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 September 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-26556
KLAMATH FIRST BANCORP, INC.
(Exact name of registrant as specified in its charter)
Oregon 93-1180440
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) I.D. Number)
540 Main Street, Klamath Falls, Oregon 97601
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: ___ (541) 882-3444_
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
Indicate by check mark whether disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the Registrant's knowledge, in definitive proxy or other
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.
YES X NO
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
YES X NO
As of November 28, 2003, there were issued and outstanding 6,746,481 shares
of the Registrant's common stock. The Registrant's common stock is traded
over-the-counter and is listed on the Nasdaq National Market under the symbol
"KFBI." The aggregate market value of the common 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 on November 28, 2003 of $25.70,
was $154,006,967. For purposes of this calculation, officers and directors of
the Registrant and the Klamath First Federal Savings and Loan Association
Employee Stock Ownership Plan are considered affiliates.
DOCUMENTS INCORPORATED BY REFERENCE
None
PART I
Item 1. Business
General
Klamath First Bancorp, Inc. ("Company"), an Oregon corporation, was
organized on June 16, 1995 for the purpose of becoming the holding company for
Klamath First Federal Savings and Loan Association ("Association") upon the
Association's conversion from a federal mutual to a federal stock savings and
loan association ("Conversion"). The Conversion was completed on October 4,
1995. At September 30, 2003, the Company had total assets of $1.54 billion,
total deposits of $1.07 billion and shareholders' equity of $120.3 million. All
references to the Company herein include the Association where applicable.
The Association was organized in 1934. The Association is regulated by the
Office of Thrift Supervision ("OTS") and its deposits are insured up to
applicable limits under the Savings Association Insurance Fund ("SAIF") of the
Federal Deposit Insurance Corporation ("FDIC"). The Association also is a member
of the Federal Home Loan Bank ("FHLB") System through the FHLB of Seattle.
In July 1997, the Association acquired 25 former First Interstate Bank
branches from Wells Fargo Bank, N.A. The branches are located in rural
communities throughout Oregon and expanded and complemented the then existing
network of the Association's branches. The acquisition was accounted for as a
purchase and resulted in the addition of approximately $241.3 million in
deposits on the acquisition date of July 18, 1997.
In September 2001, the Association acquired 13 branches from Washington
Mutual Bank ("WAMU"), 11 of which are located on the northern and southern
Oregon coast and two of which are located in northeastern Oregon. These
locations enhance the Association's geographic coverage on the coast and in
northeastern Oregon. The acquisition was accounted for as a purchase and
resulted in the addition of approximately $179.3 million in loans, assumption of
$423.5 million in deposits, and addition of 124 experienced branch personnel on
the acquisition date of September 7, 2001. As part of the purchase, the Company
also recorded $15.0 million of core deposit intangible and $24.1 million of
other intangible assets. See Note 2 of the Notes to Consolidated Financial
Statements contained in Item 8 of this Form 10-K.
The Association is a progressive, community-oriented financial institution
that focuses on serving customers within its primary market area. Accordingly,
the Association is primarily engaged in attracting deposits from the general
public through its offices and using those and other available sources of funds
to originate permanent residential one- to four-family real estate loans within
its market area, as well as commercial real estate and multi-family residential
loans, loans to consumers, and loans for commercial purposes. At September 30,
2003, permanent residential one- to four-family real estate loans totaled $195.8
million, or 34.04% of total loans. While the Association has historically
emphasized fixed rate mortgage lending, it has been diversifying its loan
portfolio by focusing on increasing the number of originations of commercial
real estate loans, multi-family residential loans, residential construction
loans, small business loans and consumer loans. Significant progress was made
toward increasing the commercial and consumer loans in the portfolio with the
purchase of the branches from WAMU. These newer loan products generally carry
adjustable rates, higher yields, or shorter terms than the traditional fixed
rate mortgages. This lending strategy is designed to enhance earnings, reduce
interest rate risk, and provide a more complete range of financial services to
customers and the local communities served by the Association. At September 30,
2003, the Association's total loan portfolio consisted of 47.99% fixed rate and
52.01% adjustable rate loans, after deducting loans in process and
non-performing loans.
On July 15, 2003, the Company announced that it had entered into an
Agreement and Plan of Merger (the "Sterling Merger") with Sterling Financial
Corporation a Washington corporation ("Sterling"). The Company will be merged
with and into Sterling, with Sterling being the surviving corporation in the
merger. The Association will be merged with and into Sterling's wholly-owned
subsidiary, Sterling Savings Bank, with Sterling Savings Bank being the
surviving institution.
1
Under the terms of the Sterling Merger, each share of the Company's common
stock will be converted into 0.77 shares of Sterling common stock subject to
certain conditions. Based upon the closing price for Sterling on July 14, 2003
of $26.55 per share, the consideration is equivalent to $20.44 per share of the
Company's common stock. The merger will be structured as a tax-free
reorganization and is expected to be completed on January 2, 2004. The merger
has received regulatory approvals and was approved by the shareholders of both
the Company and Sterling on December 11, 2003.
As of the close of business on December 12, 2003, the Association
successfully completed the sale of seven branches located in northeastern Oregon
to the Bank of Eastern Oregon. The branches are located in the towns of Burns,
Condon, Fossil, Heppner, John Day, Prairie City and Moro, Oregon. The sale
included deposit accounts of approximately $65 million. The fixed assets and
branch locations were included in the sale, but loans were not.
Market Area
In fiscal year 2003, the Association continued to expand its market area in
Oregon and Washington. At September 30, 2003, the Association had 57 branches in
26 of Oregon's 36 counties and had two in-store branches in the state of
Washington. In fiscal 2003, new in-store branches were opened in Grants Pass and
Woodburn, Oregon. After completion of the sale of branches to the Bank of
Eastern Oregon in December 2003, the Association had 52 branches. The
Association's primary market area, which encompasses the State of Oregon and
some adjacent areas of California, Idaho, and Washington, can be characterized
as a predominantly rural area containing a number of communities that are
experiencing moderate to rapid population growth. The population growth in the
market area, particularly in Southern Oregon, has been supported in large part
by the agreeable climate, and by favorable real estate values. The economy of
the market area is still based primarily on agriculture and lumber and wood
products, but is experiencing diversification into light manufacturing, health
care and other services and sectors. Tourism is a significant industry in many
regions of the market area, including Central Oregon and the Oregon coast. The
addition of branches in the Eugene-Springfield metropolitan area provides access
to this major population center.
2
Yields Earned and Rates Paid
The following table sets forth, for the periods and at the date indicated,
the weighted average yields earned on interest-earning assets, the weighted
average interest rates paid on interest-bearing liabilities, and the interest
rate spread between the weighted average yields earned and rates paid.
At Year Ended
September 30, September 30,
2003 2003 2002 2001
Weighted average yield:
Loans receivable................................................ 6.39% 7.32% 7.90% 7.86%
Mortgage-backed and related securities.......................... 3.42 3.50 5.18 6.02
Investment securities........................................... 3.78 3.82 4.72 5.64
Federal funds sold.............................................. 0.94 1.24 2.09 4.13
Interest-earning deposits....................................... 1.03 1.24 1.75 4.06
FHLB stock...................................................... 5.25 5.96 6.25 6.75
Combined weighted average yield on interest-bearing assets......... 4.68 5.12 6.35 6.99
Weighted average rate paid on:
Tax and insurance reserve....................................... 0.25 1.31 2.85 3.85
Passbook and statement savings.................................. 0.25 0.43 1.13 2.26
Interest-bearing checking. . . . . . . . . . . ................. 0.19 0.13 0.74 1.08
Money market . . . ............................................ 0.88 1.02 2.00 3.85
Certificates of deposit......................................... 3.34 3.56 4.35 5.76
FHLB advances/short term borrowings............................. 3.74 4.71 5.69 5.95
Combined weighted average rate on interest-bearing liabilities..... 2.71 2.53 3.31 4.81
Interest rate spread............................................... 1.96% 2.59% 3.04% 2.18%
Average Balances, Net Interest Income and Yields Earned and Rates Paid
Reference is made to the section entitled "Average Balances, Net Interest
Income and Yields Earned and Rates Paid" included in Item 7. "Management's
Discussion and Analysis of the Financial Condition and Results of Operations" of
this report.
Interest Sensitivity Gap Analysis
Reference is made to the section entitled "Interest Sensitivity Gap
Analysis" included in Item 7A. "Quantitative and Qualitative Disclosures about
Market Risk" of this report.
Rate/Volume Analysis
Reference is made to the section entitled "Rate/Volume Analysis" included
in Item 7. "Management's Discussion and Analysis of the Financial Condition and
Results of Operations" of this report.
Lending Activities
General. As a federally chartered savings and loan association, the
Association has authority to originate and purchase loans secured by real estate
located throughout the United States. With the expanded market area provided by
the branch acquisitions in 1997 and 2001, the Association's mortgage lending has
diversified throughout the State of Oregon. The Association will continue to
originate long-term mortgage loans for the purchase, construction or refinance
of one- to four-family residential real estate to meet the needs of customers in
our market area. However, to enhance interest income and reduce interest rate
risk, the Association is placing increased emphasis on the origination or
purchase of adjustable rate loans secured by one- to four-family residential,
multi-family residential and commercial real estate, the majority of which are
located outside Klamath, Jackson, and Deschutes counties. Subject to market
conditions, the Association sells loans to Fannie Mae (formerly the Federal
National Mortgage Association) and other agents.
Permanent residential one- to four-family mortgage loans amounted to $195.8
million, or 34.04%, of the Association's total loan portfolio before net items
at September 30, 2003. The Association originates other loans secured by
multi-family residential and commercial real estate, construction and land
loans. Those loans amounted to $191.9 million, or 33.35%, of the total loan
portfolio before net items at September 30, 2003. Approximately 32.61%, or
$187.6 million, of the Association's total loan portfolio before net items, as
of September 30, 2003, consisted of non-real estate loans. Commercial real
estate and non-real estate loans increased significantly as a result of the WAMU
branch acquisition in September 2001. The acquisition included $179.3 million in
loans, of which $118.8 million were commercial real estate and commercial
business loans and $50.7 million were consumer loans. Fiscal 2003 showed
continued growth in non-real estate loans.
Permissible loans-to-one borrower by the Association are generally limited
to 15% of unimpaired capital and surplus. The Association's loan-to-one borrower
limitation was $15.9 million at September 30, 2003. At September 30, 2003, the
Association had 62 borrowing relationships with outstanding balances in excess
of $1.0 million, the largest of which amounted to $7.0 million and consisted of
two loans which were unsecured.
The Association has emphasized the origination or purchase of adjustable
rate loans in order to increase the interest rate sensitivity of its loan
portfolio. The Association has been successful in expanding the production of
adjustable rate consumer loans and has purchased adjustable rate single family,
multi-family residential and non- residential real estate loans. See
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- Market Risk and Asset/Liability Management" and "INTEREST
SENSITIVITY GAP ANALYSIS" in the Annual Report. At September 30, 2003, $293.1
million, or 52.01%, of loans in the Association's total loan portfolio after
loans in process and non-performing loans, consisted of adjustable rate loans.
At September 30, 2002, $207.5 million, or 33.57%, of the Association's loans
carried adjustable rates.
4
Loan Portfolio Analysis. The following table sets forth the composition of
the loan portfolio by type of loan at the dates indicated.
At September 30,
--------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
----------------- ----------------- ----------------- ---------------- -----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- ------- ------- ------- ------- --------
(Dollars in thousands)
Real estate loans:
Permanent residential
one- to four-family $195,785 34.04% $339,404 54.53% $421,499 60.12% $639,165 85.12% $647,130 83.56%
Multi-family residential 32,030 5.57 21,595 3.47 23,257 3.32 19,015 2.53 18,412 2.38
Construction 16,650 2.89 15,224 2.45 21,674 3.09 25,289 3.37 53,219 6.87
Agricultural 9,383 1.63 4,889 0.79 4,218 0.60 - - - -
Commercial 125,725 21.86 91,703 14.73 99,318 14.17 42,277 5.63 37,079 4.79
Land 8,082 1.40 4,164 0.67 3,697 0.53 3,394 0.45 2,064 0.27
Total real estate loans 387,655 67.39 476,979 76.64 573,663 81.83 729,140 97.10 757,904 97.87
Non-real estate loans:
Savings accounts 1,294 0.22 1,262 0.20 2,091 0.3 1,957 0.26 1,800 0.23
Home improvement and home
equity loans 112,248 19.51 65,092 10.46 50,464 7.2 8,338 1.11 6,726 0.87
Other consumer 16,073 2.79 16,926 2.72 18,697 2.6 6,888 0.92 4,568 0.59
Commercial 57,975 10.08 62,102 9.98 56,098 8.0 4,586 0.61 3,443 0.44
Total non-real estate loans 187,590 32.61 145,382 23.36 127,350 18.1 21,769 2.90 16,537 2.13
Total loans 575,245 100.00% 622,361 100.00 701,013 100.0 750,909 100.00% 774,441 100.00%
Less:
Undisbursed portion of loans 7,541 3,609 8,473 10,350 24,176
Deferred loan fees 3,219 3,911 4,599 7,440 7,988
Allowance for loan losses 6,934 7,376 7,951 4,082 2,484
Net loans $557,551 $607,465 $679,990 $729,037 $739,793
5
The following table sets forth the amount of fixed-rate and adjustable rate
loans, net of loans in process and non-performing loans, included in the total
loan portfolio at the dates indicated.
At September 30,
------------------------------------------------
2003 2002
---------------------- ----------------------
Amount Percent Amount Percent
--------- ------- --------- --------
(Dollars in thousands)
Fixed rate . . . . . $270,479 47.99% $410,499 66.43%
Adjustable-rate... 293,106 52.01 207,458 33.57
-------- ------- -------- -------
Total........ $563,585 100.00% $617,957 100.00%
Permanent Residential One- to Four-Family Mortgage Loans. The primary
lending activity of the Association has been the origination of permanent
residential one- to four-family mortgage loans. Management believes that this
policy of focusing on single-family residential mortgage loans has been
successful in contributing to interest income while keeping delinquencies and
losses to a minimum. At September 30, 2003, $195.8 million, or 34.04%, of the
Association's total loan portfolio, before net items, consisted of permanent
residential one- to four-family mortgage loans, down from $339.4 million at
September 30, 2002. At September 30, 2003, the average balance of the
Association's permanent residential one- to four-family mortgage loans was
$73,245.
The Association presently originates both fixed-rate mortgage loans and
adjustable-rate mortgages ("ARMs") secured by one- to four-family properties
with terms of 15 to 30 years. Historically, most of the loans originated by the
Association have been fixed-rate loans secured by one- to four-family
properties. At September 30, 2003, $161.9 million, or 28.73%, of the total loans
after loans in process and non-performing loans were fixed rate one- to
four-family loans and $41.6 million, or 7.38%, were ARM loans. Borrower demand
for ARM loans versus fixed-rate mortgage loans is a function of the level of
interest rates, the expectations of changes in the level of interest rates and
the difference between the initial interest rates and fees charged for each type
of loan. The relative amount of fixed-rate mortgage loans and ARM loans that can
be originated at any time is largely determined by the demand for each in a
competitive environment. In order to improve interest rate risk, the Association
sells the majority of its conforming fixed rate one- to four-family mortgage
production, while ARM loans are retained in the portfolio.
The loan fees charged, interest rates and other provisions of the
Association's ARM loans are determined by the Association on the basis of its
own pricing criteria and competitive market conditions. At September 30, 2003,
the Association charged origination fees ranging from 1.00% to 1.75% on its ARM
loans.
In an attempt to increase adjustable rate mortgages in the loan portfolio,
the Association offers several loan products which are competitive with other
institutions originating mortgages in the Association's primary market area. The
Association has introduced variable rate loan products that bear fixed rates for
the first three or five years and then reprice annually thereafter. The loans
which bear fixed rates for five years are indexed to the One-Year Constant
Maturity Treasury Bill Index and have a maximum rate increase of 5% over the
life of the loan. The loans which bear fixed rates for the first three years are
indexed to the FHLB of Seattle 12-Month Short Term Advance Rate and have a
maximum rate increase of 6% over the life of the loan. All ARM loan products
have a maximum increase or decrease of 2% in any one year. As a supplement to
origination of ARM loans, the Association purchases ARMs from other institutions
when suitable loans can be found which meet its underwriting criteria.
The Association qualifies an ARM loan borrower based on the borrower's
ability to repay the loan using the fully indexed rate. As a result, the
Association believes that the potential for delinquencies and defaults on ARM
loans when rates adjust upwards is lessened.
6
The retention of ARM loans in the Association's loan portfolio helps reduce
the Association's exposure to changes in interest rates. There are, however,
unquantifiable credit risks resulting from the potential of increased costs due
to 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 with increased costs to the borrower. The ARM loans
originated by the Association generally provide, as a marketing incentive, for
initial rates of interest below the rates which would apply were the adjustment
index used for pricing initially (discounting). Increased risks of default or
delinquency could occur because of discounting the rate. Another consideration
is that although ARM loans allow the Association to increase the sensitivity of
its asset base to changes in the interest rates, the extent of this interest
sensitivity is limited by the periodic and lifetime interest rate adjustment
limits. Because of these considerations, the Association has no assurance that
yields on ARM loans will be sufficient to offset increases in the Association's
cost of funds.
The loan-to-value ratio, maturity and other provisions of the loans made by
the Association generally have reflected the policy of making loans in
accordance with sound lending practices, market conditions and underwriting
standards established by the Association. The Association's lending policies on
permanent residential one- to four-family mortgage loans generally limit the
maximum loan-to-value ratio to 97% of the lesser of the appraised value or
purchase price of the property. All permanent residential one- to four-family
mortgage loans in excess of an 80% loan-to-value ratio require private mortgage
insurance.
The Association also has a limited amount of non-owner-occupied permanent
residential one- to four-family mortgage loans in its portfolio. These loans are
underwritten using generally the same criteria as owner-occupied permanent
residential one- to four-family mortgage loans, except that the maximum
loan-to-value ratio is generally 80% of the lesser of the appraised value or
purchase price of the property and such loans are generally provided at an
interest rate higher than loans on owner-occupied residences.
The Association offers fixed-rate, permanent residential one- to
four-family mortgage loans with terms of 15 to 30 years. Substantially all
permanent one- to four-family loans have original contractual terms to maturity
of 30 years. Such loans are amortized on a monthly basis with principal and
interest due each month and customarily include "due-on-sale" clauses. The
Association enforces due-on-sale clauses to the extent permitted under
applicable laws. Substantially all of the Association's mortgage loan portfolio
consists of conventional loans.
Commercial and Multi-Family Real Estate Loans. The Association originates
loans secured by multi-family and commercial real estate and also purchases
participations in loans secured by multi-family and commercial real estate when
suitable investments can be found. See "-- Loan Originations, Purchases, and
Sales." At September 30, 2003, $32.0 million, or 5.57%, of the Association's
total loan portfolio before net items consisted of loans secured by existing
multi-family residential real estate and $125.7 million, or 21.86%, of the
Association's total loan portfolio before net items consisted of loans secured
by existing commercial real estate. The Association's commercial and
multi-family real estate loans primarily include loans secured by office
buildings, small shopping centers, churches, mini-storage warehouses and
apartment buildings. Substantially all of the Association's commercial and
multi-family real estate loans are secured by properties located in the
Association's primary market area. The average outstanding balance of commercial
and multi-family real estate loans was $312,617 at September 30, 2003, the
largest of which was a $4.5 million commercial loan secured by retail space.
Originations of commercial real estate and multi-family residential real estate
amounted to 17.19%,11.20% and 16.46% of the Association's total loan
originations in the fiscal years ended September 30, 2003, 2002, and 2001,
respectively. As part of the WAMU acquisition in September 2001, the Association
purchased $9.1 million in multi-family residential loans and $54.6 million in
commercial real estate loans. During the year ended September 30, 2003 the
Association purchased $3.9 million in commercial real estate participations. The
properties securing these loans were located within the Association's market
area.
The Association's commercial and multi-family loans generally have terms
which range up to 25 years and loan-to-value ratios of up to 75%. The
Association currently originates fixed and adjustable rate commercial and
multi-family real estate loans. Commercial real estate and multi-family
adjustable rate loans are priced to be competitive with other commercial lenders
in the Association's market area. A variety of terms are available to meet
specific commercial and multi-family residential financing needs. As of
September 30, 2003, $151.6 million, or 26.89%, after loans in process and
non-performing loans of other mortgage loans, including commercial and
multi-family residential real estate loans, had adjustable rates of interest.
7
Multi-family residential and commercial real estate lending is generally
considered to involve a higher degree of risk than permanent residential one- to
four-family lending. Such lending typically involves large loan balances
concentrated in a single borrower or groups of related borrowers. In addition,
the payment experience on loans secured by income-producing properties is
typically dependent on the successful operation of the related real estate
project and thus may be subject to a greater extent to adverse conditions in the
real estate market or in the economy generally. The Association generally
attempts to mitigate the risks associated with multi-family residential and
commercial real estate lending by, among other things, lending on collateral
located in its market area and following strict underwriting standards. Loans
considered for purchase are subjected to the same underwriting standards as
those originated by the Association.
Construction Loans. The Association makes construction loans to individuals
for the construction of their single-family residences. The Association also
makes loans to builders for the construction of single-family residences which
are not presold at the time of origination ("speculative loans") and for
construction of commercial properties. Speculative loans are scheduled to pay
off in 12 to 18 months. At September 30, 2003, construction loans amounted to
$16.7 million (including $804,912 of speculative loans), or 2.89%, of the
Association's total loan portfolio before net items. The Association purchased
$1.7 million in commercial construction loans from WAMU as part of the branch
purchase. During the construction phase, the borrower pays only interest on the
disbursed loan proceeds until maturity, when the total amount is due. The
Association's construction loan agreements generally provide that loan proceeds
are disbursed in increments as construction progresses. The Association
periodically reviews the progress of the underlying construction project through
physical inspections.
Construction financing is generally considered to involve a higher degree
of risk of loss than financing on improved, owner-occupied real estate because
of the uncertainties of construction, including the possibility of costs
exceeding the initial estimates and, in the case of speculative loans, the need
to obtain a purchaser. The Association has sought to minimize the risks
associated with construction lending by limiting construction loans to qualified
owner-occupied borrowers with construction performed by qualified state licensed
builders located primarily in the Association's market area. The Association's
underwriting criteria are designed to evaluate and minimize the risks of each
construction loan.
Loan proceeds are disbursed only as construction progresses and inspections
warrant. These loans are underwritten to the same standards and to the same
terms and requirements as one- to four-family purchase mortgage loans, except
the loans provide for disbursement of funds during a construction period of up
to one year. During this period, the borrower is required to make monthly
payments of accrued interest on the outstanding loan balance. Disbursements
during the construction period are limited to no more than the percent of
completion. Up to 97% loan-to-value upon completion of construction may be
disbursed if private mortgage insurance above 80% loan-to-value is in place.
Land Loans. The Association makes loans to individuals for the purpose of
acquiring land upon which to build their permanent residence. These loans
generally have 20 year amortization periods, with a balloon payment due in five
years, and maximum loan-to-value ratios of 80%. As of September 30, 2003, $8.1
million, or 1.40%, of the Association's total loan portfolio consisted of land
loans.
