UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended March 31, 2006 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 0-22957 RIVERVIEW BANCORP, INC. - ------------------------------------------------------------------------------ (Exact name of registrant as specified in its charter) Washington 91-1838969 - -------------------------------------------------- ----------------- (State or other jurisdiction of incorporation (I.R.S. Employer or organization) I.D. Number) 900 Washington St., Ste. 900,Vancouver, Washington 98660 - -------------------------------------------------- ----------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (360) 693-6650 ----------------- Securities registered pursuant to Section 12(b) of the Act: None ----------------- Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share -------------------------------------- (Title of Class) Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes No X ---- ---- Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No X ---- ---- Indicate by check mark whether the registrant (1) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and disclosure will not be contained, to the best of the registrant's knowledge, in any definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K X ---- Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act (Check One): Large accelerated filer Accelerated filer X Non-accelerated filer ---- ---- ---- Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) Yes No X ---- ---- The aggregate market value of the voting stock held by nonaffiliates of the Registrant, based on the closing sales price of the registrant's Common Stock as quoted on the Nasdaq National Market System under the symbol "RVSB" on September 30, 2005 was approximately $120,946,388 (5,811,936 shares at $20.81 per share). It is assumed for purposes of this calculation that none of the registrant's officers, directors and 5% stockholders (including the Riverview Bancorp, Inc. Employee Stock Ownership Plan) are affiliates. As of June 7, 2006, there were issued and outstanding 5,778,686 shares of the registrant's common stock. DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of registrant's Definitive Proxy Statement for the 2006 Annual Meeting of Shareholders (Part III). 1 PART I Item 1. Business - ----------------- General Riverview Bancorp, Inc. ("the Company"), a Washington corporation, is the holding company of Riverview Community Bank (the "Bank"). On July 18, 2003, the Company completed the acquisition of Today's Bancorp, Inc. ("Today's Bancorp"). The acquisition of Today's Bancorp's $122.3 million of assets and $105.1 million of deposits were accounted for using the purchase method of accounting. On April 22, 2005, the Company completed the acquisition of American Pacific Bank ("APB"). The acquisition of APB's $128.5 million of assets and $80.0 million of deposits were accounted for using the purchase method of accounting. At March 31, 2006, the Company had total assets of $763.8 million, total deposits of $607.0 million and shareholders' equity of $91.7 million. All references to the Company herein include the Bank where applicable. The Bank is regulated by the Office of Thrift Supervision ("OTS"), its primary regulator, and by the Federal Deposit Insurance Corporation ("FDIC"), the insurer of its deposits. The Bank's deposits are insured by the FDIC up to applicable legal limits under the Savings Association Insurance Fund ("SAIF"). The Bank has been a member of the Federal Home Loan Bank ("FHLB") of Seattle since 1937. The Company is a progressive community-oriented, financial institution, which emphasizes local, personal service to residents of its primary market area. The Company considers Clark, Cowlitz, Klickitat and Skamania counties of Washington and Multnomah, Clackamas and Marion counties of Oregon as its primary market area. The Company is engaged primarily in the business of attracting deposits from the general public and using such funds in its primary market area to originate primarily commercial real estate, one- to four- family residential real estate, construction, and commercial and consumer loans. Commercial real estate loans and commercial loans have grown from 30.0% and 7.98% of the loan portfolio, respectively, in fiscal 2002 to 59.42% and 9.48%, respectively, in fiscal 2006. The Company's strategic plan includes targeting the commercial banking customer base in its primary market area, specifically small and medium size businesses, professionals and wealth building individuals. In pursuit of these goals, the Company emphasizes controlled growth and the diversification of its loan portfolio to include a higher portion of commercial and commercial real estate loans. A related goal is to increase the proportion of personal and business checking account deposits used to fund these new loans. Significant portions of these new loan products carry adjustable rates, higher yields or shorter terms and higher credit risk than traditional fixed-rate mortgages. The strategic plan stresses increased emphasis on non-interest income, including increased fees for asset management and deposit service charges. The strategic plan is designed to enhance earnings, reduce interest rate risk and provide a more complete range of financial services to customers and the local communities the Company serves. The Company is well positioned to attract new customers and to increase its market share given that the administrative headquarters and ten of its 17 branches are located in the fast growing Clark County. In order to support its strategy of growth without compromising its local, personal service to its customers and a commitment to asset quality, the Company has made significant investments in experienced branch, lending, asset management and support personnel and has incurred significant costs in facility expansion. The Company's efficiency ratios reflect this investment and will likely remain relatively high by industry standards for the foreseeable future due to the emphasis on growth and local, personal service. Control of non-interest expenses remains a high priority for the Company's management. The Company continuously reviews new products and services to give its customers more financial options. With an emphasis on growth of non-interest income and control of non-interest expense, all new technology and services are reviewed for business development and cost saving purposes. The in-house processing of checks and production of images has supported the Bank's increased service to customers and at the same time has increased efficiency. The Company continues to experience growth in customer use of its online banking services. Customers are able to conduct a full range of services on a real-time basis, including balance inquiries, transfers and electronic bill paying. 2 This online service has also enhanced the delivery of cash management services to commercial customers. The internet banking branch web site is www.riverviewbank.com. Market Area The Company conducts operations from its home office in Vancouver and 17 branch offices in Camas, Washougal, Stevenson, White Salmon, Battle Ground, Goldendale, Vancouver (seven branch offices) and Longview, Washington and Portland, Wood Village and Aumsville, Oregon. The Company's market area for lending and deposit taking activities encompasses Clark, Cowlitz, Skamania and Klickitat counties in Washington, as well as Multnomah, Clackamas and Marion counties in Oregon, and throughout the Columbia River Gorge area. The Company operates a trust and financial services company, Riverview Asset Management Corp., located in downtown Vancouver, Washington. Riverview Mortgage, a mortgage broker division of the Company, originates mortgage loans for various mortgage companies predominantly in the Vancouver/Portland, metropolitan areas, as well as for the Company. The Business and Professional Banking Division located at the downtown Vancouver headquarters and the downtown Portland lending office offers commercial and business banking services. Vancouver is located in Clark County, Washington, which is just north of Portland, Oregon. Many businesses are located in the Vancouver area because of the favorable tax structure and lower energy costs in Washington as compared to Oregon. Washington has no state income tax and Clark County operates a public electric utility that provides relatively lower cost electricity. Companies located in the Vancouver area included Sharp Microelectronics, Hewlett Packard, Georgia Pacific, Underwriters Laboratory and Wafer Tech, as well as several support industries. In addition to this industrial base, the Columbia River Gorge Scenic Area has been a source of tourism, which has helped to transform the area from its past dependence on the timber industry. Lending Activities General. At March 31, 2006, the Company's total net loans receivable, including loans held for sale, amounted to $623.1 million, or 81.6% of total assets at that date. The principal lending activity of the Company is the origination of mortgage loans through its mortgage banking activities, including loans collateralized by commercial properties, land for development, and residential construction loans. While the Company has historically emphasized real estate mortgage loans secured by one-to-four residential real estate, it has diversified its loan portfolio by focusing on increasing the amount of commercial real estate and commercial loans held in its loan portfolio. A substantial portion of the Company's loan portfolio is secured by real estate, either as primary or secondary collateral, located in its primary market area. Loan Portfolio Analysis. The following table sets forth the composition of the Company's loan portfolio by type of loan at the dates indicated. 3 At March 31, ----------------------------------------------------------------------------------------- 2006 2005 2004 2003 2002 ---------------- ---------------- ---------------- -------------- --------------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- (Dollars in thousands) <s> <c> <c> <c> <c> <c> <c> <c> <c> <c> <c> Real estate loans: Commercial real estate $328,379 52.10% $223,143 51.37% $176,521 45.73% $100,886 33.13% 83,547 28.70% One- to four- family (1) 32,194 5.11 36,569 8.42 43,785 11.34 59,021 19.38 $72,406 24.87 Multi-family 2,127 0.34 2,537 0.58 5,008 1.30 6,236 2.05 9,809 3.37 Construction one- to four- family 81,167 12.88 43,633 10.05 47,589 12.33 45,579 14.97 44,156 15.17 Construction multi-family - - - - - - 935 0.31 4,000 1.37 Construction commercial 46,135 7.32 10,982 2.53 1,453 0.38 4,239 1.39 3,742 1.29 Land 49,174 7.80 28,889 6.65 25,321 6.56 28,543 9.37 23,686 8.14 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total real estate loans 539,176 85.55 345,753 79.60 299,677 77.64 245,439 80.60 241,346 82.91 Commercial 59,769 9.48 57,981 13.35 57,578 14.91 34,145 11.21 23,216 7.98 Consumer loans: Automobile loans 1,054 0.17 1,197 0.28 1,631 0.42 1,468 0.48 2,142 0.74 Savings account loans 449 0.07 268 0.06 335 0.09 321 0.11 518 0.18 Home equity loans 27,810 4.41 26,556 6.11 23,914 6.20 21,236 6.97 21,701 7.46 Other consumer loans 2,044 0.32 2,599 0.60 2,880 0.74 1,941 0.63 2,144 0.73 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total consumer loans 31,357 4.97 30,620 7.05 28,760 7.45 24,966 8.19 26,505 9.11 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total loans and loans held for sale 630,302 100.00% 434,354 100.00% 386,015 100.00% 304,550 100.00% 291,067 100.00% ====== ====== ====== ====== ====== Less: Allowance for loan losses 7,221 4,395 4,481 2,739 2,537 -------- -------- -------- -------- -------- Total loans receivable, net (1) $623,081 $429,959 $381,534 $301,811 $288,530 ======== ======== ======== ======== ======== (1) Includes loans held for sale of $65,000, $510,000, $407,000, $1.5 million and $1.8 million at March 31, 2006, 2005, 2004, 2003 and 2002, respectively. 4 Commercial Real Estate Lending. As of March 31, 2006, $374.5 million, or 59.4% of the total loan portfolio was secured by commercial real estate property. The Company originates commercial real estate loans including land development, retail shopping centers, office and medical buildings, warehouses, mini-storage facilities, industrial use buildings, multi-family and assisted living facilities primarily located in our market area. The Company actively pursues commercial real estate loans. These loans generally are priced at a higher rate of interest than one- to four-family residential loans. Typically, these loans have higher loan balances, are more difficult to evaluate and monitor, and involve a higher degree of risk than one- to four-family residential loans. Often payments on loans secured by commercial properties are dependent on the successful operation and management of the property securing the loan or business conducted on the property securing the loan; therefore, repayment of these loans may be affected by adverse conditions in the real estate market or the economy. Generally loan guarantees are required and obtained from financially capable parties based upon the review of personal financial statements. If the borrower is a corporation, personal guarantees are generally required and obtained from the corporate principals based upon a review of their personal financial statements and individual credit reports. A portion of the commercial real estate loan portfolio is relatively unseasoned and contains a higher risk of default and loss than single-family residential loans. The average size loan in the commercial real estate loan portfolios was approximately $730,000 as of March 31, 2006. The Company targets individual commercial real estate loans between $500,000 and $5.0 million; however, the loan policy allows origination of loans to one borrower up to 15% of the Bank's capital. The largest commercial real estate loan as of March 31, 2006 was an office building with an outstanding principal balance at March 31, 2006 of $7.0 million located in Vancouver, Washington. This loan is performing according to the loan payment terms, as were all commercial real estate loans as of March 31, 2006, except for one non-accrual loan with a balance of $415,000. Both fixed- and adjustable-rate loans are offered on commercial real estate loans. Loans originated on a fixed-rate basis generally are originated at fixed terms up to five years, with amortization terms up to 25 years. Interest rates on fixed-rate loans are generally established utilizing the Federal Home Loan Bank of Seattle's fixed advance rate for an equivalent period plus a margin ranging from 2.5% to 3.50%. Depending on the market conditions at the time the loan was originated, certain loan agreements may include prepayment penalties. Approximately 80.1% of our commercial real estate loan portfolio was comprised of adjustable rate loans at March 31, 2006. Adjustable-rate commercial real estate loans are originated with variable rates that generally adjust after an initial period ranging from one to five years. Adjustable-rate commercial real estate loans are generally priced utilizing the Federal Home Loan Bank of Seattle's fixed advance rate for an equivalent period plus a margin ranging from 2.5% to 3.50%, with principal and interest payments fully amortizing over terms up to 25 years. These loans generally have a prepayment penalty. Both adjustable-rate mortgages and fixed-rate mortgages generally allow provisions for assumption of a loan by another borrower subject to lender approval and a 1% assumption fee. The maximum loan-to-value ratio for commercial real estate loans is generally 75% for both purchases and refinances. Appraisals are required on all properties securing commercial real estate loans. Independent appraisers designated by us perform appraisals. Commercial real estate loan borrowers with outstanding balances in excess of $500,000 are required to submit annual financial statements and tax returns. The subject property is inspected at least every two years if the loan balance exceeds $500,000. A minimum pro forma debt coverage ratio of 1.20 times is required for loans secured by commercial properties. The Company requires title insurance insuring the status of its lien on all of the real estate secured loans and also requires that fire and extended coverage casualty insurance (and, if appropriate, flood insurance) be maintained in an amount at least equal to the lesser of the loan balance and the replacement cost of the improvements. Where the value of the unimproved real estate exceeds the amount of the loan on the real estate, the Company may make exceptions to its property insurance requirements. One- to- Four Family Real Estate Lending. The majority of the residential loans are secured by one- to- four family residences located in the Company's primary market area. Underwriting standards require that one- to- four family portfolio loans generally be owner occupied and that loan amounts not exceed 80% or (95% with private mortgage 5 insurance) of the lesser of current appraised value or cost of the underlying collateral. Terms typically range from 15 to 30 years, and the Company also offers balloon mortgage loans with terms of either five or seven years. The Company originates both fixed rate mortgages and adjustable rate mortgages ("ARMs") with repricing based on one-year constant maturity U.S. Treasury index or other index. The ability to generate volume in ARMs, however, is largely a function of consumer preference and the interest rate environment. In addition to originating one- to four- family loans for its portfolio, the Company is an active mortgage broker for several third party mortgage lenders. In recent periods, these mortgage brokerage activities have reduced the volume of fixed rate one- to- four family loans that are originated and sold by the Company. See " Loan Originations, Sales and Purchases" and " Mortgage Brokerage." The Company generally sells fixed-rate mortgage loans with maturities of 15 years or more and balloon mortgages to the Federal Home Loan Mortgage Corporation ("FHLMC"), servicing retained. See " Loan Originations, Sales and Purchases" and " Mortgage Loan Servicing." The retention of ARM loans in the portfolio helps reduce the Company's exposure to changes in interest rates. There are, however, unquantifiable credit risks resulting from the potential of increased costs arising from changed rates to be paid by the customer. It is possible that during periods of rising interest rates the risk of default on ARM loans may increase as a result of repricing and the increased costs to the borrower. Another consideration is that although ARM loans allow the Company to increase the sensitivity of its asset base to changes in interest rates, the extent of this interest sensitivity is limited by the periodic and lifetime interest rate adjustment limits. Because of these considerations, the Company has no assurance that yields on ARM loans will be sufficient to offset increases in its cost of funds. While one- to four- family residential real estate loans typically are originated with 30-year terms and the Company permits its ARM loans to be assumed by qualified borrowers, these loans generally remain outstanding for substantially shorter periods because borrowers often prepay their loans in full upon sale of the property pledged as security or upon refinancing the original loan. In addition, substantially all of the fixed interest rate loans in the Company's loan portfolio contain due-on-sale clauses providing that the Company may declare the unpaid amount due and payable upon the sale of the property securing the loan. Thus, average loan maturity is a function of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans. At March 31, 2006, the Company had no one- to- four family residential real estate loans on non-accrual status. Construction Lending. The Company actively originates three types of residential construction loans: (i) speculative construction loans, (ii) custom/presold construction loans and (iii) construction/permanent loans. Subject to market conditions, the Company intends to increase its residential construction lending activities. The Company also originates construction loans for the development of multi-family and commercial properties. At March 31, 2006 and 2005, the composition of the Company's construction loan portfolio commitments was as follows: At March 31, -------------------------------------- 2006 2005 ----------------- ----------------- Amount(1) Percent Amount(1) Percent --------- ------- -------- ------- (Dollars in thousands) Speculative construction $111,699 44.16% $ 43,749 40.61% Commercial/multi-family construction 73,436 29.03 18,912 17.55 Custom/presold construction 3,752 1.48 13,300 12.34 Construction/permanent 21,631 8.55 18,322 17.01 Construction/land 42,444 16.78 13,453 12.49 -------- ------ -------- ------ Total $252,962 100.00% $107,736 100.00% ======== ====== ======== ====== (1) Includes loans in process. Speculative construction loans are made to home builders and are termed "speculative" because the home builder does not have, at the time of loan origination, a signed contract with a home buyer who has a commitment for permanent financing 6 with either the Company or another lender for the finished home. The home buyer may be identified either during or after the construction period, with the risk that the builder will have to debt service the speculative construction loan and finance real estate taxes and other carrying costs of the completed home for a significant time after the completion of construction until the home buyer is identified. At March 31, 2006, the Company had 10 borrowers with aggregate outstanding speculative loan balances of more than $1.0 million, which totaled $17.1 million and were performing according to original terms. Unlike speculative construction loans, presold construction loans are made for homes that have buyers. Presold construction loans are made to home builders who, at the time of construction, have a signed contract with a home buyer who has a commitment for permanent financing for the finished home from the Company or another lender. Custom construction loans are made to the homeowner. Custom/presold construction loans are generally originated for a term of 12 months. At March 31, 2006, the largest custom construction loan and presold construction loan had outstanding balances of $236,000 and $560,000, respectively, and were performing according to original terms. Construction/permanent loans are originated to the homeowner rather than the home builder along with a commitment by the Company to originate a permanent loan to the homeowner to repay the construction loan at the completion of construction. The construction phase of a construction/permanent loan generally lasts six to nine months. At the completion of construction, the Company may either originate a fixed rate mortgage loan or an ARM loan or use its mortgage brokerage capabilities to obtain permanent financing for the customer with another lender. At completion of construction, the Company-originated fixed rate permanent loan's interest rate is set at a market rate and for adjustable rate loans, the interest rates adjust on their first adjustment date. See " Mortgage Brokerage," " Loan Originations, Sales and Purchases" and " Mortgage Loan Servicing." At March 31, 2006, the largest outstanding construction/permanent loan had an outstanding balance of $513,000 and was performing according to its original terms. The Company also provides construction financing for non-residential properties such as multi-family and commercial properties. The Company has increased its commercial lending resources with the intent of increasing the amount of commercial real estate loan balances such as construction commercial and construction multi-family loans. The commercial construction loans outstanding at March 31, 2006 were $47.1 million and the loan commitment amount was $73.4 million. At March 31, 2006, the largest construction commercial loan had an outstanding balance of $4.9 million and was performing according to its original repayment terms. The loan-to-value ratio, maturity and other provisions of the loans made by us generally have reflected the Bank's policy of making less than the maximum loan permissible under applicable regulations, in accordance with sound lending practices, market conditions and the Bank's underwriting standards. The Bank's current lending policy on residential real estate construction loans generally limits the maximum loan-to-value ratio to 80% of the appraised value of the property for loans to individuals and 75% of the appraised market value of the project for loans to developers, provided that the loan does not exceed 85% of total costs to complete the project. The minimum cash equity required for an individual construction loan is 15%. The minimum cash equity required for a developer loan is 15% of total costs, with up to 50% of appreciated land equity being considered as cash equity provided certain conditions are met. In addition, for loans to tract developers, the loan to discounted cash flow or bulk sale value generally may not exceed 85%. Development plans are required from both individuals and developers prior to making the loan. The Bank's loan officers are required to personally visit the proposed site of the development and the sites of competing developments. The Bank requires that developers maintain adequate insurance coverage. While maturity dates for residential construction loans are largely a function of the estimated construction period of the project, loans to an individual generally do not exceed one year while loans to developers generally do not exceed 18 months. Substantially all of the Bank's residential construction loans have adjustable rates of interest based on the Wall Street Journal Prime Rate and during the term of construction, the accumulated interest is added to the principal of the loan through an interest reserve. Construction lending affords the Company the opportunity to achieve higher interest rates and fees with shorter terms to maturity than does its single-family permanent mortgage lending. Construction lending, however, generally involves a higher degree of risk than single-family permanent mortgage lending because of the inherent difficulty in estimating both a property's value at completion of the project and the estimated cost of the project. The nature of these loans is such that they are generally more difficult to evaluate and monitor. If the estimate of construction cost proves to be inaccurate, the Company may be required to advance funds beyond the amount originally committed to permit completion of the project. 7 Projects may also be jeopardized by disagreements between borrowers and builders and by the failure of builders to pay subcontractors. The Company addresses these risks by adhering to strict underwriting policies, disbursement procedures and monitoring practices. In addition, because the Company's construction lending is in its primary market area, changes in the local economy and real estate market could adversely affect the Company's construction loan portfolio and our ability to continue to originate a significant amount of construction loans. At March 31, 2006, the Company had no construction loans on non-accrual status. Multi-Family Lending. Multi-family mortgage loans generally have terms up to 25 years with a loan-to-value ratio of up to 75%. Both fixed and adjustable rate loans are offered with a variety of terms to meet the multi-family residential financing needs. At March 31, 2006, the largest multi-family mortgage loan had an outstanding loan balance of $2.0 million and was performing according to its original repayment terms. Multi-family mortgage lending affords the Company an opportunity to receive interest at rates higher than those generally available from one- to four- family residential lending. However, loans secured by these properties usually are greater in amount, are more difficult to evaluate and monitor and, therefore, involve a greater degree of risk than one- to four- family residential mortgage loans. Because payments on loans secured by multi-family properties are often dependent on the successful operation and management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy. The Company attempts to minimize these risks by strictly scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan. The Company also generally obtains personal guarantees from financially capable parties based on a review of personal financial statements. At March 31, 2006, the Company had no multi-family loans on non-accrual status. Land Lending. The Company originates loans to local real estate developers with whom it has established relationships for the purpose of developing residential subdivisions (i.e., installing roads, sewers, water and other utilities), as well as loans to individuals to purchase building lots. Land development loans are secured by a lien on the property and made for a period not to exceed five years with an interest rate that adjusts with the prime rate, and are made with loan-to-value ratios not exceeding 75%. Monthly interest payments are required during the term of the loan. Subdivision loans are structured so that the Company is repaid in full upon the sale by the borrower of approximately 90% of the subdivision lots. All of the Company's land loans are secured by property located in its primary market area. In addition, the Company also generally obtains personal guarantees from financially capable parties based on a review of personal financial statements. At March 31, 2006, the largest outstanding land loan was $7.9 million and was performing according to its original repayment terms. At that date the Company had no land loans on non-accrual status. Loans secured by undeveloped land or improved lots involve greater risks than one- to four- family residential mortgage loans because these loans are advanced upon the predicted future value of the developed property. If the estimate of these future values proves to be inaccurate, in the event of default and foreclosure, the Company may be confronted with a property the value of which is insufficient to assure full repayment. The Company attempts to minimize this risk by limiting the maximum loan-to-value ratio on land loans to 65% of the estimated developed value of the secured property. Loans on raw land may run the risk of adverse zoning changes, environmental or other restrictions on future use. Commercial Lending. The Company's commercial loan portfolio has increased to 9.48% of the total loan portfolio at March 31, 2006 from 7.98% at March 31, 2002. The Company has been able to increase the balance of outstanding commercial loans and commitments as a result of the local economy, the consolidation of some local competitors offering commercial loans and the hiring of several experienced commercial bankers from competitors in the local market. Commercial loans are generally made to customers who are well known to the Company and are typically secured by all business assets or other property. The Company's commercial loans may be structured as term loans or as lines of credit. Commercial term loans are generally made to finance the purchase of assets and have maturities of five years or less. Commercial lines of credit are typically made for the purpose of providing working capital and usually have a term of one year or less. Lines of credit are made at variable rates of interest equal to a negotiated margin above an index rate and term loans are at a fixed rate. The Company also generally obtains personal guarantees from financially capable parties based on a review of personal financial statements. 8 Commercial lending involves greater risk than residential mortgage lending and involves risks that are different from those associated with residential and commercial real estate lending. Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral values and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default. Although commercial loans are often collateralized by equipment, inventory, accounts receivable or other business assets including real estate, the liquidation of collateral in the event of a borrower default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories and equipment may be obsolete or of limited use, among other things. Accordingly, the repayment of a commercial loan depends primarily on the cash flow of the borrower (and any guarantors), while liquidation of collateral is a secondary and often insufficient source of repayment. At March 31, 2006, the Company had no commercial loans on non- accrual status. Consumer Lending. The Company originates a variety of consumer loans, including home equity lines of credit, home equity term loans, home improvement loans, loans for debt consolidation and other purposes, automobile loans, boat loans and savings account loans. Home equity lines of credit and home equity term loans are typically secured by a second mortgage on the borrower's primary residence. Home equity lines of credit are made at loan-to-value ratios of 90% or less, taking into consideration the outstanding balance on the first mortgage on the property. Home equity lines of credit have a variable interest rate while home equity term loans have a fixed rate of interest. The Company's procedures for underwriting consumer loans include an assessment of the applicant's payment history on other debts and ability to meet existing obligations and payments on the proposed loans. Although the applicant's creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the security, if any, to the proposed loan amount. Consumer loans generally entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly, such as mobile homes, automobiles, boats and recreational vehicles. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. These loans may also give rise to claims and defenses by the borrower against the Company as the holder of the loan, and a borrower may be able to assert claims and defenses, which it has against the seller of the underlying collateral. At March 31, 2006, no consumer loans were on non-accrual status. Loan Maturity. The following table sets forth certain information at March 31, 2006 regarding the dollar amount of loans maturing in the Company's portfolio based on their contractual terms to maturity, but does not include potential prepayments. Demand loans, loans having no stated schedule of repayments and no stated maturity and overdrafts are reported as due in one year or less. Loan balances do not include unearned discounts, unearned income and allowance for loan losses. 9 Within 1 to 3 3 to 5 5 to 10 Beyond One Year Years Years Years 10 Years Total -------- ----- ----- ----- -------- ----- (In thousands) Residential one- to four- family: Adjustable rate $ - $ 256 $ 278 $ 597 $16,693 $ 17,824 Fixed rate 1,275 4,478 2,455 1,175 4,986 14,369 Construction: Adjustable rate 35,137 4,254 - - - 39,391 Fixed rate 5,805 4 - - - 5,809 Other real estate: Adjustable rate 61 824 1,802 351 2,258 5,296 Adjustable rate (Comm RE)\ 121,991 55,980 11,283 178,748 19,295 387,297 Fixed rate (Comm RE) 14,170 11,522 8,703 15,191 544 50,130 Fixed rate 2,575 7,456 7,553 1,038 448 19,070 Commercial: Adjustable rate 29,232 2,239 12,778 4,007 - 48,256 Fixed rate 1,741 4,008 4,240 1,513 - 11,502 Consumer: Adjustable rate 671 - 534 817 21,768 23,790 Fixed rate 1,216 1,377 880 616 3,479 7,568 -------- ------- ------- -------- ------- -------- Total loans $213,874 $92,398 $50,506 $204,053 $69,471 $630,302 ======== ======= ======= ======== ======= ======== 10 The following table sets forth the dollar amount of all loans due one year after March 31, 2006, which have fixed interest rates or have floating or adjustable interest rates. Fixed- Floating or Rates Adjustable Rates ---------- ---------------- (In thousands) Residential one- to four- family $ 13,094 $ 17,824 Construction loans 4 4,254 Other real estate loans 52,455 270,541 Commercial 9,761 19,024 Consumer 6,352 23,119 --------- -------- Total $ 81,666 $334,762 ========= ======== Scheduled contractual principal repayments of loans do not reflect the actual life of such assets. The average life of a loan is substantially less than its contractual terms because of prepayments. In addition, due-on-sale clauses on loans generally give the Company the right to declare loans immediately due and payable in the event, among other things, that the borrower sells the real property. The average life of mortgage loans tends to increase, however, when current mortgage loan market rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when rates on existing mortgage loans are substantially higher than current mortgage loan market rates. Furthermore, management believes that a significant number of the Company's residential mortgage loans are outstanding for a period less than their contractual terms because of the transitory nature of many of the borrowers who reside in its primary market area. Loan Solicitation and Processing. The Company's lending activities are subject to the written, non-discriminatory, underwriting standards and loan origination procedures established by the Board of Directors and management. The customary sources of loan originations are realtors, walk-in customers, referrals and existing customers. The Company also uses commissioned loan brokers and print advertising to market its products and services. The Company's loan approval process is intended to assess the borrower's ability to repay the loan, the viability of the loan, the adequacy of the value of the property that will secure the loan, if any and, in the case of commercial and multi-family real estate loans, the cash flow of the project and the quality of management involved with the project. The Company's lending policy requires borrowers to obtain certain types of insurance to protect the Company's interest in any collateral securing the loan. Loans are approved at various levels of management, depending upon the amount of the loan. Loan Commitments. The Company issues commitments to originate residential mortgage loans, commercial real estate mortgage loans, consumer loans and commercial loans conditioned upon the occurrence of certain events. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments. Commitments to extend credit are conditional, and are honored for up to 45 days subject to the Company's usual terms and conditions. Collateral is not required to support commitments. At March 31, 2006, the Company had outstanding commitments to originate loans in the amount of $18.0 million. Loan Originations, Sales and Purchases. While the Company originates adjustable-rate and fixed-rate loans, its ability to generate each type of loan depends upon relative customer demand for loans in its primary market area. During the years ended March 31, 2006 and 2005, the Company's total loan originations, including mortgage loans originated for sale and participations purchased, were $677.8 million and $434.4 million, respectively, of which 82.84% and 83.8%, respectively, were subject to periodic interest rate adjustment and 17.16% and 15.1%, respectively, were fixed-rate loans. The Company customarily sells the fixed-rate residential one- to four- family mortgage loans that it originates with maturities of 15 years or more to the FHLMC as part of its asset liability strategy. Mortgage loans are sold to FHLMC on a non-recourse basis where by foreclosure losses are generally the responsibility of the FHLMC and not the Company. Servicing is retained on loans sold to FHLMC. The sale of these loans allows the Company to continue to make loans during periods when savings flows decline or funds are not otherwise available for lending purposes; however, the Company assumes an increased risk if these loans cannot be sold in a rising interest rate environment. Changes in the level of interest rates and the condition of the local and national economies affect the amount of loans originated by the Company 11 and demanded by investors to whom the loans are sold. Generally, the Company's residential one-to-four family mortgage loan origination, and sale and mortgage brokerage activity (described below) and, therefore, its results of operations, may be adversely affected by an increasing interest rate environment to the extent such environment results in decreased loan demand by borrowers and/or investors. Accordingly, the volume of loan originations and the profitability related to the sale or brokerage of one- to- four family mortgage loans can vary significantly from period to period. During periods of reduced loan demand, our profitability may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in loan originations. Mortgage loans are sold to the FHLMC on a non-recourse basis whereby foreclosure losses are generally the responsibility of the FHLMC and not the Company. Servicing is retained on loans sold to FHLMC. Interest rates on residential one-to-four-family mortgage loan applications are typically locked with customers and the FHLMC during the application stage for periods ranging from 30 to 90 days, the most typical period being 45 days. These loans are locked with the FHLMC under a best-efforts delivery program. The Company makes every effort to deliver these loans before their rate locks expire. This arrangement requires the Company to deliver the loans to the FHLMC within ten days of funding. Delays in funding the loans can require a lock extension. The cost of a lock extension at times is borne by the borrower and at times by the Company. These lock extension costs paid by the Company are not expected to have a material impact to operations. This activity is managed daily. There can be no assurance that the Company will be successful in its efforts to reduce the risk of interest rate fluctuation between the time of origination of a mortgage loan and the time of the ultimate sale of the loan. To the extent that the Company does not adequately manage its interest rate risk, the Company may incur significant mark-to-market losses or losses relating to the sale of such loans, adversely affecting its financial condition and results of operations. The Company purchased $12.5 million of land and commercial real estate loan participations in fiscal year 2006. 