income and the recording of $49,000 of tax credits
associated with investments in limited partnerships focused on providing
affordable housing for low and moderate income families.
Asset Quality
Classified Assets: State and federal regulations require that the Bank review
and classify its problem assets on a regular basis. In addition, in connection
with examinations of insured institutions, state and federal examiners have
authority to identify problem assets and, if appropriate, require them to be
classified. The Bank's Credit Policy Division reviews detailed information with
respect to the composition and performance of the loan portfolio, including
information on risk concentrations, delinquencies and classified assets. The
Credit Policy Division approves all recommendations for new classified assets or
changes in classifications, and develops and monitors action plans to resolve
the problems associated with the assets. The Credit Policy Division also
approves recommendations for establishing the appropriate level of the allowance
for loan losses. Significant problem loans are transferred to the Bank's
Special Assets Department for resolution or collection activities. The Board of
Directors is given a detailed report on classified assets and asset quality at
least quarterly.
Allowance for Loan Losses: In originating loans, the Bank recognizes that
losses will be experienced and that the risk of loss will vary with, among other
things, the type of loan being made, the credit worthiness of the borrower over
the term of the loan, general economic conditions and, in the case of a secured
loan, the quality of the security for the loan. As a result, the Bank maintains
an allowance for loan losses consistent with the generally acceptable accounting
principles guidelines. The Company increases its allowance for loan losses by
charging provisions for probable loan losses against the Company's income. The
allowance for losses on loans is maintained at a level which, in management's
judgment, is sufficient to provide for estimated losses based on evaluating
known and inherent risks in the loan portfolio and upon continuing analysis of
the factors underlying the quality of the loan portfolio.
At September 30, 2003, the Company had an allowance for loan losses of $26.2
million, which represented 1.55% of total loans and 107% of non-performing
loans, compared to 1.69% and 74%, respectively, at December 31, 2002.
During the year ended December 31, 2002, the Bank experienced deterioration in
asset quality, which had a significant effect on operating results, primarily
through increased loan loss provisioning and increased loan collection costs.
Collection costs have remained high for the first nine months of 2003; however,
non-performing assets decreased to $31.6 million, or 1.26% of total assets, at
September 30, 2003, compared to $42.2 million, or 1.86% of total assets, at
December 31, 2002. Problem loans are primarily due from borrowers located in
the Puget Sound region and are the result of poor risk assessment at the time
they were originated, coupled with weakened economic conditions in that area.
For the quarter ended September 30, 2003, non-performing loans decreased by $3.7
million while real estate owned and other repossessed asset decreased by $1.9
million. At September 30, 2003, the Bank's largest non-performing asset
exposure consisted of two related land development loans totaling $7.0 million
secured by property located in the greater Seattle, Washington area, one of
which had been converted to real estate owned at that date. On October 31,
2003, the Company closed a sale on a significant portion of this development,
which resulted in a $5.2 million reduction in the real estate owned balance.
The Company's next largest non-performing loan exposure encompasses loans
totaling $4.1 million to an agricultural-related business operating in
northeastern Oregon which are primarily secured by non-farm real estate and
processing equipment. Balances for these loans are reflected in the non-accrual
loan totals for commercial real estate and commercial business loans at
September 30, 2003, in the table on the following page of this report. The
Company had three additional non-performing credit relationships with balances
in excess of $1.0 million, the largest of which had an aggregate carrying value
of $1.6 million at September 30, 2003. While meaningful progress was made in
the two most recent quarters, reducing non-performing loans and improving asset
quality will be important activities to enhance the Bank's operating performance
in future periods.
20
The following tables set forth information with respect to the Bank's
non-performing assets and restructured loans within the meaning of SFAS No.