Commercial Business Lending. The purchase of the branches from WAMU in
September 2001 included significant commercial business loans as well as the
lending expertise needed for commercial lending activities. As a result,
commercial business lending has increased due to both loans purchased from WAMU
and new originations during fiscal 2003. The Association's commercial business
lending activities focus primarily on small to medium size businesses owned by
individuals well known to the Association and who reside in the Association's
primary market area. At September 30, 2003, commercial business loans amounted
to $58.0 million, or 10.08% of the total loan portfolio and 30.91% of total
non-real estate loans. Included in these loans are $14.1 million of agricultural
production loans. See "-- Agricultural Lending."
8
Commercial business loans may be unsecured loans, but generally are secured
by various types of business collateral other than real estate (such as,
inventory, equipment, etc.). In many instances, however, such loans are often
also secured by junior liens on real estate. Lines of credit are generally
renewable and made for a one-year term and are generally variable rate indexed
to the prime rate. Term loans are generally originated with three to five year
maturities, with a maximum of seven years, on a fully amortizing basis. As with
commercial real estate loans, the Association generally requires annual
financial statements from its commercial business borrowers and, if the borrower
is a corporation, personal guarantees from the principals.
Commercial business lending generally involves greater risk than
residential mortgage lending and involves risks that are different from those
associated with residential, commercial and multi-family 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 business loans
are often collateralized by equipment, inventory, accounts receivable or other
business assets, the liquidation of collateral in the event of a borrower
default is often not a sufficient 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
business loan primarily depends on cash flow and profitability of the business,
and creditworthiness of the borrower (and guarantors) and requires successful
operation and management of the business entity while liquidation of the
collateral is a secondary and sometimes insufficient source of repayment.
Consequently, repayment of such loans may be affected by adverse business or
economic conditions.
As part of its commercial business lending activities, the Association
issues standby letters of credit or
performance bonds as an accommodation to its borrowers.
Agricultural Lending. The Association did not offer loans on agricultural
properties or for agricultural production until the WAMU branch acquisition,
even though agriculture is a major industry in the Association's market area. As
part of the WAMU branch acquisition, the Association purchased $4.2 million of
agricultural real estate loans and $11.9 million of agricultural production
loans, as well as obtaining lending personnel with expertise in originating and
monitoring agricultural loans. At September 30, 2003, total agricultural loans
amounted to $23.5 million, or 4.08%, of the total loan portfolio; $9.4 million
of these loans were secured by real estate and the remaining $14.1 million are
agricultural production loans.
In underwriting agricultural operating loans, the Association considers the
cash flow of the borrower based upon the expected income stream as well as the
value of collateral used to secure the loan. Collateral generally consists of
livestock or cash crops produced by the farm, such as grains, corn, and alfalfa.
In addition to considering cash flow and obtaining a blanket security interest
in the farm's cash crop, the Association may also collateralize an operating
loan with the equipment, breeding stock, real estate, and federal agricultural
program payments to the borrower. Payments on agricultural operating loans
depend on the successful operation of the farm, which may be adversely affected
by weather conditions that limit crop yields, fluctuations in market prices for
agricultural products and livestock, and changes in government regulations and
subsidies.
Agricultural real estate loans primarily are secured by first liens on
farmland and improvements thereon located in the Association's market area to
service the needs of the Association's existing customers.
Among the greater and more common risks to agricultural lending can be
weather conditions and disease. These risks can be mitigated through multi-peril
crop insurance. Uncertain supplies of water in some market areas has the
potential to decrease yields and increase energy costs for the Association's
borrowers. However, very few of the Association's agricultural loans are secured
by real estate or operations in the Klamath Basin, which was affected by
curtailment of irrigation water during the summer of 2001, and those being
financed have liquid secondary sources of repayment. Commodity prices also
present a risk which may be reduced by the use of set price contracts.
9
Federal savings and loan associations are authorized to make loans secured
by business or agricultural real estate in amounts up to 400% of capital and to
make additional loans to businesses and farms (which may, but need not be
secured by real estate) in amounts up to 20% of assets provided that all loans
in excess of the 10% of assets must be made to small businesses and farms that
qualify as small businesses. Effective January 1, 2003, the OTS increased the
dollar amount limit in the definition of small business loans from $1 million to
$2 million and farm loans from $500,000 to $2 million. As of September 30, 2003,
the Association was well within the regulatory limits for such business loans.
Consumer and Other Lending. The Association originates a variety of
consumer loans. Such loans generally have shorter terms to maturity and higher
interest rates than mortgage loans. At September 30, 2003, the Association's
consumer loans totaled $129.6 million, or 22.53%, of the Association's total
loans. A total of $50.6 million in consumer loans were added to the portfolio as
part of the WAMU branch acquisition in September 2001. The Association's
consumer loans consist primarily of home improvement and equity loans,
automobile loans, boat and recreational vehicle loans, unsecured loans, and
deposit account loans.
The Association has placed increasing emphasis on the origination of
consumer loans due to their shorter terms and higher yields than residential
mortgage loans. Factors that may affect the ability of the Association to
increase its originations in this area include the demand for such loans,
interest rates and the state of the local and national economy.
The Association offers consumer lines of credit on either a secured or
unsecured basis. Secured lines of credit are generally secured by a second
mortgage on the borrower's primary residence. Secured and unsecured lines of
credit have interest rates that vary above the prime lending rate based on the
credit risk of the borrower, collateral, and loan amount. In both cases, the
rate adjusts monthly. The Association requires minimum payment of interest only,
and depending on the loan product, may require at least 2% of the unpaid
principal balance monthly. At September 30, 2003, $57.4 million was outstanding
on approved lines of credit.
The Association offers home equity and home improvement loans that are made
on the security of primary residences. Loans normally have terms of up to 15
years requiring monthly payments of principal and interest. At September 30,
2003, home equity loans and home improvement loans amounted to $112.2 million,
or 86.60% of consumer loans, and 19.51% of total loans.
At September 30, 2003, the Association's automobile loan portfolio amounted
to $5.5 million, or 4.26%, of consumer loans and less than 1% of total loans at
that date. The maximum term for the Association's automobile loans is 72 months
with the amount financed based upon a percentage of purchase price. The
Association generally requires all borrowers to maintain the automobile
insurance, including collision, fire and theft, with a maximum allowable
deductible and with the Association listed as loss payee.
At September 30, 2003, unsecured consumer loans amounted to $5.1 million,
or less than 1%, of total loans. These loans are made for a maximum of 48 months
or less with fixed rates of interest and are offered primarily to existing
customers of the Association.
Consumer loans potentially have a greater risk than do residential mortgage
loans, particularly in the case of loans that are unsecured or secured by
rapidly depreciating assets such as automobiles and other vehicles. In such
cases, any repossessed collateral for a defaulted consumer loan may not provide
an adequate source of repayment of the outstanding loan balance as a result of
the greater likelihood of damage, loss or depreciation. The remaining deficiency
often does not warrant further substantial collection efforts against the
borrower beyond obtaining a deficiency judgment. In addition, consumer loan
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by job loss, divorce, illness or
personal bankruptcy. Furthermore, the application of various federal and state
laws, including federal and state bankruptcy and insolvency laws, may limit the
amount that can be recovered on such loans. At September 30, 2003, the
Association had $60,217 in consumer loans accounted for on a nonaccrual basis.
Loan Maturity and Repricing. The following table sets forth certain
information at September 30, 2003 regarding the dollar amount of total loans,
after loans in process and non-performing loans, maturing in the Association's
portfolio, based on the contractual terms to maturity or repricing date. Demand
loans, loans having no stated schedule of repayments and no stated maturity, and
overdrafts are reported as due in one year or less.
10
After One Year
Within One Year Through 5 Years After 5 Years Total
(In thousands)
Permanent residential
one- to four-family:
Adjustable rate.......... $17,343 $24,229 $ -- $ 41,572
Fixed rate............... 4,118 1,496 156,290 161,904
Other mortgage loans:
Adjustable rate.......... 48,895 101,515 1,144 151,554
Fixed rate............... 402 8,163 12,804 21,369
Non-real estate loans:
Adjustable rate.......... 95,402 4,228 350 99,980
Fixed rate............... 2,922 16,526 67,758 87,206
Total loans............ $169,082 $156,157 $238,346 $563,585
Scheduled contractual amortization of loans does not reflect the actual
term of the Association's loan portfolio. The average life of loans is
substantially less than their contractual terms because of prepayments and
due-on-sale clauses, which gives the Association the right to declare a
conventional loan immediately due and payable in the event, among other things,
that the borrower sells the real property subject to the mortgage and the loan
is not repaid.
Loan Commitments. The Association issues commitments for fixed and
adjustable rate loans conditioned upon the occurrence of certain events. Such
commitments are made on specified terms and conditions and are honored for up to
60 days from commitment. The Association had outstanding loan commitments of
approximately $45.1 million at September 30, 2003 consisting of $24.8 million of
variable rate loans and $20.3 million of fixed rate loans. See Note 15 of the
Notes to Consolidated Financial Statements contained in Item 8 of this Report.
Loan Solicitation and Processing. The Association originates real estate
and other loans at each of its offices. Loan originations are obtained by a
variety of sources, including developers, builders, existing customers,
newspapers, radio, periodical advertising and walk-in customers, although
referrals from local realtors have been the primary source. Loan applications
are taken by lending personnel, and the loan processing department obtains
credit reports, appraisals and other documentation involved with a loan. All of
the Association's lending is subject to its written nondiscriminatory
underwriting standards, loan origination procedures and lending policies
prescribed by the Association's Board of Directors. Property valuations are
required on all real estate loans and are prepared by employees experienced in
the field of real estate or by independent appraisers approved by the
Association's Board of Directors. Additionally, all appraisals on loans in
excess of $250,000 must meet applicable regulatory standards.
The Association'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, 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 Association generally
requires title insurance on all loans and also that borrowers provide evidence
of fire and extended casualty insurance in amounts and through insurers that are
acceptable to the Association. A loan application file is first reviewed by a
loan officer of the Association, then is submitted to a credit officer with
appropriate underwriting authority for approval. Certain large loans, where the
borrower has aggregate debt with the Association of $1 million or more, are
reviewed by the Board of Directors. For those relationships in which the
aggregate debt with the Association is $3 million or greater, Board approval is
required prior to funding of the loan. The Association can generally make loan
commitments, subject to property valuation and possible other conditions of
approval, in three to five days if income and credit data of the borrower are
readily available.
11
Loan Originations, Purchases and Sales. The Association has originated a
majority of the loans in its portfolio. During the year ended September 30,
2003, the Association originated $428.2 million in total loans, compared to
$283.3 million during the same period of 2002. The higher level of loan
originations was attributable to decreasing interest rates which fueled
refinancing activity. The Association has a program to sell loans to Fannie Mae
and other lenders. Through this program, $99.1 million of primarily fixed rate
loans were sold during the year ended September 30, 2003, all of which were one-
to four-family mortgages. Servicing was not retained on the loans sold during
fiscal 2003. During the year ended September 30, 2002, the Company sold $68.7
million of fixed rate single family mortgages on the secondary market. Servicing
was not retained on these loans.
As noted previously, the Association purchased $179.3 million in loans from
WAMU as part of the branch acquisition.
The Association has also previously purchased permanent residential one- to
four-family mortgage loans on detached residences from various localities
throughout the western United States, primarily Oregon, Washington, and
California. These loans were underwritten on the same basis as permanent
residential one- to four-family real estate loans originated by the Association.
At September 30, 2003, the balance of these loans was $2.0 million.
The Association also purchases multi-family and commercial real estate
mortgage loans secured by properties within the Association's primary market
area. At September 30, 2003, the balance of such purchased loans was $16.6
million. These loans were underwritten on the same basis as similar loans
originated by the Association.
12
The following table shows total loans originated, purchased and sold, loan
reductions and the net increase in the Association's loans during the periods
indicated.
Year Ended September 30,
--------------------------------------
2003 2002 2001
---------- --------- --------
(In thousands)
Total net loans at beginning of period...... $607,465 $679,990 $729,037
Loans originated and purchased:
Real estate loans originated (1)........... 247,256 161,278 93,907
Real estate loans purchased................ 3,875 1,683 83,192
Non-real estate loans originated........... 117,073 120,388 42,586
Non-real estate loans purchased............ -- -- 99,720
-------- -------- --------
Total loans originated and purchased..... 428,204 283,349 319,405
Loan reductions:
Principal paydowns......................... (375,880) (287,526) (145,544)
Loans sold................................. (99,100) (68,661) (30,709)
Loans securitized.......................... - - (190,300)
Other reductions (2)....................... (3,138) 313 (1,899)
-------- -------- --------
Total loan reductions................... (478,118) (355,874) (368,452)
-------- -------- --------
Total net loans at end of period............ $557,551 $607,465 $679,990
======== ======== ========
<FN>
(1) Includes decreases/increases from loans-in-process.
(2) Includes net reductions due to deferred loans fees, discounts net of
amortization, provision for loan loss and transfers to real estate owned.
</FN>
Loan Origination and Other Fees. In addition to interest earned on loans,
the Association receives loan origination fees or "points" for originating
loans. Loan points are a percentage of the principal amount of the real estate
loan and are charged to the borrower in connection with the origination of the
loan. The amount of points charged by the Association varies, though it
generally is 1.00% on permanent loans and 1.75% on construction loans.
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
91, which deals with the accounting for non-refundable fees and costs associated
with originating or acquiring loans, the Association's loan origination fees and
certain related direct loan origination costs are offset, and the resulting net
amount is deferred and amortized as income over the contractual life of the
related loans as an adjustment to the yield of such loans, or until the loan is
paid in full. At September 30, 2003, the Association had $3.2 million of net
loan fees which had been deferred and are being recognized as income over the
contractual maturities of the related loans.
13
Asset Quality
Delinquent Loans. The following table sets forth information concerning
delinquent loans at September 30, 2003, in dollar amount and as a percentage of
the Association's total loan portfolio. The amounts presented represent the
total outstanding principal balances of the related loans, rather than the
actual payment amounts which are past due.
Permanent resident Commercial Commercial
1-4 family Real Estate Non-Real Estate Consumer Total
Amount Percentage Amount Percentage Amount Percentage Amount Percentage Amount Percentage
(Dollars in thousands)
Loans delinquent for
90 days and more.. $175 0.03% $ 103 0.02% $461 0.08% $60 0.01% $799 0.14%
Delinquency Procedures. When a borrower fails to make a required payment on
a loan, the Association attempts to cure the delinquency by contacting the
borrower. In the case of loans past due, appropriate late notices are generated
on the seventh and fifteenth days after the due date. If the delinquency is not
cured, the borrower is contacted by telephone the twenty-fifth day after the
payment is due.
For real estate loans, in the event a loan is past due for 30 days or more,
the Association will attempt to arrange an in-person interview with the borrower
to determine the nature of the delinquency; based upon the results of the
interview and its review of the loan status, the Association may negotiate a
repayment program with the borrower. If a loan remains past due at 60 days, the
Association performs an in-depth review of the loan status, the condition of the
property and the circumstances of the borrower. If appropriate, an alternative
payment plan is established. At 90 days past due, a letter prepared by the
Association is sent to the borrower describing the steps to be taken to collect
the loan, including acceptance of a voluntary deed-in-lieu of foreclosure, and
of the initiation of foreclosure proceedings. A decision as to whether and when
to initiate foreclosure proceedings is made by senior management, with the
assistance of legal counsel, and reviewed by the Board of Directors.
For commercial loans, the borrowers are assigned to a commercial lender who
is responsible for monitoring the relationship including collecting on
delinquencies. When necessary, repossession, foreclosure, or other action may be
taken including use of outside counsel.
For consumer loans, at 60 days past due a letter demanding payment is sent
to the borrower. If the delinquency is not cured prior to becoming 90 days past
due, repossession procedures are implemented for collateralized loans. At 90
days past due, consumer loans are generally charged off and sent to an outside
collection agency.
Nonaccrual, Past Due and Restructured Loans. The Association's
non-performing assets consist of nonaccrual loans, accruing loans greater than
90 days delinquent, real estate owned and other repossessed assets. All loans
are reviewed on a regular basis and are placed on a nonaccrual status when, in
the opinion of management, the collection of additional interest is deemed
insufficient to warrant further accrual. Generally, the Association places all
loans more than 90 days past due on nonaccrual status. Uncollectible interest on
loans is charged-off or an allowance for losses is established by a charge to
earnings equal to all interest previously accrued and interest is subsequently
recognized only to the extent cash payments are received until delinquent
interest is paid in full and, in management's judgment, the borrower's ability
to make periodic interest and principal payments is back to normal in which case
the loan is returned to accrual status.
Real estate acquired by foreclosure is classified as real estate owned
until such time as it is sold. See Note 1 of the Notes to Consolidated Financial
Statements contained Item 8 of this Report. When such property is acquired, it
is recorded at the lower of the balance of the loan on the property at the date
of acquisition (not to exceed the net realizable value) or the estimated fair
value. Costs, excluding interest, relating to holding the property are expensed
as incurred. Valuations are periodically performed by management and an
allowance for losses is established by a charge to operations if the carrying
value of the property exceeds its estimated net realizable value. From time to
time, the Association also acquires personal property which is classified as
other repossessed assets and is carried on the books at estimated fair market
value and disposed of as soon as commercially reasonable.
14
As of September 30, 2003, the Association's total nonaccrual loans amounted
to $799,476, or 0.14% of total loans, before net items, compared with $1.1
million, or 0.18% of total loans, before net items, at September 30, 2002.
Nonaccrual loans at September 30, 2003 by type are detailed in the table below.
The decrease in nonaccrual loans is primarily attributable to decreases in
nonaccrual commercial and consumer loans. The balance of these types of loans
increased considerably with the WAMU branch acquisition in 2001, resulting in
increased nonaccrual loans of these types for 2002.
At September 30, 2003, the Association had $67,290 in restructured loans.
Real estate owned decreased somewhat from the prior year due to sales of
properties held at September 30, 2002. Real estate owned at September 30, 2003
consists of one commercial property and one single-family residence.
The following table sets forth the amounts and categories of the
Association's non-performing assets at the dates indicated.
At September 30,
2003 2002 2001 2000 1999
(Dollars in thousands)
Non-accruing loans:
One- to four-family real estate ...... $175 $444 $270 $715 $915
Commercial real estate................ 461 353 -- -- 2,400
Commercial non-real estate............ 103 47 -- -- --
Consumer.............................. 60 247 -- 95 --
Accruing loans greater than 90
days delinquent......................... -- -- -- -- --
Total non-performing loans............ 799 1,091 270 810 3,315
Real estate owned......................... 645 717 446 788 1,495
Other repossessed assets.................. 6 42 -- -- --
Total repossessed assets.............. 651 759 446 788 1,495
Total non-performing assets........... $1,450 $1,850 $ 716 $1,598 $4,810
Total non-performing assets as a
percentage of total assets.............. 0.09% 0.12% 0.05% 0.16% 0.46%
Total non-performing loans as a
percentage of total loans,
before net items........................ 0.14% 0.18% 0.04% 0.21% 0.62%
Allowance for loan losses as a
percentage of total non-performing
assets.................................. 477.88% 398.70% 1110.47% 255.44% 51.64%
Allowance for loan losses as a percentage
of total non-performing loans........... 866.75% 676.08% 2944.81% 503.95% 74.93%
The allowance for loan losses as a percentage of both total non-performing
assets and total non-performing loans decreased significantly when comparing
September 30, 2003 and 2002 to September 30, 2001. These decreases are the
result of increases in non-performing loans and non-performing assets at
September 30, 2003 and 2002 when compared with September 30, 2001. In addition,
at September 30, 2001, the allowance balance was greatly increased due to the
loans purchased from WAMU. Because the majority of the loans purchased from WAMU
were commercial and consumer loans with higher associated risks, the allowance
increased, yet, because the loans were added in September 2001 there had not
been an impact causing the level of non-performing loans and assets to increase
by
15
September 30, 2002. At present, the performance of the purchased loans has
exceeded expectations and the Association believes that current reserves are
adequate to cover the risk in the portfolio based on current levels of
delinquency and non-performing assets.
For the year ended September 30, 2003, the amount of gross income that
would have been recorded in the period then ended if non-accrual loans and
troubled debt restructurings had been current according to their original terms,
and the amount of interest income on such loans that was included in net income
for each of such periods, were, in both cases, less than 1% of total interest
income.
Classified Assets. Federal regulations require that each insured savings
association classify its assets on a regular basis. In addition, in connection
with examinations of insured institutions, federal examiners have authority to
identify problem assets and, if appropriate, classify them. There are four
categories used to classify problem assets: "special mention," "substandard,"
"doubtful," and "loss." Special mention assets are not considered classified
assets, but are assets of questionable quality that have potential or past
weaknesses that deserve management's close attention and monitoring. 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 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 loss, the insured institution must either
establish specific allowances for loan losses in the amount of 100% of the
portion of the asset classified loss or charge-off such amount. General loss
allowances established to cover probable losses related to special mention
assets and assets classified substandard or doubtful may be included in
determining an institution's regulatory capital, while specific valuation
allowances for loan losses do not qualify as regulatory capital. Federal
examiners may disagree with an insured institution's classifications and the
amounts reserved.
As of September 30, 2003, total classified assets amounted to 0.16% of
total assets, a decrease from 0.30% at September 30, 2002. Assets classified
substandard at September 30, 2003 totaled $2.5 million and included $175,640 in
one- to four-family residential loans, $1.4 million in commercial real estate,
$185,486 in commercial non-real estate loans and $651,254 in foreclosed real
estate and other repossessed assets consisting of one single family residence, a
commercial property, and an automobile. Assets classified substandard at
September 30, 2002 totaled $4.4 million and included $353,781 in one- to
four-family construction loans, a $843,144 land development loan, $2.1 million
in commercial real estate and $758,663 in foreclosed real estate and other
repossessed assets consisting of five single family residences, a commercial
property and a boat. These problem assets were not concentrated in any one
market area.
Impaired Loans. Management generally identifies loans to be evaluated for
impairment when such loans are on nonaccrual status or have been restructured.
However, not all nonaccrual loans are impaired. In accordance with SFAS No. 114,
Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118,
loans are considered impaired when it is probable that the Association will be
unable to collect all amounts contractually due, including scheduled interest
payments. Factors involved in determining impairment include, but are not
limited to, the financial condition of the borrower, the value of underlying
collateral, and current economic conditions.
Allowance for Loan Losses. The allowance for loan losses is maintained at a
level considered adequate by management to provide for probable loan losses
based on management's assessment of various factors affecting the loan
portfolio, including a review of all loans for which full collectability may not
be reasonably assured, an overall evaluation of the quality of the underlying
collateral, economic conditions, historical loan loss experience and other
factors that warrant recognition in providing for an adequate loan loss
allowance. The level of allowance for loan losses is determined based on
stratifying the loan portfolio into based on internal loan loss rates startified
by loan type, the Company's internal risk ratings for individual commercial
loans, thrift industry charge off rates by loan type, and peer group levels of
allowance for loan losses. While management believes it uses the best
information available to determine the allowance for loan losses, unforeseen
market conditions could result in adjustments to the allowance for loan losses
and net earnings could be significantly affected if circumstances differ
substantially from the assumptions used in making the final determination. At
September 30, 2003, the Association had an allowance for loan losses of $6.9
million, which was equal to 477.88% of non-performing assets and 1.21% of total
loans. 16
Provisions for loan losses are charged to earnings to bring the total
allowance for loan losses to a level deemed appropriate by management.