12 The following table shows total loans originated, sold and repaid during the periods indicated. For the Years Ended March 31, -------------------------------- 2006 2005 2004 -------- -------- -------- (In thousands) Total net loans receivable and loans held for sale at beginning of period $429,959 $381,534 $301,811 -------- -------- -------- Loans originated: Mortgage loans: One- to four- family 59,581 61,621 35,963 Multi-family 13,427 6,826 2,065 Construction one- to four- family 147,643 100,522 104,913 Construction commercial real estate 524 - 482 Construction multi-family 4,308 - 341 Land and commercial real estate 263,507 120,201 93,241 Commercial 173,657 136,726 101,432 Consumer 2,638 2,859 31,135 -------- -------- -------- Total loans originated 665,285 428,755 369,572 Loans purchased: Multi-family 40 127 - Land and commercial real estate 12,486 5,537 6,267 -------- -------- -------- Total loans purchased 12,526 5,664 6,267 Loans sold: One-to-four family (23,402) (22,840) (51,567) Multi-family (688) - - Land and commercial real estate (4,243) - - -------- -------- -------- Total loans sold (28,333) (22,840) (51,567) Repayment of principal (573,707) (363,607) (329,443) American Pacific Bank acquisition 120,077 - - Today's Bank acquisition - - 85,610 (Decrease) increase in other items, net (2,726) 453 (716) -------- -------- -------- Net increase in loans 193,122 48,425 79,723 -------- -------- -------- Total net loans receivable and loans held for sale at end of period $623,081 $429,959 $381,534 ======== ======== ======== Mortgage Brokerage. In addition to originating mortgage loans for retention in its portfolio, the Company employs ten commissioned brokers who originate mortgage loans (including construction loans) for various mortgage companies predominately in the Portland metropolitan area, as well as for the Company. The loans brokered to mortgage companies are closed in the name of and funded by the purchasing mortgage company and are not originated as an asset of the Company. In return, the Company receives a fee ranging from 1% to 1.5% of the loan amount that it shares with the commissioned broker. Loans brokered to the Company are closed on the Company's books as if the Company had originated them and the commissioned broker receives a fee of approximately 0.50% of the loan amount. During the year ended March 31, 2006, brokered loans totaled $276.6 million (including $77.8 million brokered to the Company). Gross fees of $1.9 million (excluding the portion of fees shared with the commissioned brokers) were recognized for the year ended March 31, 2006. The interest rate environment has a strong influence on the loan volume and amount of fees generated from the mortgage broker activity. In general, during periods of rising interest rates such as we are currently experiencing, the volume of loans and amount of loan fees generally decreases as a result of slower mortgage loan demand. Conversely, during periods of falling interest rates, the volume of loans and amount of loan fees generally increase as a result of the increased mortgage loan demand. 13 Mortgage Loan Servicing. The Company is a qualified servicer for the FHLMC. The Company's general policy is to close its residential loans on the FHLMC modified loan documents to facilitate future sales to the FHLMC. Upon sale, the Company continues to collect payments on the loans, to supervise foreclosure proceedings, if necessary, and otherwise to service the loans. The Company generally retains the servicing rights on the fixed-rate mortgage loans that it sells to the FHLMC. At March 31, 2006, total loans serviced for others were $139.2 million. The value of loans serviced for others is significantly affected by interest rates. In general, during periods of falling interest rates, mortgage loans repay at faster rates and the value of the mortgage servicing declines. Conversely, during periods of rising interest rates, the value of the mortgage servicing rights generally increases as a result of slower rates of prepayments. The Company may be required to recognize this decrease in value by taking a charge against its earnings, which would cause its net income to decrease. The Company has experienced a decrease in prepayments of mortgages as interest rates have changed during the past two years, which has impacted the value of the servicing asset. Accordingly, the Company recognized a decrease of $24,000 and $22,000 for fiscal years 2006 and 2005, respectively in its valuation allowance for mortgage servicing rights reflecting the increase in mortgage interest rates and slowing of prepayments. We believe, based on historical experience that the amount of prepayments and the related impairment charges should decrease as interest rates increase. Loan Origination and Other Fees. The Company generally receives loan origination fees and discount "points." Loan fees and points are a percentage of the principal amount of the loan that is charged to the borrower for funding the loan. The Company usually charges origination fees of 1.5% to 2.0% on one- to four- family residential real estate loans, long-term commercial real estate loans and residential construction loans. Commercial loan fees are based on terms of the individual loan. Current accounting standards require fees received for originating loans to be deferred and amortized into interest income over the contractual life of the loan. Deferred fees associated with loans that are sold are recognized as gain on sale of loans. The Company had $4.4 million of net deferred loan fees at March 31, 2006. The Company also receives loan servicing fees on the loans it sells and on which it retains the servicing rights. See Note 9 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K. Delinquencies. The Company's collection procedures for all loans except consumer loans provide for a series of contacts with delinquent borrowers. A late charge delinquency notice is first sent to the borrower when the loan secured by real estate becomes 17 days past due. A follow-up telephone call, or letter if the borrower cannot be contacted by telephone, is made when the loan becomes 22 days past due. A delinquency notice is sent to the borrower when the loan becomes 30 days past due. When payment becomes 60 days past due, a notice of default letter is sent to the borrower stating that foreclosure proceedings will commence unless the delinquency is cured. If a loan continues in a delinquent status for 90 days or more, the Company generally initiates foreclosure proceedings. In certain instances, however, the Company may decide to modify the loan or grant a limited moratorium on loan payments to enable borrowers to reorganize their financial affairs. A delinquent consumer loan borrower is contacted when the loan is 15 days past due. A letter of intent to repossess collateral is mailed to the borrower after the loan becomes 45 days past due and repossession proceedings are initiated after the loan becomes 90 days delinquent. Delinquencies in commercial loans are handled on a case-by-case basis. Generally, notices are sent and personal contact is made with the borrower when the loan is 15 days past due. Loan officers are responsible for collecting loans they originate or that are assigned to them. Depending on the nature of the loan or type of collateral securing the loan, negotiations, or other actions, are undertaken depending upon the circumstances. Nonperforming Assets. Loans are reviewed regularly and it is the Company's general policy that when a loan is 90 days delinquent or when collection of interest appears doubtful, it is placed on non-accrual status, at which time the accrual of interest ceases and the reserve for any unrecoverable accrued interest is established and charged against operations. Typically, payments received on a non-accrual loan are applied to the outstanding principal and interest as determined at the time of collection of the loan. 14 Real estate owned is real estate acquired in settlement of loans and consists of real estate acquired through foreclosure or deeds in lieu of foreclosure. The acquired real estate is recorded at net realizable value. The Company periodically reviews the property's net realizable value and a charge to operations is taken if the property's recorded value exceeds the property's net realizable value. The following table sets forth information with respect to the Company's nonperforming assets. At the dates indicated, the Company had no restructured loans within the meaning of Statement of Financial Accounting Standards ("SFAS") No. 15 (as amended by SFAS No. 114), Accounting by Debtors and Creditors for Troubled Debt Restructuring. At March 31, ---------------------------------------- 2006 2005 2004 2003 2002 ---------------------------------------- (Dollars in thousands) Loans accounted for on a non- accrual basis: Residential real estate $ - $ - $ 24 $ 301 $ 830 Commercial real estate 415 198 309 - 297 Land - - 31 - 180 Commercial - 97 872 - 54 Consumer - 161 65 22 39 ----- ----- ------ ----- ------ Total 415 456 1,301 323 1,400 ----- ----- ------ ----- ------ Accruing loans which are contractually past due 90 days or more - - - - 122 ----- ----- ------ ----- ------ Total of non-accrual and 90 days past due loans 415 456 1,301 323 1,522 ----- ----- ------ ----- ------ Real estate owned (net) - 270 742 425 853 ----- ----- ------ ----- ------ Total nonperforming assets $ 415 $ 726 $2,043 $ 748 $2,375 ===== ===== ====== ===== ====== Total loans delinquent 90 days or more to net loans 0.07% 0.10% 0.34% 0.11% 0.53% Total loans delinquent 90 days or more to total assets 0.05 0.08 0.25 0.08 0.39 Total nonperforming assets to total assets 0.05 0.13 0.39 0.18 0.61 The gross amount of interest income on the non-accrual loans that would have been recorded during the year ended March 31, 2006 if the non-accrual loans had been current in accordance with their original terms was approximately $21,000. For the year ended March 31, 2006, $100,000 was earned on the non-accrual loans and included in interest and fees on loans receivable interest income. Loans not included in nonperforming or past due categories, but where information about possible credit problems causes management to be uncertain about the borrower's ability to comply with existing repayment terms, totaled $3.7 million at March 31, 2006 and $5.8 million at March 31, 2005. Asset Classification. The OTS has adopted various regulations regarding problem assets of savings institutions. The regulations require that each insured institution review and classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, OTS examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified as loss is 15 considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. If an asset or portion thereof is classified as loss, the insured institution establishes specific allowances for loan losses for the full amount of the portion of the asset classified as loss. All or a portion of general loan loss allowances established to cover possible losses related to assets classified substandard or doubtful can be included in determining an institution's regulatory capital, while specific valuation allowances for loan losses generally do not qualify as regulatory capital. Assets that do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated "special mention" and monitored by the Company. The aggregate amount of the Company's classified assets, general loss allowances, specific loss allowances and charge-offs were as follows at the dates indicated: At or For the Year Ended March 31, ------------------ 2006 2005 ---- ----- (In thousands) Substandard assets $4,066 $6,209 Doubtful assets - - Loss assets - - General loss allowances 7,221 4,395 Specific loss allowances - - Charge-offs 711 669 The loans classified as substandard assets at March 31, 2006 are made up of thirteen real estate secured commercial loans totaling $2.9 million, and eleven commercial loans totaling $1.1 million. Real Estate Owned. Real estate properties acquired through foreclosure or by deed-in-lieu of foreclosure is recorded at the lower of cost or fair value less estimated costs of disposal. Management periodically performs valuations and an allowance for loan losses is established by a charge to operations if the carrying value exceeds the estimated net realizable value. At March 31, 2006, the Company owned no real estate properties acquired through foreclosure as compared to $270,000 at March 31, 2005. Allowance for Loan Losses. The Company maintains an allowance for loan losses to provide for losses inherent in the loan portfolio. The adequacy of the allowance is evaluated monthly to maintain the allowance at levels sufficient to provide for inherent losses. A key component to the evaluation is the Company's internal loan review and loan classification system. The internal loan review system provides for at least an annual review by the internal audit department of all loans that meet selected criteria. The Problem Loan Committee reviews and monitors the risk and quality of the Company's loan portfolio. The Problem Loan Committee members include the Executive Vice President Chief Credit Officer, Chairman and Chief Executive Officer, President and Chief Operating Officer, Vice President of Credit Administration, and Special Assets Manager. Credit officers are expected to monitor their portfolios and make recommendations to change loan grades whenever changes are warranted. At least annually, loans that are delinquent 60 days or more and with specified outstanding loan balances are subject to review by the internal audit department. Credit Administration approves any changes to loan grades, monitor loan grades and to recommend any changes to the loan grades. The Company uses the OTS loan classifications of special mention, substandard, doubtful and loss plus the additional loan classifications of pass and watch in order to assign a loan grade to be used in the determination of the proper amount of allowance for loan losses. The definition of a pass classification represents a level of credit quality, which contains no well-defined deficiency or weakness. The definition of watch classification is used to identify a loan that currently contains no well-defined deficiency or weakness, but management has deemed it desirable to closely monitor the loan. The Company uses the loan classifications from the internal loan review and Credit Administration in the following manner to determine the amount of the allowance for loan losses. The calculation of the allowance for loan losses must consider 16 loan classification in order to determine the amount of the allowance for loan losses for the required three separate elements of the allowance for losses: general allowances, allocated allowances and unallocated allowances. The general allowance element relates to assets with no well-defined deficiency or weakness such as assets classified pass or watch, and takes into consideration loss that is embedded within the portfolio but has not been realized. Borrowers are impacted by events that may ultimately result in a loan default and eventual loss well in advance of a lender's knowledge. Examples of such loss-causing events in the case of consumer or one- to four- family residential loans would be a borrower job loss, divorce or medical crisis. Examples in commercial or construction loans may be loss of customers as a result of competition or changes in the economy. General allowances for each major loan type are determined by applying loss factors that take into consideration past loss experience, asset duration, economic conditions and overall portfolio quality to the associated loan balance. The allocated allowance element relates to assets with well-defined deficiencies or weaknesses such as assets classified special mention, substandard, doubtful or loss. The OTS loss factors are applied against current classified asset balances to determine the amount of allocated allowances. Included in these allowances are those amounts associated with loans where it is probable that the value of the loan has been impaired and the loss can be reasonably estimated. The unallocated allowance element is more subjective and is reviewed quarterly to take into consideration estimation errors and economic trends that are not necessarily captured in determining the general and allocated allowance. The change in the balance of the allowance for loan losses at March 31, 2006 reflects the proportionate increase in loan balances, the change in mix of loan balances, the decrease in substandard assets and a change in loss rate when compared to March 31, 2005. The mix of the loan portfolio showed an increase in the balances of commercial, construction and consumer loans at March 31, 2006 as compared to balances at March 31, 2005. Substandard assets and assets classified as doubtful decreased by $2.1 million to $4.1 million at March 31, 2006 compared to $6.2 million at March 31, 2005. At March 31, 2006, the Company had an allowance for loan losses of $7.2 million, or 1.15% of total outstanding net loans at that date. Based on past experience and probable losses inherent in the loan portfolio, management believes that loan loss reserves are adequate. While the Company believes it has established its existing allowance for loan losses in accordance with accounting principles generally accepted in the United States of America ("generally accepted accounting principles" or "GAAP"), there can be no assurance that regulators, in reviewing the Company's loan portfolio, will not request the Company to increase significantly its allowance for loan losses, thereby negatively affecting the Company's financial condition and results of operations. The following table sets forth an analysis of the Company's allowance for loan losses for the periods indicated. 17 Year Ended March 31, ---------------------------------------------- 2006 2005 2004 2003 2002 ---- ---- ---- ---- ---- (Dollars in thousands) Balance at beginning of period $4,395 $4,481 $2,739 $2,537 $1,916 Provision for loan losses 1,500 410 210 727 1,116 Recoveries: Residential real estate - - - 2 - Land - - - 63 - Commercial 87 156 74 - - Consumer 62 17 17 13 25 ------ ------ ------ ------ ------ Total recoveries 149 173 91 78 25 ------ ------ ------ ------ ------ Charge-offs: Residential real estate - 84 21 140 88 Land - - 15 17 - Commercial 577 490 882 119 185 Consumer 134 95 264 152 166 ------ ------ ------ ------ ------ Total charge-offs 711 669 1,182 428 439 ------ ------ ------ ------ ------ Net charge-offs 562 496 1,091 350 414 ------ ------ ------ ------ ------ Dispositions (1) - - - - 81 Allowance acquired from Today's Bank - - 2,639 Allowance acquired from American Pacific Bank 1,888 - - - - Net change in allowance for unfunded loan commitments and lines of credit - - (16) (175) - ------ ------ ------ ------ ------ Balance at end of period $7,221 $4,395 $4,481 $2,739 $2,537 ====== ====== ====== ====== ====== Ratio of allowance to total loans outstanding at end of period 1.15% 1.01% 1.16% 0.90% 0.87% Ratio of net charge-offs to average net loans out- standing during period 0.10 0.13 0.31 0.12 0.14 Ratio of allowance to total of non-accrual and 90 days past due loans 1,740.00 963.82 344.43 847.99 166.69 (1) Allowance reclassified with securitization of one-to four-family loans to mortgage-backed securities. 18 Changes in the allowance for unfunded loan commitments and lines of credit: Year Ended March 31, ---------------------------------------------- 2006 2005 2004 2003 2002 ---- ---- ---- ---- ---- (In thousands) Balance at beginning of period $ 253 $ 191 $ 175 $ - $ - Net change in allowance for unfunded loan commitments and lines of credit 109 62 16 175 - ------- ------- ------- ------- ------- Balance at end of period $ 362 $ 253 $ 191 $ 175 $ - ======= ======= ======= ======= ======= The following table sets forth the breakdown of the allowance for loan losses by loan category and is based on applying a specific loan loss factor to the related loan category outstanding loan balances as of the date of the allocation for the periods indicated. At March 31, --------------------------------------------------------------------------------------- 2006 2005 2004 2003 2002 ---------------- ---------------- --------------- ---------------- ---------------- Loan Loan Loan Loan Loan Category Category Category Category Category as a as a as a as a as a Percent Percent Percent Percent Percent of Total of Total of Total of Total of Total Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans ------ ----- ------ ----- ------ ----- ------ ----- ------ ----- (Dollars in thousands) <s> <c> <c> <c> <c> <c> <c> <c> <c> <c> <c> Real estate loans One to four- family $ 65 5.10% $ 74 8.42% $ 89 11.34% $ 122 19.38% $ 191 24.87% Multi-family 19 0.34 14 0.58 19 1.30 24 2.05 37 3.37 Construction one- to four- family 820 12.88 176 10.05 148 12.33 194 14.97 319 15.17 Construction multi- family - - - - - - 5 0.31 20 1.37 Construction commercial 462 7.32 84 2.53 7 0.38 20 1.39 26 1.29 Land 496 7.80 219 6.65 148 6.56 196 9.37 192 8.14 Commercial real estate 3,433 52.11 1,935 51.37 2,259 45.73 1,046 33.13 869 28.70 Commercial loans 1,088 9.48 1,556 13.35 1,589 14.91 796 11.21 668 7.98 Consumer loans: Secured 175 4.75 197 6.67 175 7.01 141 7.75 180 8.61 Unsecured 41 0.22 44 0.38 37 0.44 33 0.44 27 0.50 Unallocated 622 - 96 - 10 - 162 - 8 - ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total allowance for loan losses $7,221 100.00% $4,395 100.00% $4,481 100.00% $2,739 100.00% $2,537 100.00% ====== ====== ====== ====== ====== ====== ====== ====== ====== ====== 19 Investment Activities OTS regulated institutions have authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies and of state and municipal governments, deposits at the applicable FHLB, certificates of deposit of federally insured institutions, certain bankers' acceptances and federal funds. Subject to various restrictions, OTS regulated institutions may also invest a portion of their assets in commercial paper, corporate debt securities and mutual funds, the assets of which conform to the investments that federally chartered savings institutions are otherwise authorized to make directly. Federal regulations require the Bank to maintain a minimum sufficient liquidity to ensure its safe and sound operation. Liquid assets include cash, cash equivalents consisting of short-term interest-earning deposits, certain other time deposits, and other obligations generally having remaining maturities of less than five years. It is management's intention to hold securities with short maturities in the investment portfolio in order to match more closely the interest rate sensitivities of the Company's assets and liabilities. At March 31, 2006, the Bank's liquidity ratio, the ratio of cash and eligible investments to the sum of withdrawable savings and borrowings due within one year, was 6.71%. The Investment Committee, composed of the Company's Chairman, President, Chief Financial Officer and Controller, makes investment decisions. The Company's investment objectives are: (i) to provide and maintain liquidity within regulatory guidelines; (ii) to maintain a balance of high quality, diversified investments to minimize risk; (iii) to provide collateral for pledging requirements; (iv) to serve as a balance to earnings; and (v) to optimize returns. At March 31, 2006, the Company's investment and mortgage-backed securities portfolio totaled $34.0 million and consisted primarily of obligations of federal agencies, and Federal National Mortgage Association ("FNMA") and FHLMC mortgage-backed securities. At March 31, 2006, the Company's investment securities portfolio did not contain any tax-exempt securities of any issuer with an aggregate book value in excess of 10% of the Company's consolidated shareholders' equity, excluding those securities issued by the U.S. Government or its agencies. The Board of Directors sets the investment policy of the Company which dictates that investments be made based on the safety of the principal amount, liquidity requirements of the Company and the return on the investments. At March 31, 2006, no investment securities were held for trading. The policy does not permit investment in non-investment grade bonds and permits investment in various types of liquid assets permissible under OTS regulation, which includes U.S. Treasury obligations, securities of various federal agencies, "bank qualified" municipal bonds, certain certificates of deposits of insured banks, repurchase agreements and federal funds. The Company has adopted SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, which requires the classification of securities at acquisition into one of three categories: held to maturity, available for sale or trading. See Note 1 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K. 20 The following table sets forth the investment securities portfolio and carrying values at the dates indicated. The fair value of the investment and mortgage-backed securities portfolio was $34.0 million, $37.0 million and $46.1 million at March 31, 2006, 2005 and 2004, respectively. At March 31, --------------------------------------------------------- 2006 2005 2004 ------------------ ------------------- ------------------ Percent Percent Percent Carrying of Carrying of Carrying of Value Portfolio Value Portfolio Value Portfolio ----- --------- ----- --------- ----- --------- (Dollars in thousands) Held to maturity (at amortized cost): Real estate mortgage investment conduits ("REMICs") $ 1,402 4.13% $ 1,802 4.88% $ 1,802 3.92% FHLMC mortgage-backed securities 138 0.41 218 0.59 332 0.72 FNMA mortgage-backed securities 265 0.78 323 0.88 383 0.83 ------- ------ ------- ------ ------- ------ 1,805 5.32 2,343 6.35 2,517 5.47 ------- ------ ------- ------ ------- ------ Available for sale (at fair value): Agency securities 15,028 44.25 13,842 37.51 11,194 24.33 REMICs 1,338 3.94 1,873 5.07 3,015 6.55 FHLMC mortgage-backed securities 6,635 19.54 9,507 25.76 7,190 15.63 FNMA mortgage-backed securities 161 0.47 239 0.65 402 0.88 Municipal securities 3,950 11.63 4,072 11.03 4,270 9.28 Trust preferred securities 5,044 14.85 5,031 13.63 5,019 10.91 Equity securities - - - - 12,400 26.95 ------- ------ ------- ------ ------- ------ 32,156 94.68 34,564 93.65 43,490 94.53 ------- ------ ------- ------ ------- ------ Total investment securities $33,961 100.00% $36,907 100.00% $46,007 100.00% ======= ====== ======= ====== ======= ====== The following table sets forth the maturities and weighted average yields in the securities portfolio at March 31, 2006. More Than Less Than One to Five to More Than One Year Five Years Ten Years Ten Years ----------------- ----------------- ----------------- ----------------- Weighted Weighted Weighted Weighted Average Average Average Average Amount Yield(1) Amount Yield (1) Amount Yield (1) Amount Yield(1) ------ -------- ------ -------- ------ -------- ------ -------- (Dollars in thousands) <s> <c> <c> <c> <c> <c> <c> <c> <c> Municipal securities $ 341 4.00% $ 1,623 4.20% $ 286 4.80% $ 1,700 4.48% Agency securities 4,441 3.28 10,587 3.78 - - - - REMICs - - 88 5.75 - - 2,651 5.61 FHLMC mortgage- backed securities 92 6.00 - - 6,543 4.02 138 5.03 FNMA mortgage- backed securities 23 6.89 - - 133 6.14 270 6.22 Trust preferred securities - - - - - - 5,044 6.32 ------- ---- ------- ---- ------- ---- ------- ---- Total $ 4,897 3.40% $12,298 3.85% $ 6,962 4.09% $ 9,803 5.79% ======= ==== ======= ==== ======= ==== ======= ==== (1) For available for sale securities carried at fair value, the weighted average yield is computed using amortized cost without a tax equivalent adjustment for tax exempt obligations. 21 In addition to U.S. Government treasury obligations, the Company invests in mortgage-backed securities and REMIC's. Mortgage-backed securities ("MBS"), which are also known as mortgage participation certificates or pass-through certificates, represent a participation interest in a pool of single-family or multi-family mortgages. Principal and interest payments on mortgage-backed securities are passed from the mortgage originators, through intermediaries such as FNMA, FHLMC, the Government National Mortgage Association ("GNMA") or private issuers that pool and repackage the participation interests in the form of securities, to investors such as the Company. Mortgage-backed securities generally increase the quality of the Company's assets by virtue of the guarantees that back them, are more liquid than individual mortgage loans and may be used to collateralize borrowings or other obligations of the Company. See Note 5 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K for additional information. REMICs are created by redirecting the cash flows from the pool of mortgages or mortgage-backed securities underlying these securities to create two or more classes, or tranches, with different maturity or risk characteristics designed to meet a variety of investor needs and preferences. Management believes these securities may represent attractive alternatives relative to other investments because of the wide variety of maturity, repayment and interest rate options available. Current investment practices of the Company prohibit the purchase of high risk REMICs. At March 31, 2006, the Company held REMICs with a net carrying value of $2.7 million, of which $1.4 million were classified as held-to-maturity and $1.3 million of which were available-for-sale. REMICs may be sponsored by private issuers, such as mortgage bankers or money center banks, or by U.S. Government agencies and government sponsored entities. At March 31, 2006, the Company owned no privately issued REMICs. Investments in mortgage-backed securities, including REMICs, involve a risk that actual prepayments will be greater than estimated prepayments over the life of the security, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments thereby reducing the net yield on such securities. There is also reinvestment risk associated with the cash flows from such securities. In addition, the market value of such securities may be adversely affected by changes in interest rates. The investment in municipal securities was $4.0 million at March 31, 2006 compared to $4.1 million at March 31, 2005. Deposit Activities and Other Sources of Funds General. Deposits, loan repayments and loan sales are the major sources of the Company's funds for lending and other investment purposes. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds from other sources. They may also be used on a longer-term basis for general business purposes. Deposit Accounts. The Company attracts deposits from within its primary market area by offering a broad selection of deposit instruments, including demand deposits, negotiable order of withdrawal ("NOW") accounts, money market accounts, regular savings accounts, certificates of deposit and retirement savings plans. Historically, the Company has focused on retail deposits. Expansion in commercial lending has led to growth in business deposits including demand deposit accounts. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of its deposit accounts, the Company considers the rates offered by its competition, profitability to the Company, matching deposit and loan products and its customer preferences and concerns. The Company generally reviews its deposit mix and pricing weekly. 22 Deposit Balances The following table sets forth information concerning the Company's certificates of deposit, other interest-bearing and non-interest bearing deposits at March 31, 2006. Percent Interest Minimum of Total Rate Term Category Amount Balance Deposits - ---- ---- -------- ------ ------- -------- (In thousands) 0.210% None NOW accounts $ 100 $ 62,941 10.37% 4.273 None High yield checking 25,000 66,516 10.96 0.550 None Regular savings 500 38,344 6.32 3.450 None Money market 2,500 137,451 22.65 None None Non-interest checking 100 94,592 15.58 -------- ------ Total transaction accounts 399,844 65.88 Certificates of Deposit ----------------------- 4.303 91 Days Fixed-term, Fixed-rate 2,500 23,338 3.85 3.596 182-364 Days Fixed-term, Fixed-rate 2,500 27,647 4.54 3.575 12-17 Months Fixed-term, Fixed-rate 2,500 54,746 9.02 3.612 18 Months Fixed-term, Variable rate, 100 1,429 0.24 Individual Retirement account ("IRA") 2.862 18-23 Months Fixed-term, Fixed-rate 2,500 1,810 0.30 3.529 24-35 Months Fixed-term, Fixed-rate 2,500 46,037 7.58 4.369 36-59 Months Fixed-term, Fixed-rate 2,500 29,046 4.79 4.294 60-83 Months Fixed-term, Fixed-rate 2,500 14,858 2.45 4.671 84-120 Months Fixed-term, Fixed-rate 2,500 8,209 1.35 -------- ------ Total certificates of deposit 207,120 34.12% -------- ------ Total deposits $606,964 100.00% ======== ====== 23 Deposit Flow The following table sets forth the balances of deposit accounts in the various types offered by the Company at the dates indicated. At March 31, ------------------------------------------------------------------------------------------- 2006 2005 2004 ----------------------------- ---------------------------- ---------------------------- (Increase (Increase (Increase Balance(2) Percent Decrease) Balance Percent Decrease) Balance Percent Decrease) ---------- ------- --------- ------- ------- --------- ------- ------- --------- (Dollars in thousands) <s> <c> <c> <c> <c> <c> <c> <c> <c> <c> Non-interest- bearing demand $ 94,592 15.58% $ 15,093 $ 79,499 17.40% $ 17,597 $ 61,902 15.13% $ (16,562) NOW accounts 62,941 10.37 (2,726) 65,667 14.37 (51) 65,718 16.06 38,605 High-yield checking 66,516 10.96 15,954 50,562 11.07 894 49,668 12.14 14,131 Regular savings accounts 38,344 6.32 2,831 35,513 7.77 6,179 29,334 7.17 4,479 Money market deposit accounts 137,451 22.65 61,120 76,331 16.71 6,347 69,984 17.11 16,267 Certificates of deposits which mature (1): Within 12 months 130,159 21.44 53,101 77,058 16.87 (9,214) 86,272 21.09 15,117 Within 12-36 months 65,679 10.82 26,573 39,106 8.56 6,684 32,422 7.92 9,803 Beyond 36 months 11,282 1.86 (21,860) 33,142 7.25 19,327 13,815 3.38 6,533 -------- ------ -------- -------- ------ -------- -------- ------ -------- Total $606,964 100.00% $150,086 $456,878 100.00% $ 47,763 $409,115 100.00% $ 88,373 ======== ====== ======== ======== ====== ======== ======== ====== ======== (1) IRAs of $16.6 million, $15.4 million and $13.9 million at March 31, 2006, 2005 and 2004, respectively, are included in certificate of deposit balances. (2) The April 22, 2005 acquisition of APB deposits included $38.1 million in transaction accounts and $42.0 million in certificates of deposits. 24 Certificates of Deposit by Rates and Maturities The following table sets forth the certificates of deposit in the Company classified by rates as of the dates indicated. At March 31, ---------------------------- 2006 2005 2004 ------ ------ ------ (In thousands) Below 2.00% $ 2,257 $ 34,136 $ 63,241 2.00 2.99% 22,012 37,157 23,307 3.00 3.99% 90,763 36,216 14,221 4.00 4.99% 85,746 30,277 17,224 5.00 5.99% 6,063 9,670 10,230 6.00 7.99% 279 1,850 4,286 -------- -------- -------- Total $207,120 $149,306 $132,509 ======== ======== ======== The following table sets forth the amount and maturities of certificates of deposit at March 31, 2006. Amount Due -------------------------------------------------- After Less Than 1 to 2 2 to 3 After One Year Years Years 3 Years Total -------- ------- -------- --------- ------- (In thousands) Below 2.00% $ 2,063 $ 173 $ - $ 21 $ 2,257 2.00 2.99% 20,552 1,345 78 37 22,012 3.00 3.99% 64,847 19,782 3,076 3,058 90,763 4.00 4.99% 40,640 13,973 24,185 6,948 85,746 5.00 5.99% 1,920 1,654 1,271 1,218 6,063 6.00 7.99% 137 34 108 - 279 -------- ------- ------- ------- --------- Total $130,159 $36,961 $28,718 $11,282 $ 207,120 ======== ======= ======= ======= ========= The following table presents the amount and weighted average rate of time deposits equal to or greater than $100,000 at March 31, 2006. Weighted Maturity Period Amount Average Rate - --------------- -------- ------------ (Dollars in thousands) Three months or less $ 24,477 3.81% Over three through six months 27,210 4.01 Over six through 12 months 17,135 3.91 Over 12 Months 33,164 4.36 -------- Total $101,986 4.06% ======== 25 Deposit Activities The following table sets forth the deposit activities of the Company for the periods indicated. Year Ended March 31, ------------------------------- 2006 2005 2004 -------- --------- --------- (In thousands) Beginning balance $456,878 $409,115 $320,742 Net increase before interest credited 137,743 42,342 83,618 Interest credited 12,343 5,421 4,755 Net increase in savings deposits 150,086 47,763 88,373 -------- -------- -------- Ending balance $606,964 $456,878 $409,115 ======== ======== ======== Borrowings. Savings deposits are the primary source of funds for the Company's lending and investment activities and for its general business purposes. The Company relies upon advances from the FHLB of Seattle to supplement its supply of lendable funds and to meet deposit withdrawal requirements. Advances from the FHLB of Seattle are typically secured by the Bank's first mortgage loans, commercial real estate loans and investment securities. The FHLB functions as a central reserve bank providing credit for savings and loan associations and certain other member financial institutions. As a member, the Bank is required to own capital stock in the FHLB and is authorized to apply for advances on the security of such stock and certain of its mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the United States) provided certain standards related to creditworthiness have been met. Advances are made pursuant to several different programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an institution's assets or on the FHLB's assessment of the institution's creditworthiness. The FHLB determines specific lines of credit for each member institution and the Bank has a 30% of total assets line of credit with the FHLB of Seattle to the extent the Bank provides qualifying collateral and holds sufficient FHLB stock. At March 31, 2006, the Bank had $46.1 million of outstanding advances from the FHLB of Seattle under an available credit facility of $228.5 million, which is limited to available collateral. 