15, Accounting by Debtors and Creditors for Troubled Debt Restructuring, at the
dates indicated (dollars in thousands):
September 30 December 31 September 30
2003 2002 2002
------------ ----------- ------------
Non-performing assets at end of the period:
Nonaccrual Loans:
Secured by real estate:
One- to four-family $ 283 $ 455 $ 852
Commercial 6,790 7,421 2,745
Multifamily -- -- --
Construction and land 7,578 16,030 7,276
Commercial business 8,187 9,894 11,028
Agricultural business 305 194 --
Consumer 66 255 381
-------- -------- ---------
23,209 34,249 22,282
Loans more than 90 days delinquent, still on accrual:
Secured by real estate:
One- to four-family 734 343 48
Commercial -- -- --
Multifamily -- -- --
Construction and land -- 1,283 156
Commercial business 476 163 30
Agricultural business -- -- --
Consumer 17 70 197
-------- -------- ---------
1,227 1,859 431
-------- -------- ---------
Total non-performing loans 24,436 36,108 22,713
Real estate owned, held for sale, and other
repossessed assets, net 7,164 6,062 5,362
-------- -------- ---------
Total non-performing assets at the end of
the period $ 31,600 $ 42,170 $ 28,075
======== ======== =========
Non-performing loans as a percentage of
total net loans before allowance for
loan losses at end of the period 1.44% 2.29% 1.43%
Non-performing assets as a percentage of
total assets at end of the period. 1.26% 1.86% 1.26%
Troubled debt restructuring (TDRs)
at end of the period $ 646 $ 2,057 $ 598
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 repayments 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 and purchase of investment securities. During
the nine months ended September 30, 2003, the Company purchased loans in the
amount of $29.0 million while loan originations, net of principal repayments,
totaled $596.5 million. For the nine months ended September 30, 2003,
securities purchases net of principal repayments totaled $217.9 million. This
activity was funded primarily by principal repayments on loans and securities,
sales of loans, deposit growth and borrowings. During the nine months ended
September 30, 2003, the Company sold $486.0 million of loans, net deposit growth
was $207.9 million, FHLB advances decreased $4.2 million and other borrowings
increased $17.6 million.
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 quarter ended September 30, 2003, the Bank used its
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, 2003, the Bank had
outstanding loan commitments totaling $530.3 million, including undisbursed
loans in process totaling $480.1 million. The Bank generally maintains
sufficient cash and readily marketable securities to meet short-term liquidity
needs. The Bank maintains a credit facility with the FHLB-Seattle, which
provides for advances which, in aggregate, may equal the lesser of 35% of the
Bank's assets or unencumbered qualifying collateral, up to a total possible
credit line of $875 million. Advances under this credit facility totaled $461.6
million, or 18% of the Bank's assets, at September 30, 2003.
At September 30, 2003, certificates of deposit amounted to $1.035 billion, or
61% of the Bank's total deposits, including $771.7 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 customer deposits,
FHLB-Seattle advances, other borrowings, principal and
21
interest payments and sale of mortgage loans and that it can adjust the offering
rates for savings certificates to retain deposits in changing interest rate
environments.
Capital Requirements
The Company is a bank holding company registered with the Federal Reserve. Bank
holding companies are subject to capital adequacy requirements of the Federal
Reserve under the Bank Holding Company Act of 1956, as amended, and the
regulations of the Federal Reserve. The Bank, as a state-chartered, federally
insured commercial bank, is subject to the capital requirements established by
the FDIC.
The capital adequacy requirements are quantitative measures established by
regulation that require the Company and the Bank to maintain minimum amounts and
ratios of capital. The Federal Reserve requires the Company to maintain capital
adequacy that generally parallels the FDIC requirements. The FDIC requires the
Bank to maintain minimum ratios of Tier 1 total capital to risk-weighed assets
as well as Tier 1 leverage capital to average assets. At September 30, 2003 and
December 31, 2002, the Company and the Bank exceeded all current regulatory
capital requirements. (See Item 1, "Business Regulation," and Note 18 of the
Notes to the Consolidated Financial Statements included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2002 filed with the
Securities and Exchange Commission, for additional information regarding the
Company's and the Bank's regulatory capital requirements.)