Management considers historical loan loss experience, the volume and type of
lending conducted by the Association, industry standards, the amount of
non-performing assets, general economic conditions (particularly as they relate
to the Association's market area), and other factors related to the
collectibility of the Association's loan portfolio in their determination of the
adequacy of the allowance and the provision. The provisions for loan losses
charged against income for the years ended September 30, 2003, 2002 and 2001
were zero, $156,000, and $387,000 respectively. Management believes that the
amount maintained in the allowance will be adequate to absorb probable losses in
the portfolio.
The year ended September 30, 2001 included two transactions that affected
the allowance and provision for loan losses. The sale and securitization of
$190.3 million in fixed rate single family loans to Fannie Mae reduced the
required allowance on mortgage loans. In conjunction with the sale, $231,000 of
allowance was reclassified as part of the basis of the resulting mortgage-backed
securities. The reduction in the loan portfolio reduced the need for additional
allowance and thus the provision for loan losses was much lower this year than
the previous year. The WAMU acquisition added $179.3 million of loans to the
portfolio, a significant proportion of which were commercial and consumer loans.
These loans by nature have higher credit risk. As part of the acquisition, an
allowance for loan losses was established related to the acquired loans based on
the types of loans and the best information available regarding the factors
which may affect their collectibility. The higher balance of the allowance for
loan losses reflects these changes whereby a block of low risk single family
mortgage loans were sold and were replaced by a block of higher risk loans from
the acquired branches.
17
The following table sets forth for the periods indicated information
regarding changes in the Association's allowance for loan losses. All
information is before net items.
At or for the Year Ended September 30,
2003 2002 2001 2000 1999
(Dollars in thousands)
Total loans outstanding........................ $575,245 $622,361 $701,013 $750,909 $774,441
Average loans outstanding...................... $585,737 $660,246 $611,095 $747,842 $721,658
Allowance at beginning of period............... $ 7,376 $ 7,951 $ 4,082 $ 2,484 $ 1,950
Loans charged off:
One-to four-family........................ -- -- (3) -- --
Construction.............................. (7) -- (19) (32) --
Commercial real estate.................... -- (323) -- (559) (392)
Commercial business....................... (100) (134) (12) -- --
Consumer.................................. (400) (290) (56) (16) (6)
Total charge offs (507) (747) (90) (607) (398)
Recoveries of loans previously charged off:
Commercial real estate.................... -- -- 34 440 --
Commercial business....................... 21 -- -- -- --
Consumer.................................. 44 16 8 1 --
Total recoveries 65 16 42 441 --
Provision for loans losses..................... -- 156 387 1,764 932
Acquisitions................................... -- -- 3,761 -- --
Allowance reclassified with loan securitization -- -- (231) -- --
Allowance at end of period..................... $ 6,934 $ 7,376 $ 7,951 $ 4,082 $ 2,484
Allowance for loan losses as a percentage
of total loans outstanding.................... 1.21% 1.19% 1.13% 0.54% 0.31%
Ratio of net charge-offs to average loans
outstanding during the period................. 0.08% 0.11% 0.01% 0.02% 0.06%
18
The following table sets forth the breakdown of the allowance for loan
losses by loan category and summarizes the percentage of total loans, before net
items, in each category to total loans, before net items, at the dates
indicated.
At September 30,
2003 2002 2001
Percent of Percent of Percent of
Amount Allowance in Percent of Amount Allowance in Percent of Amount Allowance in Percent of
of Category to Total Loans of Category to Total Loans of Category to Total Loans
Allowance Total Loan by Category Allowance Total Loans by Category Allowance Total Loans by Category
(Dollars in thousands)
Permanent
residential One
to Four family.. $1,365 0.24% 34.04% $1,191 0.19% 54.53% $1,292 0.19% 60.12%
residential..... 386 0.07 5.57 528 0.09 3.47 540 0.08 3.32
Construction...... 201 0.03 2.89 422 0.07 2.45 12 0.01 3.09
Agriculture....... 113 0.02 1.63 169 0.03 0.79 158 0.02 0.60
Commercial
real estate..... 1,590 0.28 21.86 2,611 0.42 14.73 3,611 0.52 14.17
Land.............. 97 0.02 1.40 77 0.01 0.67 324 0.02 0.53
Commercial and
industrial...... 1,482 0.25 10.08 1,560 0.25 9.98 1,325 0.19 8.00
Consumer.......... 1,700 0.30 22.53 818 0.13 13.38 689 0.10 10.17
Total.......... $6,934 1.21% 100.00% $7,376 1.19% 100.00% $7,951 1.13% 100.00%
At September 30,
2000 1999
Percent of Percent of
Amount Allowance in Percent of Amount Allowance in Percent of
of Category to Total Loans of Category to Total Loans
Allowance Total Loan by Category Allowance Total Loans by Category
(Dollars in thousands)
Permanent
residential One
to Four family.. $1,449 0.19% 85.12% $1,103 0.14% 83.56%
Multi-family
residential..... 385 0.05 2.53 267 0.03 2.38
Construction...... 420 0.05 3.37 221 0.03 6.87
Agriculture....... -- - - -- - -
Commercial
real estate..... 1,403 0.19 5.63 730 0.09 4.79
Land.............. 168 0.02 0.45 28 -- 0.27
Commercial and
industrial...... 86 0.01 0.61 23 -- 0.44
Consumer.......... 191 0.03 2.29 112 0.02 1.69
Total.......... $4,082 0.54% 100.00% $2,484 0.31% 100.00%
19
Although the Association believes that it has established its allowance for
loan losses in accordance with accounting principles generally accepted in the
United States of America, there can be no assurance that regulators, in
reviewing the Association's loan portfolio, will not request the Association to
significantly increase its allowance for loan losses, thereby reducing the
Association's net worth and earnings. In addition, because future events
affecting borrowers and collateral cannot be predicted with certainty, there can
be no assurance that the existing allowance for loan losses is adequate or that
substantial increases will not be necessary should the quality of any loans
deteriorate as a result of the factors discussed above. Any material increase in
the allowance may adversely affect the Association's financial condition and
results of operation.
Investment Activities
Federally chartered savings institutions have the authority to invest in
securities of various federal agencies, certain insured certificates of deposit
of banks and savings institutions, certain bankers' acceptances, repurchase
agreements and federal funds. Subject to various restrictions, federally
chartered savings institutions may also invest their assets in commercial paper,
investment grade corporate debt securities and mutual funds whose assets conform
to the investments that a federally chartered savings institution is otherwise
authorized to make directly. OTS regulations restrict investments in corporate
debt securities of any one issuer in excess of 15% of the Association's
unimpaired capital and unimpaired surplus, as defined by federal regulations,
which totaled $105.8 million at September 30, 2003, plus an additional 10% if
the investments are fully secured by readily marketable collateral. See
"REGULATION OF THE ASSOCIATION -- Federal Regulation of Savings Associations --
Loans to One Borrower" for a discussion of additional restrictions on the
Association's investment activities.
The investment securities portfolio is managed in accordance with a written
investment policy adopted by the Board of Directors and administered by the
Investment Committee, which consists of the President and four Board members.
Generally, the investment policy is to invest funds among various categories of
investments and maturities based upon the need for liquidity, to achieve the
proper balance between its desire to minimize risk and maximize yield, and to
fulfill the asset/liability management policy. The President and the Chief
Financial Officer may independently invest up to 1.0% of total assets of the
Company within the parameters set forth in the Investment Policy, to be
subsequently reviewed with the Investment Committee or Board of Directors at its
next scheduled meeting. Transactions or investments in any one security
determined by type, maturity and coupon in excess of $10.0 million or 1.0% of
assets are not permitted without investment committee or board approval.
Investment securities held to maturity are carried at cost and adjusted for
amortization of premiums and accretion of discounts. As of September 30, 2003,
the Company had no held to maturity securities. Securities to be held for
indefinite periods of time and not intended to be held to maturity are
classified as available for sale and carried at fair value. Securities available
for sale include securities that management intends to use as part of its
asset/liability management strategy that may be sold in response to changes in
interest rates or significant prepayment risks or both. As of September 30,
2003, the portfolio of securities available for sale consisted of $44.6 million
in tax exempt securities issued by states and municipalities, $10.1 million in
FHLB obligations, $15.4 million in federal agency preferred stock, and $70.8
million in investment grade corporate investments.
During the year ended September 30, 2003, the Company recorded a $3.5
million loss related to recognition of other than temporary impairment of the
federal agency preferred stock.
During the years ended September 30, 2003, 2002, and 2001, neither the
Company nor the Association held any off-balance sheet derivative financial
instruments in their investment portfolios to which the provisions of SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities, would apply.
20
The following tables set forth certain information relating to the
investment securities portfolio held to maturity and securities available for
sale at the dates indicated.
At September 30,
2003 2002 2001
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
(In thousands)
Held to maturity:
State and municipal obligations............. $ -- $ -- $ -- $ -- $ 135 $ 137
Available for sale:
U.S. Government obligations................. -- -- -- -- 40,120 40,852
State and municipal obligations............. 42,242 44,585 39,578 42,026 32,951 33,640
FHLB obligations............................ 10,000 10,087 - - - --
Corporate obligations....................... 71,382 70,834 61,648 59,423 65,404 64,718
FHLMC preferred stock....................... 15,170 15,433 18,715 18,093 15,716 15,466
Total..................................... $138,794 $140,939 $119,941 $119,542 $154,326 $154,813
At September 30,
2003 2002 2001
Amortized Percent of Amortized Percent of Amortized Percent of
Cost Portfolio Cost Portfolio Cost Portfolio
(Dollars in thousands)
Held to maturity:
State and municipal obligations............. $ -- --% $ -- --% $ 135 0.09%
Available for sale:
U.S. Government obligations................. -- -- -- -- 40,120 26.00
State and municipal obligations............. 42,242 30.44 39,578 33.00 32,951 21.35
FHLB obligations............................ 10,000 7.20 - - - -
Corporate obligations....................... 71,382 51.43 61,648 51.40 65,404 42.38
FHLMC preferred stock....................... 15,170 10.93 18,715 15.60 15,716 10.18
Total..................................... $138,794 100.00% $119,941 100.00% $154,326 100.00%
The following table sets forth the maturities and weighted average yields
of the debt securities in the investment portfolio at September 30, 2003.
One Year After One Through After Five Through After Ten
or Less Five Years Ten Years Years
Amount Yield Amount Yield Amount Yield Amount Yield
(Dollars in thousands)
Available for sale:
State and municipal
obligations (1) $485 4.11% $-- - $2,182 4.10% $39,575 5.11%
FHLB obligations -- - 10,000 3.85% -- - -- -
Corporate obligations 11,860 4.04% 39,680 3.80% -- - 19,842 1.74%
FHLMC preferred stock -- - -- - -- - 15,170 2.75%
______ ______ ____ ______
Total $12,345 $49,680 $2,182 $74,587
<FN>
(1) Interest on state and municipal obligations is tax-exempt for federal income tax purposes. The yields reported have
not been calculated on a tax-equivalent basis.
</FN>
21
At September 30, 2003 the Company did not hold any securities from a single
issuer, other than the U.S. Government, whose aggregate book value was in excess
of 10% of the Company's shareholders' equity, or $12.0 million.
Mortgage-Backed and Related Securities
At September 30, 2003, the Company's net mortgage-backed and related
securities, all designated as available- for-sale, totaled $680.7 million at
fair value ($678.9 million at amortized cost) and had a weighted average yield
of 3.42%. At September 30, 2003, 20.58% of the mortgage-backed and related
securities were adjustable rate securities.
Mortgage-backed and related securities ("MBS") can be divided into two main
groups. The first group, called mortgage participation certificates or
pass-through certificates, typically represents a participation interest in a
pool of single-family or multi-family mortgages. The principal and interest
payments on these mortgages are passed from the mortgage originators, through
intermediaries (generally U.S. Government agencies and government sponsored
enterprises) that pool and resell the participation interests in the form of
securities, to investors such as the Company. Such U.S. Government agencies and
government sponsored enterprises, which guarantee the payment of principal and
interest to investors, primarily include the Federal Home Loan Mortgage
Corporation ("FHLMC"), Fannie Mae, the Government National Mortgage Association
("GNMA") and the U.S. Small Business Administration ("SBA").
The second group, called agency-backed collateralized mortgage obligations
("CMOs"), consists of securities created from and secured by the securities in
the first group described above. CMOs are an example of a security called a
derivative, because they are derived from mortgage pass-through securities.
Underwriters of CMOs create these securities by dividing up the interest and
principal cash flows from the pools of mortgages and selling these different
slices of cash flows as a new and different class of individual securities or
"tranches." At September 30, 2003, the Company held $285.2 million of CMOs,
comprised primarily of three classes, planned amortization class tranches
("PACs"), Sequentials, and Floaters. The least volatile CMOs are PACs. With
PACs, the yields, average lives, and lockout periods when no principal payments
are received are designed to be more stable and predictable than the actual
performance of the underlying MBS. PACs are available in a variety of short term
maturities, usually two, three, five, or seven years. Sequentials, as the name
implies, pay principal and interest sequentially. For example, the "A" tranche
receives payments of principal and interest first, while the "B" and "C"
tranches only receive interest until the "A" tranche principal par value is
completely paid. Then the "B" tranche begins receiving principal and interest
until all of its principal is paid, and so on. Sequential pay CMOs are created
to obtain a more predictable cash flow than the underlying simple pass-through
securities. However, the cash flow risk from the underlying pool remains the
same. CMO floaters are similar to adjustable rate mortgages; they carry an
interest rate that changes in a fixed relationship to an interest rate index,
typically the London Interbank Offer Rate ("LIBOR"). Floaters usually have caps
that determine the highest interest that can be paid by the securities. Except
for caps on Floaters, PACs and Floaters may help to manage interest rate risk by
reducing asset duration. They also may help manage price volatility since they
typically have short maturities or coupons that reset monthly or quarterly to
reflect changes in the index rate.
MBS typically are issued with stated principal amounts, and the securities
are backed by pools of mortgages that have loans with interest rates that fall
within a specific range and have varying maturities. MBS generally yield less
than the loans that underlie such securities because of the cost of payment
guarantees and credit enhancements. In addition, MBS are usually more liquid
than individual mortgage loans and may be used to collateralize certain
liabilities and obligations of the Company. These types of securities also
permit the Association to optimize its regulatory capital because they have low
risk weighting.
22
Expected maturities of MBS will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties. Prepayments that are faster than anticipated may
shorten the life of the security and may result in a loss of any premiums paid
and thereby reduce the net yield on such securities. Although prepayments of
underlying mortgages depend on many factors, including the type of mortgages,
the coupon rate, the age of mortgages, the geographical location of the
underlying real estate collateralizing the mortgages and general levels of
market interest rates, generally the difference between the interest rates on
the underlying mortgages and the prevailing mortgage interest rates is the most
significant determinant of the rate of prepayments. During periods of declining
mortgage interest rates, if the coupon rate of the underlying mortgages exceeds
the prevailing market interest rates offered for mortgage loans, refinancing
generally increases and accelerates the prepayment of the underlying mortgages
and the related security. Under such circumstances, the Company may be subject
to reinvestment risk because, to the extent that the Company's MBS amortize or
prepay faster than anticipated, the Company may not be able to reinvest the
proceeds of such repayments and prepayments at a comparable rate.
During the year ended September 30, 2002, MBS with a fair value of $376,335
were transferred from the held- to-maturity category to the available-for-sale
portfolio. The Company does not have plans to purchase or classify securities as
held-to-maturity in the foreseeable future.
The following tables set forth certain information relating to the
mortgage-backed and related securities portfolio held to maturity and available
for sale at the dates indicated.
At September 30,
2003 2002 2001
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
(In thousands)
Held to maturity:
GNMA........................................ $ -- $ -- $ -- $ -- $ 1,621 $ 1,642
Available for sale:
Fannie Mae.................................. 259,120 260,524 128,867 130,233 56,833 57,194
FHLMC....................................... 127,321 126,188 56,605 57,348 19,538 19,797
GNMA........................................ 8,809 8,775 24,346 24,593 6,816 6,977
CMOs........................................ 283,638 285,232 430,487 438,622 336,452 337,670
Total..................................... $678,888 $680,719 $640,305 $650,796 $421,260 $423,280
At September 30,
2003 2002 2001
Amortized Percent of Amortized Percent of Amortized Percent of
Cost Portfolio Cost Portfolio Cost Portfolio
(Dollars in thousands)
Held to maturity:
GNMA........................................ $ -- -- $ -- -- $ 1,621 0.38%
Available for sale:
Fannie Mae.................................. 259,120 38.17 128,867 20.13 56,833 13.49
FHLMC....................................... 127,321 18.75 56,605 8.84 19,538 4.64
GNMA........................................ 8,809 1.30 24,346 3.80 6,816 1.62
CMOs........................................ 283,638 41.78 430,487 67.23 336,452 79.87
Total..................................... $678,888 100.00% $640,305 100.00% $421,260 100.00%
Other Interest-Earning Assets
The Company has an other interest-earning asset of $457,000 earning 8.07%
and maturing in May 2112.
23
Interest-Earning Deposits
The Company had interest-earning deposits in the FHLB of Seattle amounting
to $613,016 and $5.9 million at September 30, 2003 and 2002, respectively.
Deposit Activities and Other Sources of Funds
General. Deposits are the primary source of the Association's funds for
lending and other investment purposes. In addition to deposits, the Association
derives funds from loan principal repayments. Loan repayments are a relatively
stable source of funds, while deposit inflows and outflows 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.
Deposits. The Association's deposits are attracted principally from within
the Association's primary market area through the offering of a broad selection
of deposit instruments, including checking accounts, negotiable order of
withdrawal ("NOW") accounts, money market deposit accounts, passbook and
statement savings accounts, and individual retirement account ("IRA")
certificates and certificates of deposit. Deposit account terms vary, with the
principal differences being the minimum balance required, the time period the
funds must remain on deposit and the interest rate.
The Association occasionally accepts deposits from outside its primary
market area through both private placements and brokered deposits if the terms
of the deposits fit the Association's specific needs and are at a rate lower
than the rates on similar maturity borrowings through the FHLB of Seattle. At
September 30, 2003, there were no such deposits.
Interest rates paid, maturity terms, service fees and withdrawal penalties
are established and reviewed on a periodic basis by the Association.
Determination of rates and terms are predicated on funds acquisition and
liquidity requirements, rates paid by competitors, growth goals and federal
regulations.
For the year ended September 30, 2003, the Association experienced a net
decrease in deposits (before interest credited) of $90.2 million. The majority
of the decrease relates to declining balances in certificates of deposit. During
fiscal 2003, the Association continued the conscious effort to reduce interest
expense on higher-priced certificate accounts resulting in a decrease of $106.6
million for certificates as they matured and were not renewed. Checking,
savings, and money market accounts increased $32.7 million during the year ended
September 30, 2003.
At September 30, 2003, certificate accounts maturing during the year ending
September 30, 2004 totaled $201.3 million. Based on historical experience, the
Association expects that a significant amount will be renewed with the
Association at maturity. In the event a significant amount of such accounts are
not renewed at maturity, the Association would not expect a resultant adverse
impact on operations and liquidity because of the Association's borrowing
capacity. See "-- Borrowings."
In the unlikely event the Association is liquidated, depositors will be
entitled to full payment of their deposit accounts prior to any payment being
made to the Company, which is the sole shareholder of the Association. The
majority of the Association's depositors are residents of the State of Oregon.
24
The following table indicates the amount of certificate accounts with
balances of $100,000 or greater by time remaining until maturity as of September
30, 2003.
Certificate
Maturity Period Accounts
(In thousands)
Three months or less............... $13,204
Over three through six months...... 8,618
Over six through twelve months..... 18,018
Over twelve months................. 44,169
Total.......................... $84,009
The following table sets forth the deposit balances in the various types of
deposit accounts offered by the Association at the dates indicated.
At September 30,
-----------------------------------------------------------------------------------------------
2003 2002 2001
---------------------------------- ------------------------------------ ---------------------
Percent Percent Percent
of Increase of Increase of
Amount Total (Decrease) Amount Total (Decrease) Amount Total
---------- ------ ---------- ----------- ------- ---------- --------- --------
(Dollars in thousands)
Certificates of deposit.......... $350,113 32.78% ($106,606) $456,719 39.99% ($87,161) $543,880 47.17%
Transaction accounts:
Non-interest checking............ 161,451 15.12 18,678 142,773 12.50 12,124 130,649 11.33
Interest-bearing checking........ 136,557 12.79 10,690 125,867 11.02 9,111 116,756 10.13
Passbook and statement savings... 93,311 8.74 7,310 86,001 7.53 8,355 77,646 6.74
Money market deposits............ 326,631 30.58 (4,015) 330,646 28.96 46,753 283,893 24.63
Total transaction accounts....... 717,950 67.22 32,663 685,287 60.01 76,343 608,944 52.83
Total deposits................... $1,068,063 100.00% ($73,943) $1,142,006 100.00% ($10,818) $1,152,824 100.00%
The following table sets forth the deposit activities of the Association
for the periods indicated.
Year Ended September 30,
2003 2002 2001
(Dollars in thousands)
Beginning balance........................ $1,142,006 $1,152,824 $695,381
Increase due to acquired deposits........ -- -- 423,457
Net inflow (outflow) of deposits before
interest credited....................... (90,208) (38,002) 6,902
Interest credited........................ 16,265 27,184 27,084
Net increase (decrease) in deposits...... (73,943) (10,818) 457,443
Ending balance........................... $1,068,063 $1,142,006 $1,152,824
25
Borrowings. Deposit liabilities are the primary source of funds for the
Association's lending and investment activities and for its general business
purposes. The Association may rely upon advances from the FHLB of Seattle,
reverse repurchase agreements and bank lines of credit to supplement its supply
of lendable funds and to meet deposit withdrawal requirements. The FHLB of
Seattle serves as the Association's primary borrowing source after deposits.
The FHLB of Seattle functions as a central reserve bank, providing credit
for savings and loan associations and certain other member financial
institutions. As a member, the Association is required to own capital stock in
the FHLB of Seattle and is authorized to apply for advances on the security of
certain of its mortgage loans and other assets (principally securities which are
obligations of, or guaranteed by, the U.S. Government) provided certain
creditworthiness standards have been met. Advances are made pursuant to several
different credit 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 on the financial condition of the member institution and the
adequacy of collateral pledged to secure the credit. As a member of the FHLB,
the Association maintains a credit line that is a percentage of its regulatory
assets, subject to collateral requirements. At September 30, 2003, the credit
line was 30% of total assets of the Association. The Company has pledged
mortgage-backed securities and collateralized mortgage obligations issued by the
U.S. government and agencies thereof as collateral for the borrowings.
The Company has established credit lines at two commercial banks. These
credit lines represent aggregate borrowing capacity of $16.7 million. At
September 30, 2003, there were no borrowings under these lines of credit.
The following table sets forth certain information regarding borrowings by
the Company and Association at the end of and during the periods indicated:
At September 30,
2003 2002 2001
Weighted average rate paid on:
FHLB advances............................... 3.74% 5.07% 5.73%
Short term borrowings....................... -- 4.75% 5.58%
Year Ended September 30,
2003 2002 2001
(Dollars in thousands)
Maximum amount outstanding at any month end:
FHLB advances............................... $369,000 $205,250 $173,000
Short term borrowings....................... 1,700 1,700 6,400
Approximate average balance:
FHLB advances............................... 231,256 168,333 170,521
Short term borrowings....................... 1,216 1,705 3,265
Approximate weighted average rate paid on:
FHLB advances............................... 4.71% 5.71% 5.90%
Short term borrowings....................... 4.43% 4.32% 8.22%
Subsidiaries. The Association established an operating subsidiary, Pacific
Cascades Financial, Inc., effective July 14, 2000. Pacific Cascades Financial,
Inc. is an Oregon chartered corporation, of which the Association owns 100% of
its capital stock. Pacific Cascades Financial serves as the Association's
trustee on deeds of trust and as trustee, handles normal reconveyance
transactions on paid-off Association loans and non-judicial foreclosures.