26 The following tables set forth certain information concerning the Company's FHLB Seattle borrowings at the dates and for the periods indicated. At March 31, ------------------------------ 2006 2005 2004 ------- -------- -------- Weighted average rate on FHLB advances 4.65% 5.05% 4.88% Year Ended March 31, ------------------------------ 2006 2005 2004 ------- -------- -------- (Dollars In thousands) Maximum amounts of FHLB advances outstanding at any month end $66,400 $43,000 $40,000 Average FHLB advances outstanding 51,091 40,274 40,000 Weighted average rate on FHLB advances 4.44% 5.00% 4.96% In addition, the Bank has a Fed Funds borrowing facility with Pacific Coast Bankers' Bank with a guideline limit of $10 million through June 30, 2007. The facility may be reduced or withdrawn at any time. As of March 31, 2006, the Bank did not have any outstanding advances on this facility. At December 31, 2005, a wholly owned subsidiary grantor trust established by the Company had issued $7.0 million of pooled Trust Preferred Securities ("trust preferred securities"). Trust preferred securities accrue and pay distributions periodically at specified rates as provided in the amended and restated declaration of trust. The trust used the net proceeds from the offering to purchase a like amount of Junior Subordinated Debentures (the "Debentures") of the Company which pays interest at the same rate as distribution on the trust preferred securities. The Debentures are the sole assets of the trusts. The Company's obligations under the Debentures and related documents, taken together, constitute a full and unconditional guarantee by the Company of the obligations of the trusts. The trust preferred securities are mandatory redeemable upon the maturity of the Debentures, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the Debentures in whole or in part five years after issuance on any coupon date, at a redemption price specified in the indentures plus any accrued but unpaid interest to the redemption date. The following table is a summary of junior subordinated debentures securities at March 31, 2006: Preferred Issuance security Initial Rate at Maturing date amount Rate Type (1) Rate 12/31/05 Date ---- ------ ------------ ---- -------- ---- (Dollars in thousands) Issuance trust - -------------- Riverview Bancorp, Inc. Statutory Trust 1 12/2005 $ 7,000 Variable 5.88% 6.27% 12/2035 (1) The variable rate preferred securities reprice quarterly. The total amount of trust preferred securities outstanding at December 31, 2005 was $7.0 million. The interest rates on the trust preferred securities issued in December 2005 resets quarterly and is tied to the London Interbank Offered Rate ("LIBOR"). The Company has the right to redeem the Debentures in December 2010. The Debentures issued by the Company to the grantor trusts, totaling $7.0 million, are reflected in our consolidated balance sheet in the liabilities section at December 31, 2005, under the caption "Junior subordinated debentures." The Company records interest expense on the Debentures in the consolidated statements of income. The Company recorded $217,000 in other assets in the consolidated balance sheet at March 31, 2006, for the common capital 27 securities issued by the issuer trusts. The Company invested $5.0 million of the trust preferred securities proceeds in the Bank and retained the remaining $2.0 million for general corporate purposes. REGULATION The following is a brief description of certain laws and regulations which are applicable to the Company and the Bank. The description of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations. Legislation is introduced from time to time in the United States Congress that may affect our operations. In addition, the regulations governing us may be amended from time to time by the OTS. Any such legislation or regulatory changes in the future could adversely affect us. We cannot predict whether any such changes may occur. General The Bank, as a federally chartered savings institution, is subject to extensive regulation, examination and supervision by the OTS, as its primary federal regulator, and the FDIC, as its deposits insurer. The Bank is a member of the FHLB System and its deposit accounts are insured up to applicable limits by the SAIF managed by the FDIC. The Bank must file reports with the OTS and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. There are periodic examinations by the OTS and, under certain circumstances, the FDIC to evaluate the Bank's safety and soundness and compliance with various regulatory requirements. This regulatory structure is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such policies, whether by the OTS, the FDIC or Congress, could have a material adverse impact on the Company and the Bank and their operations. The Company, as a savings and loan holding company, is required to file certain reports with, are subject to examination by, and otherwise must comply with the rules and regulations of the OTS. The Company is also subject to the rules and regulations of the SEC under the federal securities laws. See "-- Savings and Loan Holding Company Regulations." Federal Regulation of Savings Institutions Office of Thrift Supervision. The OTS has extensive authority over the operations of savings institutions. As part of this authority, the Bank is required to file periodic reports with the OTS and is subject to periodic examinations by the OTS and the FDIC. The OTS also has extensive enforcement authority over all savings institutions and their holding companies, including the Bank and the Company. This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease-and-desist or removal orders and initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OTS. Except under certain circumstances, public disclosure of final enforcement actions by the OTS is required. In addition, the investment, lending and branching authority of the Bank also are prescribed by federal laws, which prohibit the Bank from engaging in any activities not permitted by these laws. For example, no savings institution may invest in non-investment grade corporate debt securities. In addition, the permissible level of investment by federal institutions in loans secured by non-residential real property may not exceed 400% of total capital, except with approval of the OTS. Federal savings institutions are also generally authorized to branch nationwide. The Bank is in compliance with the noted restrictions. 28 All savings institutions are required to pay assessments to the OTS to fund the agency's operations. The general assessments, paid on a semi-annual basis, are determined based on the savings institution's total assets, including consolidated subsidiaries. The Bank's OTS assessment for the fiscal year ended March 31, 2006 was $131,000. The Bank's general permissible lending limit for loans-to-one-borrower is equal to the greater of $500,000 or 15% of unimpaired capital and surplus (except for loans fully secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus). At March 31, 2006, the Bank's lending limit under this restriction was $11.8 million and, at that date, the Bank's largest single loan to one borrower was $7.7 million, which was performing according to its original terms. The OTS, as well as the other federal banking agencies, has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits. Any institution that fails to comply with these standards must submit a compliance plan. Federal Home Loan Bank System. The Bank is a member of the FHLB of Seattle, which is one of 12 regional FHLBs that administer the home financing credit function of savings institutions. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans or advances to members in accordance with policies and procedures, established by the Board of Directors of the FHLB, which are subject to the oversight of the Federal Housing Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term advances are required to provide funds for residential home financing. At March 31, 2006, the Bank had $46.1 million of outstanding advances from the FHLB of Seattle under an available credit facility of $228.5 million, which is limited to available collateral. See Business Deposit Activities and Other Sources of Funds Borrowings. As a member, the Bank is required to purchase and maintain stock in the FHLB of Seattle. At March 31, 2006, the Bank had $7.4 million in FHLB stock, which was in compliance with this requirement. In past years, the Bank has received substantial dividends on its FHLB stock until such dividends were suspended on May 18, 2005. For the year ended March 31, 2006, the Bank received no dividends from the FHLB of Seattle compared to $110,000 in dividends from the FHLB of Seattle for the year ended March 31, 2005. Under federal law, the FHLBs are required to provide funds for the resolution of troubled savings institutions and to contribute to low- and moderately-priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have affected adversely the level of FHLB dividends paid and could continue to do so in the future. These contributions could also have an adverse effect on the value of FHLB stock in the future. A reduction in value of the Bank's FHLB stock may result in a corresponding reduction in the Bank's capital. Deposit Insurance. The Bank is a member of the SAIF, which is administered by the FDIC. Deposits are insured up to the applicable limits by the FDIC and this insurance is backed by the full faith and credit of the United States. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the SAIF. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the OTS an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition. The FDIC's deposit insurance premiums are assessed through a risk-based system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums based upon their level of capital and supervisory evaluation. Under the system, institutions classified as well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1 or core capital, to risk-weighted assets ("Tier 1 risk-based capital") of at least 6% and a risk-based capital ratio of at least 10%) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (i.e., core or Tier 1 risk-based capital ratios of less than 4% or a 29 risk-based capital ratio of less than 8%) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period. The FDIC is authorized to increase assessment rates, on a semi-annual basis, if it determines that the reserve ratio of the SAIF will be less than the designated reserve ratio of 1.25% of SAIF insured deposits. In setting these increased assessments, the FDIC must seek to restore the reserve ratio to that designated reserve level, or such higher reserve ratio as established by the FDIC. The FDIC may also impose special assessments on SAIF members to repay amounts borrowed from the United States Treasury or for any other reason deemed necessary by the FDIC. Since January 1, 1997, the premium schedule for Bank Insurance Fund ("BIF") and SAIF insured institutions has ranged from 0 to 27 basis points. However, SAIF and BIF insured institutions are required to pay a Financing Corporation assessment in order to fund the interest on bonds issued to resolve thrift failures in the 1980s equal to approximately 1.5 points for each $100 in domestic deposits annually. These assessments, which may be revised based upon the level of BIF and SAIF deposits, will continue until the bonds mature in the year 2017. The Federal Deposit Insurance Reform Act of 2005 ("The Reform Act"), which was enacted in 2006, revised the laws governing the federal deposit insurance system. The Reform Act provides for the consolidation of the Bank Insurance Fund and the Savings Association Insurance Fund into a combined "Deposit Insurance Fund" and gives the FDIC the authority to determine insurance premiums based on a number of factors, primarily the risk of loss that insured institutions pose to the Deposit Insurance Fund. The legislation eliminates the current minimum 1.25% reserve ratio for the insurance funds, the mandatory assessments when the ratio fall below 1.25% and the prohibition on assessing the highest quality banks when the ratio is above 1.25%. The Reform Act provides the FDIC with flexibility to adjust the new insurance fund's reserve ratio between 1.15% and 1.5%, depending on projected losses, economic changes and assessment rates at the end of a calendar year. The Reform Act increased deposit insurance coverage limits from $100,000 to $250,000 for certain types of Individual Retirement Accounts, 401(k) plans and other retirement savings accounts. While it preserved the $100,000 coverage limit for individual accounts and municipal deposits, the FDIC was furnished with the discretion to adjust all coverage levels to keep pace with inflation beginning in 2010. Also, institutions that become undercapitalized will be prohibited from accepting certain employee benefit plan deposits. At this time, management cannot predict the effect, if any, that the Reform Act will have on insurance premiums paid by the Bank. Prompt Corrective Action. The OTS is required to take certain supervisory actions against undercapitalized savings institutions, the severity of which depends upon the institution's degree of undercapitalization. Generally, an institution that has a ratio of total capital to risk-weighted assets of less than 8%, a ratio of Tier I (core) capital to risk-weighted assets of less than 4%, or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be "undercapitalized." An institution that has a total risk-based capital ratio less than 6%, a Tier I capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be "significantly undercapitalized" and an institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized." Subject to a narrow exception, the OTS is required to appoint a receiver or conservator for a savings institution that is "critically undercapitalized." OTS regulations also require that a capital restoration plan be filed with the OTS within 45 days of the date a savings institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. "Significantly undercapitalized" and "critically undercapitalized" institutions are subject to more extensive mandatory regulatory actions. The OTS also could take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. At March 31, 2006, the Bank was categorized as "well capitalized" under the prompt corrective action regulations of the OTS. 30 Qualified Thrift Lender Test. All savings institutions, including the Bank, are required to meet a qualified thrift lender ("QTL") test to avoid certain restrictions on their operations. This test requires a savings institution to have at least 65% of its total assets, as defined by regulation, in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. As an alternative, the savings institution may maintain 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code ("Code"). Under either test, such assets primarily consist of residential housing related loans and investments. A savings institution that fails to meet the QTL is subject to certain operating restrictions and may be required to convert to a national bank charter. Recent legislation has expanded the extent to which education loans, credit card loans and small business loans may be considered "qualified thrift investments." As of March 31, 2006, the Bank maintained 70.45% of its portfolio assets in qualified thrift investments and, therefore, met the qualified thrift lender test. Capital Requirements. The OTS's capital regulations require federal savings institutions to meet three minimum capital standards: a 1.5% tangible capital to total assets ratio, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS examination rating system) and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS system) and, together with the risk-based capital standard itself, a 4% Tier I risk-based capital standard. The OTS regulations also require that, in meeting the tangible, leverage and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank. The risk-based capital standard requires federal savings institutions to maintain Tier I (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, recourse obligations, residual interests and direct credit substitutes, are multiplied by a risk-weight factor of 0% to 100%, assigned by the OTS capital regulation based on the risks believed inherent in the type of asset. Core (Tier I) capital is defined as common stockholders' equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. The OTS also has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution's capital level is or may become inadequate in light of the particular circumstances. At March 31, 2006, the Bank met each of these capital requirements. For additional information, see Note 17 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Limitations on Capital Distributions. OTS regulations impose various restrictions on savings institutions with respect to their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. Generally, savings institutions, such as the Bank, that before and after the proposed distribution are well-capitalized, may make capital distributions during any calendar year equal to up to 100% of net income for the year-to-date plus retained net income for the two preceding years. However, an institution deemed to be in need of more than normal supervision by the OTS may have its dividend authority restricted by the OTS. The Bank may pay dividends to the Company in accordance with this general authority. Savings institutions proposing to make any capital distribution need not submit written notice to the OTS prior to such distribution unless they are a subsidiary of a holding company or would not remain well capitalized following 31 the distribution. Savings institutions that do not, or would not meet their current minimum capital requirements following a proposed capital distribution or propose to exceed these net income limitations, must obtain OTS approval prior to making such distribution. The OTS may object to the distribution during that 30-day period based on safety and soundness concerns. See "- Capital Requirements." Activities of Associations and their Subsidiaries. When a savings institution establishes or acquires a subsidiary or elects to conduct any new activity through a subsidiary that the association controls, the savings institution must notify the FDIC and the OTS 30 days in advance and provide the information each agency may, by regulation, require. Savings institutions also must conduct the activities of subsidiaries in accordance with existing regulations and orders. The OTS may determine that the continuation by a savings institution of its ownership control of, or its relationship to, the subsidiary constitutes a serious risk to the safety, soundness or stability of the association or is inconsistent with sound banking practices or with the purposes of the FDIA. Based upon that determination, the FDIC or the OTS has the authority to order the savings institution to divest itself of control of the subsidiary. The FDIC also may determine by regulation or order that any specific activity poses a serious threat to the SAIF. If so, it may require that no SAIF member engage in that activity directly. Transactions with Affiliates. The Bank's authority to engage in transactions with "affiliates" is limited by OTS regulations and by Sections 23A and 23B of the Federal Reserve Act as implemented by the Federal Reserve Board's Regulation W. The term "affiliates" for these purposes generally means any company that controls or is under common control with an institution. The Company and its non-savings institution subsidiaries would be affiliates of the Bank. In general, transactions with affiliates must be on terms that are as favorable to the institution as comparable transactions with non-affiliates. In addition, certain types of transactions are restricted to an aggregate percentage of the institution's capital. Collateral in specified amounts must usually be provided by affiliates in order to receive loans from an institution. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary. The Sarbanes-Oxley Act of 2002 generally prohibits a company from making loans to its executive officers and directors. However, that act contains a specific exception for loans by a depository institution to its executive officers and directors in compliance with federal banking laws. Under such laws, the Bank's authority to extend credit to executive officers, directors and 10% stockholders ("insiders"), as well as entities such person's control is limited. The law restricts both the individual and aggregate amount of loans the Bank may make to insiders based, in part, on the Bank's capital position and requires certain Board approval procedures to be followed. Such loans must be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. There are additional restrictions applicable to loans to executive officers. Community Reinvestment Act. Under the Community Reinvestment Act, every FDIC-insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The Community Reinvestment Act does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the Community Reinvestment Act. The Community Reinvestment Act requires the OTS, in connection with the examination of the Bank, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by the Bank. An unsatisfactory rating may be used as the basis for the denial of an application by the OTS. Due to the heightened attention being given to the Community Reinvestment Act in the past few years, the Bank may be required to devote additional funds for investment and lending in its local community. The Bank was examined for Community Reinvestment Act compliance and received a rating of outstanding in its latest examination. 32 Affiliate Transactions. The Company and the Bank are separate and distinct legal entities. Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company, generally limiting any single transaction to 10% of the Bank's capital and surplus and limiting all such transactions to 20% of the Bank's capital and surplus. These transactions also must be on terms and conditions consistent with safe and sound banking practices that are substantially the same as those prevailing at the time for transactions with unaffiliated companies. Federally insured savings institutions are subject, with certain exceptions, to certain restrictions on extensions of credit to their parent holding companies or other affiliates, on investments in the stock or other securities of affiliates and on the taking of such stock or securities as collateral from any borrower. In addition, these institutions are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or the providing of any property or service. Enforcement. The OTS has primary enforcement responsibility over savings institutions and has the authority to bring action against all "institution-affiliated parties," including shareholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers or directors, receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or $1.1 million per day in especially egregious cases. The FDIC has the authority to recommend to the Director of the OTS that enforcement action be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations. Standards for Safety and Soundness. As required by statute, the federal banking agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the OTS determines that a savings institution fails to meet any standard prescribed by the guidelines, the OTS may require the institution to submit an acceptable plan to achieve compliance with the standard. Environmental Issues Associated with Real Estate Lending. The Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), a federal statute, generally imposes strict liability on all prior and present "owners and operators" of sites containing hazardous waste. However, Congress asked to protect secured creditors by providing that the term "owner and operator" excludes a person whose ownership is limited to protecting its security interest in the site. Since the enactment of the CERCLA, this "secured creditor exemption" has been the subject of judicial interpretations which have left open the possibility that lenders could be liable for cleanup costs on contaminated property that they hold as collateral for a loan. To the extent that legal uncertainty exists in this area, all creditors, including the Bank, that have made loans secured by properties with potential hazardous waste contamination (such as petroleum contamination) could be subject to liability for cleanup costs, which costs often substantially exceed the value of the collateral property. Privacy Standards. The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 ("GLBA"), which was enacted in 1999, modernized the financial services industry by establishing a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers. The Bank is subject to OTS regulations implementing the privacy protection provisions of the GLBA. These regulations require the Bank to disclose its privacy policy, including identifying with whom it shares "non-public personal information," to customers at the time of establishing the customer relationship and annually thereafter. Anti-Money Laundering and Customer Identification. Congress enacted the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "USA Patriot Act") on October 26, 2001 in response to the terrorist events of September 11, 2001. The USA Patriot Act gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded 33 surveillance powers, increased information sharing, and broadened anti-money laundering requirements. In March 2006, Congress re-enacted certain expiring provisions of the USA Patriot Act. Savings and Loan Holding Company Regulations General. The Company is a unitary savings and loan holding company subject to regulatory oversight of the OTS. Accordingly, the Company is required to register and file reports with the OTS and is subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over the Company and its non-savings institution subsidiaries which also permits the OTS to restrict or prohibit activities that are determined to present a serious risk to the subsidiary savings institution. Mergers and Acquisitions. The Company must obtain approval from the OTS before acquiring more than 5% of the voting stock of another savings institution or savings and loan holding company or acquiring such an institution or holding company by merger, consolidation or purchase of its assets. In evaluating an application for the Company to acquire control of a savings institution, the OTS would consider the financial and managerial resources and future prospects of the Company and the target institution, the effect of the acquisition on the risk to the insurance funds, the convenience and the needs of the community and competitive factors. Activities Restrictions. As a unitary savings and loan holding company, the Company generally is not subject to activity restrictions. The Company and its non-savings institution subsidiaries are subject to statutory and regulatory restrictions on their business activities specified by federal regulations, which include performing services and holding properties used by a savings institution subsidiary, activities authorized for savings and loan holding companies as of March 5, 1987, and non-banking activities permissible for bank holding companies pursuant to the Bank Holding Company Act of 1956 or authorized for financial holding companies pursuant to the GLBA. If the Bank fails the QTL test, the Company must, within one year of that failure, register as, and will become subject to, the restrictions applicable to bank holding companies. See "- Federal Regulation of Savings Institutions - - Qualified Thrift Lender Test." Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act") was signed into law on July 30, 2002 in response to public concerns regarding corporate accountability in connection with recent accounting scandals. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the Securities and Exchange Commission ("SEC") under the Securities Exchange Act of 1934, including the Company. The Sarbanes-Oxley Act includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and related rules. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees. Taxation For details regarding the Company's taxes, see Note 14 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K. Personnel As of March 31, 2006, the Company had 239 full-time equivalent employees, none of whom are represented by a collective bargaining unit. The Company believes its relationship with its employees is good. 34 Executive Officers. The following table sets forth certain information regarding the executive officers of the Company. Name Age (1) Position - ---- ------- -------- Patrick Sheaffer 66 Chairman of the Board and Chief Executive Officer Ron Wysaske 53 President and Chief Operating Officer David A. Dahlstrom 55 Executive Vice President and Chief Credit Officer Ron Dobyns 57 Senior Vice President and Chief Financial Officer John A. Karas 57 Senior Vice President (1) At March 31, 2006. Patrick Sheaffer is Chairman of the Board and Chief Executive Officer of the Company and Chief Executive Officer of the Bank. Prior to February 2004, Mr. Sheaffer served as Chairman of the Board, President and Chief Executive Officer of the Company since inception in 1997. He became Chairman of the Board of the Bank in 1993. Mr. Sheaffer joined the Bank in 1965. He is responsible for leadership and management of the Company. Mr. Sheaffer is active in numerous professional and civic organizations. Ron Wysaske is President and Chief Operating Officer of the Bank. Prior to February 2004, Mr. Wysaske served as Executive Vice President, Treasurer and Chief Financial Officer of the Bank from 1981 to 2004 and of the Company at inception in 1997. He joined the Bank in 1976. Mr. Wysaske is responsible for daily operations and management of the Bank. He holds an M.B.A. from Washington State University and is active in numerous professional and civic organizations. David A. Dahlstrom, Executive Vice President and Chief Credit Officer, was hired in May 2002. He is responsible for all Riverview lending divisions related to its commercial, mortgage and consumer loan activities. Prior to joining Riverview, Mr. Dahlstrom spent 14 years with First Interstate and progressed through a number of management positions, including serving as Senior Vice President of the Business Banking Group in Portland. In 1999, Mr. Dahlstrom joined a regional bank as Executive Vice President/Community Banking, responsible for all branch operations and small business banking. Ron Dobyns is Senior Vice President and Chief Financial Officer of the Company. Prior to February 2004, Mr. Dobyns served as Controller since 1996. He is responsible for accounting, SEC reporting as well as treasury functions for the Bank and the Company. He is a State of Oregon certified public accountant, holds an M.B.A. from the University of Minnesota and is a graduate of Pacific Coast Banking School. John A. Karas, Senior Vice President of the Bank, also serves as Chairman of the Board, President and CEO of our subsidiary, Riverview Asset Management Corp. Mr. Karas came to Riverview in 1999 with over 20 years of trust experience. He is familiar with all phases of the trust business and his experience includes trust administration, trust legal council, investments and real estate. Mr. Karas received his B.A. from Willamette University and his Juris Doctor degree from Lewis & Clark Law School's Northwestern School of Law. He is a member of the Oregon, Multnomah County and American Bar Associations and a Certified Trust and Financial Advisor. Mr. Karas is also active in numerous civic organizations. Item1A. Risk Factors An investment in our common stock is subject to risks inherent in our business. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included in this report. In addition to the risks and uncertainties described below, other risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition and results of operations. The value or market price of our common stock could decline due to any of these identified or other risks, and you could lose all or part of your investment. 35 Fluctuations in interest rates could reduce our profitability and affect the value of our assets. Like other financial institutions, we are subject to interest rate risk. Our primary source of income is net interest income, which is the difference between interest earned on loans and investments and the interest paid on deposits and borrowings. We expect that we will periodically experience imbalances in the interest rate sensitivities of our assets and liabilities and the relationships of various interest rates to each other. Over any period of time, our interest-earning assets may be more sensitive to changes in market interest rates than our interest-bearing liabilities, or vice versa. In addition, the individual market interest rates underlying our loan and deposit products may not change to the same degree over a given time period. In any event, if market interest rates should move contrary to our position, our earnings may be negatively affected. In addition, loan volume and quality and deposit volume and mix can be affected by market interest rates. Changes in levels of market interest rates could materially adversely affect our net interest spread, asset quality, origination volume and overall profitability. Interest rates have recently been at historically low levels. However, since June 30, 2004, the U.S. Federal Reserve has increased its target for the federal funds rate fifteen times, from 1.00% to 4.75%. While these short-term market interest rates (which we use as a guide to price our deposits) have increased the pricing of our loans have more than offset the rise in funding cost. In a sustained rising interest rate environment the asset yields are expected to closely match rising funding costs. A sustained falling interest rate environment would negatively impact margins. Opportunities to reduce non-maturity deposit rates become more difficult to realize in a protracted decline in rates, while asset yields come under constant pressure. We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities. In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be materially harmed. Changes in the level of interest rates also may negatively affect our ability to originate real estate loans, the value of our assets and our ability to realize gains from the sale of our assets, all of which ultimately affect our earnings. Our business is subject to various lending risks which could adversely impact our results of operations and financial condition. Our commercial real estate loans involve higher principal amounts than other loans, and repayment of these loans may be dependent on factors outside our control or the control of our borrowers. At March 31, 2006, we had $328.4 million of loans secured by commercial real estate loans, representing 52.1 % of our total loans and loans held for sale portfolio. The income generated from the operation of the property securing the loan is generally considered by us to be the principal source of repayment on this type of loan. The commercial real estate lending in which we engage typically involves larger loans to a single borrower and is generally viewed as exposing the lender to a greater risk of loss than one-four family residential lending because these loans generally are not fully amortizing over the loan period, but have a balloon payment due at maturity. A borrower's ability to make a balloon payment typically will depend on being able to either refinance the loan or timely sell the underlying property. Repayment of our commercial loans is often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value. At March 31, 2006, commercial loans totaled $59.8 million, or 9.5%, of our total loan and loans held for sale portfolio. Our commercial loans are primarily made based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Most often, this collateral consists of accounts receivable, inventory or equipment. Credit support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the pledged collateral and enforcement of a personal guarantee, if any exists. As a result, in the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. The collateral securing other loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. Our construction and land loans are based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. We originate construction loans for commercial properties, as well as for single 36 family home construction. At March 31, 2006, construction loans totaled $127.3 million, or 20.2% of total loans and loans held for sale while land loans totaled $49.2 million or 7.8% of total loans and loans held for sale. Construction and land acquisition and development lending involves additional risks because funds are advanced upon the security of the project, which is of uncertain value prior to its completion. There are also risks associated with the timely completion of the construction activities for their allotted costs, as a number of factors can result in delays and cost overruns, and the time needed to stabilize income producing properties or to sell residential tract developments. Because of the uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of governmental regulation of real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the related loan-to-value ratio. As a result, construction loans and land acquisition and development loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness, rather than the ability of the borrower or guarantor to repay principal and interest. If our appraisal of the value of the completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project and may incur a loss. Our consumer loans generally have a higher risk of default than our other loans. At March 31, 2006, consumer loans totaled $31.4 million, or 5.0%, of our total loan and loans held for sale portfolio. Consumer loans typically have shorter terms and lower balances with higher yields as compared to one- to four-family residential mortgage loans, but generally carry higher risks of default. Consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on these loans. An inadequate allowance for loan losses would reduce our earnings. We are exposed to the risk that our borrowers will be unable to repay their loans according to their terms and that any collateral securing the payment of their loans will not be sufficient to assure full repayment. Credit losses are inherent in the lending business and could have a material adverse effect on our operating results. Volatility and deterioration in the economy may also increase our risk for credit losses. We evaluate the collectibility of our loan portfolio and provide an allowance for loan losses that we believe is adequate based upon such factors as: * Cash flow of the borrower and/or the project being financed; * in the case of a collateralized loan, the changes and uncertainties as to the future value of the collateral; * the credit history of a particular borrower; * changes in economic and industry conditions; and * the duration of the loan. If our evaluation is incorrect and borrower defaults cause losses exceeding our allowance for loan losses, our earnings could be materially and adversely affected. We cannot assure you that our allowance will be adequate to cover loan losses inherent in our portfolio. We may experience losses in our loan portfolio or perceive adverse trends that require us to significantly increase our allowance for loan losses in the future, which would also reduce our earnings. In addition, the Bank's regulators, as an integral part of their examination process, may require us to make additional provisions for loan losses. The unseasoned nature of many of the commercial real estate loans we originated may lead to additional provisions for loan losses or charge-offs, which would hurt our profits. The diversification of our real estate loan portfolio has led to a significant increase in the number of commercial real estate loans in our portfolio. Many of these loans are unseasoned and have not been subjected to unfavorable economic conditions. We have limited experience in originating these types of loans and as a result do not have a 37 significant payment history pattern with which to judge future collectibility. As a result, it is difficult to predict the future performance of this part of our real estate loan portfolio. These loans may have delinquency or charge-off levels above our historical experience, which could adversely affect our profitability. Our real estate lending also exposes us to the risk of environmental liabilities. In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third persons for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition and results of operations could be materially and adversely affected. Our profitability depends significantly on economic conditions in the States of Washington and Oregon. Our success depends primarily on the general economic conditions of the States of Washington and Oregon and the specific local markets in which we operate. Unlike larger national or other regional banks that are more geographically diversified, we provide banking and financial services to customers located primarily in seven counties of Washington and Oregon. The local economic conditions in our market areas have a significant impact on the demand for our products and services as well as the ability of our customers to repay loans, the value of the collateral securing loans and the stability of our deposit funding sources. Adverse economic conditions unique to these Northwest markets could have a material adverse effect on our financial condition and results of operations. Further, a significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences, unemployment, changes in securities markets or other factors could impact these state and local markets and, in turn, also have a material adverse effect on our financial condition and results of operations. Our funding sources may prove insufficient to replace deposits and support our future growth. We rely on customer deposits and advances from the FHLB-Seattle and other borrowings to fund our operations. Although we have historically been able to replace maturing deposits and advances if desired, no assurance can be given that we would be able to replace such funds in the future if our financial condition or the financial condition of the FHLB or market conditions were to change. Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our profitability would be adversely affected. Although we consider such sources of funds adequate for our liquidity needs, we may seek additional debt in the future to achieve our long-term business objectives. There can be no assurance additional borrowings, if sought, would be available to us or, if available, would be on favorable terms. If additional financing sources are unavailable or are not available on reasonable terms, our growth and future prospects could be adversely affected. Competition with other financial institutions could adversely affect our profitability. The banking and financial services industry is very competitive. Legal and regulatory developments have made it easier for new and sometimes unregulated competitors to compete with us. Consolidation among financial service providers has resulted in fewer very large national and regional banking and financial institutions holding a large accumulation of assets. These institutions generally have significantly greater resources, a wider geographic presence or greater accessibility. Our competitors sometimes are also able to offer more services, more favorable pricing or greater customer convenience than we do. In addition, our competition has grown from new banks and 38 other financial services providers that target our existing or potential customers. As consolidation continues among large banks, we expect additional institutions to try to exploit our market. Technological developments have allowed competitors including some non-depository institutions, to compete more effectively in local markets and have expanded the range of financial products, services and capital available to our target customers. If we are unable to implement, maintain and use such technologies effectively, we may not be able to offer products or achieve cost-efficiencies necessary to compete in our industry. In addition, some of these competitors have fewer regulatory constraints and lower cost structures. We rely heavily on the proper functioning of our technology. We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations. We rely on third-party service providers for much of our communications, information, operating and financial control systems technology.. If any of our third-party service providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to locate alternative sources of such services, and we cannot assure that we could negotiate terms that are as favorable to us, or could obtain services with similar functionality, as found in our existing systems, without the need to expend substantial resources, if at all. Any of these circumstances could have an adverse effect on our business. We are dependent upon the services of our management team. We are dependent upon the ability and experience of a number of our key management personnel who have substantial experience with our operations, the financial services industry and the markets in which we offer our services. It is possible that the loss of the services of one or more of our senior executives or key managers would have an adverse effect on our operations. Our success also depends on our ability to continue to attract, manage and retain other qualified personnel as we grow. We cannot assure you that we will continue to attract or retain such personnel. We may be unable to successfully integrate any acquisition we may make. We regularly explore opportunities to acquire financial services businesses or assets and may also consider opportunities to acquire other banks or financial institutions. We cannot predict the number, size or timing of acquisitions. Difficulties in integrating an acquired business or company may cause us not to realize expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from the acquisition. The process of integrating operations could cause an interruption of, or loss of momentum in, the activities of our business and the loss of deposits, customers and key personnel. The diversion of management's attention and any delays or difficulties encountered in connection with any merger could have an adverse effect on our business and results of operations following the acquisition or otherwise adversely affect our ability to achieve the anticipated benefits of the acquisition. An increase in interest rates may reduce our mortgage revenues, which would negatively impact our non-interest income, which would negatively impact our net interest income. Our mortgage banking operations provide a significant portion of our non-interest income. We generate mortgage revenues primarily from broker loan fees on the sale of loans to investors on a servicing released basis. In a rising or 39 higher interest rate environment, our originations of mortgage loans may decrease, resulting in fewer loans that are available to be sold to investors. This would result in a decrease in mortgage revenues and a corresponding decrease in non-interest income. In addition, our results of operations are affected by the amount of non-interest expenses associated with mortgage banking activities, such as salaries and employee benefits, occupancy, equipment and data processing expense and other operating costs. During periods of reduced loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in loan originations. Terrorist activities could cause reductions in investor confidence and substantial volatility in real estate and securities markets. It is impossible to predict the extent to which terrorist activities may occur in the United States or other regions, or their effect on a particular security issue. It is also uncertain what effects any past or future terrorist activities and/or any consequent actions on the part of the United States government and others will have on the United States and world financial markets, local, regional and national economics, and real estate markets across the United States. Among other things, reduced investor confidence could result in substantial volatility in securities markets, a decline in general economic conditions and real estate related investments and an increase in loan defaults. Such unexpected losses and events could materially affect our results of operations. We are subject to extensive regulation that could restrict our activities and impose financial requirements or limitations on the conduct of our business. We are subject to extensive federal and state regulation and supervision, primarily through the Bank. Banking regulations are primarily intended to protect depositors' funds, federal deposit insurance funds and the banking system as a whole, not shareholders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur. We rely on dividends from subsidiaries for most of our revenue. Riverview Bancorp, Inc is a separate and distinct legal entity from its subsidiaries. We receive substantially all of our revenue from dividends from our subsidiaries. These dividends are the principal source of funds to pay dividends on our common stock and interest and principal on our debt. Various federal and/or state laws and regulations limit the amount of dividends that the Bank may pay us. Also, our right to participate in a distribution of assets upon a subsidiary's liquidation or reorganization is subject to the prior claims of the subsidiary's creditors. In the event the Bank is unable to pay dividends to us, we may not be able to service our debt, pay obligations or pay dividends on our common stock. The inability to receive dividends from the Bank could have a material adverse effect on our business, financial condition and results of operations If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud, and, as a result, investors and depositors could lose confidence in our financial reporting, which could adversely affect our business, the trading price of our stock and our ability to attract additional deposits. In connection with the enactment of the Sarbanes-Oxley Act of 2002 ("Act") and the implementation of the rules and regulations promulgated by the SEC, we document and evaluate our internal control over financial reporting in order to satisfy the requirements of Section 404 of the Act. This requires us to prepare an annual management report 40 on our internal control over financial reporting, including among other matters, management's assessment of the effectiveness of internal control over financial reporting and an attestation report by our independent auditors addressing these assessments. If we fail to identify and correct any significant deficiencies in the design or operating effectiveness of our internal control over financial reporting or fail to prevent fraud, current and potential shareholders and depositors could lose confidence in our internal controls and financial reporting, which could adversely affect our business, financial condition and results of operations, the trading price of our stock and our ability to attract additional deposits. Changes in accounting standards may affect our performance. Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time there are changes in the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be difficult to predict and can materially impact how we report and record our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in restating prior period financial statements. Item 1B. Unresolved Staff Comments None. Item 2. Properties - ------------------- The following table sets forth certain information relating to the Company's offices as of March 31, 2006. Approximate Location Year Opened Square Footage Deposits - -------- ----------- -------------- -------- (In millions) Main Office: 900 Washington, Suite 900 Vancouver, Washington (1) 2000 16,000 $ 84.5 Riverview Center: 17205 SE Mill Plain Boulevard Vancouver, Washington (1)(2)(8) 2006 50,000 Branch Offices: 700 N.E. Fourth Avenue Camas, Washington (1)(2) 1975 25,000 52.1 3307 Evergreen Way Washougal, Washington (1)(2)(3) 1963 3,200 39.0 225 S.W. 2nd Street Stevenson, Washington (2) 1971 1,700 33.4 330 E. Jewett Boulevard White Salmon, Washington (2)(4) 1977 3,200 32.9 15 N.W. 13th Avenue Battle Ground, Washington (2)(5) 1979 2,900 39.0 41 412 South Columbus Goldendale, Washington (2) 1983 2,500 16.8 11505-K N.E. Fourth Plain Boulevard Vancouver, Washington (2) 1994 3,500 29.7 7735 N.E. Highway 99 Vancouver, Washington (1)(6)(2) 1994 4,800 28.1 1011 Washington Way Longview, Washington (6)(2) 1994 2,000 26.4 900 Washington St., Suite 100 Vancouver, Washington (1)(2) 1998 5,300 76.0 1901-E N.E. 162nd Avenue Vancouver, Washington (1)(2) 1999 3,200 16.8 800 N.E. Tenney Road, Suite D Vancouver, Washington (2) 2000 3,200 49.3 915 MacArthur Boulevard Vancouver, Washington (1)(2)(7) 2003 3,000 24.0 320 S.E. 192nd Avenue Vancouver, Washington (1)(2)(8) 2006 3,200 1.0 315 SW Fifth Avenue Portland, Oregon (1)(2)(9) 2005 9,304 21.9 23500 NE Sandy Boulevard Wood Village, Oregon (1) (2)(9) 2005 900 8.8 112 Main Street Aumsville, Oregon (2)(9) 2005 2,500 27.3 (1) Leased. (2) Location of an automated teller machine. (3) New facility in 2001. (4) New facility in 2000. (5) New facility in 1994. (6) Former branches of Great American Federal Savings Association, San Diego, California, that were acquired from the Resolution Trust Corporation on May 13, 1994. In the acquisition, the Company assumed all insured deposit liabilities of both branch offices totaling approximately $42.0 million. (7) Former location of Today's Bank, Vancouver, Washington, acquired on July 18, 2003. (8) New facility in 2006 (9) Former location of American Pacific Bank, Aumsville, Oregon, acquired on April 22, 2005. During second quarter of fiscal year 2001, the Company's main office for administration was relocated from Camas to the downtown Vancouver address of 900 Washington Street. The Washougal branch office was relocated during the first quarter of the fiscal year 2001. 42 The Company uses an outside data processing system to process customer records and monetary transactions, post deposit and general ledger entries and record activity in installment lending, loan servicing and loan originations. At March 31, 2006, the net book value of the Company's office properties, furniture, fixtures and equipment was $19.1 million. Management believes that the facilities are of sound construction and good operating condition, and are appropriately insured and adequately equipped for carrying on the business of the Company. Item 3. Legal Proceedings - -------------------------- Periodically, there have been various claims and lawsuits involving the Company, such as claims to enforce liens, condemnation proceedings on properties in which the Company holds security interests, claims involving the making and servicing of real property loans and other issues incident to the Company's business. The Company is not a party to any pending legal proceedings that it believes would have a material adverse effect on the financial condition, results of operations or liquidity of the Company. Item 4. Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------ No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended March 31, 2006. PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities - ---------------------------------------------------------------------------- At March 31, 2006, there were 5,772,690 shares Company Common Stock issued and 5,772,686 outstanding, 837 stockholders of record and an estimated 1,500 holders in nominee or "street name." Under Washington law, the Company is prohibited from paying a dividend if, as a result of its payment, the Company would be unable to pay its debts as they become due in the normal course of business, or if the Company's total liabilities would exceed its total assets. The principal source of funds for the Company is dividend payments from the Bank. OTS regulations require the Bank to give the OTS 30 days' advance notice of any proposed declaration of dividends to the Company, and the OTS has the authority under its supervisory powers to prohibit the payment of dividends to the Company. The OTS imposes certain limitations on the payment of dividends from the Bank to the Holding Company which utilize a three-tiered approach that permits various levels of distributions based primarily upon a savings association's capital level. See "REGULATION Federal Regulation of Savings Associations Limitations on Capital Distributions." In addition, the Company may not declare or pay a cash dividend on its capital stock if the effect thereof would be to reduce the regulatory capital of the Company below the amount required for the liquidation account established pursuant to the Company's Plan of Conversion adopted in connection with the Conversion and Reorganization. See Note 1 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K. 43 The common stock of the Company has traded on the Nasdaq National Market System under the symbol "RVSB" since October 2, 1997. From October 22, 1993 until October 2, 1997, the common stock of the Company traded on The Nasdaq SmallCap Market under the same symbol. The following table sets forth the high and low trading prices, as reported by Nasdaq, and cash dividends paid for each quarter during 2006 and 2005 fiscal years. At March 31, 2006, there were 18 market makers in the Company's common stock as reported by the Nasdaq Stock Market. Cash Dividends Fiscal Year Ended March 31, 2006 High Low Declared - -------------------------------- ---- --- ---------- Quarter Ended March 31, 2006 $27.50 $23.12 $0.170 Quarter Ended December 31, 2005 23.93 20.92 0.170 Quarter Ended September 30, 2005 22.10 20.75 0.170 Quarter Ended June 30, 2005 21.80 20.33 0.170 Cash Dividends Fiscal Year Ended March 31, 2005 High Low Declared - -------------------------------- ---- --- ---------- Quarter Ended March 31, 2005 $22.48 $21.00 $0.155 Quarter Ended December 31, 2004 22.50 20.95 0.155 Quarter Ended September 30, 2004 21.65 19.85 0.155 Quarter Ended June 30, 2004 21.00 19.49 0.155 Stock Repurchase The shares are being repurchased from time-to-time in open market transactions. The timing, volume and price of purchases will be made at our discretion, and will also be contingent upon our overall financial condition, as well, as market conditions in general. The following table reflects activity for the three months ended March 31, 2006. Common Stock Repurchased Maximum Total Number Number of Average of Shares shares that May Price Purchased as Yet Be Total Number Paid Part of Publicly Purchased of Shares per Announced Under the Purchased (1) Share Plan Program January 1, 2006- January 31, 2006 50,000 $24.55 50,000 240,248 February 1, 2006- February 28, 2006 - - - - March 1, 2006- March 31, 2006 - - - - ------ ------ ------ ------- Balance at March 31, 2006 50,000 $24.55 50,000 240,248 ====== ====== ====== ======= (1) In July 2005, the Company announced a stock repurchase of up to 5%, or 290,248 shares, of its outstanding common stock. This program expires when all shares under the plan have been repurchased. Securities for Equity Compensation Plans Please refer to item 12 for a listing of securities authorized for issuance under equity compensation plans. 44 Item 6. Selected Financial Data - --------------------------------- The following tables set forth certain information concerning the consolidated financial position and results of operations of the Company at the dates and for the periods indicated. At March 31, -------------------------------------------- 2006 2005 2004 2003 2002 ------- ------- ------- ------- ------- (In thousands) FINANCIAL CONDITION DATA: Total assets $763,847 $572,571 $520,487 $419,904 $392,101 Loans receivable, net (1) 623,081 429,959 381,534 301,811 288,530 Mortgage-backed securities held to maturity, at amortized cost 1,805 2,343 2,517 3,301 4,386 Mortgage-backed securities available for sale, at fair value 8,134 11,619 10,607 13,069 36,999 Cash and interest-bearing deposits 31,346 61,719 47,907 60,858 22,492 Investment securities available for sale, at fair value 24,022 22,945 32,883 20,426 18,275 Deposit accounts 606,964 456,878 409,115 320,742 259,690 FHLB advances 46,100 40,000 40,000 40,000 74,500 Shareholders' equity 91,687 69,522 65,182 54,511 53,677 Year Ended March 31, -------------------------------------------- 2006 2005 2004 2003 2002 ------- ------- ------- ------- ------- (In thousands) OPERATING DATA: Interest income $47,229 $29,968 $27,584 $26,461 $29,840 Interest expense 14,877 7,395 6,627 8,417 14,318 ------- ------- ------- ------- ------- Net interest income 32,352 22,573 20,957 18,044 15,522 Provision for loan losses 1,500 410 210 727 1,116 ------- ------- ------- ------- ------- Net interest income after provision for loan losses 30,852 22,163 20,747 17,317 14,406 Gains (losses) from sale of loans, securities and real estate owned 382 (672) 1,003 (531) 1,964 Gain on sale of land and fixed assets 2 830 3 - 4 Other non-interest income 8,453 6,348 5,583 4,469 4,583 Non-interest expenses 25,374 19,104 17,572 14,908 13,953 ------- ------- ------- ------- ------- Income before income taxes 14,315 9,565 9,764 6,347 7,004 Provision for income taxes 4,577 3,036 3,210 1,988 2,136 ------- ------- ------- ------- ------- Net income $ 9,738 $ 6,529 $ 6,554 $ 4,359 $ 4,868 ======= ======= ======= ======= ======= (1) Includes loans held for sale 45 At March 31, -------------------------------------------- 2006 2005 2004 2003 2002 ------- ------- ------- ------- ------- OTHER DATA: Number of: Real estate loans outstanding 3,084 3,037 3,141 2,904 2,176 Deposit accounts 39,095 29,341 27,209 25,752 26,625 Full service offices 17 13 13 12 12 At or For the Year Ended March 31, -------------------------------------------- 2006 2005 2004 2003 2002 ------- ------- ------- ------- ------- KEY FINANCIAL RATIOS: Performance Ratios: Return on average assets 1.36% 1.24% 1.35% 1.07% 1.16% Return on average equity 10.95 9.56 10.60 7.99 9.01 Dividend payout ratio (1) 39.08 45.59 39.72 50.00 41.51 Interest rate spread 4.55 4.38 4.42 4.28 3.29 Net interest margin 5.03 4.74 4.76 4.83 4.04 Non-interest expense to average assets 3.54 3.62 3.61 3.66 3.34 Efficiency ratio (2) 61.60 65.70 63.79 67.82 63.21 Asset Quality Ratios: Average interest-earning assets to interest-bearing liabilities 121.14 123.45 122.53 124.62 120.49 Allowance for loan losses to total net loans at end of period 1.15 1.01 1.16 0.90 0.87 Net charge-offs to average outstanding loans during the period 0.10 0.13 0.31 0.12 0.14 Ratio of nonperforming assets to total assets 0.05 0.13 0.39 0.18 0.61 Capital Ratios: Average equity to average assets 12.39 12.92 12.72 13.39 12.93 Equity to assets at end of fiscal year 12.00 12.14 12.52 12.98 13.69 (1) Dividends per share divided by net income per share (2) Non-interest expense divided by the sum of net interest income and non-interest income 46 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - ------------------------------------------------------------------------- General Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to assist in understanding the financial condition and results of operations of the Company. The information contained in this section should be read in conjunction with the Consolidated Financial Statements and accompanying Notes thereto contained in Item 8 of this Form 10-K and the other sections contained in this Form 10-K. Special Note Regarding Forward-Looking Statements Management's Discussion and Analysis and other portions of this Form 10-K 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 our Annual Report. The Company has used "forward-looking statements" to describe future plans and strategies, including its expectations of the Company's future financial results. Management's ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors which could affect actual results include interest rate trends, the general economic climate in the Company's market area and the country as a whole, the ability of the Company to control costs and expenses, deposit flows, demand for mortgages and other loans, real estate value and vacancy rates, the ability of the Company to efficiently incorporate acquisitions into its operations, competition, loan delinquency rates, and changes in federal and state regulation. These factors should be considered in evaluating the "forward-looking statements," and undue reliance should not be placed on such statements. The Company does not undertake to update any forward-looking statement that may be made on behalf of the Company. Critical Accounting Policies The Company has established various accounting policies that govern the application of accounting principles generally accepted in the United States of America ("GAAP") in the preparation of the Company's Consolidated Financial Statements. The Company has identified three policies, that due to judgments, estimates and assumptions inherent in those policies, are critical to an understanding of the Company's Consolidated Financial Statements. These policies relate to the methodology for the determination of the allowance for loan losses, the valuation of the mortgage servicing rights ("MSR's") and the impairment of investments. These policies and the judgments, estimates and assumptions are described in greater detail in subsequent sections of Management's Discussions and Analysis contained herein and in the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K. In particular, Note 1 of the Notes to Consolidated Financial Statements, "Summary of Significant Accounting Policies," describes generally the Company's accounting policies and Note 9, "Mortgage Servicing Rights" provides details used in valuing the Company's MSR's and the effect of changes to certain assumptions. Management believes that the judgments, estimates and assumptions used in the preparation of the Company's Consolidated Financial Statements are appropriate given the factual circumstances at the time. However, given the sensitivity of the Company's Consolidated 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. Allowance for Loan Losses - ------------------------- The allowance for loan losses is maintained at a level sufficient to provide for probable loan losses based on evaluating known and inherent risks in the loan portfolio. The allowance is provided based upon management's continuing analysis of the pertinent factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, actual loan loss experience, current economic conditions, and detailed analysis of individual loans for which full collectibility may not be assured. The detailed analysis includes techniques to estimate the fair value of loan collateral and the existence of potential alternative sources of repayment. The appropriate allowance level is estimated based upon factors and trends identified by management at the time the consolidated financial statements are prepared. 47 Mortgage Servicing Rights - ------------------------- The Company stratifies its MSR's based on the predominant characteristics of the underlying financial assets including coupon interest rate and contractual maturity of the mortgage. An estimated fair value of MSR's is determined quarterly using a discounted cash flow model. The model estimates the present value of the future net cash flows of the servicing portfolio based on various factors, such as servicing costs, servicing income, expected prepayments speeds, discount rate, loan maturity and interest rate. The effect of changes in market interest rates on estimated rates of loan prepayments represents the predominant risk characteristic underlying the MSR's portfolio. The Company's methodology for estimating the fair value of MSR's is highly sensitive to changes in assumptions. For example, the determination of fair value uses anticipated prepayment speeds. Actual prepayment experience may differ and any difference may have a material effect on the fair value. Thus, any measurement of MSR's fair value is limited by the conditions existing and assumptions made as of the date made. Those assumptions may not be appropriate if they are applied to a different time. Future expected net cash flows from servicing a loan in the servicing portfolio would not be realized if the loan is paid off earlier than anticipated. Moreover, since most loans within the servicing portfolio do not contain penalty provisions for early payoff, the Company will not receive a corresponding economic benefit if the loan pays off earlier than expected. MSR's are the discounted present value of the future net cash flows projected from the servicing portfolio. Accordingly, prepayment risk subjects the Company's MSR's to impairment. MSR's impairment is recorded in the amount that the estimated fair value is less than the MSR's carrying value on a strata by strata basis. Investment Valuation - -------------------- The Company's determination of impairment for various types of investments accounted for in accordance with SFAS No. 115 is predicated on the notion of other-than-temporary. The key indicator that an investment may be impaired is that the fair value of the investment is less than its carrying value. Each reporting period, the Company reviews those investments the fair value is less than carrying value. The review includes determining whether certain indicators indicated the fair value of the investment has been negatively impacted. These indicators include deteriorating financial condition, regulatory, economic or technological changes, downgrade by a rating agency and length of time the fair value has been less than carrying value. If any indicators of impairment are present, management determines the fair value of the investment and compares this to its carrying value. If the fair value of the investment is less than the carrying value of the investment, the investment is considered impaired and a determination must be made as to whether the impairment is other-than-temporary. Securities held to maturity are carried at cost, adjusted for amortization of premiums and accretion of discounts which are recognized in interest income using the interest method. If the cost basis of these securities is determined to be other-than-temporary impaired, the amount of the impairment is charged to operations. Securities available for sale are carried at fair value. Premiums and discounts are amortized using the interest method over the remaining period to contractual maturity. Unrealized holding gains and losses, or valuation allowances established for net unrealized losses, are excluded from earnings and reported as a separate component of shareholders' equity as accumulated other comprehensive income (loss), net of income taxes, unless the security is deemed other-than-temporary impaired. If the security is determined to be other-than-temporary impaired, the amount of the impairment is charged to operations. The Company's underlying principle in determining whether impairment is other-than-temporary is an impairment shall be deemed other-than-temporary unless positive evidence indicating that an investment's carrying value is recoverable within a reasonable period of time outweighs negative evidence to the contrary. Evidence that is objectively determinable and verifiable is given greater weight than evidence that is subjective and or not verifiable. Evidence based on future events will generally be less objective as it is based on future expectations and therefore is generally less verifiable or not verifiable at all. Factors considered in evaluating whether a decline in value is other-than-temporary include, (a) the length of time and the extent to which the fair value has been less than amortized cost, (b) the financial condition and near-term prospects of the issuer and (c) the Company's intent and ability to retain the investment for a period of time. In situations in which the security's fair value is below amortized cost but 48 it continues to be probable that all contractual terms of the security will be satisfied, and that the decline is solely attributable to changes in interest rates (not because of increased credit risk), and the Company asserts that it has positive intent and ability to hold that security to maturity, no other-than-temporary impairment is recognized. Operating Strategy In the fiscal year ended March 31, 1998, the Company began to implement a growth strategy to broaden its products and services from those of a traditional thrift to those more closely related to commercial banking. The growth strategy included four elements: geographic and product expansion, loan portfolio diversification, development of relationship banking and maintenance of asset quality. The April 2005 acquisition of APB added 3 branches in Oregon: Portland, Aumsville and Wood Village. Fiscal year 2005 expansion included opening in Vancouver the Riverview Center, an operations center and the 192nd Branch. Riverview Center is a 50,000 square foot office building; over 80 employees from accounting, audit, data processing, human resources, information technology, loan origination, loan servicing, marketing and operations are located here. The 192nd Branch is a full service branch with the convenience of two drive-up teller windows, drive-up ATM and safe deposit boxes. The July 2003 acquisition of Today's Bancorp, Inc. added one branch and a lending center. The number of automated teller machines increased from six to 19 so that each branch location now is serviced by at least one automated teller machine. The Company's growing commercial customer base has enjoyed new products and the improvements in existing products. These new products include business checking, internet banking and new loan products. Retail customers have benefited from expanded choices ranging from additional automated teller machines, consumer lending products, checking accounts, debit cards, 24 hour account information service and internet banking. Fiscal 2006 marked the 83rd anniversary since the Bank opened its doors in 1923. The historical emphasis has been on residential real estate lending, however, the Company began diversifying its loan portfolio through the expansion of commercial loans in 1998. In fiscal 2002, commercial loans including commercial real estate as a percentage of the loan portfolio were 37.97%, which has increased to 68.9% of total loans at the end of fiscal year 2006. Commercial lending including commercial real estate has higher credit risk, wider interest margins and shorter loan terms than residential lending which can increase the loan portfolio's profitability. The Company's relationship banking has been enhanced by the 1998 addition of Riverview Asset Management Corp, a trust company directed by experienced trust officers, through expanded loan products serviced by experienced commercial and consumer lending officers, and an expanded branch network led by experienced branch managers. Development of relationship banking has been the key to the Company's growth. The fair market value of assets under management in Riverview Asset Management Corp. has increased from $174.8 million at March 31, 2005, to $232.8 million at March 31, 2006. Net Interest Income The Company's profitability depends primarily on its net interest income, which is the difference between the income it receives on interest-earning assets and its cost of funds, which consists of interest paid on deposits and borrowings. Net interest income is also affected by the relative amounts of interest-earning assets and interest-bearing liabilities. When interest-earning assets equal or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income. The level of non-interest income and expenses also affects the Company's profitability. Non-interest income includes deposit service fees, income associated with the origination and sale of mortgage loans, brokering loans, loan servicing fees, income from real estate owned, net gains and losses on sales of interest-earning assets, bank owned life insurance income and asset management fee income. Non-interest expenses include compensation and benefits, occupancy and equipment expenses, deposit insurance premiums, data servicing expenses and other operating costs. The Company's results of operations are also significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government legislation and regulation, and monetary and fiscal policies. 49 Comparison of Financial Condition at March 31, 2006 and 2005 At March 31, 2006, the Company had total assets of $763.8 million compared with $572.6 million at March 31, 2005. The increase in total assets was primarily as a result of the increase in loans outstanding. Cash, including interest-earning accounts, totaled $31.3 million at March 31, 2006, compared to $61.7 million at March 31, 2005, as a result of the Company's increase in total loans. Loans receivable, net, were $623.0 million at March 31, 2006, compared to $429.4 million at March 31, 2005, a 45.1% increase. The increases in commercial real estate, commercial construction, land, construction, commercial and consumer loans were partially offset by decreases in one-to-four- family residential and multi-family, loans. Decreases in one-to-four family residential loans reflect management's decision to sell fixed interest rate mortgages and retain adjustable rate interest rate mortgages in the loan portfolio. The APB acquisition at April 22, 2005, added $119.5 million in loans. As interest rates fall, loan volume shifts to fixed rate production. Conversely, in a rising interest rate environment, loan volume will shift to adjustable rate production. Selling fixed interest rate mortgage loans allows the Company to reduce the interest rate risk associated with long term fixed interest rate products. It also provides additional funds for new loans and provides a means for the diversification of the loan portfolio. The Company continues to service the loans it sells, maintaining the customer relationship and generating ongoing non-interest income. A substantial portion of the Company's loan portfolio is secured by real estate, either as primary or secondary collateral located in its primary market areas. Investment securities available-for-sale was $24.0 million at March 31, 2006, compared to $22.9 million at March 31, 2005. The increase reflects the $1.4 million of APB investment securities acquired in the acquisition, the $5.0 million of investments securities purchased in second quarter of fiscal your 2006, the $5.0 million of called investment securities in the second quarter of fiscal year 2006 and the $300,000 of pay downs. Mortgage-backed securities held-to-maturity was $1.8 million at March 31, 2006, compared to $2.3 million at March 31, 2005. The $500,000 decrease was a result of pay downs. Mortgage-backed securities available-for-sale was $8.1 million at March 31, 2006, compared to $11.6 million at March 31, 2005. The $3.5 million decrease was a result of pay downs. Deposit accounts totaled $607.0 million at March 31, 2006 compared to $456.9 million at March 31, 2005. The increase in deposits is a result of increases in all deposit balances except for NOW accounts. The APB acquisition at April 22, 2005, added $79.8 million in deposits. Checking accounts and money market accounts ("transaction accounts") total average outstanding balance increased 37.2% to $333.7 million at March 31, 2006, compared to $243.2 million at March 31, 2005. Transaction accounts represented 58.9% and 58.8% of average total outstanding balance of deposits at March 31, 2006 and March 31, 2005, respectively. FHLB advances increased to $46.1 million at March 31, 2006 as compared to $40.0 million at March 31, 2005 as the increased FHLB advances were utilized to fund the Bank's operations. Shareholders' equity increased $22.2 million to $91.7 million at March 31, 2006 from $69.5 million at March 31, 2005. The increase was primarily the result of $16.7 million stock issued in connection with the APB acquisition, $9.6 million total comprehensive income, $558,000 earned ESOP shares and $314,000 received from the exercise of stock options, partially offset by $3.8 million cash dividends paid to shareholders and $1.2 million of common stock repurchased and retired. 