The actual regulatory capital ratios calculated for the Company and the Bank as
of September 30, 2003, along with the minimum capital amounts and ratios, were
as follows (dollars in thousands):
Minimum to be
categorized as
Minimum "well-capitalized"
for capital under prompt
adequacy corrective action
Actual purposes provisions
------------- ------------- ---------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(dollars in thousands)
September 30, 2003:
The Company - consolidated
Total capital to risk-
weighted assets $236,200 12.71% $148,683 8.00% N/A N/A
Tier 1 capital to risk-
weighted assets 212,246 11.42 74,342 4.00 N/A N/A
Tier 1 leverage capital
to average assets 212,246 8.64 98,293 4.00 N/A N/A
The Bank
Total capital to risk-
weighted assets 208,842 11.26 148,400 8.00 $185,499 10.00%
Tier 1 capital to risk-
weighted assets 184,932 9.97 74,200 4.00 111,300 6.00
Tier 1 leverage capital
to average assets 184,932 7.53 98,220 4.00 122,775 5.00
22
ITEM 3 - Quantitative and Qualitative Disclosures About Market Risk
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; however, in the current low
interest rate environment, accelerated prepayments and calls on loans and
securities have resulted in shorter expected lives on many interest-earning
assets than has historically been the case, reversing this general
characterization. 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. An additional exception to these generalizations
in the current market environment has been the beneficial effect of interest
rate floors on many of the Company's floating rate loans which have helped
maintain higher loan yields despite declining levels of market interest rates.
However, in the current low interest rate environment, management anticipates
that these rate floors will decline over time. Further, because these rate
floors exceed what would otherwise be the note rate on certain variable or
floating rate loans, those loans will be less responsive to increasing market
rates than has historically been the case, injecting an additional element of
interest rate risk into the Company's operations.
The principal objectives of asset/liability management are to evaluate the
interest-rate risk exposure of the Company; to determine the level of risk
appropriate given the Company's operating environment, business plan strategies,
performance objectives, capital and liquidity constraints, and asset and
liability allocation alternatives; and to manage the Company's interest rate
risk consistent with regulatory guidelines and approved policies of the Board of
Directors. Through such management, the Company seeks to reduce the
vulnerability of its earnings and capital position to changes in the level of
interest rates. The Company's actions in this regard are taken under the
guidance of the Asset/Liability Management Committee, which is comprised of
members of the Company's senior management. The committee closely monitors the
Company's interest sensitivity exposure, asset and liability allocation
decisions, liquidity and capital positions, and local and national economic
conditions, and attempts to structure the loan and investment portfolios and
funding sources of the Company to maximize earnings within acceptable risk
tolerances.
Sensitivity Analysis
The Company's primary monitoring tool for assessing interest rate risk is
asset/liability simulation modeling which is designed to capture the dynamics of
balance sheet, interest rate and spread movements and to quantify variations in
net interest income resulting from those movements under different rate
environments. The sensitivity of net interest income to changes in the modeled
interest rate environments provides a measurement of interest rate risk. The
Company also utilizes market value analysis, which addresses changes in
estimated net market value of equity arising from changes in the level of
interest rates. The net market value of equity is estimated by separately
valuing the Company's assets and liabilities under varying interest rate
environments. The extent to which assets gain or lose value in relation to the
gains or losses of liability values under the various interest rate assumptions
determines the sensitivity of net equity value to changes in interest rates and
provides an additional measure of interest rate risk.
The interest rate sensitivity analysis performed by the Company incorporates
beginning-of-the-period rate, balance and maturity data, using various levels of
aggregation of that data, as well as certain assumptions concerning the
maturity, repricing, amortization and prepayment characteristics of loans and
other interest-earning assets and the repricing and withdrawal of deposits and
other interest-bearing liabilities into an asset/liability computer simulation
model. The Company updates and prepares simulation modeling at least quarterly
for review by senior management and the Board of 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.