The Association also owns 100% of the capital stock of Klamath First
Financial Services, Inc. Klamath First Financial serves as an investment
subsidiary, providing investment and brokerage services to customers.
The Company established a subsidiary, Klamath First Capital Trust I, in
July 2001 for the purpose of issuing mandatorily redeemable preferred
securities. The Company also established Klamath First Capital Trust II in April
2002 for the purpose of issuing additional mandatorily redeemable preferred
securities. See Note 13 of the Notes to Consolidated Financial Statements
contained in Item 8 of this Report.
26
REGULATION OF THE ASSOCIATION
General
The Association is subject to extensive regulation, examination and
supervision by the OTS, as its chartering agency, and the FDIC, as the insurer
of its deposits. The activities of federal savings institutions are governed by
the Home Owners Loan Act ("HOLA") and, in certain respects, the Federal Deposit
Insurance Act, and the regulations issued by the OTS and the FDIC to implement
these statutes. These laws and regulations delineate the nature and extent of
the activities in which federal savings associations may engage. Lending
activities and other investments must comply with various statutory and
regulatory capital requirements. In addition, the Association's relationship
with its depositors and borrowers is also regulated to a great extent,
especially in such matters as the ownership of deposit accounts and the form and
content of the Association's mortgage documents. The Association is required to
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 the FDIC to review
the Association's compliance with various regulatory requirements. 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, the Association and their operations.
Federal Regulation of Savings Associations
Office of Thrift Supervision. The OTS is an office in the Department of the
Treasury subject to the general oversight of the Secretary of the Treasury. The
OTS has extensive authority over the operations of savings associations. Among
other functions, the OTS issues and enforces regulations affecting federally
insured savings associations and regularly examines these institutions.
All savings associations 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 association's total assets, including
consolidated subsidiaries. The Association's OTS assessment for the fiscal year
ended September 30, 2003 was $263,722.
Federal Home Loan Bank System. The FHLB System, consisting of 12 FHLBs, is
under the jurisdiction of the Federal Housing Finance Board ("FHFB"). The
designated duties of the FHFB are to supervise the FHLBs, to ensure that the
FHLBs carry out their housing finance mission, to ensure that the FHLBs remain
adequately capitalized and able to raise funds in the capital markets, and to
ensure that the FHLBs operate in a safe and sound manner.
The Association, as a member of the FHLB of Seattle, is required to acquire
and hold shares of capital stock in the FHLB of Seattle in an amount equal to
the greater of (i) 1.0% of the aggregate outstanding principal amount of
residential mortgage loans, home purchase contracts and similar obligations at
the beginning of each year, or (ii) 1/20 of its advances (i.e., borrowings) from
the FHLB of Seattle. The Association is in compliance with this requirement with
an investment in FHLB of Seattle stock of $17.2 million at September 30, 2003.
Among other benefits, the FHLB provides a central credit facility for
member institutions. It is funded primarily from proceeds derived from the sale
of consolidated obligations of the FHLB System. It makes advances to members in
accordance with policies and procedures established by the FHFB and the Board of
Directors of the FHLB of Seattle.
Federal Deposit Insurance Corporation. The FDIC is an independent federal
agency established originally to insure the deposits, up to prescribed statutory
limits, of federally insured banks and to preserve the safety and soundness of
the banking industry. The FDIC maintains two separate insurance funds: the Bank
Insurance Fund ("BIF") and the SAIF. The Association's deposit accounts are
insured by the FDIC under the SAIF to the maximum extent permitted by law. As
insurer of the Association's deposits, the FDIC has examination, supervisory and
enforcement authority over the Association.
27
As insurer, the FDIC imposes deposit insurance premiums and is authorized
to conduct examinations of and to require reporting by FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious risk
to the SAIF or the BIF. The FDIC also has the authority to initiate enforcement
actions against savings 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
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.
The premium schedule for BIF and SAIF insured institutions ranged from 0 to
27 basis points. However, SAIF insured institutions 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. This amount is
currently equal to about 1.70 points for each $100 in domestic deposits for SAIF
and BIF insured institutions. These assessments, which may be revised based upon
the level of BIF and SAIF deposits, will continue until the bonds mature in 2017
through 2019.
Under the Federal Deposit Insurance Act, insurance of deposits may be
terminated by the FDIC upon a finding that the institution has engaged in unsafe
or unsound practices, is in an unsafe or unsound condition to continue
operations or has violated any applicable law, regulation, rule, order or
condition imposed by the FDIC or the OTS. Management of the Association does not
know of any practice, condition or violation that might lead to termination of
deposit insurance.
Prompt Corrective Action. The OTS is required to take certain supervisory
actions against undercapitalized savings associations, 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." Compliance
with the plan must be guaranteed by any parent holding company in an amount of
up to the lesser of 5% of the institution's assets or the amount which would
bring the institution into compliance with all capital standards. 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. 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.
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At September 30, 2003, the Association was categorized as "well
capitalized" under the prompt corrective action regulations of the OTS.
Standards for Safety and Soundness. The federal banking regulatory agencies
have prescribed, by regulation, standards for all insured depository
institutions relating to: (i)-internal controls, information systems and
internal audit systems; (ii)-loan documentation; (iii)-credit underwriting;
(iv)-interest rate risk exposure; (v)-asset growth; (vi) asset quality; (vii)
earnings; and (viii)-compensation, fees and benefits ("Guidelines"). The
Guidelines set forth the safety and soundness standards that the federal banking
agencies use to identify and address problems at insured depository institutions
before capital becomes impaired. If the OTS determines that the Association
fails to meet any standard prescribed by the Guidelines, it may require the
Association to submit to the agency an acceptable plan to achieve compliance
with the standard. Management is aware of no conditions relating to these safety
and soundness standards which would require submission of a plan of compliance.
Qualified Thrift Lender Test. All savings associations, including the
Association, are required to meet a qualified thrift lender ("QTL") test to
avoid certain restrictions on their operations. This test requires a savings
association to have at least 65% of its portfolio assets (as defined by
regulation) in qualified thrift investments on a monthly average for nine out of
every 12 months on a rolling basis. As an alternative, the savings association
may maintain 60% of its assets in those assets specified in Section 7701(a)(19)
of the Internal Revenue Code ("Code"). Under either test, such assets primarily
consist of residential housing related loans and investments. At September 30,
2003, the Association met the qualified thrift investment test and its QTL
percentage was 79.63%.
Any savings association that fails to meet the QTL test must convert to a
national bank charter, unless it requalifies as a QTL and thereafter remains a
QTL. If an association does not requalify and converts to a national bank
charter, it must remain SAIF-insured until the FDIC permits it to transfer to
the BIF. If such an association has not yet requalified or converted to a
national bank, its new investments and activities are limited to those
permissible for both a savings association and a national bank, and it is
limited to national bank branching rights in its home state. In addition, the
association is immediately ineligible to receive any new FHLB borrowings and is
subject to national bank limits for payment of dividends. If such association
has not requalified or converted to a national bank within three years after the
failure, it must divest of all investments and cease all activities not
permissible for a national bank. In addition, it must repay promptly any
outstanding FHLB borrowings, which may result in prepayment penalties. If any
association that fails the QTL test is controlled by a holding company, then
within one year after the failure, the holding company must register as a bank
holding company and become subject to all restrictions on bank holding
companies. See "REGULATION OF THE COMPANY."
Capital Requirements. Federally insured savings associations, such as the
Association, are required to maintain a minimum level of regulatory capital. The
OTS has established capital standards, including a tangible capital requirement,
a leverage ratio (or core capital) requirement and a risk-based capital
requirement applicable to such savings associations.
The capital regulations require tangible capital of at least 1.5% of
adjusted total assets (as defined by regulation). At September 30, 2003, the
Association had tangible capital of $98.9 million, or 6.6% of adjusted total
assets, which is approximately $76.6 million above the minimum requirement of
1.5% of adjusted total assets in effect on that date. At September 30, 2003, the
Association had $36.7 million of intangible assets consisting of core deposit
intangible and goodwill related to the Wells Fargo branch acquisition in 1997
and the WAMU branch acquisition in 2001.
The capital standards also require core capital equal to at least 3% to 4%
of adjusted total assets, depending on an institution's supervisory rating. Core
capital generally consists of tangible capital. At September 30, 2003, the
Association had core capital equal to $98.9 million, or 6.6% of adjusted total
assets, which is $39.3 million above the minimum leverage ratio requirement of
4% as in effect on that date.
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The OTS risk-based requirement requires savings associations to have total
capital of at least 8% of risk-weighted assets. Total capital consists of core
capital, as defined above, and supplementary capital. Supplementary capital
consists of certain permanent and maturing capital instruments that do not
qualify as core capital and general valuation loan and lease loss allowances up
to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used
to satisfy the risk-based requirement only to the extent of core capital.
In determining the amount of risk-weighted assets, all assets, including
certain off-balance sheet items, are multiplied by a risk weight, ranging from
0% to 100%, based on the risk inherent in the type of asset. For example, the
OTS has assigned a risk weight of 50% for prudently underwritten permanent one-
to four- family first lien mortgage loans not more than 90 days delinquent and
having a loan-to-value ratio of not more than 80% at origination unless insured
to such ratio by an insurer approved by Fannie Mae or FHLMC.
On September 30, 2003, the Association had total risk-based capital of
approximately $105.8 million, including $98.9 million in core capital and $6.8
million in qualifying supplementary capital, and risk-weighted assets of $830.8
million, or total capital of 12.7% of risk-weighted assets. This amount was
$39.3 million above the 8% requirement in effect on that date.
The OTS is authorized to impose capital requirements in excess of these
standards on individual associations on a case-by-case basis. The OTS and the
FDIC are authorized and, under certain circumstances required, to take certain
actions against savings associations that fail to meet their capital
requirements. The OTS is generally required to take action to restrict the
activities of an "undercapitalized association" (generally defined to be one
with less than either a 4% core capital ratio, a 4% Tier 1 risked-based capital
ratio or an 8% risk-based capital ratio). Any such association must submit a
capital restoration plan and until such plan is approved by the OTS, may not
increase its assets, acquire another institution, establish a branch or engage
in any new activities, and generally may not make capital distributions. The OTS
is authorized to impose the additional restrictions that are applicable to
significantly undercapitalized associations.
The OTS is also generally authorized to reclassify an association into a
lower capital category and impose the restrictions applicable to such category
if the institution is engaged in unsafe or unsound practices or is in an unsafe
or unsound condition.
The imposition by the OTS or the FDIC of any of these measures on the
Company or the Association may have a substantial adverse effect on their
operations and profitability.
Limitations on Capital Distributions. The OTS imposes various restrictions
on savings associations with respect to their ability to make distributions of
capital, which include dividends, stock redemptions or repurchases, cash-out
mergers and other transactions charged to the capital account. The OTS also
prohibits a savings association from declaring or paying any dividends or from
repurchasing any of its stock if, as a result of such action, the regulatory
capital of the association would be reduced below the amount required to be
maintained for the liquidation account established in connection with the
association's mutual to stock conversion.
The Association may make a capital distribution without OTS approval
provided that the Association notifies the OTS 30 days before it declares the
capital distribution and that the following requirements are met: (i) the
Association has a regulatory rating in one of the two top examination
categories, (ii) the Association is not of supervisory concern, and will remain
adequately or well capitalized, as defined in the OTS prompt corrective action
regulations, following the proposed distribution, and (iii) the distribution
does not exceed the Association's net income for the calendar year-to-date plus
retained net income for the previous two calendar years (less any dividends
previously paid). If the Association does not meet these stated requirements, it
must obtain the prior approval of the OTS before declaring any proposed
distributions.
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In the event the Association's capital falls below its regulatory
requirements or the OTS notifies it that it is in need of more than normal
supervision, the Association's ability to make capital distributions will be
restricted. In addition, no distribution will be made if the Association is
notified by the OTS that a proposed capital distribution would constitute an
unsafe and unsound practice, which would otherwise be permitted by the
regulation.
Loans to One Borrower. Federal law provides that savings institutions are
generally subject to the national bank limit on loans to one borrower. A savings
institution may not make a loan or extend credit to a single or related group of
borrowers in excess of 15% of its unimpaired capital and surplus. An additional
amount may be lent, equal to 10% of unimpaired capital and surplus, if secured
by specified readily-marketable collateral. At September 30, 2003, the
Association's limit on loans to one borrower was $15.9 million. At September 30,
2003, the Association's largest aggregate amount of loans to one borrower was
$7.0 million, all of which were performing according to their original terms.
Activities of Associations and Their Subsidiaries. When a savings
association establishes or acquires a subsidiary or elects to conduct any new
activity through a subsidiary that the association controls, the savings
association must notify the FDIC and the OTS 30 days in advance and provide the
information each agency may, by regulation, require. Savings associations also
must conduct the activities of subsidiaries in accordance with existing
regulations and orders.
The OTS may determine that the continuation by a savings association of its
ownership or 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 association 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. Savings associations must comply with
Sections 23A and 23B of the Federal Reserve Act relative to transactions with
affiliates in the same manner and to the same extent as if the savings
association were a Federal Reserve member association. Generally, transactions
between a savings association or its subsidiaries and its affiliates are
required to be on terms as favorable to the association as transactions with
non-affiliates. In addition, certain of these transactions, such as loans to an
affiliate, are restricted to a percentage of the association's capital.
Affiliates of the Association include the Company and any company which is under
common control with the Association. In addition, a savings association may not
lend to any affiliate engaged in activities not permissible for a savings
association holding company or acquire the securities of most affiliates. The
OTS has the discretion to treat subsidiaries of savings associations as
affiliates on a case by case basis.
Certain transactions with directors, officers or controlling persons are
also subject to conflict of interest regulations enforced by the OTS. These
conflict of interest regulations and other statutes also impose restrictions on
loans to such persons and their related interests. Among other things, such
loans must be made on terms substantially the same as for loans to unaffiliated
individuals.
Community Reinvestment Act. Under the federal Community Reinvestment Act
("CRA"), all federally- insured financial institutions have a continuing and
affirmative obligation consistent with safe and sound operations to help meet
all the credit needs of its delineated community. The CRA does not establish
specific lending requirements or programs nor does it limit an institution's
discretion to develop the types of products and services that it believes are
best suited to meet all the credit needs of its delineated community. The CRA
requires the federal banking agencies, in connection with regulatory
examinations, to assess an institution's record of meeting the credit needs of
its delineated community and to take such record into account in evaluating
regulatory applications to establish a new branch office that will accept
deposits, relocate an existing office, or merge or consolidate with, or acquire
the assets or assume the liabilities of, a federally regulated financial
institution, among others. The CRA requires public disclosure of an
institution's CRA rating. The Association received a "satisfactory" rating as a
result of its latest evaluation.
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Regulatory and Criminal Enforcement Provisions. The OTS has primary
enforcement responsibility over savings institutions and has the authority to
bring action against all "institution-affiliated parties," including
stockholders, 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 $27,500 per day, or
$1.1 million per day in especially egregious cases. Under the FDIA, 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.
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REGULATION OF THE COMPANY
General
The Company is a unitary savings and loan holding company within the
meaning of the HOLA. As such, it is registered with the OTS and is subject to
OTS regulations, examinations, supervision and reporting requirements. The
Company is also subject to the information, proxy solicitation, insider trading
restrictions, and other requirements of the Securities Exchange Act of 1934, as
amended.
Company Acquisitions
The HOLA and OTS regulations issued thereunder generally prohibit a savings
and loan holding company, without prior OTS approval, from acquiring more than
5% of the voting stock of any other savings association or savings and loan
holding company or controlling the assets thereof. They also prohibit, among
other things, any director or officer of a savings and loan holding company, or
any individual who owns or controls more than 25% of the voting shares of such
holding company, from acquiring control of any savings association not a
subsidiary of such savings and loan holding company, unless the acquisition is
approved by the OTS.
Holding Company Activities
As a unitary savings and loan holding company, the Company generally is not
subject to activity restrictions. If the Company acquires control of another
savings association as a separate subsidiary, it would become a multiple savings
and loan holding company. There generally are more restrictions on the
activities of a multiple savings and loan holding company than a unitary savings
and loan holding company. Specifically, if either federally insured subsidiary
savings association fails to meet the QTL test, the activities of the Company
and any of its subsidiaries (other than the Company or other federally insured
subsidiary savings associations) would thereafter be subject to further
restrictions. The HOLA provides that, among other things, no multiple savings
and loan holding company or subsidiary thereof which is not an insured
association shall commence or continue for more than two years after becoming a
multiple savings and loan association holding company or subsidiary thereof, any
business activity other than: (i) furnishing or performing management services
for a subsidiary insured institution, (ii) conducting an insurance agency or
escrow business, (iii) holding, managing, or liquidating assets owned by or
acquired from a subsidiary insured institution, (iv) holding or managing
properties used or occupied by a subsidiary insured institution, (v) acting as
trustee under deeds of trust, (vi) those activities previously directly
authorized by regulation as of March 5, 1987 to be engaged in by multiple
holding companies or (vii) those activities authorized by the Federal Reserve
Board as permissible for bank holding companies, unless the OTS by regulation,
prohibits or limits such activities for savings and loan holding companies.
Those activities described in (vii) above also must be approved by the OTS prior
to being engaged in by a multiple holding company.
Recent Federal Legislation
Gramm-Leach-Bliley Financial Services Modernization Act of 1999. On
November 12, 1999, the Gramm- Leach-Bliley Financial Services Modernization Act
of 1999 ("GLBA") was signed into law. The purpose of this legislation is to
modernize the financial services industry by establishing a comprehensive
framework to permit affiliations among commercial banks, insurance companies,
securities firms and other financial service providers. Generally, the GLBA:
a. repealed the historical restrictions and eliminates many federal and
state law barriers to affiliations among banks, securities firms,
insurance companies and other financial service providers;
b. provided a uniform framework for the functional regulation of the
activities of banks, savings institutions and their holding companies;
c. broadened the activities that may be conducted by national banks,
banking subsidiaries of bank holding companies and their financial
subsidiaries;
d. provided an enhanced framework for protecting the privacy of consumer
information;
33
e. adopted a number of provisions related to the capitalization,
membership, corporate governance and other measures designed to
modernize the FHLB system;
f. modified the laws governing the implementation of the CRA; and
g. addressed a variety of other legal and regulatory issues affecting
day-to-day operations and long-term activities of financial
institutions.
The GLBA also imposes certain obligations on financial institutions to
develop privacy policies, restrict the sharing of nonpublic customer data with
nonaffiliated parties at the customer's request, and establish procedures and
practices to protect and secure customer data. These privacy provisions were
implemented by regulations that were effective on November 12, 2000. Compliance
with the privacy provisions was required by July 1, 2001.
The USA Patriot Act. In response to the terrorist events of September 11th,
2001, President George W. Bush signed into law the Uniting and Strengthening
America by Providing Appropriate Tools Required to Intercept and Obstruct
Terrorism Act of 2001, or the USA PATRIOT Act, on October 26, 2001. The USA
PATRIOT Act gives the federal government new powers to address terrorist threats
through enhanced domestic security measures, expanded surveillance powers,
increased information sharing, and broadened anti-money laundering requirements.
By way of amendments to the Bank Secrecy Act, Title III of the USA PATRIOT Act
takes measures intended to encourage information sharing among bank regulatory
agencies and law enforcement bodies. Further, certain provisions of Title III
impose affirmative obligations on a broad range of financial institutions,
including banks, thrifts, brokers, dealers, credit unions, money transfer agents
and parties registered under the Commodity Exchange Act.
Among other requirements, Title III of the USA PATRIOT Act imposes the
following requirements with respect to financial institutions:
- Pursuant to Section 352, all financial institutions must establish
anti-money laundering programs that include, at minimum: (i) internal policies,
procedures, and controls, (ii) specific designation of an anti-money laundering
compliance officer, (iii) ongoing employee training programs, and (iv) an
independent audit function to test the anti- money laundering program.
- Section 326 of the Act authorizes the Secretary of the Department of
Treasury, in conjunction with other bank regulators, to issue regulations by
October 26, 2002 that provide for minimum standards with respect to customer
identification at the time new accounts are opened.
- Section 312 of the Act requires financial institutions that establish,
maintain, administer, or manage private banking accounts or correspondent
accounts in the United States for non-United States persons or their
representatives (including foreign individuals visiting the United States) to
establish appropriate, specific, and, where necessary, enhanced due diligence
policies, procedures, and controls designed to detect and report money
laundering.
- Effective December 25, 2001, financial institutions are prohibited from
establishing, maintaining, administering or managing correspondent accounts for
foreign shell banks (foreign banks that do not have a physical presence in any
country), and will be subject to certain recordkeeping obligations with respect
to correspondent accounts of foreign banks.
- Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on Federal Reserve Act
and Bank Merger Act applications.
The Association has implemented a Customer Identification porgram pursuant
to the regualtions under the USA PATRIOT Act. The impact to the Company and the
Association has not been material.
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley
Act") was signed into law by President Bush on July 30, 2002 in response to
public concerns regarding corporate accountability in connection with the recent
accounting scandals at Enron and WorldCom. 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.
34
The Sarbanes-Oxley Act is the most far-reaching U.S. securities legislation
enacted in some time. 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 ("Exchange Act").
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
other related rules and mandates further studies of certain issues by the SEC
and the Comptroller General. 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.
The Sarbanes-Oxley Act addresses, among other matters:
- audit committees;
- certification of financial statements by the chief executive
officer and the chief financial officer;
- the forfeiture of bonuses or other incentive-based compensation
and profits from the sale of an issuer's securities by directors
and senior officers in the twelve month period following initial
publication of any financial statements that later require
restatement;
- a prohibition on insider trading during pension plan black out
periods;
- disclosure of off-balance sheet transactions;
- a prohibition on personal loans to directors and officers;
- expedited filing requirements for Form 4s;
- disclosure of a code of ethics and filing a Form 8-K for a change
or waiver of such code;
- "real time" filing of periodic reports
- the formation of a public accounting oversight board;
- auditor independence; and
- various increased criminal penalties for violations of securities
laws.
The Sarbanes-Oxley Act contains provisions which became effective upon
enactment on July 30, 2002 and provisions which will become effective from
within 30 days to one year from enactment. The SEC has been delegated the task
of enacting rules to implement various of the provisions with respect to, among
other matters, disclosure in periodic filings pursuant to the Exchange Act.
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Affiliate Restrictions
The affiliate restrictions contained in Sections 23A and 23B of the Federal
Reserve Act apply to all federally insured savings associations and any such
"affiliate." A savings and loan holding company, its subsidiaries and any other
company under common control are considered affiliates of the subsidiary savings
association under the HOLA. Generally, Sections 23A and 23B: (i) limit the
extent to which the insured association or its subsidiaries may engage in
certain covered transactions with an affiliate to an amount equal to 10% of such
institution's capital and surplus, and contain an aggregate limit on all such
transactions with all affiliates to an amount equal to 20% of such capital and
surplus, and (ii) require that all such transactions be on terms substantially
the same, or at least as favorable to the institution or subsidiary, as those
provided to a non-affiliate. The term "covered transaction" includes the making
of loans, purchase of assets, issuance of a guarantee and other similar types of
transactions. Also, a savings association may not make any loan to an affiliate
unless the affiliate is engaged only in activities permissible for bank holding
companies. Only the Federal Reserve may grant exemptions from the restrictions
of Sections 23A and 23B. The OTS, however, may impose more stringent
restrictions on savings associations for reasons of safety and soundness.