50 Comparison of Operating Results for the Years Ended March 31, 2006 and 2005 Net Income. Net income was $9.7 million, or $1.72 per diluted earning share for the year ended March 31, 2006, compared to $6.5 million, or $1.33 per diluted share for the year ended March 31, 2005. Net Interest Income. Net interest income for fiscal year 2006 was $32.4 million, representing a $9.8 million, or a 43.3% increase, from $22.6 million in fiscal year 2005. This improvement reflected a 34.5% increase in the average balance of interest earning assets (primarily as a result of increases in the average balance of mortgage and non-mortgage loans due primarily to the APB acquisition, partially offset by a decrease in the average balance of mortgage-backed and investment securities and daily interest bearing assets) to $645.1 million, which was offset by a 37.1% increase in the average balance of interest-bearing liabilities (an increase in all deposit categories reflecting deposits assumed as part of the APB acquisition and a $13.0 million increase in average FHLB borrowings) to $532.5 million. The ratio of average interest earning assets to average interest bearing liabilities decreased to 121.14% in fiscal 2006 from 123.45% in fiscal 2005 which indicates that the interest-earning asset growth is being funded more by interest-bearing liabilities as compared to capital and non-interest-bearing demand deposits. Interest Income. Interest income was $47.2 million for the fiscal year ended March 31, 2006 compared to $30.0 million, for the fiscal year ended 2005. Increased interest income is the result of the increase in the average balance of interest earning assets and the increased yield on interest earning assets. Average interest-bearing assets increased $165.6 million to $645.1 million for fiscal 2006 from $479.5 million for fiscal 2005. The yield on interest-earning assets was 7.34% for fiscal year 2006 compared to 6.28% for fiscal 2005. The increased yield is primarily the result of the higher yields on loans, investment securities and other interest earning assets reflecting the increasing interest rate environment. The increased interest income is the result of the increase in the average balance of interest earning assets and the increase in the yield on interest earning assets. Interest Expense. Interest expense for the year ended March 31, 2006 totaled $14.9 million, a $7.5 million increase from $7.4 million for the year ended March 31, 2005. The increase in interest expense is the result of higher rates of interest that occurred during fiscal years 2005 and 2006. The weighted average interest rate of total deposits increased from 1.55% for the year ended March 31, 2005 to 2.58% for the year ended March 31, 2006. The weighted average interest rate of FHLB borrowings decreased from 5.00% for the year ended March 31, 2005 to 4.44% for the year ended March 31, 2006. Provision for Loan Losses. The provision for loan losses for fiscal year 2006 was $1.5 million, compared to $410,000 for the same period in the prior year. For this time period the loan receivable balance increased $196.4 million to $630.2 million at March 31, 2006 from $433.8 million at March 31, 2005. Excluding the impact of the American Pacific Bank acquisition, organic loan growth during the fiscal year 2006 was $77.4 million, consisting primarily of commercial and construction loans. Management analyzes the probable loss factors that drive the loan loss reserve on a quarterly basis. These probable loss factors contemplate historical loss rates, adjusted for qualitative factors that are included in our analysis. Such factors include the relative strength of the local economy, concentrations in certain categories, such as commercial real estate and construction loans, the impact of an increasing interest rate environment, as well as the overall impact of integrating APB's lending business with ours, along with other factors. As part of that ongoing process, we have continued to refine our reserving methodologies with regard to larger and/or high-risk loans that we consider to be "nonhomogeneous", such as commercial, speculative, and commercial construction loans. Such loans have continued to be an increasing part of our loan portfolio in recent quarters, which tends to result in an increased loan loss requirement. For example, as a percentage of total loans, our commercial real estate loans increased from 53.97% to 59.41% and construction loans from 10.05% to 12.88% at March 31, 2006 as compared to March 31, 2005. Based on our continuing analysis of these loans, we increased certain loss factors assigned to some of these loan categories during the current fiscal year. For example, the estimated loan loss rate for land and lots for development was increased by 0.25% to 1.0%, commercial real estate loans was increased by 0.125% to 0.875%, commercial construction loans was increased by 0.125% to 0.875%, speculative construction loans was increased by 0.50% to 1.00%, multi-family loans was increased by 0.375% to 0.875% and raw land and lots was increased by 0.25% to 1.00% to cover the probable losses inherent in the loan portfolio. Such changes resulted in approximately $900,000 of increased provision for the fiscal year of 2006. The increased loan loss provision during the fiscal year 2006 was due to this combination of loan 51 growth, as well as the higher percentage of loans falling into higher risk categories. Net charge-offs to average net loans was 0.10% for fiscal year 2006 as compared to 0.13% for prior year. Non-accrual loans continued to decrease from $456,000 at March 31, 2005 to $415,000 at March 31, 2006. The allowance for loan losses was $7.2 million at March 31, 2006 compared to $4.4 million at March 31, 2005. The quality of the loan portfolio continues to be very good, as the criticized classified loan balances have increased just $872,000 and non-accrual loans decreased by $41,000 at March 31, 2006 compared to March 31, 2005. Net charge-offs for the twelve months ended March 31, 2006 were $562,000, compared to $496,000 for the same period of last year. The ratio of allowance for credit losses and loan commitments to total net loans at March 31, 2006 increased to 1.20% from 1.07% at March 31, 2005 with such increase reflecting the changing mix of our loan portfolio and the additional risk of these loans as described above. Management believes that our allowance for loan losses as of March 31, 2006 was adequate to absorb the known and inherent risks of loss in the loan portfolio at that date. While management believes the estimates and assumptions used in its determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. In addition, the determination of the amount of the Bank's allowance for loan losses is subject to review by bank regulators, as part of the routine examination process, which may result in the establishment of additional reserves based upon their judgment of information available to them at the time of their examination. Non-Interest Income. Non-interest income increased $2.3 million, or 35.8%, to $8.8 million for the year ended March 31, 2006 from $6.5 million for the same period in 2005 primarily as a result of a $1.3 million increase in fees and service charges, an increase of $361,000 in asset management fees and the non-recurring $311,000 gain on sale of the credit card portfolio acquired in the APB acquisition. The $1.3 million increase in fees and service charges was primarily a result of the $544,000 or 34.6% growth in mortgage broker fees and the acquisition of APB in fiscal year 2006 as compared to fiscal year 2005. The increase in loan servicing income for fiscal year 2006 reflects the $68,000 decrease in servicing amortization as the servicing portfolio has decreased. For the year ended March 31, 2006, fees and service charges increased $1.3 million, or 22.4%, when compared to the year ended March 31, 2005. The $1.3 million increase in fees and service charges is primarily a result of the $544,000, or 34.6%, growth in mortgage broker fees and the acquisition of APB in fiscal year 2006 as compared to fiscal year 2005. The increase in the number of mortgage brokers from 12 to 13 in fiscal year 2005 combined with the increasing mortgage interest rates experienced in fiscal 2006 increased the volume of mortgage refinance activity as compared to fiscal 2005. The increased mortgage refinance activity resulted in increased mortgage broker activity. The reduced gains on sale of loans held for sale reflected the mortgage broker activity having a higher proportion of brokered loans versus portfolio loans. Mortgage brokered loan production increased from $194.4 million in 2005 to $276.6 million in 2006. Mortgage broker fees (included in fees and service charges) totaled $2.1 million for the year ended March 31, 2006 compared to $1.6 million for the previous year. Mortgage broker commission compensation expense was $1.3 million for the fiscal ended March 31, 2006 compared to $1.0 million for the fiscal ended March 31, 2005. Asset management services income increased $1.5 million reflecting the increase in assets under management for the fiscal year 2006 compared to $1.1 million for the fiscal year 2005. Riverview Asset Management Corp. had $232.8 million in total assets under management at March 31, 2006 compared to $174.8 million at March 31, 2005 Non-Interest Expense. Non-interest expense increased $6.3 million, or 33.0%, to $25.4 million for fiscal year 2006 compared to $19.1 million for fiscal year 2005. One measure of a bank's ability to contain non-interest expense is the efficiency ratio, which is calculated by dividing total non-interest expense (less intangible asset amortization) by the sum of net interest income plus non-interest income (less intangible asset amortization, lower of cost or market adjustments and securities impairment charge). The Company's efficiency ratio excluding intangible asset amortization, lower of cost or market adjustments and securities impairment charge was 60.79% in fiscal 2006 compared to 61.63% in fiscal 2005. The principle component of the increase in the Company's non-interest expense is salaries and employee benefits. For the year ended March 31, 2006, salaries and employee benefits, which includes mortgage broker commission compensation, was $14.5 million, a 34.9% increase over the prior year total of $10.8 million. Salaries increased as the number of full-time equivalent employees increased to 239 at March 31, 2006 from 197 at March 31, 2005, which was primarily the result of the expansion related to increased staffing in branches and operations. 52 The acquisition of APB and the related acquisition of $80.0 million in deposit accounts created a $526,000 core deposit intangible ("CDI") representing the excess of cost over fair market value of the acquired deposits. The CDI is being amortized over a ten-year life using an accelerated method. The amortization expense was $93,000 for fiscal 2006, compared to none in fiscal 2005. The acquisition of Today's Bancorp and the related acquisition of $105.1 million in deposit accounts created an $820,000 CDI. The CDI is being amortized over a ten-year life using an accelerated amortization method. The amortization expense was $116,000 for fiscal 2006, compared to $138,000 for fiscal 2005. The acquisition of the Hazel Dell and Longview branches from the Resolution Trust Corporation in fiscal 1995 (see Item 2. Properties), and the related acquisition of $42.0 million in customer deposits created a $3.2 million core deposit intangible asset, representing the excess of fair value of deposits over the acquired cost. CDI was $42,000 at March 31, 2005 and was fully amortized during the fiscal year 2005. The amortization expense of CDI was $42,000 for the fiscal year 2005. Provision for Income Taxes. The provision for income taxes was $4.6 million for the year ended March 31, 2006 compared to $3.0 million for the year ended March 31, 2004. The primary reason the tax provision is higher in the current year compared to the prior year is a result of the higher income in the current year. The effective tax rate for fiscal year 2006 was 32.7% compared to 31.7% for fiscal 2005. The primary reason for the increase in the effective tax rate was the entry into a new tax jurisdiction including the state of Oregon and Multnomah County. Reference is made to Note 13 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K, for further discussion of the Company's income taxes. Comparison of Operating Results for the Years Ended March 31, 2005 and 2004 Net Income. Net income was $6.5 million, or $1.33 per diluted share for the year ended March 31, 2005, compared to $6.6 million, or $1.39 per diluted share for the year ended March 31, 2004. Net Interest Income. Net interest income for fiscal year 2005 was $22.6 million, representing a $1.6 million, or a 7.7% increase, from $21.0 million in fiscal year 2004. This improvement reflected an 8.11% increase in the average balance of interest earning assets (primarily as a result of increases in the average balance of mortgage and non mortgage loans, mortgage-backed securities and investment securities, partially offset by a decrease in the average balance of daily interest bearing assets) to $479.5 million, which was offset by a 7.3% increase in the average balance of interest-bearing liabilities (an increase in all deposit categories and a $274,000 increase in FHLB borrowings) to $388.4 million. The ratio of average interest earning assets to average interest bearing liabilities increased to 123.45% in fiscal 2005 from 122.5% in fiscal 2004 which indicates that the interest-earning asset growth is being funded less by interest-bearing liabilities as compared to capital and non-interest-bearing demand deposits. Interest Income. Interest income was $30.0 million for the fiscal year ended March 31, 2005 compared to $27.6 million, for the fiscal year ended 2004. Average interest-bearing assets increased $36.0 million to $479.5 million for fiscal 2005 from $443.5 million for fiscal 2004. The yield on interest-earning assets was 6.28% for fiscal year 2005 compared to 6.25% for fiscal 2004. The increased yield is the primarily the result of the higher yields on investment securities and daily interest earning assets that reflect the increases in interest rates that occurred during fiscal year 2005. The increased interest income is the result of the increase in the average balance of interest earning assets and the increase in the yield on interest earning assets. Interest Expense. Interest expense for the year ended March 31, 2005 totaled $7.4 million, an $800,000 increase from $6.6 million for the year ended March 31, 2004. The increase in interest expense is the result of higher rates of interest that occurred during fiscal years 2004 and 2005. The weighted average interest rate of total deposits increased from 1.44% for the year ended March 31, 2004 to 1.55% for the year ended March 31, 2005. The weighted average interest rate of FHLB borrowings increased from 4.96% for the year ended March 31, 2004 to 53 5.00% for the year ended March 31, 2005. The level of liquidity in fiscal year 2005 allowed the runoff of high interest rate deposits acquired in the acquisition of Today's Bancorp and held FHLB borrowings at $40.0 million. Provision for Loan Losses. The provision for loan losses for the year ended March 31, 2005 was $410,000 compared to $210,000 for the year ended March 31, 2004. The provision for loan losses increased during the year ended March 31, 2005 as net charge-offs decreased to $496,000 from $1.1 million in fiscal year 2004. Net charge-offs to average net loans was 0.13% for fiscal year 2005 as compared to 0.31% for prior year. Non-accrual loans continued to decrease from $1.3 million at March 31, 2004 to $456,000 at March 31, 2005. The allowance for loan losses was $4.4 million at March 31, 2005 compared to $4.5 million at March 31, 2004. The ratio of allowance for loan losses to total net loans was 1.01% at March 31, 2005 compared to 1.16% at March 31, 2004. The quality of the loan portfolio continues to increase as the criticized classified loan balances have decreased by $1.7 million and non-accrual loans decreased by $845,000 at March 31, 2005 compared to March 31, 2004. The mix of the loan portfolio reflected an increase in the balances of commercial real estate loans, and construction, and consumer loans at March 31, 2005 as compared to balances at March 31, 2004. The loan loss rates for consumer and construction-other loans were increased by 0.25 basis points, speculative construction and multi-family loans were increased by 0.125 basis points, land and lots loans were increased by 0.50 basis points and commercial real estate loans were decreased by 0.25 basis points during fiscal year 2005 in order to reflect the risk of loss. Management considered the allowance for loan losses at March 31, 2005 to be adequate to cover probable losses inherent in the loan portfolio based on the assessment of various factors affecting the loan portfolio Non-Interest Income. Non-interest income decreased $83,000, or 1.3%, to $6.5 million for the year ended March 31, 2005 from $6.6 million for the same period in 2004. Excluding the $1.2 million net impairment charge of investment securities and subsequent gain on sale, non-interest income increased $1.1 million or 16.7% for the year ended March 31, 2005 when compared to the prior year. The decrease in loan servicing income for fiscal year 2005 reflects the $177,000 decrease in servicing amortization as the servicing portfolio has decreased. It also reflects a $22,000 increase in market valuation of mortgage servicing right compared to the $307,000 increase in market valuation of mortgage servicing rights in fiscal 2004. For the year ended March 31, 2005, fees and service charges increased $264,000, or 6.1%, when compared to the year ended March 31, 2004. The $264,000 increase in fees and service charges is primarily a result of the $240,000, or 18.1%, growth in mortgage broker fees and a $46,000 increase in fees from deposit services in fiscal year 2005 as compared to fiscal year 2004. The increase in the number of mortgage brokers from nine to ten in fiscal year 2005 combined with the mortgage interest rates experienced in fiscal 2005 increased the volume of mortgage refinance activity as compared to the mortgage refinance activity in fiscal 2004. The increased mortgage refinance activity resulted in increased mortgage broker activity. The reduced gains on sale of loans held for sale reflected the mortgage broker activity having a higher proportion of brokered loans versus portfolio loans. Mortgage brokered loan production increased from $183.0 million in 2004 to $194.4 million in 2005. Mortgage broker fees (included in fees and service charges) totaled $1.6 million for the year ended March 31, 2005 compared to $1.3 million for the previous year. Mortgage broker commission compensation expense was $1.0 million for the fiscal ended March 31, 2005 compared to $976,000 for the fiscal ended March 31, 2004. Asset management services income was $1.1 million for the fiscal year 2005 compared to $906,000 for the fiscal year 2004. Riverview Asset Management Corp. had $174.8 million in total assets under management at March 31, 2005 compared to $134.7 million at March 31, 2004. In first quarter of fiscal year 2005 the Camas branch and operations center was sold and leased back resulting in a gain of $828,000. Non-Interest Expense. Non-interest expense increased $1.5 million, or 8.7%, to $19.1 million for fiscal year 2005 compared to $17.6 million for fiscal year 2004. One measure of a bank's ability to contain non-interest expense is the efficiency ratio, which is calculated by dividing total non-interest expense (less intangible asset amortization) by the sum of net interest income plus non-interest income (less intangible asset amortization, lower of cost or market adjustments and securities impairment charge). The Company's efficiency ratio excluding intangible asset amortization, lower cost or market adjustments and securities impairment charge was 64.46% in fiscal 2005 compared to 61.84% in fiscal 2004. The principle component of the Company's non-interest expense is salaries and employee benefits. For the year ended March 31, 2005, salaries and employee benefits, which includes mortgage broker commission compensation, was $10.8 million, an 8.71% increase over the prior year total of $9.9 million. Salaries also increased as the number 54 of full-time equivalent employees increased to 197 at March 31, 2005 from 186 at March 31, 2004, which was primarily the result of the expansion related to increased staffing in branches and operations. The acquisition of Today's Bancorp and the related acquisition of $105.1 million in deposit accounts created an $820,000 core deposit intangibles ("CDI"), representing the excess of cost over fair market of the acquired deposits. The CDI is being amortized over a ten-year life using an accelerated amortization method. The amortization expense was $138,000 for fiscal 2005, compared to $103,000 for fiscal 2004. The acquisition of the Hazel Dell and Longview branches from the Resolution Trust Corporation in fiscal 1995 (see Item 2. Properties), and the related acquisition of $42.0 million in customer deposits created a $3.2 million core deposit intangible asset, representing the excess of fair value of deposits over the acquired cost. CDI was $42,000 at March 31, 2005 and was fully amortized during the fiscal year 2005. The amortization expense of CDI was $327,000 for the fiscal year 2004. Provision for Income Taxes. The provision for income taxes was $3.0 million for the year ended March 31, 2005 compared to $3.2 million for the year ended March 31, 2004. The primary reason the tax provision is lower in the current year compared to the prior year is a result of the tax treatment of an increase in the cash surrender value of bank owned life insurance. The effective tax rate for fiscal year 2005 was 31.7% compared to 32.8% for fiscal 2004. Reference is made to Note 14 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K, for further discussion of the Company's income taxes. Average Balance Sheet. The following table sets forth, for the periods indicated, information regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resultant yields, interest rate spread, ratio of interest-earning assets to interest-bearing liabilities and net interest margin. Average balances for a period have been calculated using monthly average balances during such period. Interest income on tax-exempt securities has been adjusted to a taxable-equivalent basis using the statutory federal income tax rate of 34%. Non-accruing loans were included in the average loan amounts outstanding. Loan fees of $3.1 million, $2.5 million and $2.3 million are included in interest income for the twelve months ended March 31, 2006, 2005 and 2004, respectively. 55 Year Ended March 31, ------------------------------------------------------------------------------- 2006 2005 2004 ------------------------- ------------------------ -------------------------- Interest Interest Interest Average and Yield/ Average and Yield/ Average and Yield/ Balance Dividends Cost Balance Dividends Cost Balance Dividends Cost ------- --------- ---- ------- --------- ---- ------- --------- ----- (Dollars in thousands) <s> <c> <c> <c> <c> <c> <c> <c> <c> <c> Interest-earning assets: Real estate loans $485,554 $37,916 7.81% $307,750 $22,345 7.26% $274,763 $20,471 7.45% Non-real estate loans 96,472 7,123 7.38 89,050 5,419 6.09 82,126 5,163 6.29 --------- -------- ------ -------- ------- ----- -------- ------- ------ Total net loans (1) 582,026 45,039 7.74 396,800 27,764 7.00 356,889 25,634 7.18 Mortgage-backed securities(2) 12,144 530 4.36 15,616 634 4.06 13,170 613 4.65 Investment securities(2) 24,101 1,106 4.59 30,021 1,055 3.51 28,283 889 3.14 Daily interest-bearing assets 19,480 649 3.33 30,987 565 1.82 39,334 372 0.95 Other earning assets 7,333 3 0.04 6,088 110 1.81 5,849 231 3.95 -------- -------- ------ -------- ------- ----- -------- ------- ------ Total interest-earning assets 645,084 47,327 7.34 479,512 30,128 6.28 443,525 27,739 6.25 Non-interest-earning assets: Office properties and equipment, net 12,358 8,778 10,165 Other non-interest-earning assets 60,294 40,038 32,400 -------- -------- -------- Total assets $717,736 $528,328 $486,090 ======== ======== ======== Interest-bearing liabilities: Regular savings accounts $ 38,818 $ 213 0.55 $ 32,420 $ 178 0.55 $ 27,534 $ 163 0.59 NOW accounts 126,045 2,248 1.78 102,736 923 0.90 97,017 836 0.86 Money market accounts 120,188 3,276 2.73 75,063 901 1.20 65,176 582 0.89 Certificates of deposit 194,253 6,646 3.42 137,933 3,378 2.45 132,257 3,062 2.32 -------- -------- ------ -------- ------- ----- -------- ------- ------ Total interest-bearing deposits 479,304 12,383 2.58 348,152 5,380 1.55 321,984 4,643 1.44 Other interest-bearing liabilities 53,217 2,494 4.69 40,274 2,015 5.00 40,000 1,984 4.96 -------- ------- ------ -------- ------- ----- -------- ------- ------ Total interest-bearing liabilities 532,521 14,877 2.79 388,426 7,395 1.90 361,984 6,627 1.83 Non-interest-bearing liabilities: Non-interest-bearing deposits $ 87,490 $ 65,415 $ 57,899 Other liabilities 8,777 6,202 4,390 -------- -------- -------- Total liabilities 628,788 460,043 424,273 Shareholders' equity 88,948 68,285 61,817 -------- -------- -------- Total liabilities and shareholders' equity $717,736 $528,328 $486,090 ======== ======== ======== Net interest income $32,450 $22,733 $21,112 ======= ======= ======= Interest rate spread 4.55% 4.38% 4.42% ====== ====== ====== Net interest margin 5.03% 4.74% 4.76% ====== ====== ====== Ratio of average interest- earning assets to average interest-bearing liabilities 121.14% 123.45% 122.53% ====== ====== ====== Tax Equivalent Adjustment (3) $ 98 $ 161 $ 155 ======= ======= ======= (1) Includes non-accrual loans. Includes amortized loan fees of $3.1 million, $2.5 million and $2.3 million for fiscal year 2006, 2005 and 2004, respectively. (2) For purposes of the computation of average yield on investments available for sale, historical cost balances were utilized, therefore, the yield information does not give effect to change in fair value that are reflected as a component of shareholders' equity. (3) Tax-equivalent adjustment relates to non-taxable investment interest income and preferred equity securities dividend income. The federal statutory tax rate was 34% for all years presented. 56 Yields Earned and Rates Paid The following table sets forth for the periods and at the date indicated the weighted average yields earned on the Company's assets, the weighted average interest rates paid on the Company's liabilities, together with the net yield on interest-earning assets on a tax equivalent basis. At March 31, Year Ended March 31, ----------- ------------------------- 2006 2006 2005 2004 ----- ---- ----- ---- Weighted average yield earned on: Total net loans (1) 7.74% 7.20% 6.36% 6.53% Mortgage-backed securities 4.57 4.36 4.06 4.65 Investment securities 4.66 4.59 3.51 3.14 All interest-earning assets (1) 7.47 6.85 5.76 5.73 Weighted average rate paid on: Deposits 2.62 2.58 1.55 1.44 FHLB advances and other borrowings 4.65 4.69 5.00 4.96 All interest-bearing liabilities 2.80 2.79 1.90 1.83 Interest rate spread (spread between weighted average rate on all interest-earning assets and all interest-bearing liabilities)(1) 4.67 4.06 3.86 3.90 Net interest margin (net interest income (expense) as a percentage of average interest-earning assets) (1) 5.03 4.55 4.22 4.23 (1) Weighted average yield on total net loans excludes deferred loan fees. 57 Rate/Volume Analysis The following table sets forth the effects of changing rates and volumes on net interest income of the Company. Information is provided with respect to: (i) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate); (ii) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) changes in rate/volume (change in rate multiplied by change in volume). Rate/volume variance is allocated based on the percentage relationship of changes in volume and changes in rate to the total net change. Year Ended March 31, ------------------------------------------------------------------- 2006 vs 2005 2005 vs 2004 ---------------------------- -------------------------- Increase Increase (Decrease) (Decrease) Due to Total Due To Total -------------- Increase -------------- Increase Volume Rate (Decrease) Volume Rate (Decrease) ------ ---- --------- ------ ---- -------- (In thousands) <s> <c> <c> <c> <c> <c> <c> Interest Income: Real estate loans $13,769 $1,802 $15,571 $2,406 $(532) $1,874 Non-real estate loans 481 1,223 1,704 425 (169) 256 Mortgage-backed securities (149) 45 (104) 105 (84) 21 Investment securities (1) (233) 284 51 57 109 166 Daily interest-bearing (263) 347 84 (93) 286 193 Other earning assets 19 (126) (107) 9 (130) (121) ------- ------ ------- ------- ------ ------- Total interest income 13,624 3,575 17,199 2,909 (520) 2,389 ------- ------ ------- ------- ------ ------- Interest Expense: Regular savings accounts 35 0 35 28 (13) 15 NOW accounts 250 1,075 1,325 50 37 87 Money market accounts 762 1,613 2,375 97 222 319 Certificates of deposit 1,659 1,609 3,268 134 182 316 Other interest-bearing liabilities 611 (132) 479 15 16 31 ------- ------ ------- ------- ------ ------- Total interest expense 3,317 4,165 7,482 324 444 768 ------- ------ ------- ------- ------ ------- Net interest income (1) $10,307 $ (590) $ 9,717 $ 2,585 $ (964) $ 1,621 ======= ====== ======= ======= ====== ======= (1) Taxable equivalent Asset and Liability Management The Company's principle financial objective is to achieve long-term profitability while reducing its exposure to fluctuating market interest rates. The Company has sought to reduce the exposure of its earnings to changes in market interest rates by attempting to manage the difference between asset and liability maturities and interest rates. The principal element in achieving this objective is to increase the interest rate sensitivity of the Company's interest-earning assets and interest-bearing liabilities. Interest rate sensitivity increases by retaining portfolio loans with interest rates subject to periodic adjustment to market conditions and selling fixed-rate one- to four-family mortgage loans with terms of more than 15 years. The Company relies on retail deposits as its primary source of funds. Management believes retail deposits reduce the effects of interest rate fluctuations because they generally represent a stable source of funds. As part of its interest rate risk management strategy, the Company promotes transaction accounts and certificates of deposit with terms up to ten years. The Company has adopted a strategy that is designed to maintain or improve the interest rate sensitivity of assets relative to its liabilities. The primary elements of this strategy involve: the origination of adjustable rate loans or purchase of adjustable rate mortgage-backed securities for its portfolio; increasing commercial, consumer and 58 residential construction loans as a portion of total net loans receivable because of their generally shorter terms and higher yields than other one- to- four family residential mortgage loans; matching asset and liability maturities; investing in short term securities; and the origination of fixed-rate loans for sale in the secondary market and the retention of the related loan servicing rights. The strategy for liabilities has been to shorten the maturities for both deposits and borrowings. This approach has remained consistent throughout the past year as the Company has experienced a change in the mix of loans, deposits and FHLB advances. At March 31, 2006, loans and adjustable rate mortgage-backed securities constituted $524.5 million, or 81.9%, of the Company's total combined loans and securities portfolio. This compares to loans and adjustable rate securities at March 31, 2005 that totaled $268.0 million, or 74.5%, of the Company's total combined loan and securities portfolio. Although the Company has sought to originate adjustable rate loans, the ability to originate and purchase such loans depends to a great extent on market interest rates and borrowers' preferences. Particularly in lower interest rate environments, borrowers often prefer to obtain fixed rate loans. The Company's mortgage servicing activities provide additional protection from interest rate risk. The Company retains servicing rights on all mortgage loans sold. As market interest rates rise, the fixed rate loans held in portfolio diminish in value. However, the value of the servicing portfolio tends to rise as market interest rates increase because borrowers tend not to prepay the underlying mortgages, thus providing an interest rate risk hedge versus the fixed rate loan portfolio. The loan servicing portfolio totaled $116.0 million at March 31, 2006, including $1.6 million of purchased mortgage servicing. The purchase of loan servicing replaced loan servicing balances extinguished through prepayment of the underlying loans. The average balance of the servicing portfolio was $118.5 million and produced loan servicing income of $91,000 for the year ended March 31, 2006. See "Item 1. Business - -- Lending Activities -- Mortgage Loan Servicing." Consumer loans, commercial loans and construction loans typically have shorter terms and higher yields than permanent residential mortgage loans, and accordingly reduce the Company's exposure to fluctuations in interest rates. Adjustable interest rate consumer, commercial, construction and other loans totaled $521.9 million or 82.8% of total gross loans at March 31, 2006 as compared to $335.0 million, or 77.1%, at March 31, 2005. At March 31, 2006, the construction, commercial, consumer and other loan portfolios amounted to $127.3 million, $59.8 million, $31.4 million and $411.9 million, or 20.2%, 9.5%, 5.0% and 65.3% of total loans, net of deferred fees, respectively. See "Item 1. Business -- Lending Activities -- Construction Lending" and " -- Lending Activities -- Consumer Lending." The Company also invests in short-term to medium-term U.S. Government securities as well as mortgage-backed securities issued or guaranteed by U.S. Government agencies. At March 31, 2006, the combined portfolio carried at $34.0 million had an average term to repricing or maturity of 2.69 years. See "Item 1. Business -- Investment Activities." A measure of the Company's exposure to differential changes in interest rates between assets and liabilities is provided by the test required by OTS Thrift Bulletin No. 13a, "Interest Rate Risk Management." This test measures the impact on net interest income and on net portfolio value of an immediate change in interest rates in 100 basis point increments. Using data compiled by the OTS, the Company receives a report which measures interest rate risk by modeling the change in net portfolio value ("NPV") over a variety of interest rate scenarios. This procedure for measuring interest rate risk was developed by the OTS to replace the "gap" analysis (the difference between interest-earning assets and interest-bearing liabilities that mature or reprice within a specific time period). NPV is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts. The following table provides the estimated impacts of immediate changes in interest rates at the specified levels based on the latest OTS report dated December 31, 2005. 59 At December 31, 2005 --------------------------------------------------- Net Net Portfolio Value as a Portfolio Value Percent of Present ------------------------- Value of Assets Change Dollar Dollar Percent --------------------- In Rates Amount Change Change NPV Ratio Change - -------- ------ ------ ------- --------- -------- (Dollars in thousands) 300 bp $114,715 $3,768 +3% 15.20% +44 bp 200 bp 113,974 3,027 +3 15.12 +36 bp 100 bp 112,537 1,590 +1 14.96 +19 bp 0 bp 110,947 - - 14.76 - (100) bp 108,379 (2,568) (2) 14.45 (32)bp (200) bp 104,863 (6,084) (5) 14.01 (75)bp For example, the above table illustrates that an instantaneous 100 basis point increase in market interest rates at December 31, 2005 would increase the Company's NPV by approximately $1.6 million, or 1%, at that date. At December 31, 2004, an instantaneous 100 basis point increase in market interest rates would have increased the Company's NPV by approximately $3.1 million, or 4%, at that date. The $31.5 million increase in the NPV to $110,947 at December 31, 2005 is the result of the impact of more adjustable loan balances in the loan portfolio at December 31, 2005 as compared to December 31, 2004. Certain assumptions used by the OTS in assessing the interest rate risk of savings associations within its region were used in preparing the preceding table. These assumptions relate to interest rates, loan prepayment rates, deposit decay rates and the market values of certain assets under differing interest rate scenarios, among others. As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as ARM loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Furthermore, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates could deviate significantly from those assumed in calculating the table. Liquidity and Capital Resources The Company's primary source of cash flows is its operations as a lender, which generate interest income on loans. This is supplemented by fee income, service charges, and interest on investment securities, and reduced by payment of interest expense and non-interest expenses. After payment of expenses, the Company has significant positive cash flow from operating activities. The Company's investing activities typically use cash, primarily for loan originations. For the year ended March 31, 2006, additional cash flows were provided by the Company's financing activities as a result of a significant increase in deposit accounts. The Company's primary source of funds are customer deposits, proceeds from principal and interest payments on loans, the sale of loans, maturing securities and FHLB advances. While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. The Company must maintain an adequate level of liquidity to ensure the availability of sufficient funds to fund loan originations and deposit withdrawals, satisfy other financial commitments and to take advantage of investment opportunities. The Company generally maintains sufficient cash and short-term investments to meet short-term liquidity needs. At March 31, 2006, cash totaled $31.3 million, or 4.1%, of total assets. The Bank has a 30% of total assets line of credit with the FHLB of Seattle to the extent the Bank provides qualifying collateral and holds sufficient 60 FHLB stock. At March 31, 2006, the Bank had $46.1 million of outstanding advances from the FHLB of Seattle under an available credit facility of $228.5 million, limited to available collateral. Liquidity management is both a short- and long-term responsibility of the Company's management. The Company adjusts its investments in liquid assets based upon management's assessment of (i) expected loan demand, (ii) projected loan sales, (iii) expected deposit flows, (iv) yields available on interest-bearing deposits and (v) its asset/liability management program objectives. Excess liquidity is invested generally in interest-bearing overnight deposits and other short-term government and agency obligations. If the Company requires funds beyond its ability to generate them internally, it has additional borrowing capacity with the FHLB and collateral for borrowing at the Federal Reserve Bank discount window. At March 31, 2006, the Bank's ratio of cash and eligible investments to the sum of withdrawable savings and borrowings due within one year was 6.71%. The Company's primary investing activity is the origination of loans. During the years ended March 31, 2006, 2005 and 2004, the Company originated $655.3 million, $434.4 million and $375.8 million of loans held for investment and loans held for sale, respectively. At March 31, 2006, the Company had outstanding mortgage loan commitments of $2.3 million and undisbursed balance of mortgage loans closed of $94.6 million. Consumer loan commitments totaled $2.4 million and unused lines of consumer credit totaled $24.7 million at March 31, 2006. Commercial real estate loan commitments totaled $12.4 million and undisbursed balance of commercial real estate loans closed was $8.4 million at March 31, 2006. Commercial loan commitments totaled $850,000 and unused commercial lines of credit totaled $42.6 million at March 31, 2006. The Company anticipates that it will have sufficient funds available to meet current loan commitments. Certificates of deposit that are scheduled to mature in less than one year from March 31, 2006 totaled $130.2 million. Historically, the Company has been able to retain a significant amount of its deposits as they mature. At March 31, 2006, scheduled maturities of certificates of deposit, FHLB advances, Debentures, commitments to originate loans, undisbursed loan funds, unused lines of credit, standby letters of credit and future operating minimum lease commitments were as follows: Within 1-3 4-5 Over Total 1 year Years Years 5 Years Balance -------- ------ ------ ------- -------- (In thousands) Certificates of deposit $130,159 $65,679 $ 6,354 $4,928 $207,120 FHLB advances 41,100 5,000 - - 46,100 Debentures - - - 7,000 7,000 Commitments to originate loans Adjustable 13,452 - - - 13,452 Fixed 4,540 - - - 4,540 Undisbursed loan funds, unused lines of credit and standby letters of credit 127,675 38,232 209 5,911 172,027 Operating leases 1,616 3,218 2,376 5,027 12,237 -------- -------- ------ ------- --------- Total other contractual obligations $318,542 $112,129 $8,939 $22,866 $462,476 ======== ======== ====== ======= ========= The table above does not include interest payments on borrowings, deposit liabilities or increases in common area charges on operating leases. The Bank's primary sources of funds are deposits, FHLB borrowings, proceeds from the principal and interest payments on loans and securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows, prepayment of mortgage loans and mortgage-backed securities are greatly influenced by general interest rates, economic conditions and competition. The increase in interest rates during the fiscal year 2006 has created an interest rate environment that caused the demand for fixed rate single family loans and repayment of existing single family mortgage loans and mortgage- backed securities to be less than in the prior year. The Company's business plan emphasizes the sale of fixed rate mortgages as part of its interest rate risk strategy. The decrease in the cash flows from operating activities of loans 61 sold to $17.8 million for the fiscal 2006 compared to $22.9 million for fiscal 2005 reflects this strategy under the changing interest rate environment. The Bank has experienced growth in deposit accounts that is attributable to organic growth. The information contained in "Item 1, Business Deposit Activities and Other Sources of Funds -- Deposit Flow" reflects this net increase in cash flows from deposits of $150.1 million for fiscal 2006 as compared to an $47.8 million increase in net cash flows for the same period in the prior year. The higher interest rate certificates of deposit have been allowed to runoff. Should the Bank require funds beyond its ability to generate them internally, additional funds are available through the use of FHLB and Pacific Coast Banker's Bank borrowings. At March 31, 2006 advances from FHLB totaled $46.1 million and the Bank had additional borrowing capacity available of $182.4 million from the FHLB, subject to collateral limitations. At March 31, 2006 the Bank's available borrowing line subject to collateral limitations was $91.7 million. The Bank has a $10.0 million fed funds line with Pacific Coast Banker's Bank at March 31, 2006. Sources of capital and liquidity for the Company on a stand-alone basis include distributions from the Bank and the issuance of debt or equity. Dividends and other capital distributions from the Bank are subject to regulatory restrictions. OTS regulations require the Bank to maintain specific amounts of regulatory capital. As of March 31, 2006, the Bank complied with all regulatory capital requirements as of that date with tangible, core and risk-based capital ratios of 9.70%, 9.70% and 11.48%, respectively. For a detailed discussion of regulatory capital requirements, see "REGULATION -- Federal Regulation of Savings Associations -- Capital Requirements." Effect of Inflation and Changing Prices The Consolidated Financial Statements and related financial data presented herein have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The primary impact of inflation is reflected in the increased cost of the Company's operations. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services. New Accounting Pronouncements For a discussion of new accounting pronouncement and their impact on the Company, see Note 1 of the Notes to the Consolidated Financial Statement included in Item 8 of this Form 10-K. Contractual Obligations The following table shows the contractual obligations by expected period, as of March 31, 2006. Further discussion of these commitments is included in Note 20 to the consolidated financial statements included in Item 8 of this report. At March 31, 2006, scheduled maturities of certificates of deposit, FHLB advances, future operating minimum lease commitments and subordinated Debentures were as follows (in thousands): Within 1-3 4-5 Over Total 1 year Years Years 5 Years Balance -------- ------ ------ ------- -------- Certificates of deposit $130,159 $65,679 $ 6,354 $ 4,928 $207,120 FHLB advances 41,100 5,000 - - 46,100 Operating leases 1,616 3,218 2,376 5,027 12,237 Junior subordinates Debentures - - - 7,217 7,217 -------- ------- ------- -------- -------- Total other contractual obligations $172,875 $73,897 $ 8,730 $17,172 $272,674 ======== ======= ======= ======== ======== 63 The Company is party to litigation arising in the ordinary course of business. In the opinion of management, these actions will not have a material adverse effect, if any, on the Company's financial position, results of operations, or liquidity. The Bank has entered into employment contracts with certain key employees which provide for contingent payment subject to future events. Off-Balance Sheet Arrangements The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments generally include commitments to originate mortgage, commercial and consumer loans. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company's maximum exposure to credit loss in the event of nonperformance by the borrower is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments. Commitments to extend credit are conditional, and are honored for up to 45 days subject to the Company's usual terms and conditions. Collateral is not required to support commitments. At March 31, 2006, the Company had commitments to extend credit of $188.3 million, up 40.0% compared to $134.5 million at March 31, 2005. The increase reflects the expansion in residential and commercial construction business. For additional information regarding future financial commitments, this discussion and analysis should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this report including Footnote 20, "Commitments and Contingencies." Item 7A. Quantitative and Qualitative Disclosures About Market Risk - ------------------------------------------------------------------- Quantitative Aspects of Market Risk. The Company does not maintain a trading account for any class of financial instrument nor does it engage in hedging activities or purchase high-risk derivative instruments. Furthermore, the Company is not subject to foreign currency exchange rate risk or commodity price risk. For information regarding the sensitivity to interest rate risk of the Company's interest-earning assets and interest-bearing liabilities, see the tables under "Item 1. Business -- Lending Activities -- Loan Portfolio Analysis," "-- Investment Activities" and "-- Deposit Activities and Other Sources of Funds -- Certificates of Deposit by Rates and Maturities" contained herein. Qualitative Aspects of Market Risk. The Company's principal financial objective is to achieve long-term profitability while limiting its exposure to fluctuating market interest rates. The Company intends to reduce risk where appropriate but accept a degree of risk when warranted by economic circumstances. The Company has sought to reduce the exposure of its earnings to changes in market interest rates by attempting to manage the mismatch between asset and liability maturities and interest rates. The principal element in achieving this objective is to increase the interest rate sensitivity of the Company's interest-earning assets. Interest rate sensitivity will increase by retaining portfolio loans with interest rates subject to periodic adjustment to market conditions and selling fixed-rate one- to four- family mortgage loans with terms of more than 15 years. Interest rates on residential one- to four- family mortgage loan applications are typically locked during the application stage for periods ranging from 30 to 90 days, the most typical period being 45 days. These loans are locked with the FHLMC under a best-efforts delivery program. The Company makes every effort to deliver these loans before their rate locks expire. This arrangement requires the Company to deliver the loans to the FHLMC within ten days of funding. Delays in funding the loans can require a lock extension. The cost of a lock extension at times is borne by the borrower and at times by the Company. These lock extension costs paid by the Company are not expected to have a material impact to operations. This activity is managed daily. Consumer and commercial loans are originated and held in portfolio as the short term nature of these portfolio loans match durations more closely with the short term nature of retail deposits such as NOW accounts, money market accounts and savings accounts. The Company relies on retail deposits as its primary source of funds. Management believes retail deposits reduce the effects of interest rate fluctuations because they generally represent a more stable 63 source of funds. As part of its interest rate risk management strategy, the Company promotes transaction accounts and certificates of deposit with longer terms to maturity. Except for immediate short-term cash needs, and depending on the current interest rate environment, FHLB advances will usually be of longer term. For additional information, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" contained herein. 64 The following table shows the Company's financial instruments that are sensitive to changes in interest rates, categorized by expected maturity, and the instruments' fair values at March 31, 2006. Market risk sensitive instruments are generally defined as on- and off-balance sheet derivatives and other financial instruments. Within After After Beyond Average One 1 to 3 3 to 5 5 to 10 10 Fair Rate Year Years Years Years Years Total Value ---- ---- ----- ----- ----- ----- ----- ----- (Dollars in thousands) <s> <c> <c> <c> <c> <c> <c> <c> <c> Interest-Sensitive Assets: Loans receivable (1) 7.74% $213,873 $ 92,400 $ 50,506 $204,052 $69,471 $630,302 $620,172 Mortgage-backed securities 4.57 2,757 639 6,543 - - 9,939 9,964 Investments and other interest-earning assets 4.62 22,556 6,722 1,189 - 1,341 31,808 31,808 FHLB stock - 1,470 2,940 2,940 - - 7,350 7,350 -------- -------- -------- -------- -------- -------- -------- Total assets 240,656 102,701 61,178 204,052 70,812 679,399 669,294 ======== ======== ======== ======== ======== ======== ======== Interest-Sensitive Liabilities: NOW accounts 0.21 12,588 25,176 25,177 - - 62,941 62,941 High-yield checking 4.27 13,303 26,607 26,606 - - 66,516 66,516 Non-interest checking accounts - 18,918 37,837 37,837 - - 94,592 94,592 Savings accounts 0.55 7,668 15,338 15,338 - - 38,344 38,344 Money market accounts 3.45 27,491 54,980 54,980 - - 137,451 137,451 Certificate accounts 3.85 130,159 65,679 6,354 4,722 206 207,120 205,718 FHLB advances 4.65 41,100 5,000 - - - 46,100 45,846 Subordinated debentures 6.27 - - - - 7,217 7,217 7,236 Obligations under capital lease 7.16 29 74 83 374 2,193 2,753 2,753 -------- -------- --------- -------- -------- -------- -------- Total liabilities 251,256 230,691 166,375 5,096 9,616 663,034 661,397 -------- -------- --------- -------- -------- -------- -------- Interest sensitivity gap (10,600) (127,990) (105,197) 198,956 61,196 16,635 7,125 -------- --------- --------- -------- -------- -------- -------- Cumulative interest sensitivity gap $(10,600)$(138,590)$(243,787) $(44,831) $ 16,365 ======== ========= ========= ======== ======== Off-Balance Sheet Items: Commitments to extend credit - 17,993 - - - - 17,993 - Unused lines of credit - 170,270 - - - - 170,270 - (1) Includes loans held for sale 65 Item 8. Financial Statements and Supplementary Data - ----------------------------------------------------- RIVERVIEW BANCORP, INC. AND SUBSIDIARY Consolidated Financial Statements for Years Ended March 31, 2006, 2005 and 2004 Independent Auditor's Reports TABLE OF CONTENTS - --------------------------------------------------------------------------- Page Report of Independent Registered Public Accounting Firm - Deloitte & Touche LLP 67 Report of Independent Registered Public Accounting Firm - McGladrey & Pullen, LLP 68 Consolidated Balance Sheets as of March 31, 2006 and 2005 69 Consolidated Statements of Income for the Years Ended March 31, 2006, 2005 and 2004 70 Consolidated Statements of Shareholders' Equity for the Years Ended March 31, 2006, 2005 and 2004 71 Consolidated Statements of Cash Flows for the Years Ended March 31, 2006, 2005 and 2004 72 Notes to Consolidated Financial Statements 73 66 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Riverview Bancorp, Inc. Vancouver, Washington We have audited the accompanying consolidated balance sheets of Riverview Bancorp, Inc. & Subsidiary (the "Company") as of March 31, 2006, and the related consolidated statements of income, cash flows, and changes in stockholders' equity for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of March 31, 2006, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company's internal control over financial reporting as of March 31, 2006, based on the criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated June 13, 2006, expressed an unqualified opinion on management's assessment of the effectiveness of the Company's internal control over financial reporting and an unqualified opinion on the effectiveness of the Company's internal control over financial reporting. /s/Deloitte & Touche LLP Portland, Oregon June 13, 2006 67 McGladrey& Pullen Certified Public Accountants Report of Independent Registered Public Accounting Firm To the Board of Directors Riverview Bancorp, Inc. Vancouver, Washington We have audited the consolidated balance sheet of Riverview Bancorp, Inc. and Subsidiary as of March 31, 2005, and the related consolidated statements of income, shareholders' equity and cash flows for each of the two years in the period ended March 31, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Riverview Bancorp, Inc. and Subsidiary as of March 31, 2005, and the results of their operations and their cash flows for each of the two years in the period ended March 31, 2005, in conformity with U.S. generally accepted accounting principles. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Riverview Bancorp, Inc. and Subsidiary's internal control over financial reporting as of March 31, 2005, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated June 10, 2005, expressed an unqualified opinion on management's assessment of the effectiveness of Riverview Bancorp, Inc.'s internal control over financial reporting and an unqualified opinion on the effectiveness of Riverview Bancorp, Inc.'s internal control over financial reporting. /s/McGladrey & Pullen, LLP Tacoma, Washington June 10, 2005 68 RIVERVIEW BANCORP, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS MARCH 31, 2006 AND 2005 (In thousands, except share data) 2006 2005 - ----------------------------------------------------------------------------- ASSETS Cash (including interest-earning accounts of $7,786 and $45,501) $ 31,346 $ 61,719 Loans held for sale 65 510 Investment securities available for sale, at fair value (amortized cost of $24,139 and $22,993) 24,022 22,945 Mortgage-backed securities held to maturity, at amortized cost (fair value of $1,830 and $2,402) 1,805 2,343 Mortgage-backed securities available for sale, at fair value (cost of $8,436 and $11,756) 8,134 11,619 Loans receivable (net of allowance for loan losses of $7,221 and $4,395) 623,016 429,449 Real estate owned - 270 Prepaid expenses and other assets 2,210 1,538 Accrued interest receivable 3,058 2,151 Federal Home Loan Bank stock, at cost 7,350 6,143 Premises and equipment, net 19,127 8,391 Deferred income taxes, net 3,771 2,624 Mortgage servicing rights, net 384 470 Goodwill 25,572 9,214 Core deposit intangible, net 895 578 Bank owned life insurance 13,092 12,607 ------- ------- TOTAL ASSETS $763,847 $572,571 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES: Deposit accounts $606,964 $456,878 Accrued expenses and other liabilities 8,768 5,858 Advance payments by borrowers for taxes and insurance 358 313 Federal Home Loan Bank advances 46,100 40,000 Junior subordinated debentures 7,217 - Capital lease obligation 2,753 - ------- ------- Total liabilities 672,160 503,049 COMMITMENTS AND CONTINGENCIES (See Note 19) - - SHAREHOLDERS' EQUITY: Serial preferred stock, $.01 par value; 250,000 authorized, issued and outstanding, none - - Common stock, $.01 par value; 50,000,000 authorized, issued and outstanding: 2006 5,772,690 issued, 5,772,686 outstanding 57 50 2005 5,015,753 issued, 5,015,749 outstanding Additional paid-in capital 57,316 41,112 Retained earnings 35,776 29,874 Unearned shares issued to employee stock ownership trust (1,186) (1,392) Accumulated other comprehensive loss (276) (122) ------- ------- Total shareholders' equity 91,687 69,522 ------- ------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $763,847 $572,571 ======= ======= See notes to consolidated financial statements. 69 RIVERVIEW BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED MARCH 31, 2006, 2005 AND 2004 (In thousands, except share data) 2006 2005 2004 - ----------------------------------------------------------------------------- INTEREST AND DIVIDEND INCOME: Interest and fees on loans receivable $ 45,039 $ 27,764 $ 25,634 Interest on investment securities - taxable 809 521 357 Interest on investment securities - non taxable 170 174 121 Interest on mortgage-backed securities 530 634 613 Other interest and dividends 681 875 859 -------- -------- -------- Total interest and dividend income 47,229 29,968 27,584 -------- -------- -------- INTEREST EXPENSE: Interest on deposits 12,383 5,380 4,643 Interest on borrowings 2,494 2,015 1,984 -------- -------- -------- Total interest expense 14,877 7,395 6,627 -------- -------- -------- Net interest income 32,352 22,573 20,957 Less provision for loan losses 1,500 410 210 -------- -------- -------- Net interest income after provision for loan losses 30,852 22,163 20,747 -------- -------- -------- NON-INTEREST INCOME: Fees and service charges 5,913 4,588 4,324 Asset management fees 1,481 1,120 906 Net gain on sale of loans held for sale 361 513 954 Impairment of securities, net of gain on sale - (1,185) - Gain on sale of other real estate owned 21 - 49 Loan servicing income 91 47 158 Gain on sale of land and fixed assets 2 830 3 Gain of sale of credit card portfolio 311 - - Bank owned life insurance 485 486 121 Other 172 107 74 -------- -------- -------- Total non-interest income 8,837 6,506 6,589 -------- -------- -------- NON-INTEREST EXPENSE: Salaries and employee benefits 14,536 10,773 9,910 Occupancy and depreciation 3,798 2,991 2,900 Data processing 1,414 991 917 Amortization of core deposit intangible 210 180 430 Advertising and marketing expense 853 766 772 FDIC insurance premium 70 58 64 State and local taxes 580 519 426 Telecommunications 395 288 269 Professional fees 1,328 842 501 Other 2,190 1,696 1,383 -------- -------- -------- Total non-interest expense 25,374 19,104 17,572 -------- -------- -------- INCOME BEFORE INCOME TAXES 14,315 9,565 9,764 PROVISION FOR INCOME TAXES 4,577 3,036 3,210 -------- -------- -------- NET INCOME $ 9,738 $ 6,529 $ 6,554 ======== ======== ======== Earnings per common share: Basic $ 1.74 $ 1.36 $ 1.41 Diluted 1.72 1.33 1.39 Weighted average number of shares outstanding: Basic 5,602,240 4,816,745 4,640,485 Diluted 5,675,168 4,891,173 4,714,329 See notes to consolidated financial statements. 70 RIVERVIEW BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED MARCH 31, 2006, 2005 AND 2004 Unearned Shares Issued to Employee Unearned Accumulated Common Stock Additional Stock Shares Other (In thousands, ----------------- Paid-In Retained Ownership Issued to Comprehensive except share data) Shares Amount Capital Earnings Trust MRDP Income(Loss) Total - ----------------------------------------------------------------------------------------------------------- <s> <c> <c> <c> <c> <c> <c> <c> <c> Balance April 1, 2003 4,580,401 $ 46 $ 33,525 $ 22,389 $(1,804) $ (15) $ 370 $54,511 Cash dividends ($0.56 per share) - - - (2,613) - - - (2,613) Exercise of stock options 40,281 1 484 - - - - 485 Stock repurchased and retired (81,500) (1) (1,509) - - - - (1,510) Stock issued in connection with acquisition 430,655 4 7,343 - - - - 7,347 Earned ESOP shares - - 271 - 206 - - 477 Tax benefit, stock option and MRDP - - 73 - - - - 73 Earned MRDP shares 5,138 - - - - 15 - 15 --------- ------ ------- -------- ----- ------ ----------- ------- 4,974,975 50 40,187 19,776 (1,598) - 370 58,785 Comprehensive income: Net income - - - 6,554 - - - 6,554 Other comprehensive income: Unrealized holding loss on securities of $157 (net of $81 tax effect) - - - - - - (157) (157) ------- Total comprehensive income - - - - - - - 6,397 --------- ------ ------- -------- ----- ------ ----------- ------- Balance March 31, 2004 4,974,975 50 40,187 26,330 (1,598) - 213 65,182 Cash dividends ($0.62 per share) - - - (2,985) - - - (2,985) Exercise of stock options 40,774 - 536 - - - - 536 Earned ESOP shares - - 314 - 206 - - 520 Tax benefit, stock option - - 75 - - - - 75 --------- ------ ------- -------- ----- ------ ----------- ------- 5,015,749 50 41,112 23,345 (1,392) - 213 63,328 Comprehensive income: Net income - - - 6,529 - - - 6,529 Other comprehensive income: Unrealized holding gain on securities of $1,120 (net of $577 tax effect) less classification adjustment for net losses included in net income of $785 (net of $404 tax effect) - - - - - - (335) (335) ------- Total comprehensive income - - - - - - - 6,194 --------- ------ ------- -------- ----- ------ ----------- ------- Balance March 31, 2005 5,015,749 $ 50 $41,112 $ 29,874 $(1,392) $ - $ (122) $ 69,522 Cash dividends ($0.68 per share) - - - (3,836) - - - (3,836) Exercise of stock options 18,572 - 314 - - - - 314 Stock repurchased and retired (50,000) - (1,227) - - - - (1,227) Stock issued in connection with acquisition 788,365 7 16,706 - - - - 16,713 Earned ESOP shares - - 352 - 206 - - 558 Tax benefit, stock option - - 59 - - - - 59 --------- ------ ------- -------- ----- ------ ----------- ------- 5,772,686 57 57,316 26,038 (1,186) - (122) 82,103 Comprehensive income: Net income - - - 9,738 - - - 9,738 Other comprehensive income: Unrealized holding loss on securities of $154 (net of $79 tax effect) - - - - - - (154) (154) ------- Total comprehensive income - - - - - - - 9,584 ---------- ------ ------- -------- ----- ------ ----------- ------- Balance March 31, 2006 5,772,686 $ 57 $57,316 $ 35,776 $(1,186) $ - $ (276) $ 91,687 ========= ====== ======= ======== ===== ====== =========== ======= See notes to consolidated financial statements. 71 RIVERVIEW BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED MARCH 31, 2006, 2005 AND 2004 (In thousands) 2006 2005 2004 - ---------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 9,738 $ 6,529 $ 6,554 Adjustments to reconcile net income to cash provided by operating activities: Depreciation and amortization 1,907 1,492 2,157 Mortgage servicing rights valuation adjustment (24) (22) (307) Provision for loan losses 1,500 410 210 (Benefits) provision for deferred income taxes (704) 285 421 Noncash expense related to ESOP 558 520 477 Noncash expense related to MRDP - - 15 Noncash expense related to REO donation - - 61 Noncash loss on impairment of securities - 1,349 - Noncash interest expense on capital lease obligation 49 - - Increase in deferred loan origination fees, net of amortization 933 382 759 Federal Home Loan Bank stock dividend - (110) (229) Origination of loans held for sale (17,308) (22,943) (50,472) Proceeds from sales of loans held for sale 17,786 22,919 51,700 Net gain on loans held for sale, sale of real estate owned, mortgage-backed securities, investment securities and premises and equipment (363) (1,310) (852) Income from bank owned life insurance (485) (486) (121) Changes in assets and liabilities, net of acquisition: Prepaid expenses and other assets (455) (484) 190 Accrued interest receivable (371) (364) (294) Accrued expenses and other liabilities 2,488 (602) 521 ------ ------ ------ Net cash provided by operating activities 15,249 7,565 10,790 ------ ------ ------ CASH FLOWS FROM INVESTING ACTIVITIES: Loan originations (647,978) (411,476) (325,366) Principal repayments/refinance on loans 571,762 363,607 329,443 Proceeds from call, maturity, or sale of investment securities available for sale 5,250 13,515 6,250 Principal repayments on investment securities available for sale 37 75 - Purchase of investment securities available for sale (4,996) (5,014) (12,490) Purchase of mortgage-backed securities available for sale - (5,000) (4,937) Principal repayments on mortgage-backed securities available for sale 3,320 3,657 7,690 Principal repayments on mortgage-backed securities held to maturity 538 173 782 Purchase of premises and equipment (8,087) (561) (307) Acquisition, net of cash received (14,663) - 7,206 Additions to real estate owned - (621) (546) Purchase of bank owned life insurance - - (12,000) Proceeds from sale of real estate owned and premises and equipment 275 2,513 749 ------ ------ ------ Net cash used by investing activities (94,542) (39,132) (3,526) ------ ------ ------ CASH FLOWS FROM FINANCING ACTIVITIES: Net change in deposit accounts, net of deposits acquired 70,331 47,763 (16,740) Dividends paid (3,631) (2,904) (2,490) Repurchase of common stock (1,228) - (1,510) Proceeds from borrowings 157,100 - - Repayment of borrowings (174,000) - - Principal payments under capital lease obligation (10) - - Net increase (decrease) in advance payments by borrowers 44 (16) 40 Proceeds from exercise of stock options 314 536 485 ------ ------ ------ Net cash provided(used) by financing activities 48,920 45,379 (20,215) ------ ------ ------ NET (DECREASE) INCREASE IN CASH (30,373) 13,812 (12,951) CASH, BEGINNING OF YEAR 61,719 47,907 60,858 ------ ------ ------ CASH, END OF YEAR $ 31,346 $ 61,719 $ 47,907 ====== ====== ====== SUPPLEMENTAL DISCLOSURES: Cash paid during the year for: Interest $ 14,663 $ 7,418 $ 6,741 Income taxes 5,206 2,675 3,070 NONCASH INVESTING AND FINANCING ACTIVITIES: Transfer of loans to real estate owned $ - $ 304 $ 340 Loans to finance the sale of real estate owned - 578 - Receivable due to sale & leaseback of branch - 2,391 - Dividends declared and accrued in other liabilities 955 749 668 Fair value adjustment to securities available for sale (234) (507) (238) Income tax effect related to fair value adjustment 79 172 81 Common stock issued upon business combination 16,713 - 7,347 Borrowings under capital lease obligation 2,715 - - See notes to consolidated financial statements. 72 RIVERVIEW BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED MARCH 31, 2006 AND 2005 - ----------------------------------------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation - The consolidated financial statements of Riverview Bancorp, Inc. and Subsidiary (the "Company") include all the accounts of Riverview Bancorp, Inc. and the consolidated accounts of its wholly-owned subsidiary, Riverview Community Bank (the "Bank"), the Bank's wholly-owned subsidiary, Riverview Services, Inc., and the Bank's majority owned subsidiary, Riverview Asset Management Corp. All inter-company transactions and balances have been eliminated in consolidation. Nature of Operations - The Bank is a seventeen branch community-oriented financial institution operating in rural and suburban communities in southwest Washington State and Multnomah, Clackamas and Marion counties of Oregon. The Bank is engaged primarily in the business of attracting deposits from the general public and using such funds, together with other borrowings, to invest in various consumer-based real estate loans, other consumer and commercial loans, investment securities and mortgage-backed securities. Use of Estimates in the Preparation of Financial Statements - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("generally accepted accounting principles" or "GAAP"), requires management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of related revenue and expense during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of mortgage servicing rights, goodwill, core deposit intangibles and deferred tax assets. Loans - Loans are stated at the amount of unpaid principal, reduced by deferred loan origination fees and an allowance for loan losses. Interest on loans is accrued daily based on the principal amount outstanding. Generally the accrual of interest on loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due or when they are past due 90 days as to either principal or interest, unless they are well secured and in the process of collection. When interest accrual is discontinued, all unpaid accrued interest is reversed against current income. If management determines that the ultimate collectibility of principal is in doubt, cash receipts on non-accrual loans are applied to reduce the principal balance on a cash-basis method, until the loans qualify for return to accrual status. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. Loan origination and commitment fees and certain direct loan origination costs are deferred and amortized as an adjustment of the yield of the related loan. Securities - In accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain Investments in Debt and Equity Securities, investment securities are classified as held to maturity where the Company has the ability and positive intent to hold them to maturity. Investment securities held to maturity are carried at cost, adjusted for amortization of premiums and accretion of discounts to maturity. Unrealized losses on securities held to maturity or available for sale due to fluctuations in fair value are recognized when it is determined that an- other-than temporary decline in value has occurred. Investment securities bought and held principally for the purpose of sale in the near term are classified as trading securities. Securities that the Company intends to hold for an indefinite period, but not necessarily to maturity are classified as available for sale. Such securities may be sold to implement the Bank's asset/liability management strategies and in response to changes in interest rates and similar factors. Securities available for sale are reported at fair value. Unrealized gains and losses, net of related deferred tax effect, are reported as net amount in a separate component of shareholders' equity entitled "accumulated other comprehensive income (loss)." Realized gains and losses on securities available for sale, determined using the specific identification method, are included in earnings. Amortization of premiums and accretion of discounts are recognized in interest income over the period to maturity. The Company analyzes investment securities for other than temporary impairment on a periodic basis. Declines in 73 value that are deemed other than temporary, if any are reported in non-interest income. Real Estate Owned ("REO") - REO consists of properties acquired through foreclosure. Specific charge-offs are taken based upon detailed analysis of the fair value of collateral underlying loans on which the Company is in the process of foreclosing. Such collateral is transferred into REO at the lower of recorded cost or fair value less estimated costs of disposal. Subsequently, properties are evaluated and for any additional declines in value, the Company writes down the REO directly and charges operations for the diminution in value. The amounts the Company will ultimately recover from REO may differ from the amounts used in arriving at the net carrying value of these assets because of future market factors beyond the Company's control or because of changes in the Company's strategy for the sale of the property. Allowance for Loan Losses - The allowance for loan losses is maintained at a level sufficient to provide for probable loan losses based on evaluating known and inherent risks in the loan portfolio. The allowance is provided based upon management's continuing analysis of the pertinent factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, delinquency levels, actual loan loss experience, current economic conditions, and detailed analysis of individual loans for which full collectibility may not be assured. The detailed analysis includes techniques to estimate the fair value of loan collateral and the existence of potential alternative sources of repayment. The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. The appropriate allowance level is estimated based upon factors and trends identified by management at the time the consolidated financial statements are prepared. When available information confirms that specific loans or portions thereof are uncollectible, identified amounts are charged against the allowance for loan losses. The existence of some or all of the following criteria will generally confirm that a loss has been incurred: the loan is significantly delinquent and the borrower has not demonstrated the ability or intent to bring the loan current; the Bank has no recourse to the borrower, or if it does, the borrower has insufficient assets to pay the debt; the estimated fair value of the loan collateral is significantly below the current loan balance, and there is little or no near-term prospect for improvement. In accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan, and SFAS No. 118, An amendment of SFAS No. 114, a loan is considered impaired when it is probable that a creditor will be unable to collect all amounts (principal and interest) due according to the contractual terms of the loan agreement. Large groups of smaller balance homogenous loans such as consumer secured loans, residential mortgage loans and consumer unsecured loans are collectively evaluated for potential loss. When a loan has been identified as being impaired, the amount of the impairment is measured by using discounted cash flows, except when, as a practical expedient, the current fair value of the collateral, reduced by costs to sell, is used. When the measurement of the impaired loan is less than the recorded investment in the loan (including accrued interest, net deferred loan fees or costs, and unamortized premium or discount), an impairment is recognized by creating or adjusting an allocation of the allowance for loan losses. A provision for loan losses is charged against income and is added to the allowance for loan losses based on regular assessments of the loan portfolio. The allowance for loan losses is allocated to certain loan categories based on the relative risk characteristics, asset classifications and actual loss experience of the loan portfolio. While management has allocated the allowance for loan losses to various loan portfolio segments, the allowance is general in nature and is available for the loan portfolio in its entirety. The ultimate recovery of all loans is susceptible to future market factors beyond the Bank's control. These factors may result in losses or recoveries differing significantly from those provided in the consolidated financial 74 statements. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan loses, and may require the Bank to make additions to the allowance based on their judgment about information available to them at the time of their examinations. Federal Home Bank Loan Bank Stock The Bank, as a member of Federal Home Loan Bank ("FHLB"), is required to maintain an investment in capital stock of the FHLB in an amount equal to the greater of 1% of its outstanding home loans or 5% of advances from the FHLB. The recorded amount of FHLB stock equals its fair value because the shares can only be redeemed by the FHLB at the $100 per share value. Allowance for Unfunded Loan Commitments - The allowance for unfunded loan commitments is maintained at a level believed by management to be sufficient to absorb estimated probable losses related to these unfunded credit facilities. The determination of the adequacy of the allowance is based on periodic evaluations of the unfunded credit facilities including an assessment of the probability of commitment usage, credit risk factors for loans outstanding to these same customers, and the terms and expiration dates of the unfunded credit facilities. The allowance for unfunded loan commitments is included in other liabilities on the consolidated balance sheets, with changes to the balance charged against non-interest expense. Premises and Equipment - Premises and equipment are stated at cost less accumulated depreciation. Leasehold improvements are amortized over the term of the lease or the estimated useful life of the improvements, whichever is less. Gains or losses on dispositions are reflected in earnings. Depreciation is generally computed on the straight-line method over the estimated useful lives as follows: Buildings and improvements 3 to 45 years Furniture and equipment 3 to 20 years Leasehold improvements 15 to 25 years The assets are reviewed for impairment when events indicate their carrying value may not be recoverable. If management determines impairment exists the asset is reduced by an offsetting charge to expense. The capitalized lease, less accumulated amortization is included in premises and equipment. The capitalized lease is amortized on a straight-line basis over the lease term and the amortization is included in depreciation expense. Loans Held for Sale - The Company identifies loans held for sale at the time of origination and they are carried at the lower of aggregate cost or net realizable value. Market values are derived from available market quotations for comparable pools of mortgage loans. Adjustments for unrealized losses, if any, are charged to income. Gains or losses on sales of loans held for sale are recognized at the time of the sale and are determined by the difference between the net sales proceeds and the allocated basis of the loans sold. The Company capitalizes mortgage servicing rights ("MSR's") acquired through either the purchase of MSR's, the sale of originated mortgage loans or the securitization of mortgage loans with servicing rights retained. Upon sale of mortgage loans held for sale the total cost of the mortgage loans designated for sale is allocated to mortgage loans with and without MSR's based on their relative fair values. The MSR's are included as a component of gain on sale of loans. The MSR's are amortized in proportion to and over the estimated period of the net servicing life. This amortization is reflected as a component of loan servicing income (expense). Mortgage Servicing - Fees earned for servicing loans for the Federal Home Loan Mortgage Corporation ("FHLMC") are reported as income when the related mortgage loan payments are collected. Loan servicing costs are charged to expense as incurred. MSR's are the rights to service loans. Loan servicing includes collecting payments, remitting funds to investors, insurance companies and tax authorities, collecting delinquent payments, and foreclosing on properties when necessary. The Company records its originated mortgage servicing rights at fair values in accordance with SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, which requires the 75 Company to allocate the total cost of all mortgage loans sold to the MSR's and the loans (without the MSR's) based on their relative fair values if it is practicable to estimate those fair values. The Company stratifies its MSR's based on the predominant characteristics of the underlying financial assets including coupon interest rate and contractual maturity of the mortgage. An estimated fair value of MSR's is determined quarterly using a discounted cash flow model. The model estimates the present value of the future net cash flows of the servicing portfolio based on various factors, such as servicing costs, servicing income, expected prepayment speeds, discount rate, loan maturity and interest rate. The effect of changes in market interest rates on estimated rates of loan prepayments represents the predominant risk characteristic underlying the MSR's portfolio. The Company is amortizing the MSR, which totaled $384,000 and $470,000 at March 31, 2006 and 2005, respectively, in proportion to and over the period of estimated net servicing income. The MSR's are periodically reviewed for impairment based on their fair value. The fair value of the MSR's, for the purposes of impairment, is measured using a discounted cash flow analysis based on market adjusted discount rates, anticipated prepayment speeds, mortgage loan term and coupon rate. Market sources are used to determine prepayment speeds, ancillary income, servicing cost and pre-tax required yield. Impairment losses are recognized through a valuation allowance for each impaired stratum, with any associated provision recorded as a component of loan servicing income (expense). Goodwill - Goodwill is initially recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. Goodwill is presumed to have an indefinite useful life and is tested, at least annually, for impairment at the reporting unit level. We perform an annual review in the third quarter of each year, or more frequently if indicators of potential impairment exist, to determine if the recorded goodwill is impaired. If the fair value exceeds the carrying value, goodwill at the subsidiary is not considered impaired and no additional analysis is necessary. As of March 31, 2006, there have been no events or changes in circumstances that would indicate a potential impairment. Core Deposit Intangible - The core deposit intangible is being amortized to non-interest expense using an accelerated method (based on expected attrition and cash flows of core deposit accounts purchased) over ten years. Advertising and Marketing Expense - Costs incurred for advertising, merchandising, market research, community investment, travel and business development are classified as marketing expense and are expensed as incurred. Income Taxes - Income taxes are accounted for using the asset and liability method. Under this method, a deferred tax asset or liability is determined based on the enacted tax rates which will be in effect when the differences between the financial statement carrying amounts and tax basis of existing assets and liabilities are expected to be reported in the Company's income tax returns. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established to reduce the net carrying amount of deferred tax assets if it is determined to be more likely than not, that all or some portion of the potential deferred tax asset will not be realized. The Company files a consolidated federal income tax return. The Bank provides for income taxes separately and remits to the Company amounts currently due. Trust Assets - Assets held by Riverview Asset Management Corp. in a fiduciary or agency capacity for Trust customers are not included in the consolidated financial statements because such items are not assets of the Company. Assets totaling $232.8 million and $174.8 million were held in trust as of March 31, 2006 and 2005, respectively. Earnings Per Share - The Company accounts for earnings per share in accordance with SFAS No. 128, Earnings Per Share, which requires all companies whose capital structure includes dilutive potential common shares to make a dual presentation of basic and diluted earnings per share for all periods presented. Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period, excluding restricted stock. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised and has 76 been computed after giving consideration to the weighted average diluted effect of the Company's stock options and the shares issued under the Company's Management Recognition and Development Plan ("MRDP"). Cash and Cash Flows Cash includes amounts on hand, due from banks and interest-earning deposits in other banks. Cash flows from interest-earning deposits in other banks and deposits are reported net. Stock-Based Compensation At March 31, 2006, the Company had two stock option plans, which are described further in Note 14. The Company accounts for these plans under the recognition and measurement principles of Accounting Principles Board No. 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, no stock-based compensation cost is reflected in net income as all options granted under these plans had an exercise price equal to the market value of the underlying common stock on the date of grant. SFAS No. 123 requires the disclosure of pro forma net income and earnings per share had the Company adopted the fair value method as of the beginning of fiscal 1996. Under SFAS No. 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The Company's calculations were made using the Black-Scholes option-pricing model with the following weighted average assumptions: Risk Free Expected Expected Expected Interest Rate Life (yrs) Volatility Dividends ------------- --------- ---------- --------- Fiscal 2006 4.67% 10.00 26.32% 3.07% Fiscal 2005 4.00% 10.00 29.25% 3.01% Fiscal 2004 4.00% 10.00 31.02% 3.07% The weighted average grant-date fair value of fiscal 2006, 2005 and 2004 awards was $7.59, $5.93 and $5.47, respectively. Only stock options are considered in this calculation and not MRDP shares. If the accounting provisions of SFAS No. 123 had been adopted, the effect on fiscal 2006, 2005 and 2004 net income would have been reduced to the following pro forma amounts (dollars in thousands, except per share amounts): Year ended March 31, ---------------------------- 2006 2005 2004 ------ ------ ------ Net income: As reported $9,738 $6,529 $6,554 Deduct: Total stock based compensation expense determined under fair value based method for all options, net of related tax benefit (1,345) (96) (109) ------ ------ ------ Pro forma $8,393 $6,433 $6,445 ====== ====== ====== Earnings per common share basic: As reported $ 1.74 $ 1.36 $ 1.41 Pro forma 1.50 1.34 1.39 Earnings per common share fully diluted: As reported $ 1.72 $ 1.33 $ 1.39 Pro forma 1.48 1.32 1.37 Employee Stock Ownership Plan ("ESOP") - The Company sponsors a leveraged ESOP. The ESOP is accounted for in accordance with the AICPA Statement of Position ("SOP") 93-6, Employer's Accounting for Employee Stock Ownership Plans. Stock and cash dividends on allocated shares are recorded as a reduction of additional paid in capital and paid directly to plan participants or distributed directly to participants' accounts. As shares are released, compensation expense is recorded equal to the then current market price of the shares and the shares become available for earnings per share calculations. The Company records cash dividends on unallocated shares 77 as a reduction of debt and accrued interest. Business segments - The Company operates a single business segment. The financial information that is used by the chief operating decision maker in allocating resources and assessing performance is only provided for one reportable segment as of March 31, 2006, 2005 and 2004. Acquisitions - Acquisitions are accounted for in accordance with SFAS 41, Business Combinations under the purchase method of accounting, which allocates costs to assets purchased and liabilities assumed at their estimated fair market values. The results of operations subsequent to the date of acquisition are included in the consolidated financial statements of the Company. New Accounting Pronouncements - In December 2004, the Financial Accounting Standards Board ("FASB") issued a SFAS No. 123 (Revised), Share-Based Payment. This statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. This statement requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. In addition, this statement establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair-value based measurement method in accounting for share-based payment transactions. This statement replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees. In addition, this statement amends SFAS No. 95, Statement of Cash Flows, to require that excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid. This statement is effective for the Company as of April 1, 2006. Management is currently evaluating the impact on the Company's financial position, results of operation and cash flows upon adoption of SFAS No.123 (Revised). Estimated future levels of compensation expense recognized related to stock based awards would be impacted by new awards, modifications to awards, or cancellation of awards after the adoption of SFAS No. 123 (Revised). At its November 12-13, 2003 meeting, the Emerging Issues Task Force ("EITF") reached a consensus on Issue 03-01, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments," that certain quantitative and qualitative disclosures should be required for debt and marketable equity securities classified as available-for-sale or held-to-maturity under SFAS No. 115 and 124 that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. The Company adopted the disclosure requirements in fiscal year 2004. At the March 17-18, 2004 meeting, the EITF reached a consensus, which approved an impairment model for debt and equity securities. In FASB Staff Position ("FSP") 03-01-01, issued in September 2004, the effective date for the measurement and recognition guidance contained in paragraphs 10-20 of Issue 03-01 was delayed. On November 3, 2005, FSP FAS Nos. 115-1 and FAS 124-1 "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments," was issued. This FSP nullifies certain requirements of Issue 03-1 and supersedes EITF Topic No. D-44, "Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value." This FSP nullified the requirements of paragraphs 10-18 of Issue 03-1, carried forward the requirements of paragraph 8 and 9 of Issue 03-1 with respect to cost-method investments and carries forward the disclosure requirements included in paragraphs 21 and 22 of Issue 03-1 and related examples. The guidance in this FSP is applied to reporting periods beginning after December 15, 2005. The Company believes the adoption of this FSP in fiscal 2006 will not materially impact our results of operations, financial condition, or related disclosures. In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of Financial Assets", that amends accounting and reporting standards for servicing assets and liabilities under SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". Specifically, SFAS 156 requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. For subsequent measurement purposes, SFAS 156 permits an entity to choose to measure servicing assets and liabilities either based on fair value or lower of cost or market ("LOCOM"). This statement is effective for the Company as of April 1, 2007. The Company is currently evaluating whether to elect to measure servicing 78 assets and liabilities based on fair value or lower of cost or market ("LOCOM"). Additional information regarding mortgage servicing rights is disclosed in Note 9 in the Notes to Consolidated Financial Statements. 2. RESTRICTED ASSETS Federal Reserve Board regulations require that the Bank maintain minimum reserve balances either on hand or on deposit with the Federal Reserve Bank, based on a percentage of deposits. The amounts of such balances for the years ended March 31, 2006 and 2005 were approximately $627,000 and $145,000, respectively. 3. ACQUISITION On April 22, 2005, the Company completed the acquisition of American Pacific Bank ("APB"), a commercial bank located in Portland, Oregon. The cost to acquire APB's 2,804,618 shares of common stock was a payment in cash for 1,404,000 shares at a transaction value of $11.94 per share and the issuance of 788,365 shares of the Company's common stock at a price of $21.20 per share for the remaining 1,400,618 shares. All APB stock options were cashed out at a cost of $873,240, the difference between the transaction value of $11.94 per share and the options' respective exercise prices prior to completion of the merger. The acquisition was accounted for using the purchase method of accounting and, accordingly, the assets and liabilities of APB were recorded at their respective fair values. The resulting core deposit intangible is being amortized using an accelerated method over ten years. The excess of the purchase price over net fair value of the assets and liabilities acquired was recorded as goodwill in the amount of $17.1 million. Goodwill is not tax deductible because the transaction is nontaxable for Internal Revenue Service purposes. The purchased assets and assumed liabilities were recorded as follows (dollars in thousands): Assets ------ Cash $ 3,433 Investments 1,417 Building and equipment 1,080 Loans 119,536 Core deposit intangible 526 Goodwill 16,359 Other, net 2,547 ------- Total assets 144,898 Liabilities ----------- Deposits (79,755) Borrowings (29,882) Other liabilities (452) ------- Total liabilities (110,089) Net assets $ 34,809 Less: Stock issued in acquisition (16,713) Cash acquired (3,433) Cash used in acquisition, net ------- of cash acquired $ 14,663 ======= Subsequent to the acquisition, tax amounts were adjusted as part of the allocation of the purchase price. At March 31, 2006, the goodwill asset recorded in connection with the APB acquisition was $16.4 million. The following unaudited pro forma financial information for the twelve months ended March 31, 2006 and 2005 assumes that the APB acquisition occurred as of April 1, 2004, after giving effect to certain adjustments. The pro forma results have been prepared for comparative purposes only and are not necessarily indicative of the results of operations which may occur in the future or that would have occurred had the APB acquisition been consummated on the date indicated. 79 Pro Forma Financial Information for Twelve Months Ended (In thousands, except per share data) March 31, ------------------- 2006 2005 ------ ------ Net interest income $ 31,999 $ 28,474 Non-interest income 8,824 7,015 Non-interest expense 26,021 24,985 Net income $ 9,081 $ 5,897 Earnings per common share: Basic $ 1.62 $ 1.05 Diluted 1.60 1.04 4. INVESTMENT SECURITIES The amortized cost and approximate fair value of investment securities available for sale consisted of the following (in thousands): Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- March 31, 2006 - -------------- Trust Preferred $ 5,000 $ 44 $ - $ 5,044 Agency securities 15,246 - (218) 15,028 Municipal bonds 3,893 57 - 3,950 ------ ------ ------ ------ Total $ 24,139 $ 101 $ (218) $ 24,022 ====== ====== ====== ====== March 31, 2005 - -------------- Trust Preferred $ 5,000 $ 31 $ - $ 5,031 Agency securities 14,021 - (179) 13,842 Municipal bonds 3,972 100 - 4,072 ------ ------ ------ ------ Total $ 22,993 $ 131 $ (179) $ 22,945 ====== ====== ====== ====== The fair value of temporarily impaired securities, the amount of unrealized losses and the length of time these unrealized losses existed as of March 31, 2006 are as follows (in thousands): Less than 12 months 12 months or longer Total ------------------------------------------------------ Description of Fair Unrealized Fair Unrealized Fair Unrealized Securities Value Losses Value Losses Value Losses ----- ------ ----- ------ ----- ------ Agency securities $6,124 $ (61) $ 8,904 $ (157) $15,028 $ (218) Total temporarily ----- ----- ----- ----- ------ ----- impaired securities $6,124 $(61) $ 8,904 $(157) $15,028 $(218) ===== ===== ===== ===== ====== ===== The fair value of temporarily impaired securities, the amount of unrealized losses and the length of time these unrealized losses existed as of March 31, 2005 are as follows (in thousands): Less than 12 months 12 months or longer Total -------------------------------------------------------- Description of Fair Unrealized Fair Unrealized Fair Unrealized Securities Value Losses Value Losses Value Losses ----- ------ ----- ------ ----- ------ Agency securities $11,890 $ (131) $1,952 $ (48) $13,842 $ (179) Total temporarily ------ ------ ----- ------ ------ ------ impaired securities 11,890 $ (131) $1,952 $ (48) $13,842 $ (179) ====== ====== ===== ====== ====== ====== The Company has evaluated these securities and has determined that the decline in the value is temporary. The 80 decline in value is not related to any company or industry specific event. The Company anticipates full recovery of amortized cost with respect to these securities at maturity or sooner in the event of a more favorable market interest rate environment. The contractual maturities of investment securities available for sale are as follows (in thousands): Amortized Estimated Cost Fair Value --------- ---------- March 31, 2006 - -------------- Due in one year or less $ 4,833 $ 4,782 Due after one year through five years 12,347 12,210 Due after five years through ten years 274 286 Due after ten years 6,685 6,744 ------ ------ Total $ 24,139 $ 24,022 ====== ====== Investment securities with an amortized cost of $10.2 million and $9.0 million and a fair value of $10.1 million and $8.9 million at March 31, 2006 and March 31, 2005, respectively, were pledged as collateral for advances at the FHLB. Investment securities with an amortized cost of $1.1 million and $1.1 million and a fair value of $1.2 million and $1.2 million at March 31, 2006 and March 31, 2005, respectively, were pledged as collateral for treasury tax and loan funds held by the Bank. At March 31, 2006 investment securities with an amortized cost of $5.0 million and a fair value of $5.0 million were pledged as collateral for borrowings from the discount window at the Federal Reserve Bank. In the third quarter of fiscal 2005, the Company recognized a pre-tax other-than-temporary impairment for investments in Federal Home Loan Mortgage Corporation ("FHLMC") preferred stock and Federal National Mortgage Association ("FNMA") preferred stock that totaled $1.3 million. The Company accounts for these securities in accordance with SFAS No. 115. Under SFAS No. 115, if the decline in fair market value below cost is determined to be other-than-temporary, the unrealized loss will be realized as expense on the consolidated income statement. Based on a number of factors, including the magnitude of the drop in the market value below the Company's cost and the length of time the market value had been below cost, management concluded that the decline in value was other-than-temporary at the end of the third quarter of fiscal 2005. Accordingly, the pre-tax other-than-temporary impairment was realized in the income statement, in the amount of $699,000 for FNMA preferred stock and $650,000 for FHLMC preferred stock. A corresponding reduction in unrealized losses in shareholders' equity was realized in fiscal 2005 in the amount of $461,000 for FNMA preferred stock and $429,000 for FHLMC preferred stock. The Company realized before tax $0 and $164,000 in net gains on sales of investment securities available for sale in fiscal 2006 and 2005, respectively. The Company realized no gains or losses on sales of investment securities available for sale in fiscal 2004. 5. MORTGAGE-BACKED SECURITIES Mortgage-backed securities held to maturity consisted of the following (in thousands): Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- March 31, 2006 - -------------- Real estate mortgage investment conduits $ 1,402 $ 18 $ - $ 1,420 FHLMC mortgage-backed securities 138 2 - 140 FNMA mortgage-backed securities 265 5 - 270 ------ ------ ------ ------ Total $ 1,805 $ 25 $ - $ 1,830 ====== ====== ====== ====== March 31, 2005 - -------------- Real estate mortgage investment conduits $ 1,802 $ 43 $ - $ 1,845 FHLMC mortgage-backed securities 218 6 - 224 FNMA mortgage-backed securities 323 10 - 333 ------ ------ ------ ------ Total $ 2,343 $ 59 $ - $ 2,402 ====== ====== ====== ====== 81 Mortgage-backed securities held to maturity with an amortized cost of $1.4 million and $1.8 million and a fair value of $1.4 million and $1.9 million at March 31, 2006 and 2005, respectively, were pledged as collateral for governmental public funds held by the Bank. Mortgage-backed securities held to maturity with an amortized cost of $199,000 and $248,000 and a fair value of $203,000 and $255,000 at March 31, 2006 and March 31, 2005, respectively, were pledged as collateral for treasury tax and loan funds held by the Bank. The real estate mortgage investment conduits consist of FHLMC and FNMA securities. The contractual maturities of mortgage-backed securities classified as held to maturity are as follows (in thousands): Amortized Estimated Cost Fair Value --------- ---------- March 31, 2006 - -------------- Due in one year or less $ 5 $ 5 Due after one year through five years - - Due after five years through ten years 24 24 Due after ten years 1,776 1,801 ------ ------ Total $ 1,805 $ 1,830 ====== ====== Mortgage-backed securities available for sale consisted of the following (in thousands): Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- March 31, 2006 - -------------- Real estate mortgage investment conduits $ 1,326 $ 19 $ (7) $ 1,338 FHLMC mortgage-backed securities 6,951 - (316) 6,635 FNMA mortgage-backed securities 159 2 - 161 ------ ------ ------ ------ Total $ 8,436 $ 21 $ (323) $ 8,134 ====== ====== ====== ====== March 31, 2005 - -------------- Real estate mortgage investment conduits $ 1,846 $ 27 $ - $ 1,873 FHLMC mortgage-backed securities 9,677 12 (182) 9,507 FNMA mortgage-backed securities 233 6 - 239 ------ ------ ------ ------ Total $ 11,756 $ 45 $ (182) $ 11,619 ====== ====== ====== ====== The fair value of temporarily impaired mortgage-backed securities, the amount of unrealized losses and the length of time these unrealized losses existed as of March 31, 2006 are as follows (in thousands): Less than 12 months 12 months or longer Total ------------------------------------------------------ Description of Fair Unrealized Fair Unrealized Fair Unrealized Securities Value Losses Value Losses Value Losses ----- ------ ----- ------ ----- ------ Real estate mortgage $ 523 $ (6) $ - $ - $ 523 $ (6) FHLMC mortgage-backed securities 66 (1) 6,543 (315) 6,609 (316) FNMA mortgage-backed securities 17 (1) - - 17 (1) Total temporarily ----- ------ ----- ------ ----- ------ impaired securities $ 606 $ (8) $6,543 $ (315) $7,149 $ (323) ===== ====== ===== ====== ===== ====== 82 The fair value of temporarily impaired mortgage-backed securities, the amount of unrealized losses and the length of time these unrealized losses existed as of March 31, 2005 as follows (in thousands): Less than 12 months 12 months or longer Total ------------------------------------------------------ Description of Fair Unrealized Fair Unrealized Fair Unrealized Securities Value Losses Value Losses Value Losses ----- ------ ----- ------ ----- ------ FHLMC mortgage-backed securities $8,209 $(182) - - $8,209 $(182) ------ ------ ------ ------ ------ ------ Total temporarily impaired securities $8,209 $(182) - - $8,209 $(182) ====== ===== ====== ====== ====== ====== The Company has evaluated these securities and has determined that the decline in the value is temporary. The decline in value is not related to any company or industry specific event. The Company anticipates full recovery of amortized cost with respect to these securities at maturity or sooner in the event of a more favorable market interest rate environment. The contractual maturities of mortgage-backed securities available for sale are as follows (in thousands): Amortized Estimated March 31, 2006 Cost Fair Value - -------------- --------- ---------- Due in one year or less $ 109 $ 110 Due after one year through five years 87 88 Due after five years through ten years 6,968 6,652 Due after ten years 1,272 1,284 --------- ---------- Total $ 8,436 $ 8,134 ========= ========== Expected maturities of mortgage-backed securities held to maturity and available for sale will differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties. Mortgage-backed securities available for sale with an amortized cost of $8.3 million and $11.5 million and a fair value of $8.0 million and $11.4 million at March 31, 2006 and March 31, 2005, respectively, were pledged as collateral for advances at the FHLB. Mortgage-backed securities available for sale with an amortized cost of $17,000 and $45,000 and a fair value of $18,000 and $47,000 at March 31, 2006 and March 31, 2005, respectively, were pledged as collateral for treasury tax and loan funds held by the Bank. The Company realized no gains or losses on sale of mortgage-backed securities available for sale in fiscal 2006, 2005 and 2004. 6. LOANS RECEIVABLE A summary of the major categories of loans outstanding is shown in the following table. Outstanding loan balances at March 31, 2006 and 2005, are net of unearned income, including net deferred loan fees of $4.4 million and $3.2 million, respectively. 83 Loans receivable excluding loans held for sale consisted of the following (in thousands): March 31, ------------------- 2006 2005 ------ ------ Residential: One- to- four family $ 32,129 $ 36,059 Multi-family 2,127 2,537 Construction: One- to- four family 81,167 43,633 Commercial real estate 46,135 10,982 Commercial 59,769 57,981 Consumer Secured 29,942 28,951 Unsecured 1,415 1,668 Land 49,174 28,889 Commercial real estate 328,378 223,144 ------- ------- 630,237 433,844 Less: Allowance for loan losses 7,221 4,395 ------- ------- Loans receivable, net $ 623,016 $ 429,449 ======= ======= The Company originates residential real estate loans, commercial real estate, multi-family real estate, commercial and consumer loans. Substantially all of the mortgage loans in the Company's portfolio are secured by properties located in Washington and Oregon. A further economic downturn in these areas would likely have a negative impact on the Company's results of operations depending on the severity of such downturn. Loans receivable including loans held for sale, by maturity or repricing date, were as follows (in thousands): March 31, ------------------- 2006 2005 ------ ------ Adjustable rate loans: Within one year $187,093 $207,906 After one but within three years 63,555 96,676 After three but within five years 26,675 22,988 After five but within ten years 184,519 7,439 After ten years 60,014 - ------- ------- 521,856 335,009 Fixed rate loans: Within one year 26,780 26,171 After one but within three 28,845 28,724 After three but within five years 23,831 28,009 After five but within ten years 19,533 8,815 After ten years 9,457 7,626 ------- ------- 108,446 99,345 ------- ------- $630,302 $434,354 ======= ======= Mortgage loans receivable with adjustable rates primarily reprice based on the one year U.S. Treasury index and reprice a maximum of 2% per year and up to 6% over the life of the loan. The remaining adjustable rate loans reprice based on the prime lending rate or the FHLB cost of funds index. Commercial loans with adjustable rates primarily reprice based on the prime rate. 84 Aggregate loans to officers and directors, all of which are current, consist of the following (in thousands): Year Ended March 31, -------------------- 2006 2005 2004 ------ ------ ------ Beginning balance $ 408 $ 732 $ 315 Originations 5 10 753 Principal repayments (405) (334) (336) ------ ------ ------ Ending balance $ 7 $ 408 $ 732 ====== ====== ====== 7. ALLOWANCE FOR LOAN LOSSES A reconciliation of the allowance for loan losses is as follows (in thousands): Year Ended March 31, -------------------- 2006 2005 2004 ------ ------ ------ Beginning balance $ 4,395 $ 4,481 $ 2,739 Provision for losses 1,500 410 210 Charge-offs (711) (669) (1,182) Recoveries 149 173 91 Allowance transferred from Today's Bancorp acquisition - - 2,639 Allowance transferred from American Pacific Bank ("APB") acquisition 1,888 - - Net change in allowance for unfunded loan commitments and lines of credit - - (16) ------ ------ ------ Ending balance $ 7,221 $ 4,395 $ 4,481 ====== ====== ====== Changes in the allowance for unfunded loan commitments and lines of credit were as follows (in thousands): Year Ended March 31, -------------------- 2006 2005 2004 ------ ------ ------ Beginning balance $ 253 $ 191 $ 175 Net change in allowance for unfunded loan commitments and lines of credit 109 62 16 ------ ------ ------ Ending balance $ 362 $ 253 $ 191 ====== ====== ====== The allowance for unfunded loan commitments is included in other liabilities on the consolidated balance sheets. At March 31, 2006, 2005 and 2004, the Company's recorded investment in non-acrual loans was $415,000, $456,000, and $1.3 million respectively. None of the impaired loans as of March 31, 2006, 2005 or 2004 had a specific valuation allowance. The allowance for loan losses in excess of specific reserves is available to absorb losses from all loans, although allocations have been made for certain loans and loan categories as part of management's analysis of the allowance. The average investment in impaired loans was approximately $889,000, $1.0 million and $1.2 million during the years ended March 31, 2006, 2005 and 2004, respectively. Interest income recognized on impaired loans was $100,000, $9,000 and $44,000 during the years ended March 31, 2006, 2005 and 2004, respectively. There were no loans past due 90 days or more and still accruing interest at March 31, 2006, 2005 and 2004, respectively. 85 8. PREMISES AND EQUIPMENT, NET Premises and equipment consisted of the following (in thousands): March 31, ------------------- 2006 2005 ------ ------ Land $ 1,988 $ 1,879 Buildings and improvements 7,802 5,476 Leasehold improvements 1,887 1,310 Furniture and equipment 8,938 6,681 Buildings under capitalized leases 2,715 - Construction in progress 4,436 101 ------ ------ Total 27,766 15,447 Less accumulated depreciation and amortization (8,639) (7,056) ------ ------ Premises and equipment, net $19,127 $ 8,391 ====== ====== During fiscal year 2005, the Company sold to a private investor and leased back the Camas branch and operations center. The net gain on the sale of the building was $1.6 million, of which $828,000 was recognized in the first quarter of fiscal year 2005 and the remainder is being amortized over the six-year life of the lease. Deferred gains of $141,000 and $180,000 were recognized in fiscal years 2006 and 2005, respectively. The lease of the building is being accounted for as an operating lease and is included in the future minimum rental payments schedule shown below. Depreciation expense was $1.2 million, $1.0 million and $1.1 million for years ended March 31, 2006, 2005 and 2004, respectively. The Company is obligated under various noncancellable lease agreements for land and buildings that require future minimum rental payments, exclusive of taxes and other charges. As of and for year ended March 31, 2006 the Company has recorded $37,600 in accumulated amortization and amortization expense related to the capital lease. The Company entered into a capital lease during fiscal year 2006. The capital lease was for the shell of the building constructed for the new operations center. The lease period is for twelve years with two six-year lease renewal options. The following is a schedule by years of future minimum lease payments under capital leases together with the present value of net minimum lease payments as of March 31, 2006 and the future minimum rental payments required under operating leases that have initial or noncancellable lease terms in excess of one year as of March 31, 2006 (in thousands): Operating Capital Year Ending March 31: Leases Leases ------ ------ 2007 $ 1,616 $ 228 2008 1,626 228 2009 1,592 228 2010 1,467 228 2011 909 228 After 2011 5,027 4,672 ------ ------ Total minimum lease payments $12,237 5,812 Less amount representing interest ====== (3,059) Present value of net minimum lease ===== payments $2,753 ===== Rent expense was $1.6 million, $1.2 million and $857,000 for the years ended March 31, 2006, 2005 and 2004, respectively. 86 9. MORTGAGE SERVICING RIGHTS The following table is a summary of the activity in MSR's and the related valuation allowance for the periods indicated and other related financial data (in thousands): March 31, -------------------- 2006 2005 2004 ------ ------ ------ Balance at beginning of year, net $ 470 $ 624 $ 629 Additions 123 126 167 Amortization (233) (302) (479) Change in valuation allowance 24 22 307 ---- ---- ---- Balance end of year, net $ 384 $ 470 $ 624 ==== ==== ==== Valuation allowance at beginning of year $ 84 $ 106 $ 413 Change in valuation allowance (24) (22) (307) ---- ---- ---- Valuation allowance balance at end of year $ 60 $ 84 $ 106 ==== ==== ==== The Company evaluates MSR's for impairment by stratifying MSR's based on the predominant risk characteristics of the underlying financial assets. At March 31, 2006 and 2005, the MSR's fair value totaled $1.1 million. The 2006 fair value was estimated using discount rate and a range of PSA values (The Bond Market Association's standard prepayment values) that ranged from 133 to 560. Amortization expense for the net carrying amount of MSR's at March 31, 2006 is estimated as follows (in thousands): Year ending March 31, --------------------- 2007 $135 2008 98 2009 78 2010 39 2011 22 After 2011 12 ---- Total $384 ==== Mortgage loans serviced for others (in millions): March 31, ---------------------- 2006 2005 2004 ------ ------ ------ Total $ 139.2 $ 129.3 $ 133.5 ====== ====== ====== The estimated sensitivity of the fair value of the mortgage servicing rights portfolio to changes in interest rates at March 31, 2006 was as follows (dollars in thousands): Down Scenario Up Scenario ------------- ----------- 300 bp 200 bp 100 bp 100 bp 200 bp 300 bp ------ ------ ------ ------ ------ ------ Fair Value $ (729) $ (552) $ (191) $ 38 $ 62 $ 90 The fair value of mortgage servicing rights and its sensitivity to changes in interest rates is influenced by the mix of the servicing portfolio and characteristics of each segment of the portfolio. The Bank's servicing portfolio is comprised of conventional fixed rate mortgages that meet FHLMC guidelines. 10. CORE DEPOSIT INTANGIBLE Net unamortized core deposit intangible totaled $895,000 and $578,000 at March 31, 2006 and 2005, respectively. Amortization expense related to the core deposit intangible during the year ended March 31, 2006, 2005 and 2004 totaled $210,000, $180,000 and $430,000, respectively. During the year ended March 31, 2006, 87 the Company had additions to core deposit intangibles totaling $526,000 in connection with the acquisition of American Pacific Bank. Amortization expense for the net core deposit intangible at March 31, 2006 is estimated to be as follows (in thousands): Year Ending March 31, ---------------------- 2007 $ 184 2008 155 2009 131 2010 111 2011 95 After 2011 219 ------ Total $ 895 ====== 11. DEPOSIT ACCOUNTS Deposit accounts consisted of the following (dollars in thousands): Weighted Weighted Average March 31, Average March 31, Account Type Rate 2006 Rate 2005 ---- ---- ---- ---- NOW Accounts: Non-interest-bearing 0.00% $ 94,592 0.00% $ 79,499 Regular 0.21 62,941 0.20 65,667 High yield checking 4.27 66,516 2.55 50,562 Money market 3.45 137,451 1.44 76,331 Savings accounts 0.55 38,344 0.55 35,513 Certificates of deposit 3.85 207,120 3.13 149,306 ---- ------- ---- ------- Total 2.62% $606,964 1.62% $456,878 ==== ======= ==== ======= The weighted average rate is based on interest rates at the end of the period. Certificates of deposit (which include $18.7 million of broker certificates of deposit) as of March 31, 2006, mature as follows (in thousands): Amount ------ Less than one year $ 130,159 One year to two years 36,961 Two years to three years 28,718 Three years to four years 3,225 Four years to five years 3,129 After five years 4,928 ------- Total $ 207,120 ======= Deposit accounts in excess of $100,000 are not insured by the Federal Deposit Insurance Corporation ("FDIC"). Deposits with balances in excess of $100,000 totaled $329.3 million and $227.9 million at March 31, 2006 and 2005, respectively. 88 Interest expense by deposit type was as follows (in thousands): Year Ended March 31, ---------------------- 2006 2005 2004 ------ ------ ------ NOW Accounts: Regular $ 321 $ 108 $ 122 High yield checking 1,927 815 713 Money market 3,276 901 583 Savings accounts 213 178 163 Certificates of deposit 6,646 3,378 3,062 ------ ----- ----- Total $12,383 $5,380 $4,643 ====== ===== ===== 12. FEDERAL HOME LOAN BANK ADVANCES At March 31, 2006 and 2005, advances from FHLB, totaled $46.1 million and $40.0 million with a weighted average interest rate of 4.65% and 5.05%. The fixed rate borrowings of $8.0 million had fixed interest rates ranging from 2.57% to 3.61%. The March 31, 2005 fixed rate borrowings of $35.0 million had fixed interest rates ranging from 4.65% to 6.38%. The remaining adjustable rate advance at March 31, 2006 and 2005 had a weighted average interest rate of 5.02% and 2.67%, which is based on three-month London Interbank Offered Rate Index ("LIBOR") plus 11 basis points as quited by the FHLB.The weighted average interest rate for fixed and adjustable rate advances was 4.44%, 5.00%, and 4.96% for the years ended March 31, 2006, 2005 and 2004, respectively. The Bank has a credit line with the FHLB equal to 30% of total assets, limited by available collateral. At March 31, 2006, based on collateral values, the Bank had additional borrowing commitments available of $91.7 million from the FHLB. FHLB advances are collateralized as provided for in the Advance, Pledge and Security Agreements with the FHLB by certain investment and mortgage-backed securities, FHLB stock owned by the Bank, deposits with the FHLB, and certain mortgages on deeds of trust securing such properties as provided in the agreements with the FHLB. At March 31, 2006, loans carried at $210.4 million and investments and mortgage-backed securities carried at $18.0 million were pledged as collateral to the FHLB. Payments required to service the Bank's FHLB advances during the next five years ended March 31 are as follows (in millions): 2007 $41.1 2008 5.0 Thereafter - ----- $46.1 ===== In addition, the Bank has a Fed Funds borrowing facility with Pacific Coast Bankers' Bank with a guideline limit of $10 million through June 30, 2006. The facility may be reduced or withdrawn at any time. As of March 31, 2006 the Bank did not have any outstanding advances on this facility. 13. JUNIOR SUBORDINATED DEBENTURES At December 31, 2005, a wholly-owned subsidiary grantor trusts established by the Company issued $7.0 million of pooled Trust Preferred Securities ("trust preferred securities"). Trust preferred securities accrue and pay distributions periodically at specified annual rates as provided in the indentures. The trust used the net proceeds from the offering to purchase a like amount of junior subordinated Debentures (the "Debentures") of the Company. The Debentures are the sole assets of the trust. The Company's obligations under the Debentures and related documents, taken together, constitute a full and unconditional guarantee by the Company of the obligations of the trust. The trust preferred securities are mandatory redeemable upon the maturity of the Debentures, or upon earlier redemption as provided in the indentures. The Company has the right to redeem the 89 Debentures in whole or in part after year 5 on any coupon date, at a redemption price specified in the indentures plus any accrued but unpaid interest to the redemption date. The following table is a summary of current Debentures at March 31, 2006: Preferred Issuance security Rate Initial Rate at Maturing date amount Type(1) Rate 12/31/05 Date ---- ------ -------- ---- -------- ---- Issuance trust (Dollars in thousands) - --------------- Riverview Bancorp, Inc. Statutory Trust 1 12/2005 $7,000 Variable 5.88% 6.27% 12/2035 (1) The variable rate preferred securities reprice quarterly. The total amount of trust preferred securities outstanding at March 31, 2006 was $7.0 million. The interest rates on the trust preferred securities issued in December 2005 resets quarterly and is tied to the London Interbank Offered Rate ("LIBOR"). The Company has the right to redeem the debentures in December 2010. The Debentures issued by the Company to the grantor trusts, totaling $7.0 million, are reflected in our consolidated balance sheet in the liabilities section at March 31, 2006, under the caption "junior subordinated debentures." The Company records interest expense on the Debentures in the consolidated statements of income. The Company recorded $217,000 in other assets in the consolidated balance sheet at March 31, 2006, for the common capital securities issued by the issuer trusts. The Company invested $5.0 million of the trust preferred securities proceeds in the Bank and retained the remaining $2.0 million to be used for general corporate purposes. On July 2, 2003, the Federal Reserve Bank ("Federal Reserve") issued Supervisory Letter SR 03-13 clarifying that Bank Holding Companies should continue to report trust preferred securities in accordance with current Federal Reserve Bank instructions which allows trust preferred securities to be counted in Tier 1 capital subject to certain limitations. The Federal Reserve has indicated it will review the implications of any accounting treatment changes and, if necessary or warranted, will provide appropriate guidance. 14. INCOME TAXES Income tax provision for the years ended March 31 consisted of the following (in thousands): 2006 2005 2004 ------ ------ ------ Current $ 5,281 $ 2,751 $ 2,789 Deferred (704) 285 421 ----- ----- ----- Total $ 4,577 $ 3,036 $ 3,210 ===== ===== ===== A reconciliation between income taxes computed at the statutory rate and the effective tax rate for the years ended March 31 is as follows: 2006 2005 2004 ------ ------ ------ Statutory federal income tax rate 35.0% 34.0% 34.0% State and local income tax rate 1.0 - - ESOP market value adjustment 0.9 1.1 0.9 Interest income on municipal securities (0.4) (0.6) (0.4) Dividend received deduction 0.0 (0.5) (0.6) Bank owned life insurance (1.2) (1.7) - Other, net (3.4) (0.6) (1.1) ---- ---- ---- Effective federal income tax rate 31.9% 31.7% 32.8% ==== ==== ==== 90 Taxes related to gains on sales of securities were none, $56,000 and none for the years ended March 31, 2006, 2005 and 2004, respectively. The tax effect of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at March 31, 2006 and 2005 are as follows (in thousands): 2006 2005 ------ ------ Deferred tax assets: Deferred compensation $ 629 $ 555 Loan loss reserve 2,720 1,581 Core deposit intangible 245 306 Accrued expenses 376 235 Accumulated depreciation 508 206 Net operating loss carryforward 493 821 Net realized loss on securities available for sale 143 63 Capital loss carryforward 715 733 REO expense 184 - Non-compete 79 - Other 42 219 ------ ------ Total deferred tax asset 6,134 4,719 ------ ------ Deferred tax liabilities: FHLB stock dividend (1,078) (971) Deferred gain on sale (116) - Tax qualified loan loss reserve (243) (280) Purchase accounting (376) (249) Prepaid expense (82) (146) Loan fees/costs (468) (449) ------ ------ Total deferred tax liability (2,363) (2,095) ------ ------ Deferred tax asset, net $ 3,771 $ 2,624 ====== ====== The Bank's retained earnings at March 31, 2006 and 2005 include base year bad debt reserves which amounted to approximately $2.2 million, for which no federal income tax liability has been recognized. The amount of unrecognized deferred tax liability at March 31, 2006 and 2005 is approximately $760,000. This represents the balance of bad debt reserves created for tax purposes as of December 31, 1987. These amounts are subject to recapture in the unlikely event that the Company's banking subsidiaries (1) make distributions in excess of current and accumulated earnings and profits, as calculated for federal tax purposes, (2) redeem their stock, or (3) liquidate. Management does not expect this temporary difference to reverse in the foreseeable future. The Company also has net operating loss carry forwards of approximately $1.3 million for federal tax purposes in connection with the acquisition of Today's Bancorp, Inc. Utilization of the net operating losses, which begin to expire at various times starting in 2019, is subject to certain limitations under Section 382 of the Internal Revenue Code. The tax effects of certain tax benefits related to stock options are recorded directly to shareholders' equity. No valuation allowance for deferred tax assets was deemed necessary at March 31, 2006 or 2005 based upon the Company's anticipated future ability to generate taxable income from operations. 