23
The table of Interest Rate Risk Indicators sets forth, as of September 30, 2003,
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)
+300 (996) (1.2%) (63,151) (32.8%)
+200 (1,376) (1.6%) (35,978) (18.7%)
+100 (1,375) (1.6%) (10,585) (5.5%)
0 0 0 0 0
-100 (2,492) (2.9%) (11,187) (5.8%)
-200 (7,289) (8.6%) (15,683) (8.2%)
__________
(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 adjustable-rate 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, 2003. 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, 2003, total interest-bearing assets maturing or
repricing within one year exceeded total interest-earning liabilities maturing
or repricing in the same time period by $116.9 million, representing a one-year
gap to total assets ratio of 4.67%.
24
Table of Interest Sensitivity Gap
As of September 30, 2003 Within 6 Months 1-3 3-5 5-10 Over 10
6 Months to One Year Years Years Years Years Total
-------- ----------- ------- ------- ------- ------- -------
(dollars in thousands)
Interest-earning assets (1):
<s> <c> <c> <c> <c> <c> <c> <c>
Construction loans $271,190 $ 9,439 $ 6,399 $ -- $ -- $ -- $287,028
Fixed-rate mortgage loans 68,377 44,795 111,822 99,402 133,032 36,949 494,377
Adjustable-rate mortgage loans 220,825 56,343 89,548 64,192 3,727 -- 434,635
Fixed-rate mortgage-backed securities 38,877 26,522 79,276 49,050 57,240 22,677 273,642
Adjustable-rate mortgage-backed
securities 57,846 -- -- -- -- -- 57,846
Fixed-rate commercial/agriculture
loans 51,571 27,836 32,027 17,147 6,904 103 135,588
Adjustable-rate commercial/
agriculture loans 269,959 4,000 6,120 6,855 325 -- 287,259
Consumer and other loans 31,804 6,714 13,365 5,093 1,969 229 59,174
Investment securities and --------- -------- -------- -------- -------- -------- ---------
interest-bearing deposits 191,545 15,830 18,285 3,405 15,718 63,479 308,262
Total rate-sensitive assets 1,201,994 191,479 356,842 245,144 218,915 123,437 2,337,811
--------- -------- -------- -------- -------- -------- ---------
Interest-bearing liabilities (2):
Regular savings and NOW accounts 42,122 42,122 98,285 98,285 -- -- 280,814
Money market deposit accounts 93,480 56,088 37,392 -- -- - 186,960
Certificates of deposit 653,472 118,195 164,204 83,693 14,938 49 1,034,551
FHLB advances 106,594 51,500 137,600 69,930 95,328 600 461,552
Other borrowings 35,519 -- -- -- -- -- 35,519
Trust preferred 55,000 -- -- -- -- -- 55,000
Retail repurchase agreements 20,652 1,836 274 -- 483 -- 23,245
--------- -------- -------- -------- -------- -------- ---------
Total rate-sensitive liabilities 1,006,839 269,741 437,755 251,908 110,749 649 2,077,641
--------- -------- -------- -------- -------- -------- ---------
Excess (deficiency) of interest-
sensitive assets over interest-
sensitive liabilities $ 195,155 $(78,262) $(80,913) $ (6,764) $108,166 $122,788 $260,170
Cumulative excess (deficiency) of ========= ======== ======== ======== ======== ======== ========
interest-sensitive assets $ 195,155 $116,893 $ 35,980 $ 29,216 $137,382 $260,170 $260,170
========= ======== ======== ======== ======== ======== ========
Cumulative ratio of interest-earning
assets to interest-bearing
liabilities 119.38% 109.16% 102.10% 101.49% 106.61% 112.52% 112.52%
========= ======== ======== ======== ======== ======== ========
Interest sensitivity gap to
total assets 7.80% (3.13%) (3.23%) (0.27%) 4.32% 4.91% 10.40%
========= ======== ======== ======== ======== ======== ========
Ratio of cumulative gap to total assets 7.80% 4.67% 1.44% 1.17% 5.49% 10.40% 10.40%
========= ======== ======== ======== ======== ======== ========
(footnotes on following page)
25
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 Bank's 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 $117.1 million, or (4.68%)
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.