Qualified Thrift Lender Test
The HOLA requires any savings and loan holding company that controls a
savings association that fails the QTL test, as explained under "REGULATION OF
THE ASSOCIATION - Federal Regulation of Savings Associations -- Qualified Thrift
Lender Test," to, within one year after the date on which the association ceases
to be a QTL, register as and be deemed a bank holding company subject to all
applicable laws and regulations.
TAXATION
Federal Taxation
General. The Company and the Association report their income on a fiscal
year basis using the accrual method of accounting and are subject to federal
income taxation in the same manner as other corporations, with some exceptions.
The following discussion of tax matters is intended only as a summary and does
not purport to be a comprehensive description of the tax rules applicable to the
Company and the Association.
Bad Debt Reserve. Historically, savings institutions such as the
Association which met certain definitional tests primarily related to their
assets and the nature of their business ("qualifying thrift") were permitted to
establish a reserve for bad debts and to make annual additions thereto, which
may have been deducted in arriving at their taxable income. The Association's
deductions with respect to "qualifying real property loans," which are generally
loans secured by certain interest in real property, were computed using an
amount based on the Association's actual taxable income, computed with certain
modifications and reduced by the amount of any permitted additions to the non-
qualifying reserve. Each year, the Association selected the most favorable way
to calculate the deduction attributable to an addition to the tax bad debt
reserve.
The provisions repealing the current thrift bad debt rules were passed by
Congress as part of "The Small Business Job Protection Act of 1996." The new
rules eliminated the 8% of taxable income method for deducting additions to the
tax bad debt reserves for all thrifts for tax years beginning after December 31,
1995. These rules also require that all institutions recapture all or a portion
of their bad debt reserves added since the base year (last taxable year
beginning before January 1, 1988). The Association has previously recorded a
deferred tax liability equal to the bad debt recapture and as such the new rules
will have no effect on net income or federal income tax expense. For taxable
years beginning after December 31, 1995, the Association's bad debt deduction
will be determined on the basis of net charge-offs during the taxable year. The
new rules allow an institution to suspend bad debt reserve recapture for the
1996 and 1997 tax years if the institution's lending activity for those years is
equal to or greater than the institution's average mortgage lending activity for
the six taxable years preceding 1996 adjusted for inflation. For this purpose,
only home purchase or home improvement loans are included and the institution
can elect to have the tax years with the highest and lowest lending activity
removed from the average calculation. If an institution is permitted to postpone
the reserve recapture, it must begin its six year recapture no later than the
1998 tax year (fiscal year ending September 30, 1999 for the Company). The
unrecaptured base year reserves will not be subject to recapture as long as the
institution continues to carry on the business of banking. In addition, the
balance of the pre-1988 bad debt reserves continue to be subject to provisions
of present law referred to below that require recapture in the case of certain
excess distributions to shareholders.
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Distributions. To the extent that the Association makes "nondividend
distributions" to the Company, such distributions will be considered to result
in distributions from the balance of its bad debt reserves as of December 31,
1987 (or a lesser amount if the Association's loan portfolio decreased since
December 31, 1987) and then from the supplemental reserve for losses on loans
("Excess Distributions"), and an amount based on the Excess Distributions will
be included in the Association's taxable income. Nondividend distributions
include distributions in excess of the Association's current and accumulated
earnings and profits, distributions in redemption of stock and distributions in
partial or complete liquidation. However, dividends paid out of the
Association's current or accumulated earnings and profits, as calculated for
federal income tax purposes, will not be considered to result in a distribution
from the Association's bad debt reserve. The amount of additional taxable income
created from an Excess Distribution is an amount that, when reduced by the tax
attributable to the income, is equal to the amount of the distribution. The
Association does not intend to pay dividends that would result in a recapture of
any portion of its tax bad debt reserve.
Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986, as
amended ("Code"), imposes a tax on alternative minimum taxable income ("AMTI")
at a rate of 20%. The excess of the tax bad debt reserve deduction using the
percentage of taxable income method over the deduction that would have been
allowable under the experience method is treated as a preference item for
purposes of computing AMTI. In addition, only 90% of AMTI can be offset by net
operating loss carryovers. AMTI is increased by an amount equal to 75% of the
amount by which the Association's adjusted current earnings exceeds its AMTI
(determined without regard to this preference and prior to reduction for net
operating losses). For taxable years beginning after December 31, 1986, and
before January 1, 1996, an environmental tax of 0.12% of the excess of AMTI
(with certain modification) over $2.0 million is imposed on corporations,
including the Association, whether or not an Alternative Minimum Tax ("AMT") is
paid.
Dividends-Received Deduction. The Company may exclude from its income 100%
of dividends received from the Association as a member of the same affiliated
group of corporations. The corporate dividends-received deduction is generally
70% in the case of dividends received from unaffiliated corporations with which
the Company and the Association will not file a consolidated tax return, except
that if the Company or the Association owns more than 20% of the stock of a
corporation distributing a dividend, then 80% of any dividends received may be
deducted.
Other Federal Tax Matters. During the year ended September 30, 2003, the
Internal Revenue Service performed an audit of the returns for the tax year 1999
(year ended September 30, 2000). The audit was completed during the year and
resulted in no change to the tax return as filed.
State Taxation
The Company and the Association are subject to an Oregon corporate excise
tax at a statutory rate of 6.6% of income. Neither the Company's nor the
Association's Oregon state income tax returns have been audited during the past
five years. The Association is subject to Washington State Business and
Organization tax at the rate of 1.5% of gross receipts for the operations in
that state. There have not been any audits of the Company's Washington state tax
returns during the past five years.
Competition
The Association originates most of its loans to and accepts most of its
deposits from residents of its market area. The Association is the oldest
financial institution headquartered in Klamath Falls. The Association believes
that it is a major competitor in the markets in which it operates. Nonetheless,
the Association faces competition in attracting deposits and making real estate
loans from various financial institutions, including banks, savings associations
and mortgage brokers. In addition, the Association has faced additional
significant competition for investors' funds from short-term money market
securities and other corporate and government securities. The financial
institution industry in the Association's market area is characterized by a mix
of local independent financial institutions and offices of larger out-of-state
financial institutions, including several multi-national bank holding companies.
The ability of the Association to attract and retain savings deposits depends on
its ability to generally provide a rate of return and liquidity risk comparable
to that offered by competing investment opportunities. The Association competes
for loans principally through the interest rates and loan fees it charges and
the efficiency and quality of services it provides borrowers. Competition may
increase as restrictions on the interstate operations of financial institutions
continue to be reduced.
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Personnel
As of September 30, 2003, the Association had 418 full-time and 92
part-time employees. The employees are not represented by a collective
bargaining unit. The Association believes its relationship with its employees is
good.
Executive Officers. The following table sets forth certain information
regarding the executive officers of the Company.
Name Age(1) Position
Kermit K. Houser 60 President and Chief Executive Officer
Marshall J. Alexander 52 Executive Vice President and Chief Financial Officer
Ben A. Gay 56 Executive Vice President and Chief Credit Officer
Frank X. Hernandez 48 Senior Vice President and Chief Operations Officer
Craig M Moore 46 Senior Vice President/Chief Auditor/Corporate Counsel/Secretary
Walter F. Dodrill 52 Senior Vice President - Business Banking
James E. Essany 49 Senior Vice President - Corporate Marketing Director
Nina G. Drake 50 Vice President - Human Resource Manager
<FN>
______________
(1) At September 30, 2003.
</FN>
Kermit K. Houser has served as President and Chief Executive Officer of the
Company and the Association since November 2000. Mr. Houser was previously
employed in various capacities by the Bank of America from 1983 to November
2000, as senior vice president and manager for commercial banking, executive
vice president and senior credit officer, and most recently, as senior vice
president and market executive for Bank of America's South Valley commercial
banking, in Fresno, California. Mr. Houser has 32 years of experience in
banking, and has been an active member of numerous civic and community
organizations.
Marshall J. Alexander has 28 years of banking experience, including 17
years with the Association. He has served as Vice President and Chief Financial
Officer since August 1994 and was named an Executive Vice President in December
2000.
Ben A. Gay joined Klamath First in September 2001 after a 30-year career in
commercial banking and finance, on both the East and West coasts. Mr. Gay has
served in a variety of managerial positions in lending, credit risk and loan
management and has most recently served as a western regional executive for
credit risk management for Bank of America.
Frank X. Hernandez has been employed by the Association since 1992. He
served as Human Resources Officer until July 1998 when he was appointed Senior
Vice President and Chief Operating Officer. He has 22 years' experience in
banking operations.
38
Craig M Moore has a banking career of more than 25 years, with six of
those years at Klamath First. He is an attorney, a Certified Internal Auditor
and a Certified Financial Services Auditor.
Walter F. Dodrill has served as Senior Vice President and Manager of the
Business Banking Group of the Company since January 2002. Mr. Dodrill was
previously employed by Western Bank from February 1974 to December 2001. Western
Bank became a division of Washington Mutual in January 1996. Mr. Dodrill served
as Senior Vice President - Regional Credit Administrator and Senior Vice
President - Regional Manager for Western Bank. Mr. Dodrill has 30 years of
experience in banking and has been active in civic and community organizations.
James E. Essany is a native of Gary, Indiana and a graduate of Indiana
University with a Bachelor's of Science in Marketing. He began his banking
career in 1979 and worked with three financial institutions in Indiana before
joining Klamath First in May of 2000.
Nina G. Drake joined Klamath First in June 2002 as Vice President-Human
Resources. Prior to joining Klamath First, Ms. Drake attended the University of
New Mexico and earned her Master of Business Administration (MBA). She has 24
years experience in human resource management in financial institutions and
related service industries and holds a lifetime certification as a Senior
Professional in Human Resource Management (SPHR).
39
Item 2. Properties
The following table sets forth the location of the Association's offices
and other facilities used in operations as well as certain additional
information relating to these offices and facilities as of September 30, 2003.
See note below regarding the subsequent sale of seven branches to Bank of
Eastern Oregon
Year Square
Description/Address Opened Leased/Owned Footage
Main Office
540 Main Street 1939 Owned 25,660
Klamath Falls, Oregon
Branch Offices
2943 South Sixth Street 1972 Owned 3,820
Klamath Falls, Oregon
2420 Dahlia Street 1979 Owned 1,876
Klamath Falls, Oregon
512 Walker Avenue 1977 Owned 4,216
Ashland, Oregon
1420 East McAndrews Road 1990 Owned 4,006
Medford, Oregon
61515 S. Highway 97 1993 Owned 5,415
Bend, Oregon
2300 Madison Street 1995 Owned 5,000
Klamath Falls, Oregon
721 Chetco Avenue 1997 Owned 5,409
Brookings, Oregon
293 North Broadway 1997 Owned 5,087
Burns, Oregon (1)
111 West Main Street 1997 Owned 1,958
Carlton, Oregon
103 South Main Street 1997 Owned 2,235
Condon, Oregon (1)
259 North Adams 1997 Owned 5,803
Coquille, Oregon
106 Southwest 1st Street 1997 Owned 4,700
Enterprise, Oregon
40
Year Square
Description/Address Opened Leased/Owned Footage
555 1st Street 1997 Owned 1,844
Fossil, Oregon (1)
708 Garibaldi Avenue 1997 Owned 1,400
Garibaldi, Oregon
29804 Ellensburg Avenue 1997 Owned 3,136
Gold Beach, Oregon
111 North Main Street 1997 Owned 4,586
Heppner, Oregon (1)
810 South Highway 395 1997 Leased 6,000
Hermiston, Oregon
200 West Main Street 1997 Owned 4,552
John Day, Oregon (1)
1 South E Street 1997 Owned 5,714
Lakeview, Oregon
206 East Front Street 1997 Owned 2,920
Merrill, Oregon
165 North 5th Street 1997 Owned 2,370
Monroe, Oregon
217 Main Street 1997 Owned 6,067
Nyssa, Oregon
48257 East 1st Street 1997 Owned 3,290
Oakridge, Oregon
227 West Main Street 1997 Owned 2,182
Pilot Rock, Oregon
716 Northeast Highway 101 1997 Owned 2,337
Port Orford, Oregon
178 Northwest Front Street 1997 Owned 2,353
Prairie City, Oregon (1)
315 North Main Street 1997 Owned 3,638
Riddle, Oregon
38770 North Main Street 1997 Owned 2,997
Scio, Oregon
41
Year Square
Description/Address Opened Leased/Owned Footage
508 Main Street 1997 Owned 2,282
Moro, Oregon (1)
144 South Main Street 1997 Owned 2,146
Union, Oregon
165 North Maple Street 1997 Owned 2,192
Yamhill, Oregon
475 NE Windy Knolls Drive 1998 Owned 3,120
Bend, Oregon
185 East California 1998 Owned 2,116
Jacksonville, Oregon
1217 Plaza Boulevard, Suite A 2000 Leased 2,400
Central Point, Oregon
948 Southwest 9th Street 2001 Owned 3,277
Redmond, Oregon
2203 SW Court Place 2001 Leased 540
Pendleton, Oregon
1775 East Idaho Avenue 2001 Leased 693
Ontario, Oregon
2727 South Quillan Street 2001 Leased 693
Kennewick, Washington
2801 Duportail Street 2001 Leased 966
Richland, Washington
303 11th Street 2001 Leased 2,920
Astoria, Oregon
2245 Main Street 2001 Owned 4,911
Baker City, Oregon
1095 Oregon Avenue 2001 Owned 4,382
Bandon, Oregon
110 North Redwood Highway 199 2001 Owned 3,091
Cave Junction, Oregon
199 North Nehalem 2001 Owned 2,400
Clatskanie, Oregon
42
Year Square
Description/Address Opened Leased/Owned Footage
212 South 5th Street 2001 Owned 6,200
Coos Bay, Oregon
150 South Wall 2001 Owned 9,271
Coos Bay, Oregon
430 Highway 101 2001 Owned 4,783
Florence, Oregon
2212 Island Avenue 2001 Leased 4,616
LaGrande, Oregon
1611 Virginia Avenue 2001 Leased 5,631
North Bend, Oregon
761 Avenue G 2001 Owned 2,416
Seaside, Oregon
2405 3rd Street 2001 Leased 4,690
Tillamook, Oregon
411 Pacific Avenue 2001 Owned 2,819
Tillamook, Oregon
620 Stewart Avenue 2002 Owned 2,721
Medford, Oregon
1350 N. First Street 2002 Leased 693
Hermiston, Oregon
2659 Olympic Street 2002 Leased 528
Springfield, Oregon
4550 West 11th Avenue 2002 Leased 528
Eugene, Oregon
3002 Stacy Allison Way 2003 Leased 693
Woodburn, Oregon
305 NE Terry Lane 2003 Leased 693
Grants Pass, Oregon
Backoffice Processing Facilities
600 Main Street 1998 Leased 2,800
Klamath Falls, Oregon
714 Main Street 2001 Leased 14,532
Klamath Falls, Oregon
533 Main Street 2000 Leased 1,325
Klamath Falls, Oregon
706 Main Street 2003 Leased 5,020
Klamath Falls, Oregon
43
The net book value of the Company's investment in office, properties and
equipment totaled $23.3 million at September 30, 2003. See Note 6 of the Notes
to Consolidated Financial Statements contained in the Annual Report.
(1) As of the close of business on December 12, 2003, the Association
successfully completed the sale of seven branches located in northeastern
Oregon to the Bank of Eastern Oregon. The branches are located in the towns
of Burns, Condon, Fossil, Heppner, John Day, Prairie City and Moro, Oregon.
The sale included deposit accounts of approximately $65 million. The fixed
assets and branch locations were included in the sale, but loans were not.
Item 3. Legal Proceedings
Periodically, there have been various claims and lawsuits involving the
Company, mainly as a defendant, such as claims to enforce liens, condemnation
proceedings on properties in which the Association holds security interests,
claims involving the making and servicing of real property loans and other
issues incident to the Association'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 or operations 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 September 30, 2003.
44
PART II
Item 5. Market for the Registrant's Common Equity and Related Shareholder
Matters
Since October 4, 1995, the Company's common stock has traded on the National
Association of Security Dealers Automated Quotation ("Nasdaq") National Market
under the symbol "KFBI". As of September 30, 2003, there were approximately
1,110 shareholders of record. This total does not reflect the number of persons
or entities who hold stock in nominee or "street" name through various brokerage
firms.
The high and low common stock prices by quarter were as follows:
Year Ended September 30,
____________________________________________
2003 2002
__________________ __________________
High Low High Low
______ ______ ______ ______
First quarter $16.44 $13.24 $13.71 $11.91
Second quarter 17.75 15.86 13.67 13.00
Third quarter 17.64 16.32 16.75 13.05
Fourth quarter 22.24 16.71 16.25 13.35
The cash dividends declared by quarter were as follows:
Year Ended September 30,
___________________________________________
2003 2002
________________ _________________
First quarter $0.130 $0.130
Second quarter 0.130 0.130
Third quarter 0.130 0.130
Fourth quarter 0.130 0.130
Any dividend payments by the Company are subject to the sole discretion of the
Board of Directors and depend primarily on the ability of the Association to pay
dividends to the Company. Under Federal regulations, the dollar amount of
dividends a federal savings association may pay depends on the association's
capital surplus position and recent net income. Generally, if an association
satisfies its regulatory capital requirements, it may make dividend payments up
to the limits prescribed in the OTS regulations. However, an institution that
has converted to the stock form of ownership may not declare or pay a dividend
on, or repurchase any of, its common stock if the effect thereof would cause the
regulatory capital of the institution to be reduced below the amount required
for the liquidation account which was established in accordance with OTS
regulations and the association's Plan of Conversion. In addition, earnings of
the association appropriated to bad debt reserves and deducted for federal
income tax purposes are not available for payment of cash dividends without
payment of taxes at the then current tax rate by the association on the amount
removed from the reserves for such distributions. The Association does not
contemplate any distributions that would limit the Association's bad debt
deduction or create federal tax liabilities.
Item 6. Selected Consolidated Financial Data
The following tables set forth certain information concerning the consolidated
financial position and consolidated results of operations of Klamath First
Bancorp, Inc. and its wholly owned subsidiaries (the "Company") at the dates and
for the periods indicated. This information does not purport to be complete and
should be read in conjunction with, and is qualified in its entirety by
reference to, the Consolidated Financial Statements and Notes thereto appearing
elsewhere in this Annual Report.
At September 30,
--------------------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- --------- ----------
FINANCIAL CONDITION DATA (In thousands)
Assets $1,537,118 $1,513,495 $1,468,572 $995,575 $1,041,641
Cash and cash equivalents 47,305 45,791 118,389 29,947 24,523
Loans receivable, net 557,551 607,465 679,990 729,037 739,793
Investment securities held to maturity -- -- 135 267 560
Investment securities available for sale 140,939 119,542 154,676 116,628 158,648
Mortgage-backed & related securities held to maturity -- -- 1,621 2,160 2,601
Mortgage-backed & related securities available for sale 680,720 650,796 421,638 75,331 72,695
Stock in FHLB of Seattle, at cost 17,190 13,510 12,698 11,877 10,957
Advances from FHLB of Seattle 308,000 205,250 168,000 173,000 197,000
Deposit liabilities 1,068,063 1,142,006 1,152,824 695,381 720,401
Shareholders' equity 120,335 119,938 114,141 108,725 109,585
Year Ended September 30,
--------------------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- -----------------------
SELECTED OPERATING DATA (In thousands, except per share data)
Total interest income $71,291 $87,293 $70,133 $72,158 $71,691
Total interest expense 29,524 39,531 40,751 40,756 38,382
Net interest income 41,767 47,762 29,382 31,402 33,309
Provision for loan losses -- 156 387 1,764 932
- - - - -
Net interest income after provision for loan losses 41,767 47,606 28,995 29,638 32,377
Non-interest income 17,106 12,614 11,013 4,094 3,629
Non-interest expense 55,899 50,171 28,720 23,773 21,186
Earnings before income taxes 2,974 10,049 11,288 9,959 14,820
Provision for income tax 577 3,260 3,717 3,533 5,665
- - - - -
Net Earnings $2,397 $6,789 $7,571 $6,426 $9,155
====== ====== ====== ====== ======
Basic earnings per share $0.37 $1.06 $1.14 $0.94 $1.21
At or For the Years Ended September 30,
---------------------------------------------------------------------
2003 2002 2001 2000 1999
--------- ----------- --------- ---------- ---------
KEY OPERATING RATIOS
Performance Ratios
Return on average assets
(net earnings divided by average assets) 0.16% 0.46% 0.72% 0.62% 0.88%
Return on average equity
(net earnings divided by average equity) 2.01% 5.92% 6.64% 5.82% 7.55%
Interest rate spread
(difference between average yield on interest-earning
assets and average cost of interest-bearing liabilities) 2.67% 3.04% 2.18% 2.50% 2.73%
Net interest margin (net interest income as a
percentage of average interest-earning assets) 3.03% 3.48% 2.93% 3.14% 3.37%
Average interest-earning assets to average
interest-bearing liabilities 117.12% 115.18% 118.37% 115.71% 116.47%
Net interest income after provision for loan losses
to total non-interest expenses 74.72% 94.89% 100.96% 124.39% 152.82%
Non-interest expense to average total assets 3.68% 3.37% 2.74% 2.29% 2.05%
Efficiency ratio (non-interest expense divided by
net interest income plus non-interest income) 94.95% 83.10% 55.48% 66.97% 57.36%
Dividend payout ratio (dividends declared per share
divided by net earnings per share) 140.54% 49.06% 45.61% 54.79% 38.98%
Book value per share $17.86 $18.84 $17.40 $16.25 $15.52
Asset Quality Ratios
Allowance for loan losses to total loans at
end of period 1.21% 1.19% 1.13% 0.54% 0.32%
Non-performing assets to total assets 0.09% 0.12% 0.05% 0.16% 0.46%
Non-performing loans to total loans, before net items 0.11% 0.18% 0.04% 0.11% 0.43%
Capital Ratios
Equity to assets ratio 7.83% 7.92% 7.77% 10.92% 10.52%
Tangible capital ratio 6.64% 6.55% 5.16% 10.35% 8.91%
Core capital ratio 6.64% 6.55% 5.16% 10.35% 8.91%
Risk-based capital ratio 12.73% 14.01% 10.36% 20.30% 17.41%
Other Data
Number of
Real estate loans outstanding 10,259 11,835 12,624 8,807 9,297
Deposit accounts 124,420 131,001 111,542 85,706 85,112
Full service offices (1) 59 57 52 35 34
<FN>
(1) As of the close of business on December 12, 2003, the Association
successfully completed the sale of seven branches located in tnortheastern
Oregon to the Bank of Eastern Oregon. The branches are located in the towns
of Burns, Condon, Faossil, Heppner, John Day, Prairie City, and Moro,
Oregon.