15. EMPLOYEE BENEFITS PLANS Retirement Plan - The Riverview Bancorp, Inc. Employees' Savings and Profit Sharing Plan (the "Plan") is a defined contribution profit-sharing plan incorporating the provisions of Section 401(k) of the Internal Revenue Code. The plan covers all employees with at least six months and 500 hours of service who are over the age of 18. The Company matches the employee's elective contribution up to 4% of the employee's compensation. Company expenses related to the Plan for the years ended March 31, 2006, 2005 and 2004 were $359,000, $154,000 and $93,000, respectively. 91 Directors Deferred Compensation Plan - Directors may elect to defer their monthly directors' fees until retirement with no income tax payable by the director until retirement benefits are received. Chairman, President, Executive and Senior Vice Presidents of the Company may also defer salary into this plan. This alternative is made available to them through a nonqualified deferred compensation plan. The Company accrues annual interest on the unfunded liability under the Directors Deferred Compensation Plan based upon a formula relating to gross revenues, which amounted to 6.66%, 6.04%, and 7.12% for the years ended March 31, 2006, 2005 and 2004, respectively. The estimated liability under the plan is accrued as earned by the participant. At March 31, 2006 and 2005, the Company's aggregate liability under the plan was $1.7 million and $1.6 million, respectively. Bonus Programs - The Company maintains a bonus program for senior management and certain key individuals. The senior management bonus represents approximately 5% of fiscal year profits, assuming profit goals are attained, and is divided among senior management members in proportion to their salaries. The Company has an incentive program for branch managers that are paid to the managers based on the attainment of certain goals. The Company expensed $1.3 million, $564,000, $482,000 in bonuses during the years ended March 31, 2006, 2005 and 2004, respectively. Management Recognition and Development Plan - On July 23, 1998, shareholders of the Company approved the adoption of the MRDP for the benefit of officers, employees and non-employee directors of the Company. The objective of the MRDP is to retain personnel of experience and ability in key positions by providing them with a proprietary interest in the Company. The Company reserved 142,830 shares of common stock to be issued under the MRDP, which are authorized but unissued shares. Awards under the MRDP were made in the form of restricted shares of common stock that are subject to restrictions on transfer of ownership. Compensation expense in the amount of the fair value of the common stock at the date of the grant to the plan participants was recognized over a five-year vesting period, with 20% vesting immediately upon grant. At March 31, 2006, all shares have been issued and fully vested. Compensation expense of $0, $0 and $15,000 was recognized for the years ended March 31, 2006, 2005 and 2004, respectively. Stock Option Plans - In July 1998, shareholders of the Company approved the adoption of the 1998 Stock Option Plan ("1998 Plan"). The 1998 Plan was effective October 1, 1998 and will expire on the tenth anniversary of the effective date, unless terminated sooner by the Board. Under the 1998 Plan, the Company may grant both incentive and non-qualified stock options up to 357,075 shares of its common stock to officers, directors and employees. The exercise price of each option granted under the 1998 Plan equals the fair market value of the Company's stock on the date of grant with a maximum term of ten years and options vest over five years. At March 31, 2006, there were options for 14,481 shares available for grant under the 1998 Plan. In July 2003, shareholders of the Company approved the adoption of the 2003 Stock Option Plan ("2003 Plan"). The 2003 Plan was effective July 2003 and will expire on the tenth anniversary of the effective date, unless terminated sooner by the Board. Under the 2003 Plan, the Company may grant both incentive and non-qualified stock options up to 229,277 shares of its common stock to officers, directors and employees. The exercise price of each option granted under the 2003 Plan equals the fair market value of the Company's stock on the date of grant with a maximum term of ten years from date of grant and options vest over 0 to 5 years. On March 15, 2006, 157,000 stock options from the 2003 Plan were granted to officers and directors. Each option was granted at the fair market value of the Company's stock on the date of grant with a maximum term of 10 years from date of grant and were fully vested at grant date. 92 Stock option activity is summarized in the following table: Weighted Average Number of Exercise Shares Price --------- -------- Outstanding April 1, 2003 262,550 $ 12.92 Grants 23,000 18.30 Options exercised (40,281) 12.02 --------- -------- Outstanding March 31, 2004 245,269 13.57 --------- -------- Grants 23,000 20.62 Options exercised (40,774) 13.14 --------- -------- Outstanding March 31, 2005 227,495 14.36 --------- -------- Grants 177,000 25.40 Options exercised (26,572) 16.95 --------- -------- Outstanding March 31, 2006 377,923 $ 19.35 ========= ======== Additional information regarding options outstanding as of March 31, 2006 is as follows: Options Outstanding Options Exercisable --------------------- --------------------- Weighted Avg Weighted Weighted Remaining Average Average Range of Contractual Number Exercise Number Exercise Exercise Price Life(years) Outstanding Price Exercisable Price - -------------- ---------- ----------- ----- ----------- ----- $ 8.06 - $12.31 3.71 43,498 $ 10.94 43,498 $ 10.94 13.51 - 13.75 2.80 120,625 13.73 120,625 13.73 14.97 - 19.02 7.13 23,000 17.42 14,800 17.26 20.20 - 21.65 8.86 33,800 20.88 9,520 20.81 25.95 9.96 157,000 25.95 157,000 25.95 ------- ------- 377,923 345,443 ======= ======= 16. EMPLOYEE STOCK OWNERSHIP PLAN The Company ESOP covers all employees with at least one year and 1000 hours of service who are over the age of 21. Shares are released for allocation at the discretion of the Board of Directors and allocated to participant accounts on December 31 of each year until 2011. ESOP compensation expense included in salaries and benefits was $558,000, $520,000 and $477,000 for years ended March 31, 2006, 2005 and 2004, respectively. ESOP share activity is summarized in the following table: Fair Value Allocated of Unreleased and Unreleased ESOP Released Shares Shares Shares Total ---------- ---------- --------- -------- Balance, April 1, 2003 $3,490,000 221,697 259,595 481,292 Allocation December 31, 2003 (24,633) 24,633 - ------- ------- ------- Balance, March 31, 2004 $4,083,000 197,064 284,228 481,292 Allocation December 31, 2004 (24,633) 24,633 - ------- ------- ------- Balance, March 31, 2005 $3,664,000 172,431 308,861 481,292 Allocation December 31, 2005 (24,633) 24,633 - ------- ------- ------- Balance, March 31, 2006 $3,955,000 147,798 333,494 481,292 ======= ======= ======= 93 17. SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL REQUIREMENTS The Company's Board of Directors authorized 250,000 shares of serial preferred stock as part of the Conversion and Reorganization completed on September 30, 1997. No preferred shares were issued or outstanding at March 31, 2006 or 2005. The Bank is subject to various regulatory capital requirements administered by the Office of Thrift Supervision ("OTS"). Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk, weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and Tier I capital to risk-weighted assets, of core capital to total assets and tangible capital to tangible assets (set forth in the table below). Management believes the Bank meets all capital adequacy requirements to which it is subject as of March 31, 2006. As of March 31, 2006, the most recent notification from the OTS categorized the Bank as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well capitalized," the Bank must maintain minimum total capital and Tier I capital to risk weighted assets, core capital to total assets and tangible capital to tangible assets (set forth in the table below). There are no conditions or events since that notification that management believes have changed the Company's category. The Bank's actual and required minimum capital amounts and ratios are presented in the following table (dollars in thousands): Categorized as "Well Capitalized" Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provision ------------------------------------------------ Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- March 31, 2006 Total Capital: (To Risk Weighted Assets) $78,469 11.48% $54,688 8.0% $68,361 10.0% Tier I Capital: (To Risk Weighted Assets) 71,248 10.42 27,344 4.0 41,016 6.0 Tier I Capital: (To Adjusted Tangible Assets) 71,248 9.70 22,038 3.0 36,730 5.0 Tangible Capital: (To Tangible Assets) 71,248 9.70 11,019 1.5 N/A N/A 94 Categorized as "Well Capitalized" Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provision ------------------------------------------------ Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- March 31, 2005 Total Capital: (To Risk Weighted Assets) $57,397 12.37% $37,116 8.0% $46,396 10.0% Tier I Capital: (To Risk Weighted Assets) 53,002 11.42 18,558 4.0 27,837 6.0 Tier I Capital: (To Adjusted Tangible Assets) 53,002 9.54 16,664 3.0 27,773 5.0 Tangible Capital: (To Tangible Assets) 53,002 9.54 8,332 1.5 N/A N/A The following table is a reconciliation of the Bank's capital, calculated according to GAAP to regulatory tangible and risk-based capital at March 31, 2006 (in thousands): Equity $ 97,595 Net unrealized securities loss 276 Core deposit intangible, goodwill and software (26,585) Servicing asset (38) -------- Tangible capital 71,248 General valuation allowance 7,221 -------- Total capital $ 78,469 ======== At periodic intervals, the OTS and the FDIC routinely examine the Company's financial statements as part of their legally prescribed oversight of the savings and loan industry. Based on their examinations, these regulators can direct that the Company's financial statements be adjusted in accordance with their findings. A future examination by the OTS or the FDIC could include a review of certain transactions or other amounts reported in the Company's 2006 financial statements. In view of the uncertain regulatory environment in which the Company operates, the extent, if any, to which a forthcoming regulatory examination may ultimately result in adjustments to the 2006 financial statements cannot presently be determined. The following table summarizes the Company's common stock repurchased in each of the last three fiscal years (dollars in thousands): Shares Value ------ ------- 2006 50,000 $1,228 2005 - - 2004 81,500 $1,510 18. EARNINGS PER SHARE Basic earning per share ("EPS") is computed by dividing net income applicable to common stock by the weighted average number of common shares outstanding during the period, without considering any dilutive items. Diluted EPS is computed by dividing net income applicable to common stock by the weighted average number of common shares and common stock equivalents for items that are dilutive, net of shares assumed to be repurchased using the treasury stock method at the average share price for the Company's common stock during the period. Common stock equivalents arise from assumed conversion of outstanding stock options and from assumed vesting of shares awarded but not released under the Company's MRDP plan. ESOP shares are not considered outstanding for earnings per share purposes until they are committed to be released. 95 Years Ended March 31, ------------------------------ 2006 2005 2004 ------ ------ ------ Basic EPS computation: Numerator-Net income $9,738,000 $6,529,000 $6,554,000 Denominator-Weighted average common shares outstanding 5,602,240 4,816,745 4,640,485 Basic EPS $ 1.74 $ 1.36 $ 1.41 Diluted EPS computation: ========= ========= ========= Numerator-Net Income $9,738,000 $6,529,000 $6,554,000 Denominator-Weighted average common shares outstanding 5,602,240 4,816,745 4,640,485 Effect of dilutive stock options 72,928 74,428 72,149 Effect of dilutive MRDP - - 1,695 Weighted average common shares --------- --------- --------- and common stock equivalents 5,675,168 4,891,173 4,714,329 Diluted EPS $ 1.72 $ 1.33 $ 1.39 ========= ========= ========= 19. FAIR VALUE OF FINANCIAL INSTRUMENTS The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, Disclosures About Fair Value of Financial Instruments. The Company, using available market information and appropriate valuation methodologies, has determined the estimated fair value amounts. However, considerable judgment is necessary to interpret market data in the development of the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The estimated fair value of financial instruments is as follows (in thousands): March 31, -------------------------------------- 2006 2005 ----------------- ----------------- Carrying Fair Carrying Fair Value Value Value Value -------- ----- -------- ----- Assets: Cash $ 31,346 $31,346 $ 61,719 $61,719 Investment securities available for sale 24,022 24,022 22,945 22,945 Mortgage-backed securities held to maturity 1,805 1,830 2,343 2,402 Mortgage-backed securities available for sale 8,134 8,134 11,619 11,619 Loans receivable, net 623,016 620,107 429,449 428,368 Loans held for sale 65 65 510 510 Mortgage servicing rights 384 1,080 470 1,100 FHLB stock 7,350 7,350 6,143 6,143 Liabilities: Demand - Savings deposits 399,844 399,844 307,572 307,572 Time deposits 207,120 205,718 149,306 148,941 FHLB advances - long-term 46,100 45,846 40,000 40,120 Junior subordinated debentures 7,217 7,236 - - Fair value estimates, methods and assumptions are set forth below. Cash - Fair value approximates the carrying amount. Investments and Mortgage-Backed Securities - Fair values were based on quoted market rates and dealer quotes. 96 Loans Receivable and Loans Held for Sale - Loans were priced using a discounted cash flow method. The discount rate used was the rate currently offered on similar products, risk adjusted for credit concerns or dissimilar characteristics. For variable rate loans that reprice frequently and have no significant change in credit, fair values are based on carrying values. Mortgage Servicing Rights - The fair value of mortgage servicing rights was determined using the Company's model, which incorporates the expected life of the loans, estimated cost to service the loans, servicing fees received and other factors. The Company calculates MSR's fair value by stratifying MSR's based on the predominant risk characteristics that include the underlying loan's interest rate, cash flows of the loan, origination date and term. Key economic assumptions that vary due to changes in market interest rates are used to determine the fair value of the MSR's and include expected prepayment speeds, which impact the average life of the portfolio, annual service cost, annual ancillary income and the discount rate used in valuing the cash flows. At March 31, 2006, the MSR's fair value totaled $1.1 million, which was estimated using a range of prepayment speed assumptions (The Bond Market Association's standard prepayment) values that ranged from 133 to 560. Federal Home Loan Bank Stock - Fair value approximates the carrying amounts. Deposits - The fair value of time deposits with no stated maturity such as non-interest-bearing demand deposits, savings, NOW accounts, and money market and checking accounts was equal to the amount payable on demand. The fair value of time deposits with stated maturity was based on the discounted value of contractual cash flows. The discount rate was estimated using rates currently available in the local market. Federal Home Loan Bank Advances - The fair value for FHLB advances was based on the discounted cash flow method. The discount rate was estimated using rates currently available from the FHLB. Junior Subordinated Debentures - The fair value of junior subordinated debentures was based on the discounted cash flow method. The discount rate was estimated using rates currently available for the junior subordinated debentures. Off-Balance Sheet Financial Instruments - The estimated fair value of loan commitments approximates fees recorded associated with such commitments as of March 31, 2006 and 2005. Since the majority of the Bank's off-balance-sheet instruments consist of non-fee producing, variable rate commitments, the Bank has determined they do not have a distinguishable fair value. Other - The carrying value of other financial instruments was determined to be a reasonable estimate of their fair value. Limitations - The fair value estimates presented herein were based on pertinent information available to management as of March 31, 2006 and 2005. Although management was not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements on those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein. Fair value estimates were based on existing financial instruments without attempting to estimate the value of anticipated future business. The fair value has not been estimated for assets and liabilities that were not considered financial instruments. 20. COMMITMENTS AND CONTINGENCIES The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments generally include commitments to originate mortgage, commercial and consumer loans. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company's maximum exposure to credit loss in the event of nonperformance by the borrower is represented by the contractual amount 97 of those instruments. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments. Commitments to extend credit are conditional, and are honored for up to 45 days subject to the Company's usual terms and conditions. Collateral is not required to support commitments. At March 31, 2006, the Company had commitments to originate fixed rate mortgage loans of $1.9 million at interest rates ranging from 6.0% to 8.25%. At March 31, 2006, commitments to originate adjustable rate mortgage loans were $420,000 at an average interest rate of 6.10%. Undisbursed balance of mortgage loans closed was $94.6 million at March 31, 2006. Commitments to originate consumer loans totaled $2.4 million and unused lines of consumer credit totaled $24.7 million at March 31, 2006. Commercial real estate loan commitments to originate loans totaled $12.4 million. Undisbursed balance of commercial real estate mortgage loans closed was $8.4 million at March 31, 2006. Commercial loan commitments totaled $850,000 and unused commercial lines of credit totaled $42.6 million. The allowance for unfunded loan commitments was $362,000 at March 31, 2006. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily used to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies as specified above, and is required in instances where the Bank deems necessary. At March 31, 2006 and 2005, standby letters of credit totaled $1.8 million and $346,000, respectively. Most of the Bank's business activity is with customers located in the states of Washington and Oregon. Investments in state and municipal securities involve government entities primarily within the state of Washington. Loans are generally limited, by federal and state banking regulation, to 10% of the Bank's shareholder's equity, excluding accumulated other comprehensive income (loss). As of March 31, 2006 and 2005, the Bank had no individual industry concentrations. At March 31, 2006, the Company had firm commitments to sell $65,000 of residential loans to FHLMC. These agreements are short term fixed rate commitments and no material gain or loss is likely. In connection with certain asset sales, the Bank typically makes representation and warranties about the underlying assets conforming to specified guidelines. If the underlying assets do not conform to the specifications, the Bank may have an obligation to repurchase the assets or indemnify the purchaser against loss. As of March 31, 2006 loans under warranty totaled $112.8 million, which substantially represents the unpaid principal balance of the Company's loans serviced for others. The Bank believes that the potential for loss under these arrangements is remote. Accordingly, no contingent liability is recorded in the financial statements. At March 31, 2006, scheduled maturities of certificates of deposit, FHLB advances, junior subordinated debentures and future operating minimum lease commitments were as follows (in thousands): Within 1-3 4-5 Over Total 1 year Years Years 5 Years Balance ------ ----- ----- ------- ------- Certificates of deposit $130,159 $65,679 $6,354 $ 4,928 $207,120 FHLB advances 41,100 5,000 - - 46,100 Operating leases 1,616 3,218 2,376 5,027 12,237 Junior subordinated debentures - - - 7,217 7,217 Total other contractual ------- ------ ------ ------ ------- obligations $172,875 $73,897 $ 8,730 $17,172 $242,674 ======= ====== ====== ====== ======= The Company is party to litigation arising in the ordinary course of business. In the opinion of management, these actions will not have a material adverse effect, if any, on the Company's financial position, results of operations, or liquidity. The Bank has entered into employment contracts with certain key employees which provide for contingent payment subject to future events. 98 21. RIVERVIEW BANCORP, INC. (PARENT COMPANY) BALANCE SHEETS MARCH 31, 2006 AND 2005 (In thousands) 2006 2005 - ---------------------------------------------------------------------------- ASSETS Cash (including interest earning accounts of $1,572 and $6,623) $ 1,651 $ 6,921 Investment in the Bank 97,595 62,832 Other assets 629 726 Deferred income taxes 35 31 ------ ------ TOTAL ASSETS $ 99,910 $ 70,510 ====== ====== LIABILITIES AND SHAREHOLDERS' EQUITY Accrued expenses and other liabilities $ 50 $ 237 Borrowings 7,217 - Dividend payable 956 751 Shareholders' equity 91,687 69,522 ------ ------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 99,910 $ 70,510 ====== ====== STATEMENTS OF INCOME YEARS ENDED MARCH 31, 2006, 2005 AND 2004 (In thousands) 2006 2005 2004 - ---------------------------------------------------------------------------- INCOME: Dividend income from Bank $ 15,000 $ 3,813 $ 12,952 Interest on investment securities and other short-term investments 73 98 28 Interest on loan receivable from the Bank 149 165 180 Other income - - 2 ------ ------ ------ Total income 15,222 4,076 13,162 ------ ------ ------ EXPENSE: Management service fees paid to the Bank 143 143 122 Other expenses 360 213 189 ------ ------ ------ Total expense 503 356 311 ------ ------ ------ INCOME BEFORE INCOME TAXES AND EQUITY IN UNDISTRIBUTED INCOME OF THE BANK 14,719 3,720 12,851 BENEFIT FOR INCOME TAXES (363) (31) (117) ------ ------ ------ INCOME OF PARENT COMPANY 15,082 3,751 12,968 EQUITY IN UNDISTRIBUTED (LOSS) INCOME OF THE BANK (5,344) 2,778 (6,414) ------ ------ ------ NET INCOME $ 9,738 $ 6,529 $ 6,554 ====== ====== ====== 99 RIVERVIEW BANCORP, INC. (PARENT COMPANY) STATEMENTS OF CASH FLOWS YEARS ENDED MARCH 31, 2006, 2005 AND 2004 (In thousands) 2006 2005 2004 - ---------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 9,738 $ 6,529 $ 6,554 Adjustments to reconcile net income cash provided by operating activities: Equity in undistributed earnings(loss) of the Bank 5,344 (2,778) 6,414 Provision for deferred income taxes (4) 78 2 Earned ESOP shares 558 520 477 Earned MRDP shares - - 15 Changes in assets and liabilities, net of acquisition Other assets 323 (301) (536) Accrued expenses and other liabilities (588) (159) (246) ------ ------ ------ Net cash provided by operating activities 15,371 3,889 12,680 ------ ------ ------ CASH FLOWS FROM INVESTING ACTIVITIES: Additional investment in subsidiary (5,000) - - Acquisition, net of cash acquired (18,096) - (9,482) ------ ------ ------ Net cash used by investing activities (23,096) - (9,482) ------ ------ ------ CASH FLOWS FROM FINANCING ACTIVITIES: Dividends paid (3,631) (2,904) (2,490) Proceeds from borrowings 7,000 - - Repurchase of common stock (1,228) - (1,510) Proceeds from exercise of stock options 314 536 485 ------ ------ ------ Net cash used by financing activities 2,455 (2,368) (3,515) ------ ------ ------ NET (DECREASE) INCREASE IN CASH (5,270) 1,521 (317) CASH, BEGINNING OF YEAR 6,921 5,400 5,717 ------ ------ ------ CASH, END OF YEAR $ 1,651 $ 6,921 $ 5,400 ====== ====== ====== 100 Riverview Bancorp, Inc. Selected Quarterly Financial Data (Unaudited): (In thousands, except share data) Three Months Ended - ------------------------------------------------------------------------------------------------------------ March 31 December 31 September 30 June 30 -------- ----------- ------------ -------- <s> <c> <c> <c> <c> Fiscal 2006: Interest income $ 13,076 $ 12,290 $ 11,636 $ 10,225 Interest expense 4,462 3,747 3,541 3,127 Net interest income 8,616 8,543 8,095 7,098 Provision for loan losses 200 400 450 450 Non-interest income 2,025 2,143 2,482 2,187 Non-interest expense 6,869 6,148 6,261 6,096 Income before income taxes 3,572 4,138 3,866 2,739 Provision for income taxes 965 1,390 1,304 918 --------- ---------- --------- --------- Net income $ 2,607 $ 2,748 $ 2,562 $ 1,821 ========= ========== ========= ========= Basic earnings per share (1) $ 0.46 $ 0.49 $ 0.45 $ 0.33 ========= ========== ========= ========= Diluted earnings per share $ 0.46 $ 0.48 $ 0.45 $ 0.33 ========= ========== ========= ========= Fiscal 2005: Interest income $ 7,849 $ 7,496 $ 7,530 $ 7,093 Interest expense 2,145 1,947 1,764 1,539 Net interest income 5,704 5,549 5,766 5,554 Provision for loan losses 150 70 50 140 Non-interest income 1,845 323 1,698 2,640 Non-interest expense 4,915 4,743 4,614 4,832 Income before income taxes 2,484 1,059 2,800 3,222 Provision for income taxes 816 299 898 1,023 --------- ---------- --------- --------- Net income $ 1,668 $ 760 $ 1,902 $ 2,199 ========= ========== ========= ========= Basic earnings per share (1) $ 0.34 $ 0.16 $ 0.40 $ 0.46 ========= ========== ========= ========= Diluted earnings per share (1) $ 0.34 $ 0.16 $ 0.39 $ 0.45 ========= ========== ========= ========= (1) Quarterly earnings per share varies from annual earnings per share due to rounding. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure - ----------------------------------------------------------------------- Not Applicable Item 9A. Controls and Procedures - -------------------------------- (a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company's disclosure controls and procedures (as defined in Section 13(a)- 15(e) of the Securities Exchange Act of 1934) 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 Securities and Exchange Act of 1934 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 as of the end of the period covered by this report. The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all error and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent 101 limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected. (b) Changes in Internal Controls: There was no change in the Company's internal control over financial reporting during the Company's most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. (c) Management's Annual Report on Internal Control Over Financial Reporting: The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Act). As required by Rule 13a-15(c) of the Act, management has evaluated the effectiveness of the Company's internal control over financial reporting. Management's Annual Report on Internal Control Over Financial Reporting appears in Item 9 of this Form 10-K. 102 RIVERVIEW BANCORP, INC Sarbanes-Oxley 404 FY 04-05 Management's Report on Internal Controls over Financial Reporting The management of Riverview Bancorp, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. This internal control system has been designed to provide reasonable assurance to the Company's management and board of directors regarding the preparation and fair presentation of the company's published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. The management of Riverview Bancorp, Inc. has assessed the effectiveness of the Company's internal control over financial reporting as of March 31, 2006. To make the assessment, we used the criteria for effective internal control over financial reporting described in Internal Control Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, we believe that, as of March 31, 2006, the Company's internal control over financial reporting met those criteria. The Company's independent registered public accounting firm that audits the Company's consolidated financial statements has issued an audit report on our assessment of the Company's internal control over financial reporting. 103 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Riverview Bancorp, Inc. Vancouver, Washington We have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting, that Riverview Bancorp, Inc. & Subsidiary (the "Company") maintained effective internal control over financial reporting as of March 31, 2006, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing, and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that the Company maintained effective internal control over financial reporting as of March 31, 2006, is fairly stated, in all material respects, based on the criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2006, based on the criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended March 31, 2006, of the Company and our report dated June 13, 2006, expressed an unqualified opinion on those financial statements. /s/Deloitte & Touche LLP Portland, Oregon June 13, 2006 104 Item 9B. Other Information - -------------------------- There was no information to be disclosed by the Company in a report on Form 8-K during the fourth quarter of fiscal 2006 that was not so disclosed. 105 PART III Item 10. Directors and Executive Officers of the Registrant - ------------------------------------------------------------ The information contained under the section captioned "Proposal I - Election of Directors" contained in the Company's Proxy Statement for the 2006 Annual Meeting of Stockholders, and "Part I -- Business -- Personnel -- Executive Officers" of this Form 10-K, is incorporated herein by reference. Reference is made to the cover page of this Form 10-K for information regarding compliance with Section 16(a) of the Exchange Act. In December 2003, the Board of Directors adopted the Officer and Director Code of Ethics. The code is applicable to each of the Company's officers, including the principal executive officer and senior financial officers, and requires individuals to maintain the highest standards of professional conduct. A copy of the Code of Ethics is available on the Company's website at www.riverviewbank.com. Item 11. Executive Compensation - -------------------------------- The information contained under the sections captioned "Executive Compensation" and "Directors' Compensation" under "Proposal I - Election of Directors" in the Proxy Statement for the 2006 Annual Meeting of Stockholders is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters - ---------------------------------------------------------------------------- The information required by this item is incorporated herein by reference to the sections captioned "Security Ownership of Certain Beneficial Owners and Management" and "Executive Compensation" in the Proxy Statement for the 2006 Annual Meeting of Stockholders. Equity Compensation Plan Information. The following table summarizes share and exercise price information about the Company's equity compensation plan as of March 31, 2006. Number of securities remaining available for future issuance Number of under equity com- securities Weighted- pensation plans to be issued average price excluding securities upon exercise of of outstanding reflected in column Plan category outstanding options options (A) Equity compensation plans approved by security holders: (A) (B) (C) 2003 Stock Option Plan 157,000 $25.95 72,277 1998 Stock Option Plan 227,495 14.36 14,481 Equity compensation plans not approved by security holders: - - - ------- ------- Total 381,495 86,758 ======= ======= Item 13. Certain Relationships and Related Transactions - -------------------------------------------------------- The information set forth under the section captioned "Proposal I - Election of Directors - Transactions with Management" in the Proxy Statement for the 2006 Annual Meeting of Stockholders is incorporated herein by reference. 106 Item 14. Principal Accounting Fees and Services - ------------------------------------------------- This information set forth under the section captioned "Independent Auditors" in the Proxy statement for the 2006 Annual Meeting of Stockholders is incorporated herein by reference. 107 PART IV Item 15. Exhibits, Financial Statement Schedules - ------------------------------------------------- (a) 1. Financial Statements See "Part II Item 8. Financial Statements and Supplementary Data." 2. Financial Statement Schedules All schedules are omitted because they are not required or applicable, or the required information is shown in the consolidated financial statements or the notes thereto. 3. Exhibits 3.1 Articles of Incorporation of the Registrant (1) 3.2 Bylaws of the Registrant (2) 4 Form of Certificate of Common Stock of the Registrant (1) 10.1 Employment Agreement with Patrick Sheaffer (3) 10.2 Employment Agreement with Ronald A. Wysaske (3) 10.3 Severance Agreement with Karen Nelson (3) 10.4 Severance Agreement with John A. Karas (4) 10.5 Employee Severance Compensation Plan (3) 10.6 Employee Stock Ownership Plan (5) 10.7 Management Recognition and Development Plan (6) 10.8 1998 Stock Option Plan (6) 10.9 1993 Stock Option and Incentive Plan (6) 10.10 2003 Stock Option Plan (7) 10.11 Form of Incentive Stock Option Award Pursuant to 2003 Stock Option Plan (8) 10.12 Form of Non-qualified Stock Option Award Pursuant to 2003 Stock Option Plan (8) 21 Subsidiaries of Registrant 23 Consent of Independent Registered Public Accounting Firm 23.1 Consent of Independent Registered Public Accounting Firm 31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act 31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act 32 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act (1) Filed as an exhibit to the Registrant's Registration Statement on Form S-1 (Registration No. 333-30203), and incorporated herein by reference. (2) Filed as an exhibit to the Registrant's Current Report on Form 8-K dated April 20, 2005, and incorporated herein by reference. (3) Filed as an exhibit to the Registrant's Form 10-Q for the quarter ended September 30, 1997, and incorporated herein by reference. (4) Filed as an exhibit to the Registrant's Form 10-K for the year ended March 31, 2002, and incorporated herein by reference. (5) Filed as an exhibit to the Registrant's Form 10-K for the year ended March 31, 1998, and incorporated herein by reference. (6) Filed on October 23, 1998, as an exhibit to the Registrant's Registration Statement on Form S-8, and incorporated herein by reference. (7) Filed as an exhibit to the Registrant's Annual Meeting Proxy Statement dated June 5, 2003 and incorporated herein by reference. (8) Filed as an exhibit to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2005, and incorporated herein by reference. 108 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. RIVERVIEW BANCORP, INC. Date: June 8, 2006 By: /s/ Patrick Sheaffer -------------------- Patrick Sheaffer Chairman of the Board and Chief Executive Officer (Duly Authorized Representative) Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ Patrick Sheaffer By: /s/ Ronald A. Wysaske -------------------- --------------------- Patrick Sheaffer Ronald A. Wysaske Chairman of the Board and President and Chief Operating Officer Chief Executive Officer Director (Principal Executive Officer) Date: June 8, 2006 Date: June 8, 2006 By: /s/ Ron Dobyns By: /s/ Paul L. Runyan -------------- ------------------ Ron Dobyns Paul L. Runyan Senior Vice President and Director Chief Financial Officer (Principal Financial and Accounting Officer) Date: June 8, 2006 Date: June 8, 2006 By: /s/ Robert K. Leick By: /s/ Gary R. Douglass ------------------- -------------------- Robert K. Leick Gary R. Douglass Director Director Date: June 8, 2006 Date: June 8, 2006 By: /s/ Edward R. Geiger By: /s/ Michael D. Allen -------------------- -------------------- Edward R. Geiger Michael D. Allen Director Vice Chairman of the Board and Director Date: June 8, 2006 Date: June 8, 2006 109 Exhibit 21 Subsidiaries of the Registrant Parent - ------ Riverview Bancorp, Inc. Subsidiaries (a) Percentage State of Incorporation - ---------------- Owned ---------------------- ----- Riverview Community Bank 100% Federal Riverview Services, Inc. (b) 100% Washington Riverview Asset Management Corp. (b) 85% Washington (a) The operation of the Registrant's wholly and majority owned subsidiaries are included in the Registrant's Financial Statements contained in Item 8 of this Form 10-K. (b) This corporation is a subsidiary of Riverview Community Bank. 110 Exhibit 23 Consent of Independent Registered Public Accounting Firm 111 Exhibit 23 Consent of Independent Registered Public Accounting Firm We consent to the incorporation by reference in Registration Statement Nos. 333-66049, 333-38887 and 333-109894 on Form S-8 of our reports dated June 13, 2006, relating to the consolidated financial statements of Riverview Bancorp, Inc. & Subsidiary and management's report on the effectiveness of internal control over financial reporting, appearing in this Annual Report on Form 10-K of Riverview Bancorp, Inc. For the year ended March 31, 2006. /s/Deloitte & Touche LLP June 13, 2006 112 Exhibit 23.1 Consent of Independent Registered Public Accounting Firm 113 Consent of Independent Registered Public Accounting Firm We consent to the incorporation by reference in Registration Statements Nos. 333-66049, 333-38887 and 333-109894 on Form S-8 of Riverview Bancorp, Inc., of our reports dated June 10, 2005, relating to our audits of the consolidated financial statements, which appear in this Annual Report on Form 10-K of Riverview Bancorp, Inc. For the year ended March 31, 2005. /s/McGladrey & Pullen, LLP McGladrey & Pullen, LLP June 13, 2006 114 Exhibit 31.1 ------------ Certification Required By Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934 I, Patrick Sheaffer, certify that: 1. I have reviewed this Annual Report on Form 10-K of Riverview Bancorp, Inc.; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) 4 and 15d-15(e) 4) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we 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 annual report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) 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; d) 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 fiscal fourth 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 officers 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 registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weakness 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 data 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. Date: June 8, 2006 /S/ Patrick Sheaffer -------------------- Patrick Sheaffer Chairman and Chief Executive Officer 115 Exhibit 31.2 - ------------- Certification Required By Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934 I, Ron Dobyns, certify that: 1. I have reviewed this Annual Report on Form 10-K of Riverview Bancorp, Inc.; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) 4 and 15d-15(e) 4) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we 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 annual report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) 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; d) 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 fiscal fourth 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 officers 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 registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weakness 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 data 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. Date: June 8, 2006 /S/ Ron Dobyns --------------- Ron Dobyns Chief Financial Officer 116 Exhibit 32 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER OF RIVERVIEW BANCORP, INC. PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The undersigned herby certify, pursuant to Section 906 of the Sarbanes-Oxley act of 2002 and in connection with this Annual Report on Form 10-K that: 1. the report fully complies with the requirements of sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, and 2. the information contained in the report fairly presents, in all material respects, the company's financial condition and results of operations as of the dates and for the periods presented in the financial statements included in such report. /S/ Patrick Sheaffer /S/ Ron Dobyns -------------------- -------------- Patrick Sheaffer Ron Dobyns Chief Executive Officer Chief Financial Officer Dated: June 8, 2006 This certification accompanies this periodic report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended. 117