26
ITEM 4 - Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of
Company disclosure controls and procedures (as defined in Section 13(a)-15(e) of
the Securities Exchange Act of 1934 (the Act)) was carried out under the
supervision and with the participation of the Company's Chief Executive Officer,
Chief Financial Officer and several other members of the Company's senior
management as of the end of the period covered by this report. The Company's
Chief Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures as currently in effect are effective in
ensuring that the information required to be disclosed by the Company in the
reports it files or submits under the Act is (i) accumulated and communicated to
the Company's management (including the Chief Executive Officer and Chief
Financial Officer) in a timely manner, and (ii) recorded, processed, summarized
and reported within the time periods specified in the SEC's rules and forms.
(b) Changes in Internal Controls: In the quarter ended September 30, 2003,
there was no change in the Company's internal control over financial reporting
that has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
27
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In the normal course of business, the Company and the Bank have various legal
proceedings and other contingent matters outstanding. These proceedings and the
associated legal claims are often contested and the outcome of individual
matters is not always predictable. These claims and counter claims typically
arise during the course of collection efforts on problem loans or with respect
to action to enforce liens on properties in which the Bank holds a security
interest. Presently the Company has four such counter claims by borrowers or
involved parties. The Company and the Bank are not a party to any pending legal
proceedings that management believes would have a material adverse effect on the
financial condition or operations of the Company.
Item 2. Changes in Securities and Use of Proceeds
Not Applicable
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Stockholders
None
Item 5. Other Information
Not Applicable
Item 6. Exhibits and Reports on Form 8K
(a) Exhibits
31.1 Certificates of Chief Executive Officer and Chief Financial Officer
pursuant to the Securities Exchange Act Rules 13a-15(e)
31.2 and 15d-15(e) as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 dated November 13, 2003.
32 Certificate of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 dated
November 13, 2003.
(b) Report(s) on Form 8-K filed during the quarter ended September 30, 2003,
are as follows:
Date Filed Purpose
---------- -------
July 23, 2003 Announce Banner Corporation financial results
for the quarter ended June 30, 2003.
28
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 13, 2003 /s/D. Michael Jones
----------------------
D. Michael Jones
President and Chief Executive Officer
(Principal Executive Officer)
November 13, 2003 /s/ Lloyd W. Baker
----------------------
Lloyd W. Baker
Treasurer and Chief Financial Officer
(Principal Financial and Accounting
Officer)
29
Exhibit 31.1
CERTIFICATION
I, D. Michael Jones, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Banner Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the
end of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
November 13, 2003 /s/D. Michael Jones
------------------------
D. Michael Jones
Chief Executive Officer
30
Exhibit 31.2
CERTIFICATION
I, Lloyd W. Baker, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Banner Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the
end of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
November 13, 2003 /s/Lloyd W. Baker
------------------------
Lloyd W. Baker
Chief Financial Officer
31
Exhibit 32
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
OF BANNER CORPORATION
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The undersigned hereby certify, pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 and in connection with this Quarterly Report on Form 10-Q, that:
- the report fully complies with the requirements of Sections 13(a) and 15(d)
of the Securities Exchange Act of 1934, as amended, and
- the information contained in the report fairly presents, in all material
respects, the company's financial condition and results of operations.
November 13, 2003 /s/D. Michael Jones
-------------------------
D. Michael Jones
Chief Executive Officer
November 13, 2003 /s/Lloyd W. Baker
-------------------------
Lloyd W. Baker
Chief Financial Officer
A signed original of the written statement required by Section 906 has been
provided to Banner Corporation and will be retained by Banner Corporation and
furnished to the Securities and Exchange Commission or its staff upon request.
32