</FN>
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Special Note Regarding Forward-Looking Statements
Management's Discussion and Analysis of Financial Condition and Results of
Operations and other portions of this Annual Report contain certain
"forward-looking statements" concerning the future operations of Klamath First
Bancorp, Inc. Management desires to take advantage of the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995 and is
including this statement for the express purpose of availing the Company of the
protections of such safe harbor with respect to all "forward-looking statements"
contained in the Annual Report. We have used "forward-looking statements" to
describe future plans and strategies, including our expectations of the
Company's future financial results. Management's ability to predict results or
the effect of future plans or strategies is inherently uncertain. Factors which
could affect actual results include interest rate trends, the general economic
climate in the Company's market area and the country as a whole which could
affect the collectibility of loan balances, the ability to increase non-interest
income through expansion of new lines of business, the ability of the Company to
control costs and expenses, competitive products and pricing, loan delinquency
rates, and changes in federal and state regulation. These factors should be
considered in evaluating the "forward-looking statements," and undue reliance
should not be placed on such statements.
General
Klamath First Bancorp, Inc. (the "Company"), an Oregon corporation, is the
unitary savings and loan holding company for Klamath First Federal Savings and
Loan Association (the "Association").
The Association is a progressive, community-oriented financial institution that
focuses on customer service within its primary market area. Accordingly, the
Association is primarily engaged in attracting deposits from the general public
through its offices and using those and other available sources of funds to
originate permanent residential one- to four-family real estate loans and loans
on commercial real estate, multi-family residential properties, and to consumers
and businesses within its market area. While the Association has historically
emphasized fixed- rate mortgage lending, it has been diversifying its loan
portfolio by focusing on increasing the number of originations of commercial
real estate, multi-family residential loans, residential construction loans,
commercial and industrial loans, small business loans and non-mortgage consumer
loans. A significant portion of these newer loan products carry adjustable
rates, higher yields, or shorter terms than the traditional fixed rate
mortgages. This lending strategy is designed to enhance earnings, reduce
interest rate risk, and provide a more complete range of financial services to
customers and the local communities served by the Association. The acquisition
of 13 branches from Washington Mutual Bank, which was completed in September
2001, moved the Company strongly in this direction and the progress has
continued through 2003.
The Company's profitability depends primarily on its net interest income, which
is the difference between interest and dividend income on interest-earning
assets, principally loans and investment securities, and interest expense on
interest-bearing deposits and borrowings. Because the Company is primarily
dependent on net interest income for its earnings, the focus of the Company's
planning is to devise and employ strategies that provide stable, positive
spreads between the yield on interest-bearing assets and the cost of
interest-bearing liabilities in order to maximize the dollar amount of net
interest income. The Company's net earnings are dependent, to a lesser extent,
on the level of its non-interest income, such as service charges, commission
income, and other fees, and the controlling of its non-interest expense, such as
employee compensation and benefits, occupancy and equipment expense, deposit
insurance premiums and miscellaneous other expenses, as well as federal and
state income taxes.
The Association is regulated by the Office of Thrift Supervision ("OTS") and its
deposits are insured up to applicable limits under the Savings Association
Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC").
The Association is a member of the Federal Home Loan Bank system. As of
September 30, 2003, the Association conducted its business through 59 office
facilities, with the main office located in Klamath Falls, Oregon. The branch
sale, which was completed in December 2003, reduced the number of branch offices
to 52. The Association considers its primary market area to be the state of
Oregon, particularly the 26 counties in which the offices are located. During
2001, the Company expanded into the Tri-Cities area of Washington state by
opening in-store branches in Kennewick and Richland.
Federal Legislation In federal legislation enacted in 1996, the reserve method
of accounting for thrift bad debt reserves (including the percentage of taxable
income method) was repealed for tax years beginning after December 31, 1995. The
resulting change in accounting method triggers bad debt reserve recapture for
post-1987 reserves over a six-year period, thereby generating an additional tax
liability. At September 30, 2003 and 2002, the Association's post-1987 reserves
amounted to $1.4 million and $2.0 million, respectively. Pre-1988 reserves would
only be subject to recapture if the institution fails to qualify as a thrift.
Recapture of post-1987 reserves was required to begin during the tax year ended
September 30, 1999.
The Sarbanes-Oxley Act was enacted by Congress during the summer of 2002 to
enhance corporate governance practices. The Company's management and Board of
Directors are informed about the requirements of the Sarbanes-Oxley Act and the
Company is actively monitoring regulatory implementation of the Act. However,
due to the regulated environment in which financial institutions operate, many
requirements of the new legislation were already part of the Company's internal
control structure. Executive management has taken steps to ensure that all
managers are aware of the importance of controls and that any issues are
reported and resolved in a timely manner.
Pending Merger. On July 15, 2003, the Company announced that it had entered into
an Agreement and Plan of Merger (the "Sterling Merger") with Sterling Financial
Corporation a Washington corporation ("Sterling"). The Company will be merged
with and into Sterling, with Sterling being the surviving corporation in the
merger. The Association will be merged with and into Sterling's wholly-owned
subsidiary, Sterling Savings Bank, with Sterling Savings Bank being the
surviving institution.
Under the terms of the Sterling Merger, each share of the Company's common stock
will be converted into 0.77 shares of Sterling common stock subject to certain
conditions. Based upon the closing price for Sterling on July 14, 2003 of $26.55
per share, the consideration is equivalent to $20.44 per share of the Company's
common stock.
On December 11, 2003, the merger was approved by a vote of the stockholders of
both the Company and Sterling. All necessary regulatory approvals had previously
been received. The transaction is expected to close on January 2, 2004.
Sale of Branches. As of the close of business on December 12, 2003, the
Association successfully completed the sale of seven branches located in
northeastern Oregon to the Bank of Eastern Oregon. The branches are located in
the towns of Burns, Condon, Fossil, Heppner, John Day, Prairie City and Moro,
Oregon. The sale included deposit accounts of approximately $65 million. The
fixed assets and branch locations were included in the sale, but loans were not.
Critical Accounting Policies and Estimates
The "Management's Discussion and Analysis of Financial Condition and Results of
Operations," as well as disclosures included elsewhere in this Form 10-K, are
based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America. The preparation of these financial statements requires management to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses. On an ongoing basis, management evaluates
the estimates used, including the adequacy of the allowance for loan losses,
impairment of intangible assets and investments, and contingencies and
litigation. Estimates are based upon historical experience, current economic
conditions and other factors that management considers reasonable under the
circumstances. These estimates result in judgments regarding the carrying values
of assets and liabilities when these values are not readily available from other
sources as well as assessing and identifying the accounting treatments of
commitments and contingencies. Actual results may differ from these estimates
under different assumptions or conditions. The following critical accounting
policies involve the more significant judgments and assumptions used in the
preparation of the consolidated financial statements.
The allowance for loan losses is established to absorb known and inherent losses
attributable to loans outstanding and related off-balance sheet commitments. The
adequacy of the allowance is monitored on an ongoing basis and is based on
management's evaluation of numerous factors. These factors include the quality
of the current loan portfolio, the trend in the loan portfolio's risk ratings,
current economic conditions, loan concentrations, loan growth rates, past-due
and non-performing trends, evaluation of specific loss estimates for all
significant problem loans, historical charge-off and recovery experience and
other pertinent information. Approximately 70 percent of the Company's loan
portfolio is secured by real estate, both residential and commercial properties,
and a significant depreciation in real estate values in Oregon would cause
management to increase the allowance for loan and lease losses.
Retained mortgage servicing rights are measured by allocating the carrying value
of the loans between the assets sold and the interest retained, based on the
relative fair value at the date of the sale. The fair market values are
determined using a discounted cash flow model. Mortgage servicing assets are
amortized over the expected life of the loan and are evaluated periodically for
impairment. The expected life of the loan can vary from management's estimates
due to prepayments by borrowers. Prepayments in excess of management's estimates
would negatively impact the recorded value of the mortgage servicing rights. The
value of the mortgage servicing rights is also dependent upon the discount rate
used in the model. Management reviews this rate on an ongoing basis based on
current market rates. A significant increase in the discount rate would
negatively impact the value of mortgage servicing rights.
The extended period of low interest rates has resulted in prepayment of mortgage
loans, including those related to the mortgage servicing rights. The Company
monitors the value of the mortgage servicing rights and recognizes impairment,
when necessary, on a monthly basis. While management expects that there may be
additional impairment of the value of mortgage servicing rights in the continued
low interest rate environment, the net balance of mortgage servicing rights at
September 30, 2003 was less than $500,000, limiting the amount of impairment
which can be experienced. As of September 30, 2003, the Company had recorded
$193,443 of impairment related to mortgage servicing rights.
At September 30, 2003 the Company had approximately $36.7 million in core
deposit intangibles and goodwill as a result of business combinations. Periodic
analysis of the fair value of recorded core deposit intangibles and goodwill for
impairment will involve a substantial amount of judgment, as will establishing
and monitoring estimated lives of other amortizable intangible assets. The
Company is party to various legal proceedings. These matters have a high degree
of uncertainty associated with them. There can be no assurance that the ultimate
outcome will not differ materially from our assessment of them. There can also
be no assurance that all matters that may be brought against us are known to us
at any point in time.
Liquidity and Capital Resources
The Company generates cash through operating activities, primarily as a result
of net income. The adjustments to reconcile net income to net cash provided by
operations during the periods presented consisted primarily of net amortization
of premiums paid on investment and mortgage-backed securities, depreciation and
amortization, stock-based compensation expense, amortization of deferred loan
origination fees, net gain on the sale of investment and mortgage-backed
securities, increases or decreases in various escrow accounts and increases or
decreases in other assets and liabilities. The primary investing activity of the
Association is lending, which is funded with cash provided from operations and
financing activities, as well as proceeds from amortization and prepayments on
existing loans and mortgage backed and related securities. For additional
information about cash flows from operating, financing, and investing
activities, see the Consolidated Statements of Cash Flows included in the
Consolidated Financial Statements.
The Company has borrowing agreements with banks that can be used if funds are
needed. (See Notes 10 and 11 to the Consolidated Financial Statements.)
OTS capital regulations require the Association to have: (i) tangible capital
equal to 1.5% of adjusted total assets, (ii) core capital equal to 4.0% of
adjusted total assets, and (iii) total risk-based capital equal to 8.0% of
risk-weighted assets. At September 30, 2003, the Association was in compliance
with all regulatory capital requirements effective as of such date, with
tangible, core and risk-based capital of 6.64%, 6.64% and 12.73%, respectively.
(See Note 21 to the Consolidated Financial Statements.)
Changes in Financial Condition
At September 30, 2003, the consolidated assets of the Company totaled $1.54
billion, virtually unchanged with $1.51 billion at September 30, 2002.
Total cash and cash equivalents increased $1.5 million, or 3.30%, from $45.8
million at September 30, 2002 to $47.3 million at September 30, 2003. The
increase is primarily the result of the cash from loan prepayments being held in
federal funds at September 30, 2003 while other appropriate investment
alternatives were evaluated.
Net loans receivable decreased by $49.9 million, or 8.22% to $557.6 million at
September 30, 2003, compared to $607.5 million at September 30, 2002. The
decrease is the result of increased prepayments on loans coupled with sale of
new one- to four- family loan production which together exceeded the new loan
originations of $428.2 million.
Investment securities increased $21.4 million, or 17.90%, from $119.5 million at
September 30, 2002 to $140.9 million at September 30, 2003. This increase was
the result of $50.7 million in purchases offset by $17.6 million in scheduled
maturities and sale of $10.2 million of investment securities available for
sale.
During the year ended September 30, 2003, $351.7 million of principal payments
were received on mortgage-backed and related securities ("MBS") and $214.7
million were sold, thus reducing the
balance of MBS. This reduction was more than offset by the purchase of $612.5
million in MBS, resulting in a net increase in total MBS from $650.8 million at
September 30, 2002 to $680.7 million at September 30, 2003. The purchases of
investment securities and MBS were funded by cash obtained from maturities of
securities, funds generated by loan repayments, and borrowings.
Real estate owned decreased from $758,663 at September 30, 2002 to $651,254 at
September 30, 2003. The balance at September 30, 2003 consisted of one
single-family residence and one commercial property. The balance at September
30, 2002 consisted of four single family residences and one commercial property.
During the year ended September 30, 2003, the Company purchased $15.8 million in
bank-owned life insurance. This insurance is used to fund director benefits,
supplemental executive retirement benefits, and provide life insurance to key
employees. Income on bank-owned life insurance, which increased the cash value,
totaled $524,821 for the year ended September 30, 2003, resulting in the
year-end balance of $16.3 million.
Other assets increased $4.7 million from $3.7 million at September 30, 2002 to
$8.5 million at September 30, 2003. The increase resulted primarily from
recognition of a $1.7 million receivable for loans sold at September 30, 2003
for which payment had not been received, a $1.4 million receivable related to
sale of investment securities and a $2.4 million increase in low income housing
tax credits.
Deposit liabilities decreased $73.9 million, or 6.47%, from $1.14 billion at
September 30, 2002 to $1.07 billion at September 30, 2003. The decrease is
primarily due to a reduction in time deposits as a result of a strategy to
reduce interest expense.
Advances from the FHLB of Seattle increased from $205.3 million at September 30,
2002 to $308.0 million at September 30, 2003. The increase was the result of
funding purchases of investments and MBS with short term borrowings, in
anticipation of accelerated payments on loans and MBS in the portfolio.
Total shareholders' equity increased $397,422 from $119.9 million at September
30, 2002 to $120.3 million at September 30, 2003. The increase is the combined
effect of a $3.8 million decrease in net unrealized gains on securities
available for sale and $3.5 million in dividends paid on common shares offset by
$2.4 million in net earnings for the year, $1.7 million related to ESOP
contributions, and $3.3 million in proceeds from exercise of stock options.
Asset Quality
Non-Performing Assets
At September 30, 2003, the ratio of non-performing assets (including nonaccrual
loans, accruing loans greater than 90 days delinquent, real estate owned, and
other repossessed assets) to total assets was 0.09%, compared to 0.12% at
September 30, 2002. The decrease is the result of a decrease in the balance of
nonaccrual loans from $1.1 million at September 30, 2002 to $799,476 at
September 30, 2003 and a $107,409 decrease in real estate owned. The Association
intends to maintain asset quality by continuing its focus on conscientious
underwriting. With the expansion of other lending options
such as commercial and multi-family real estate loans, equity lines of credit,
other consumer loan products, and commercial loans, the Association has
evaluated the trade off associated with planned loan growth and the greater
credit risk associated with such forms of lending.
Classified Assets
The Association has established a Classification of Assets Committee that meets
at least quarterly to approve and develop action plans to resolve problems
associated with the assets. They also review recommendations for new
classifications and make any changes in present classifications, as well as
making recommendations for the adequacy of reserves.
In accordance with regulatory requirements, the Association reviews and
classifies on a regular basis, and as appropriate, its assets as "special
mention," "substandard," "doubtful," and "loss." All nonaccrual loans and
non-performing assets are included in classified assets.
Allowance for Loan Losses
The Association has established a systematic methodology for determination of
provisions for loan losses. The methodology is set forth in a formal policy and
takes into consideration the need for an overall general valuation allowance as
well as specific allowances that are tied to individual loans. Provision for
loan losses is recorded based on the Association's evaluation of specific loans
in its portfolio, historical loan loss experience, the volume and type of
lending, general economic conditions, and the existing level of the
Association's allowance for loan losses.
The following table sets forth at the dates indicated the loan loss allowance,
charge-offs, and recoveries:
At or For the Year Ended September 30,
---------------------------------------------
2003 2002 2001
---------------------------------------------
(In thousands)
General loan loss allowance $6,932 $7,376 $7,951
Specific loss allowance 2 - -
Charge-offs 507 747 90
Recoveries 65 16 42
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED SEPTEMBER 30, 2003
AND 2002
General
During fiscal 2003, the Company operated in an economy that experienced record
low interest rates. Strategic decisions to lower interest rates paid on deposits
resulted in lower interest expense. However, the effect of lower interest rates
was more evident in the reduction of interest income, resulting in a 12.55%
decrease in net interest income from the prior year. Non-interest income
improved significantly over the prior year. Non-interest expense was
significantly increased due to the recording of investment losses related to
"other-than-temporary" impairment of preferred stock. Net earnings decreased by
$4.4 million, or 64.69% from $6.8 million for the year ended September 30, 2002
to $2.4 million for the year ended September 30, 2003.
Interest Income
Interest income decreased $16.0 million, or 18.33%, from $87.3 million for the
year ended September 30, 2002 to $71.3 million for the year ended September 30,
2003. Interest rates declined during the year. While efforts were continuing to
change the composition of the loan portfolio to include a higher percentage of
loans with relatively higher interest rates, this trend was not enough to
overcome the effect of the decline in rates. Rates on short term investments
such as federal funds and interest- earning deposits decreased sharply over the
year. The combined result of these changes is reflected in the average yield on
interest earning assets which decreased from 6.35% for the year ended September
30, 2002 to 5.12% for the year ended September 30, 2003.
Interest income on loans receivable decreased $9.3 million, or 17.78%, from
$52.2 million for the year ended September 30, 2002 to $42.9 million for the
current year. Average loans receivable decreased $74.5 million due to
prepayments from refinancing activity and sales of new loan production. In
addition, the yield on loans decreased 58 basis points. The average balance of
investment securities decreased $12.3 million, or 8.10%, however the average
rate decreased by 90 basis points, resulting in a $1.8 million decrease in
interest income on investment securities compared with the same period in 2002.
The average balance of MBS increased $116.5 million, or 22.91%; however the
average rate earned on MBS decreased 168 basis points, resulting in a $4.5
million decrease in interest income on MBS for the year ended September 30, 2003
compared with the same period in 2002.
Interest Expense
During the year ended September 30, 2003, the Company continued to reduce
interest rates paid on deposit accounts as part of the strategic plan to improve
profitability. This strategic move also resulted in a reduction in time deposits
and is evidenced by the $65.0 million, or 6.37%, decrease in average deposits
for the year ended September 30, 2003 compared to the year ended September 30,
2002. While time deposits decreased, there was a $32.7 million increase in
balances of lower-cost transaction accounts for the year, which also contributed
to the lower cost of funds for total deposits. The average interest paid on
interest-bearing deposits decreased significantly from 2.92% for the year ended
September 30, 2002 to 1.90% for the year ended September 30, 2003. As a result,
total interest expense decreased $10.0 million, or 25.31%, comparing the year
ended September 30, 2003 to 2002.
Interest expense on deposits decreased $11.6 million, from $29.8 million for the
year ended September 30, 2002 to $18.2 million for the year ended September 30,
2003.
Interest expense on FHLB borrowings increased $1.3 million due to a $62.5
million increase in average borrowings which was partially offset by a 98 basis
point decrease in the average rate paid.
As noted previously, the general interest rate environment during the year was
represented by declining or continued low rates. The impact of this environment
is evident in the decrease in interest rates on interest-earning assets from
6.35% for the year ended September 30, 2002 to 5.12% for the year ended
September 30, 2003. Decreases were noted in yields for all categories of assets.
However, due to the strategic moves made by the Company in deposit pricing,
overall rates on interest-bearing liabilities decreased 86 basis points from
3.31% for the year ended September 30, 2002 to 2.45% for the year ended
September 30, 2003. As a result, the decrease in interest rate spread was
limited to 37 basis points, from 3.04% for the year ended September 30, 2002 to
2.67% for the year ended September 30, 2003. Net interest margin (net interest
income as a percent of average interest-earning assets) also decreased from
3.48% for the fiscal year ended September 30, 2002 to 3.03% for the year ended
September 30, 2003.
AVERAGE BALANCES, NET INTEREST INCOME and YIELDS EARNED and RATES PAID
The following table presents, for the periods indicated, information regarding
average balances of assets and liabilities, as well as the total dollar amounts
of interest income from average interest-earning assets and interest expense on
average interest-bearing liabilities, resultant yields, interest rate spread,
net interest margin and the ratio of average interest-earning assets to average
interest-bearing liabilities. Dividends received are included as interest
income. The table does not reflect any effect of income taxes. Nonaccrual loans
are reflected as carrying a zero yield.
Year Ended September 30,
---------------------------------------------------------------------------------------------------
2003 2002 2001
------------------------------ -------------------------------- ------------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
--------- -------- ------ ------------ -------- ------ ---------- -------- ------
INTEREST-EARNING ASSETS (Dollars in thousands)
Loans receivable $585,737 $42,902 7.32% $660,246 $52,179 7.90% $611,095 $48,051 7.86%
Mortgage backed and
related securities 625,235 21,864 3.50% 508,712 26,369 5.18% 192,976 11,611 6.02%
Investment securities 139,453 5,320 3.82% 151,749 7,159 4.72% 129,171 7,282 5.64%
Federal funds sold 9,668 120 1.24% 21,092 440 2.09% 38,686 1,599 4.13%
Interest earning deposits 18,635 230 1.24% 19,027 333 1.75% 18,930 768 4.06%
FHLB stock 14,346 855 5.96% 13,013 813 6.24% 12,175 822 6.75%
---------- ------- ----- ---------- ------- ----- ---------- ------- -----
Total interest-earning assets 1,393,074 71,291 5.12% 1,373,839 87,293 6.35% 1,003,033 70,133 6.99%
Non-interest-earning assets 129,544 114,405 44,817
---------- ------- ----- ---------- ------- ----- ---------- ------- -----
Total Assets $1,519,618 $1,488,244 $1,047,850
= = =
INTEREST-BEARING LIABILITIES
Tax and insurance reserve $1,567 $20 1.31% $2,316 $66 2.85% $2,952 $114 3.85%
Passbook and statement savings 89,203 384 0.43% 82,358 930 1.13% 47,278 1,067 2.26%
Interest-bearing checking 133,930 176 0.13% 122,610 907 0.74% 75,070 812 1.08%
Money market 331,556 3,367 1.02% 319,336 6,377 2.00% 164,523 6,332 3.85%
Certificates of deposit 400,693 14,247 3.56% 496,070 21,569 4.35% 383,796 22,093 5.76%
FHLB advances/Short term
borrowings 232,486 10,940 4.71% 170,037 9,682 5.69% 173,786 10,333 5.95%
---------- ------- ----- ---------- ------- ----- ---------- ------- -----
Total interest-bearing
liabilities 1,189,435 29,134 2.45% 1,192,727 39,531 3.31% 847,405 40,751 4.81%
Non-interest-bearing liabilities 210,839 180,765 86,406
---------- ------- ----- ---------- ------- ----- ---------- ------- -----
Total liabilities 1,400,274 1,373,492 933,811
Shareholders' equity 119,343 114,752 114,039
---------- ------- ----- ---------- ------- ----- ---------
Total Liabilities and
Shareholders' Equity $1,519,618 $1,488,244 $1,047,850
========== ========== ==========
Net interest income $42,157 $47,762 $29,381
======= ======= =======
Interest rate spread 2.67% 3.04% 2.18%
===== ===== =====
Net interest margin 3.03% 3.48% 2.93%
===== ===== =====
Average interest-earning
assets to average
interest-bearing liabilities 117.12% 115.18% 118.37%
======= ======= =======
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 average
volume multiplied by prior rate); (ii) effects on interest income attributable
to changes in rate (changes in rate multiplied by prior average volume); and
(iii) changes in rate/volume (change in rate multiplied by change in average
volume).
For the Year Ended September 30, For the Year Ended September 30,
2002 vs 2003 2002 vs 2001
------------------------------------------------- ---------------------------------------------------
Increase(Decrease) Due To Increase (Decrease) Due To
-------------------------------- Net Increase ------------------------------------- Net Increase
Rate Volume Rate/Vol (Decrease) Rate Volume Rate/Vol (Decrease)
-------- -------- -------- ------------- -------- -------- -------- ------------
INTEREST EARNING ASSETS (In thousands)
Loans ($3,819) ($5,888) $431 ($9,276) $ 242 $3,864 $20 $4,126
Mortgage backed and (8,580) 6,040 (1,965) (4,505) (1,608) 18,997 (2,631) 14,758
related securities
Investment securities (1,370) (580) 111 (1,839) (1,187) 1,273 (208) (122)
Federal funds sold (179) (238) 97 (320) (791) (727) 360 (1,158)
Interest bearing deposits (98) (7) 2 (103) (437) 4 (2) (435)
FHLB stock (37) 83 (4) 42 (61) 57 (4) (8)
-------- -------- -------- ------------- -------- -------- -------- ------------
Total Interest-Earning
Assets ($14,083) ($590) ($1,328) ($16,001) ($3,842) $23,468 ($2,465) $17,161
======== ======== ======== ========= ======== ========= ======== =========
INTEREST BEARING LIABILITIES
Tax and insurance reserves ($36) ($21) $12 ($45) ($29) ($24) $6 ($47)
Savings (576) 77 (48) (547) (532) 791 (395) (136)
Interest bearing checking (746) 84 (69) (731) (257) 514 (163) 94
Money market (3,134) 244 (120) (3,010) (3,047) 5,959 (2,867) 45
Certificates of deposit (3,931) (4,147) 756 (7,322) (5,406) 6,463 (1,581) (524)
FHLB advances/Short term (1,681) 3,556 (617) 1,258 (437) (223) 9 (651)
borrowings
-------- -------- -------- ------------- -------- -------- -------- ------------
Total Interest-Bearing
Liabilities ($10,104) $207 ($86) ($10,397) ($9,708) $13,480 ($4,991) ($1,219)
======== ======== ======== ========= ======== ========= ======= ==========
Increase (Decrease) in ($5,604) $18,380
Net Interest Income ======== =======
Provision for Loan Losses
The provision for loan losses was zero, recoveries were $65,000, and charge offs
were $507,000 during the year ended September 30, 2003 compared to a provision
for loan losses of $156,000, with $16,000 of recoveries, and charge offs of
$747,000 during the year ended September 30, 2002. Charge offs during the year
ended September 30, 2003 included $100,240 related to numerous commercial
business loans and $400,000 related to numerous consumer loans. Charge offs
during the year ended September 30, 2002 related primarily to a land development
loan and various consumer loans.
Based on analysis of the loan portfolio, it was determined that the allowance
for loan losses was adequate at September 30, 2003, without the need for
additional reserves, thus no provision for loan losses was recorded. In
accordance with contemporary regulatory guidance on the allowance for loan
losses, the Company is required to estimate reserves based on the current
inherent risk in the portfolio. Because payoffs have reduced the one- to four-
family mortgage portfolio and historical losses have been low, the allowance
indicated has not required additional provision.
At September 30, 2002, the allowance for loan losses was equal to 398.7% of
non-performing assets compared to 477.9% at September 30, 2003. The increase in
the coverage ratio at year end 2003 was the result of a decrease in
non-performing assets.
Non-Interest Income
Non-interest income continues to improve, increasing $4.5 million, or 35.61%, to
$17.1 million for the year ended September 30, 2003 from $12.6 million for the
year ended September 30, 2002. Income from fees and service charges on deposit
accounts increased by $1.7 million, or 34.92 %, from $4.9 million for the year
ended September 30, 2002 to $6.7 million for the year ended September 30, 2003.
While overall deposits have decreased, checking, money market and savings
accounts, which generate fees and service charges, have increased during fiscal
2003. These increases in account balances coupled with increases in fees and
service charges have boosted non- interest income for the year. Brokerage and
annuity commissions also showed significant growth, increasing by 42.69% from
$1.4 million for the year ended September 30, 2002 to $2.0 million for the year
ended September 30, 2003. This growth is a result of the expanded presence of
Klamath First Financial Services, making brokerage and investment services
available to customers in more of the Company's market areas.
With the high loan volume due to refinancing activity and subsequent sale of
single family mortgage loans production, gain on sale of mortgage loans has
increased 98.80% from $1.1 million for the year ended September 30, 2002 to $2.1
million for the same period this year.
A $1.5 million gain on sale of investments was recorded for the year ended
September 30, 2003 which is similar to the $1.7 million gain recorded in prior
year. Both gain on sale of securities for fiscal 2003 and loss on sale, as noted
below, were part of the ongoing management of the Company's large investment
portfolio to reposition the portfolio for higher long term yields in the current
interest rate environment. Non-interest income increased $4.5 million to a total
of $17.1 million which included the $1.5 million gain on sale of securities. As
noted above, the increase is the result of continued improvement in fees and
service charges due to more accounts and a revised fee structure and a $1.1
million increase in gain on sale of mortgage loans, as well as growth in
commission income from the investment subsidiary.
Non-Interest Expense
The Company's continued efforts to control expenses are evident in the
comparison of non-interest expense items, most of which show modest increases
from the prior year. Non-interest expense increased $5.7 million, or 11.42%,
from a total of $50.2 million for the prior year to $55.9 million for the year
ended September 30, 2003. However, excluding the $3.5 million
other-than-temporary impairment loss on investment securities, the increase is
only 4.95%.
Compensation, employee benefits, and related expense increased $2.3 million, or
10.53%, from $22.1 million for the year ended September 30, 2002 to $24.5
million for the same period of 2003. Increases in compensation expense arose
from salary increases and increases in the cost of insurance and other employee
benefits. Occupancy expense increased 12.71% due to the increase in number of
branch locations and additional space leased for back office operations.
The Company recorded $901,599 in loss on sale of investments as part of the
repositioning of the investment portfolio, as noted above. Amortization of
intangible assets decreased as adoption of SFAS No. 142 and SFAS No. 147
required the Company to cease amortization of goodwill related to the WAMU
branch acquisition beginning October 1, 2002. In addition, during the year ended
September 30, 2003, the Company recognized a $3.5 million loss related to
reductions in market value on certain floating rate preferred stocks that were
considered to have other-than-temporary impairment. See further discussion in
Note 1 of the Notes to Consolidated Financial Statements.
The Company incurred $377,826 of merger-related cost associated with the pending
Sterling Merger. Included in this amount are legal expenses, accounting
expenses, and cost of merger-related employee travel.
Other expense only increased $563,651, or 4.03%, from $14.0 million for the year
ended September 30, 2002 to $14.5 million for the current year. The increase
relates to routine increases related to an increase in locations and more
accounts to service.
The ratio of non-interest expense to average total assets was 3.68% and 3.37%
for the years ended September 30, 2003 and 2002, respectively.
Income Taxes
The provision for income taxes was $577,000 for the year ended September 30,
2003, representing an effective tax rate of 19.4% compared with $3.3 million for
the year ended September 30, 2002 representing an effective tax rate of 32.44%.
Income taxes decreased due partially to the lower income level for the current
year. As part of the overall plan to reduce the effective tax rate and enhance
the level of investments qualifying under the Community Reinvestment Act, the
Company has increased investment in low income housing tax credits and
tax-exempt municipal securities. There are also tax benefits related to purchase
of bank-owned life insurance and supplemental executive retirement benefits
which were added in fiscal 2003 and further reduced the effective tax rate. (See
Note 13 to the Consolidated Financial Statements.)
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED SEPTEMBER 30, 2002
AND 2001
General
The purchase of 13 branches from Washington Mutual Bank in September 2001 had
significant impact on the operations of the Company during fiscal 2002. The
transaction contributed significantly to loan and deposit balances, added 13
locations, and introduced 124 employees to the Klamath First family at year end
2001. Therefore, the income and expenses related to this significant change had
little effect on fiscal 2001, but had a dominant impact on fiscal 2002. The
influence of this change is evident in all categories of income and expenses
during the current fiscal year.
During fiscal 2002, the Company operated in an economy that experienced
declining interest rates and a relatively normal yield curve. Strategic
decisions to revise interest rates paid on deposits to lower interest expense
resulted in improvement in both interest rate spread and interest rate margin
over the previous year. Net earnings decreased by $782,226, or 10.3% from $7.6
million for the year ended September 30, 2001 to $6.8 million for the year ended
September 30, 2002. Net earnings for the year ended September 30, 2001 were
enhanced by gains on sale on securities totaling $5.4 million which were not
repeated to that extent for 2002.
Interest Income
Interest income increased $17.2 million, or 24.5%, from $70.1 million for the
year ended September 30, 2001 to $87.3 million for the year ended September 30,
2002. The general interest rate environment during the year showed declining
interest rates but the branch acquisition in September 2001 included significant
commercial and consumer loan balances, increasing the earning assets, and also
providing loans with somewhat higher yields. Rates on short term investments
such as federal funds and interest-earning deposits decreased sharply over the
year. The combined result of these changes is reflected in the average yield on
interest earning assets which decreased from 6.99% for the year ended September
30, 2001 to 6.35% for the year ended September 30, 2002.
Average loans receivable increased $49.2 million and the yield on loans
increased 4 basis points, resulting in a $4.1 million increase in interest
income on loans. Purchases of MBS boosted interest income on MBS by $14.8
million. The average balance of investment securities increased $22.6 million,
or 17.48%, however the average rate decreased by 92 basis points, resulting in a
$122,019 decrease in interest income on investment securities compared with the
same period in 2001.
Interest Expense
Average deposits increased by $349.7 million for the year ended September 30,
2002 compared to the year ended September 30, 2001, due to the deposit balances
acquired in the WAMU branch transaction in September 2001. The average interest
paid on interest-bearing deposits decreased significantly from 4.52% for the
year ended September 30, 2001 to 2.92% for the year ended September 30, 2002.
During the year ended September 30, 2002, the Company reduced interest rates
paid on deposit accounts as part of a strategic plan to improve profitability.
This strategic move is evidenced by the decrease in interest expense which was
coupled with a 52.14% increase in average deposit balances. As a result interest
expense decreased $48,319, or 0.2%, comparing the year ended September 30, 2002
to 2001. Interest expense on deposits decreased $521,672 from $30.3 million for
the year ended September 30, 2001 to $29.8 million for the year ended September
30, 2002.
Interest expense on FHLB borrowings decreased $650,505 due to decreased average
borrowings of $3.7 million which was partially offset by a 25 basis point
increase in the average rate paid..
As noted previously, the general interest rate environment during the year was
represented by declining rates. The impact of this environment is evident in the
decrease in interest rates on
interest-earning assets from 6.99% for the year ended September 30, 2001 to
6.35% for the year ended September 30, 2002. Decreases were noted in yields for
all categories of assets. However, due to the strategic moves made by the
Company in deposit pricing, overall rates on interest-bearing liabilities
decreased 150 basis points from 4.81% for the year ended September 30, 2001 to
3.31% for the year ended September 30, 2002. As a result, interest rate spread
increased from 2.18% for the year ended September 30, 2001 to 3.04% for the year
ended September 30, 2002. Net interest margin (net interest income as a percent
of average interest-earning assets) also improved significantly from 2.93% for
the fiscal year ended September 30, 2001 to 3.48% for the year ended September
30, 2002.
Provision for Loan Losses
The provision for loan losses was $156,000, recoveries were $16,224, and charge
offs were $747,092 during the year ended September 30, 2002 compared to a
provision for loan losses of $387,000, with $42,406 of recoveries, and charge
offs of $90,173 during the year ended September 30, 2001. Charge offs during the
year ended September 30, 2002 related primarily to a land development loan and
various consumer loans. Charge offs during the year ended September 30, 2001
related primarily to construction loans from one borrower and various consumer
loans.
The provision for loan losses for the year ended September 30, 2002 was less
than for the previous year because the strategy to sell newly originated one- to
four-family loans in the secondary market meant that fewer loans were added to
the loan portfolio. The loans added in the branch acquisition were allocated
allowance as part of the purchase accounting and thus did not significantly
impact the provision for fiscal years ended 2002 and 2001.
The composition of the loan portfolio is monitored on a regular basis.
Significant increases in commercial and consumer loans, which are considered to
have more associated credit risk than the Company's traditional portfolio of
one- to four-family residential mortgages, are considered in the determination
of the appropriate level of allowance for loan losses. As part of the branch
acquisition, a loan loss allowance was allocated to the acquired loans. At
September 30, 2001, the allowance for loan losses was equal to 1,108.9% of
non-performing assets compared to 398.7% at September 30, 2002. The decrease in
the coverage ratio at year end 2002 was the result of an increase in non-
performing assets.
Non-Interest Income
Non-interest income increased $1.6 million, or 14.5%, to $12.6 million for the
year ended September 30, 2002 from $11.0 million for the year ended September
30, 2001. During the year ended September 30, 2001, the Company realized $5.4
million in gains on sales of investments when it sold MBS resulting from
securitization of single family mortgage loans. This is compared to $1.7 million
in gain on sale of securities for the year ended September 30, 2002. The
increases in non-interest income items other than gain on sale of securities are
the result of continued improvement in fees and service charges due to more
accounts and a revised fee structure and a $502,860 increase in gain on sale of
mortgage loans. Growth in the activity in the Association's investment
subsidiary, Klamath First Financial Services, increased commission income by
over $1.0 million.
Non-Interest Expense
Non-interest expense increased $21.5 million, or 74.7%, from a total of $28.7
million for the prior
year to $50.2 million for the year ended September 30, 2002. The increase is
primarily attributed to the expansion of the branch network through the branch
acquisition in September 2001 and addition of de novo branches. Compensation,
employee benefits, and related expense increased $7.7 million, or 53.1%, from
$14.4 million for the year ended September 30, 2001 to $22.1 million for the
same period of 2002. Increases in compensation expense arose from the addition
of 124 employees as part of the WAMU branch acquisition and other back office
personnel added to handle the increased activity resulting from a 48% increase
in accounts, as well as personnel added at five de novo branches opened during
the year ended September 30, 2002. Other expense increased $5.8 million, or
71.4%, from $8.2 million for the year ended September 30, 2001 to $14.0 million
for the current year. Increases were noted as a result of the branch
acquisition, opening of the second Medford, Oregon branch and opening of four
new in-store branches. For example, postage and courier expense increased
$629,632, and supplies expense increased $411,765. Checking department expense
increased by $1.2 million and ATM expense increased by $274,301, both due to the
increase in number of locations and deposit accounts. Advertising expense
increased $294,808 due to the expansion of the branch network. Professional
service fees increased $131,468 with items relating to recruitment of
executives, training enhancements, and the hiring of a consulting firm for a
commercial loan project. The ratio of non-interest expense to average total
assets was 3.28% and 2.72% for the years ended September 30, 2002 and 2001,
respectively.
Income Taxes
The provision for income taxes was $3.3 million for the year ended September 30,
2002, representing an effective tax rate of 32.4% compared with $3.7 million for
the year ended September 30, 2001 representing an effective tax rate of 32.9%.
The decrease in effective tax rate for 2002 is primarily due to an increase in
income on tax-exempt municipal securities. (See Note 13 to the Consolidated
Financial Statements.)
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market Risk and Asset/Liability Management
The Company's financial performance is affected by the success of the fee
generating products it offers to its customers, the credit quality of its loans
and securities, and the extent to which its earnings are affected by changes in
interest rates. Credit risk is the risk that borrowers will become unable to
repay their debts as they become due. The Company relies on strict underwriting
standards, loan review, and an adequate allowance for loan losses to mitigate
its credit risk.
Interest rate risk is the risk of loss in principal value and risk of earning
less net interest income due to changes in interest rates. Put simply, savings
institutions solicit deposits and lend the funds they receive to borrowers. The
difference between the rate paid on deposits and the rate received on loans is
the interest rate spread. If the rates paid on deposits change, or reprice, with
the same timing and magnitude as the rates change on the loans, there is perfect
matching of interest rate changes and thus, no change in interest rate spread
and no interest rate risk. In actuality, interest rates on deposits and other
liabilities do not reprice at the same time and/or with the same magnitude as
those on loans, investments and other interest-earning assets. For example,
historically the Company primarily originated fixed-rate residential loans for
its portfolio. Because fixed-rate loans do not
reprice until payoff and because the majority of residential loans have terms of
15 to 30 years (with actual expected lives of seven to ten years), the interest
rate characteristics of the loan portfolio do not exactly match the Company's
liabilities, which consist of deposits with maturities ranging up to ten years
and borrowings which mature or reprice in five years or less. When interest
rates change, this mismatch creates changes in interest rate spread that
influence net interest income and result in interest rate risk.
Changes in interest rates also impact the fair value of the assets and
liabilities on the Company's balance sheet, expressed as changes in the net
portfolio value ("NPV"). NPV represents the market value of portfolio equity and
is equal to the market value of assets minus the market value of liabilities
plus or minus the estimated market value of off-balance sheet instruments. For
example, the market value of investment securities and loans is impacted by
changes in interest rates. Fixed- rate loans and investments held in the
Company's portfolio increase in market value if interest rates decline.
Conversely, the market value of fixed-rate portfolio assets decreases in an
increasing interest rate environment. It is generally assumed that assets with
adjustable rates are less subject to market value changes due to interest rate
fluctuations based on the premise that their rates will adjust with the market.
The OTS Thrift Bulletin 13a ("TB 13a") contains the prevailing guidance on the
management of interest rate risk and provides a description of how the
"Sensitivity to Market Risk" rating is to be determined. Sensitivity to Market
Risk represents the "S" component of the CAMELS rating which is used by
regulators in their evaluation of financial institutions. The OTS has
established detailed minimum guidelines for two areas of interest rate risk
management. These guidelines establish minimum expectations for (1) the
establishment and maintenance of board-approved risk limits and (2) an
institution's ability to measure their interest rate risk exposure. Each
thrift's board of directors is responsible for establishing risk limits for the
institution. The interest rate risk limits are expected to include limits on the
change in NPV as well as limits on earnings sensitivity.
NPV limits include minimums for the NPV ratio, which is calculated by dividing
the NPV by the present value of the institution's assets for a given rate
scenario. The board of directors should specify the minimum NPV ratio it is
willing to allow under interest rate shifts of 100 and 200 basis points up and
down. Both the NPV limits and the actual NPV forecast calculations play a role
in determining a thrift's Sensitivity to Market Risk. The prudence of the limits
and the compliance with board-prescribed limits are factors in the determination
of whether or not the institution's risk management is sufficient. In addition,
the NPV ratio permitted by the institution's policies under an adverse 200 basis
point rate shift scenario is combined with the institution's current interest
rate sensitivity to determine the institution's "Level of Interest Rate Risk."
The level of interest rate risk is then utilized in conjunction with an
assessment of the "Quality of Risk Management Practices" to determine the "S"
component of the CAMELS rating.
The Company's exposure to interest rate risk is reviewed on at least a quarterly
basis by the Board of Directors and the Asset Liability Management Committee
("ALCO"), which includes senior management representatives. The ALCO monitors
and considers methods of managing interest rate risk by monitoring changes in
NPV, the NPV ratio, and net interest income under various interest rate
scenarios. The ALCO attempts to manage the various components of the Company's
balance
sheet to minimize the impact of sudden and sustained changes in interest rates
on NPV and the NPV ratio. If potential changes to NPV and the NPV ratio
resulting from hypothetical interest rate swings are not within the limits
established by the Board, the Board may direct management to adjust its asset
and liability mix to bring interest rate risk within Board-approved limits.
NPV is calculated based on the net present value of estimated cash flows
utilizing market prepayment assumptions and market rates of interest provided by
independent broker quotations and other public sources. Computation of
forecasted effects of hypothetical interest rate changes are based on numerous
assumptions, including relative levels of market interest rates, loan
prepayments, and deposit decay, and should not be relied upon as indicative of
actual future results. Further, the computations do not contemplate any actions
the ALCO could undertake in response to changes in interest rates.
The Company has historically originated primarily fixed-rate residential loans.
Many of these loans have been sold to Fannie Mae (formerly, the Federal National
Mortgage Association) with servicing retained, and currently loans are sold to
other entities with servicing released, while few are held in its portfolio. In
order to reduce the exposure to interest rate fluctuations, the Company has
developed strategies to manage its liquidity, shorten the effective maturities
and increase the repricing of certain interest-earning assets, and increase the
effective maturities of certain interest-bearing liabilities. During recent
years, the Company undertook significant projects to manage and reduce interest
rate risk. In February 2001, the Company securitized $190.3 million in
fixed-rate single family mortgage loans. The loans were sold to Fannie Mae with
servicing retained and the resulting FNMA mortgage-backed securities ("MBS")
were recorded as available for sale securities on the Company's books.
Subsequently, the MBS were sold with the two-fold benefit of producing $5.4
million in gain on sale of investments and eliminating long term fixed-rate
assets from the interest rate risk profile. The second significant event
impacting interest rate risk was the acquisition of 13 branches from Washington
Mutual Bank in September 2001. These were commercial bank branches which
included $118.8 million of commercial loans and $50.7 million of consumer loans.
Most of these loans are adjustable rate shorter term loans. Cash obtained in the
transaction was primarily invested in MBS and collateralized mortgage
obligations ("CMO's") having shorter terms than conventional single-family
mortgage loans. All these events serve to improve the Company's interest rate
risk position.
The Company's Board of Directors has established risk limits which are in
compliance with TB 13a. NPV values for the Association are regularly calculated
by the OTS based on regulatory guidelines. The following table presents the
Association's projected change in NPV and the NPV ratio for the various rate
shock levels as of September 30, 2003 and 2002, using the regulatory
calculations. The assets and liabilities at the parent company level are not
considered in the analysis. The exclusion of holding company assets and
liabilities does not have a significant effect on the analysis of NPV
sensitivity. All market rate sensitive instruments presented in these tables are
classified as either held-to-maturity or available-for-sale. The Association has
no trading securities.
PROJECTED CHANGES IN NET PORTFOLIO VALUE
At September 30, 2003 At September 30, 2002
-------------------------------- ------------------------------
Change in NPV Sensitivity NPV Sensitivity
Interest Rates Ratio Measure Ratio Measure
(Basis points) (Basis points)
------ --------------- ----- --------------
200 basis point rise 4.57% (281) 6.67% (126)
100 basis point rise 6.17% (121) 7.79% (14)
Base Rate Scenario 7.39% -- 7.93% --
100 basis point decline 7.80% 41 7.11% (82)
200 basis point decline (1) N/A N/A N/A N/A
<FN>
(1) Given the abnormally low prevailing interest rate environment, information related to a 200 basis
point decline is not considered meaningful.
</FN>
While interest sensitivity improved for the year ended September 30, 2002, the
Association became more interest sensitive during fiscal 2003. As interest rates
have continued downward, loan refinancing activity has remained high, lowering
rates on loans held in the portfolio. Loan refinancing has also contributed to
increased prepayments on MBS. In order to maintain yields, the proceeds from the
prepayments and maturities of investments have been reinvested in instruments
with extended maturities, resulting in increased sensitivity. Adjustable-rate
instruments have now repriced at these historical low rates, further increasing
sensitivity.
The preceding table indicates that at September 30, 2003, in the event of a
sudden and sustained increase in prevailing market interest rates, the
Association's NPV and NPV ratio would be expected to decrease, and would
decrease to a greater extent than under the previous year's asset/liability mix.
Certain shortcomings are inherent in the method of analysis presented in the
computation of NPV. Actual values may differ from those projections presented,
should market conditions vary from assumptions used in the calculation of NPV.
Certain assets, such as adjustable-rate loans, have features which restrict
changes in interest rates on a short-term basis and over the life of the assets.
In addition, the proportion of adjustable-rate loans in the Association's
portfolio could decrease in future periods if market interest rates remain at or
decrease below current levels due to refinance activity. Further, in the event
of a change in interest rates, prepayment and early withdrawal levels would
likely deviate significantly from those assumed in the NPV. Finally, the ability
of many borrowers to repay their adjustable-rate mortgage loans may decrease in
the event of interest rate increases.
A conventional measure of interest rate sensitivity for savings institutions is
the calculation of interest rate "gap." This measure of interest rate
sensitivity is a measure of the difference between amounts of interest-earning
assets and interest-bearing liabilities which either reprice or mature within a
given period of time. The difference, or the interest rate repricing "gap,"
provides an indication of the extent to which an institution's interest rate
spread will be affected by changes in interest rates. A gap is considered
positive when the amount of interest-rate sensitive assets exceed the amount of
interest-rate sensitive liabilities, and is considered negative when the amount
of interest-rate sensitive liabilities exceeds the amount of interest-rate
sensitive assets. Generally, during a period of rising interest rates, a
negative gap within shorter maturities would result in a decrease in net
interest income. Conversely, during a period of falling interest rates, a
negative gap within shorter maturities would result in an increase in net
interest income.
At September 30, 2003, the Association's one-year cumulative gap was a negative
20.26% of total assets consistent with a negative 20.61% of total assets at
September 30, 2002.
The following table sets forth certain historical information relating to the
Company's interest- earning assets and interest-bearing liabilities that are
estimated to mature or are scheduled to reprice within one year.
At September 30,
---------------------------------------------------------------
2003 2002 2001
----------- ---------------- ------------
(In thousands)
Earning assets maturing
or repricing within one year $250,767 $221,598 $318,777
Interest-bearing liabilities
maturing or repricing
within one year 562,265 533,486 541,016
Deficiency of earning assets
over interest-bearing liabilities
as a percent of total assets (20.26%) (20.61%) (15.13%)
Percent of assets to liabilities
maturing or repricing
within one year 44.60% 41.54% 58.92%
INTEREST SENSITIVITY GAP ANALYSIS
The following table presents the difference between the Company's
interest-earning assets and interest-bearing liabilities within specified
maturities at September 30, 2003. This table does not necessarily indicate the
impact of general interest rate movements on the Company's net interest income
because the repricing of certain assets and liabilities is subject to
competitive and other limitations. As a result, certain assets and liabilities
indicated as maturing or otherwise repricing within a stated period may in fact
mature or reprice at different times and at different volumes.
ASSETS 3 Months > 3 Months > 6 Months > 1 to 3 > 3 to 5 > 5 to 10 > 10 to 20 > 20
or Less to 6 Months to 1 Year Years Years Years Years Years TOTAL
-------- ----------- ----------- -------- -------- --------- ---------- -------- -------
Permanent 1-4 Mortgages:
Adjustable-rate $3,819 $3,576 $9,948 $16,416 $7,133 $680 $-- $-- $41,572
Fixed-rate 985 1,237 1,896 (51) 1,547 8,327 37,665 110,298 161,904
Other Mortgage Loans:
Adjustable-rate 17,437 13,652 17,806 38,418 63,097 1,144 -- -- 151,554
Fixed-rate 292 19 91 1,235 6,928 8,060 3,497 1,247 21,369
Mortgage-Backed Securities 9,604 904 985 25,178 111,835 49,596 411,158 69,628 678,888
Non-Real Estate Loans:
Adjustable-rate 87,938 3,580 3,884 913 3,315 337 13 -- 99,980
Fixed-rate 1,452 546 924 6,551 9,975 13,830 53,758 170 87,206
Investment Securities 45,070 20,148 4,974 7,258 44,817 2,182 35,107 2,467 164,023
Other Interest-Bearing Assets -- -- -- -- -- 457 -- -- 457
-------- ------- ---------- ---------- -------- ---------- ---------- ---------- ----------
Total Rate Sensitive
Assets $166,597 $43,662 $40,508 $95,918 $248,647 $84,613 $543,198 $183,810 $1,406,953
======== ======= ======== ======== ======== ======== ======== ======== ========
LIABILITIES
Deposits - Fixed Maturity $70,071 $55,010 $76,209 $82,522 $31,837 $34,029 $335 $100 $350,113
Deposits - Interest Bearing
Checking 5,582 5,582 11,164 14,270 12,181 39,397 30,916 17,465 136,557
Deposits - Money Market 16,936 16,936 33,872 80,906 53,763 52,000 71,663 555 326,631
Deposits - Passbook and
Statement Savings 2,368 2,368 4,736 8,006 10,609 22,283 19,903 23,038 93,311
Other Interest Bearing
Liabilities 148,431 91,000 22,000 37,000 12,000 -- -- -- 310,431
--------- -------- ---------- ---------- -------- ---------- ---------- ---------- ----------
Total Rate Sensitive
Liabilities $243,388 $170,896 $147,981 $222,704 $120,390 $147,709 $122,817 $41,158 $1,217,043
======== ======== ======== ======== ======== ======== ======== ======== ========
Interest Rate
Sensitivity Gap ($76,791)($127,234) ($107,473) ($126,786) $128,257 ($63,096) $420,381 $142,652 $189,910
Cumulative Interest Rate
Sensitivity Gap ($76,791)($204,025) ($311,498) ($438,284) ($310,027) ($373,123) $47,258 $189,910 --
Sensitivity Gap to
Total Assets (4.99%) (8.27%) (6.99%) (8.24%) 8.34% 4.10% 27.34% 9.28% --
Cumulative Interest Rate
Sensitivity Gap
to Total Assets (4.99%) (13.27%) (20.26%) (28.50%) (20.16%) (24.26%) 3.07% 12.35% --
Item 8. Financial Statements and Supplementary Data
(a) Financial Statements
Independent Auditors' Report
Board of Directors
Klamath First Bancorp, Inc.
Klamath Falls, Oregon
We have audited the accompanying consolidated balance sheets of Klamath
First Bancorp, Inc. and Subsidiaries (the "Company") as of September 30, 2003
and 2002, and the related consolidated statements of earnings, shareholders'
equity, and cash flows for each of the three years in the period ended September
30, 2003. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Klamath First Bancorp, Inc. and
Subsidiaries as of September 30, 2003 and 2002 and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 2003, in conformity with accounting principles generally accepted
in the United States of America.
Deloitte & Touche LLP
Portland, Oregon
December 26, 2003
KLAMATH FIRST BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 2003 September 30, 2002
ASSETS ------------------------ ------------------------
Cash and due from banks $39,266,748 $38,444,500
Interest bearing deposits with banks 5,838,016 5,762,373
Federal funds sold and securities purchased under agreements to resell 2,200,000 1,584,540
------------------ ------------------
Total cash and cash equivalents 47,304,764 45,791,413
Investment securities available for sale, at fair value
(amortized cost: $138,794,722 and $119,940,845) 140,939,164 119,542,052
Mortgage-backed and related securities available for sale, at fair
value (amortized cost: $678,888,417 and $640,304,722) 680,719,515 650,796,164
Loans receivable, net 557,551,402 607,464,660
Real estate owned and repossessed assets 651,254 758,663
Premises and equipment, net 23,331,046 23,410,847
Stock in Federal Home Loan Bank of Seattle, at cost 17,190,400 13,510,400
Accrued interest receivable 7,164,190 8,177,014
Deferred federal and state income taxes 824,844 --
Core deposit intangible, net 13,777,700 17,426,074
Goodwill and other intangible assets 22,872,915 22,872,915
Bank-owned life insurance 16,324,821 --
Other assets 8,465,528 3,745,151
------------------ ------------------
Total assets $1,537,117,543 $1,513,495,353
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposit liabilities $1,068,063,030 $1,142,005,997
Accrued interest on deposit liabilities 696,596 721,810
Advances from borrowers for taxes and insurance 3,062,959 5,105,955
Advances from Federal Home Loan Bank of Seattle 308,000,000 205,250,000
Short term borrowings -- 1,700,000
Accrued interest on borrowings 949,476 820,975
Mandatorily redeemable preferred securities 27,338,107 --
Pension liabilities 929,022 842,272
Deferred federal and state income taxes -- 1,466,556
Other liabilities 7,742,895 8,438,245
------------------ ------------------
Total liabilities 1,416,782,085 1,366,351,810
------------------ ------------------
Mandatorily redeemable preferred securities -- 27,205,507
Commitments and contingent liabilities
Shareholders' Equity
Preferred stock, $.01 par value, 500,000 shares authorized; none issued -- --
Common stock, $.01 par value, 35,000,000 shares authorized,
September 30, 2003 - 6,982,634 issued, 6,739,164 outstanding
September 30, 2002 - 6,744,040 issued, 6,366,546 outstanding 69,826 67,440
Additional paid-in capital 34,330,667 30,282,059
Retained earnings-substantially restricted 86,211,951 87,265,334
Unearned shares issued to ESOP (1,956,480) (2,935,130)
Unearned shares issued to MRDP (785,340) (999,111)
Accumulated other comprehensive income 2,464,834 6,257,444
------------------ ------------------
Total shareholders' equity 120,335,458 119,938,036
------------------ ------------------
Total liabilities and shareholders' equity $1,537,117,543 $1,513,495,353
=========== ===========
<FN>
See notes to consolidated financial statements.
</FN>
KLAMATH FIRST BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
Year Ended Year Ended Year Ended
September 30, September 30, September 30,
2003 2002 2001
-------------- -------------- --------------
INTEREST INCOME
Loans receivable $42,902,391 $52,178,747 $48,051,228
Mortgage-backed and related securities 21,863,936 26,368,930 11,611,184
Investment securities - taxable 4,088,155 6,126,126 6,599,562
Investment securities - tax-exempt 2,086,941 1,846,131 1,503,756
Federal funds sold and securities purchased under
agreements to resell 119,508 440,220 1,598,662
Interest bearing deposits 230,567 333,019 768,192
-------------- -------------- --------------
Total interest income 71,291,498 87,293,173 70,132,584
-------------- -------------- --------------
INTEREST EXPENSE
Deposit liabilities 18,173,471 29,782,599 30,304,271
Advances from FHLB of Seattle 10,885,897 9,608,659 10,065,991
Mandatorily redeemable preferred securities 390,596 -- --
Other 74,295 139,857 380,579
-------------- -------------- --------------
Total interest expense 29,524,259 39,531,115 40,750,841
-------------- -------------- --------------
Net interest income 41,767,239 47,762,058 29,381,743
Provision for loan losses -- 156,000 387,000
-------------- -------------- --------------
Net interest income after provision for
loan losses 41,767,239 47,606,058 28,994,743
-------------- -------------- --------------
NON-INTEREST INCOME
Fees and service charges on deposit accounts 6,669,340 4,943,213 2,339,973
Other fees and service charges 3,645,642 2,933,689 1,954,010
Gain on sale of investments 1,457,140 1,707,172 5,374,723
Gain on sale of real estate owned 37,272 25,852 86,927
Gain on sale of loans 2,140,620 1,076,745 573,885
Brokerage and annuity commissions 1,952,072 1,368,057 362,387
Bank-owned life insurance income 524,821 -- --
Other income 678,470 559,103 321,758
-------------- -------------- --------------
Total non-interest income 17,105,377 12,613,831 11,013,663
-------------- -------------- --------------
NON-INTEREST EXPENSE
Compensation, employee benefits and related expense 24,454,759 22,125,329 14,448,997
Occupancy expense 5,422,942 4,811,472 2,858,504
Data processing expense 1,583,206 1,499,490 1,007,040
Insurance premium expense 181,583 181,449 133,407
Loss on sale of investments 901,599 628,823 30,632
Impairment loss on investments 3,530,005 -- --
Loss on sale of real estate owned 26,018 771 39,911
Amortization of core deposit intangible 3,648,374 3,895,043 1,794,330
Amortization of goodwill -- 1,625,637 --
Mandatorily redeemable preferred securities expense 1,229,348 1,423,774 252,367
Merger costs 377,826 -- --
Other expense 14,543,237 13,979,591 8,154,956
-------------- -------------- --------------
Total non-interest expense 55,898,897 50,171,379 28,720,144
-------------- -------------- --------------
Earnings before income taxes 2,973,719 10,048,510 11,288,262
Provision for income taxes 576,896 3,259,734 3,717,260
-------------- -------------- --------------
Net earnings $2,396,823 $6,788,776 $7,571,002
========= ========= =========
Earnings per common share - basic $0.37 $1.06 $1.14
Earnings per common share - fully diluted $0.36 $1.05 $1.13
Weighted average common shares outstanding - basic 6,562,515 6,411,351 6,627,200
Weighted average common shares outstanding - with dilution 6,743,220 6,495,498 6,702,045
<FN>
See notes to consolidated financial statements.
</FN>
KLAMATH FIRST BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Unearned Unearned Accumulated
Common Common Additional shares shares other Total
stock stock paid-in Retained issued issued comprehensive shareholders'
shares amount capital earnings to ESOP to MRDP income (loss) equity
-------------- -------- ----------- ------------ ------------ ---------- ------------- ------------
Balance at
October 1, 2000 6,692,428 $73,662 $37,701,796 $79,713,255 ($4,893,250) ($2,498,378) ($1,372,524) $108,724,561
Cash dividends -- -- -- (3,467,950) -- -- -- (3,467,950)
Stock repurchased
and retired (550,221) (5,502) (7,393,921) -- -- -- -- (7,399,423)
ESOP contribution 97,974 -- 396,471 -- 979,740 -- -- 1,376,211
MRDP contribution 76,618 -- 13,708 -- -- 1,199,519 -- 1,213,227
Exercise of stock
options 244,662 2,447 3,208,742 -- -- -- -- 3,211,189
-------------- -------- ----------- ------------ ------------ ---------- ------------- ------------
6,561,461 70,607 33,926,796 76,245,305 (3,913,510) (1,298,859) (1,372,524) 103,657,815
Comprehensive income
Net earnings -- -- -- 7,571,002 -- -- -- 7,571,002
Other comprehensive
income:
Unrealized gain on
securities, net of
tax and reclassification
adjustment (1) -- -- -- -- -- -- 2,912,088 2,912,088
--------------
Total comprehensive income 10,483,090
-------------- -------- ----------- ------------ ------------ ---------- ------------- ------------
Balance at
September 30, 2001 6,561,461 70,607 33,926,796 83,816,307 (3,913,510) (1,298,859) 1,539,564 114,140,905
Cash dividends -- -- -- (3,339,749) -- -- -- (3,339,749)
Stock repurchased
and retired (345,986) (3,460) (4,747,387) -- -- -- -- (4,750,847)
ESOP contribution 97,865 -- 410,593 -- 978,380 -- -- 1,388,973
MRDP contribution 23,847 -- 11,511 -- -- 299,748 -- 311,259
Exercise of stock
options 29,359 293 369,295 -- -- -- -- 369,588
Tax benefit of
stock options -- -- 311,251 -- -- -- -- 311,251
-------------- -------- ----------- ------------ ------------ ---------- ------------- -----------
6,366,546 67,440 30,282,059 80,476,558 (2,935,130) ( 999,111) 1,539,564 108,431,380
Comprehensive income
Net earnings -- -- -- 6,788,776 -- -- -- 6,788,776
Other comprehensive
income:
Unrealized gain on
securities, net of
tax and reclassification
adjustment (2) -- -- -- -- -- -- 4,717,880 4,717,880
--------------
Total comprehensive income 11,506,656
-------------- -------- ----------- ------------ ------------ ---------- ------------- ------------
Balance at
September 30, 2002 6,366,546 67,440 30,282,059 87,265,334 (2,935,130) (999,111) 6,257,444 119,938,036
Cash dividends -- -- -- (3,450,206) -- -- -- (3,450,206)
Stock repurchased
and retired (13,660) (137) (232,623) -- -- -- -- (232,760)
ESOP contribution 97,865 -- 734,225 -- 978,650 -- -- 1,712,875
MRDP contribution 36,159 -- 5,514 -- -- 213,771 -- 219,285
Exercise of stock
options 252,254 2,523 3,310,876 -- -- -- -- 3,313,399
Tax benefit of
stock options -- -- 230,616 -- -- -- -- 230,616
-------------- -------- ----------- ------------ ------------ ---------- ------------- ------------
6,739,164 69,826 34,330,667 83,815,128 (1,956,480) ( 785,340) 6,257,444 121,731,245
Comprehensive loss
Net earnings -- -- -- 2,396,823 -- -- -- 2,396,823
Other comprehensive
loss:
Unrealized loss on
securities, net of
tax and reclassification
adjustment (3) -- -- -- -- -- -- (3,792,610) (3,792,610)
-------------
Total comprehensive loss (1,395,787)
-------------- -------- ----------- ------------ ------------ ---------- ------------- ------------
Balance at
September 30, 2003 6,739,164 $69,826 $34,330,667 $86,211,951 ($1,956,480) ($785,340) $2,464,834 $120,335,458
============= ========= =========== =========== =========== ========= ========== ============
<FN>
(1) Net unrealized holding gain on securities of $2,893,883 (net of $1,773,670 tax expense) less reclassification adjustment
for net gains included in net earnings of $49,982 (net of $30,634 tax expense)
(2) Net unrealized holding gain on securities of $5,095,497 (net of $3,123,389 tax expense) less reclassification adjustment
for net gains included in net earnings of $377,617 (net of $231,443 tax expense)
(3) Net unrealized holding loss on securities of $1,369,131 (net of $839,138 tax benefit) less reclassification adjustment
for net gains included in net earnings of $2,423,479 net of $1,485,358 tax expense)
See notes to consolidated financial statements.
</FN>
KLAMATH FIRST BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended Year Ended Year Ended
September 30, September 30, September 30,
2003 2002 2001
-------------- -------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings $2,396,823 $6,788,776 $7,571,002
ADJUSTMENTS TO RECONCILE NET EARNINGS TO
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
Depreciation and amortization 5,856,301 7,715,652 3,161,017
Deferred income taxes 33,104 (2,022,392) (956,590)
Provision for loan losses -- 156,000 387,000
Compensation expense related to ESOP benefit 1,712,875 1,388,973 1,376,211
Compensation expense related to MRDP Trust 219,285 311,259 1,213,227
Tax benefit associated with stock options 230,616 311,251 --
Net amortization of premiums paid on
investment and mortgage-backed and related securities 8,609,473 3,930,135 249,371
Decrease in deferred loan fees, net of amortization (692,444) (688,264) (2,848,812)
Net (gain) loss on sale of real estate owned and
premises and equipment (23,605) (25,081) 39,452
Net gain on sale of investment and mortgage
backed and related securities (555,541) (1,078,349) (5,344,091)
Impairment loss on investment securities 3,530,005 -- --
FHLB stock dividend (854,700) (812,400) (821,500)
CHANGES IN ASSETS AND LIABILITIES
Accrued interest receivable 1,012,824 480,572 (2,225,513)
Other assets (5,252,239) 3,685,333 (7,456,909)
Accrued interest on deposit liabilities (25,214) (852,796) 389,530
Accrued interest on borrowings 128,502 19,232 (55,420)
Pension liabilities 86,750 (99,876) 54,252
Other liabilities (447,467) 1,916,541 3,194,579
-------------- -------------- --------------
Net cash provided by (used in) operating activities 15,965,348 21,124,566 (2,073,194)
-------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturity of investment securities
held to maturity -- 135,000 130,000
Proceeds from maturity of investment securities
available for sale 17,597,000 15,000,000 33,425,000
Principal repayments received on mortgage
backed and related securities held to maturity -- 1,238,278 531,435
Principal repayments received on mortgage
backed and related securities available for sale 351,664,191 108,276,166 46,429,807
Principal repayments received on loans 375,433,075 286,803,701 145,496,311
Loan originations (420,397,256) (281,665,175) (136,492,447)
Loans purchased (3,875,225) (1,683,363) --
Loans sold 99,100,042 68,661,105 30,708,858
Purchase of investment securities available
for sale (50,666,979) (41,854,162) (78,456,931)
Purchase of mortgage-backed and related
securities available for sale (612,548,001) (419,414,542) (383,198,597)
Purchase of FHLB stock (2,825,300) -- --
Proceeds from sale of investment securities
available for sale 10,228,950 61,977,158 10,367,746
Proceeds from sale of mortgage-backed and related
securities available for sale 214,703,334 87,131,357 187,991,361
Proceeds from sale of real estate owned and
premises and equipment 476,071 653,574 1,261,175
Investment in real estate owned -- -- (86,742)
Purchases of premises and equipment (2,121,085) (8,533,907) (5,392,241)
Acquisitions, net of cash acquired -- -- 206,548,213
Purchase of bank-owned life insurance (15,800,000) -- --
------------- ------------- -------------
Net cash provided by (used in) investing activities (39,031,183) (123,274,810) 59,262,948
------------- ------------- -------------
KLAMATH FIRST BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
Year Ended Year Ended Year Ended
September 30, September 30, September 30,
2003 2002 2001
-------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase(decrease) in deposit liabilities ($73,942,967) ($10,818,147) $33,986,127
Proceeds from FHLB advances 391,300,000 99,950,000 2,000,000
Repayments of FHLB advances (288,550,000) (62,700,000) (7,000,000)
Proceeds from short term borrowings 3,300,000 200,000 3,400,000
Repayments of short term borrowings (5,000,000) (200,000) (4,700,000)
Issuance of mandatorily redeemable preferred stock -- 12,651,823 14,553,684
Stock repurchase and retirement (232,760) (4,750,847) (7,399,423)
Proceeds from exercise of stock options 3,313,399 369,588 3,211,189
Advances from borrowers for taxes and insurance (2,042,996) (1,532,039) (3,015,382)
Dividends paid (3,565,490) (3,617,287) ( 3,783,983)
-------------- -------------- --------------
Net cash provided by financing activities 24,579,186 29,553,091 31,252,212
-------------- -------------- --------------
Net (decrease) increase in cash and cash
equivalents 1,513,351 (72,597,153) 88,441,966
Cash and cash equivalents at beginning
of year 45,791,413 118,388,566 29,946,600
-------------- -------------- --------------
Cash and cash equivalents at end of year $47,304,764 $45,791,413 $118,388,566
========= ========= =========
SUPPLEMENTAL SCHEDULE OF INTEREST AND
INCOME TAXES PAID
Interest paid $30,650,318 $40,364,979 $42,020,217
Income taxes paid 1,775,000 2,795,000 3,930,000
SUPPLEMENTAL SCHEDULE OF NONCASH
INVESTING AND FINANCING ACTIVITIES
ACTIVITIES
Net unrealized gain (loss) on securities
available for sale ($3,792,610) $4,717,880 $2,912,088
Dividends declared and accrued in other
liabilities 907,742 883,136 934,233
Loans transferred to real estate owned 346,770 949,830 870,128
Loans securitized and recorded as mortgage-backed
securities available for sale -- -- 190,300,518
Mortgage-backed securities held to maturity
transferred to available for sale, at fair value -- 376,335 --
<FN>
See notes to consolidated financial statements.
</FN>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Klamath First
Bancorp, Inc. (the "Company") and its wholly-owned subsidiaries, Klamath Capital
Trust I and Klamath First Federal Savings and Loan Association (the
"Association"), including the Association's subsidiaries, Klamath First
Financial Services and Pacific Cascades Financial, Inc. All intercompany
accounts and transactions have been eliminated in consolidation.
Certain prior year amounts have been reclassified to conform to current year
presentation.
Nature of Operations
The Company provides banking and limited non-banking services to its customers
who are located throughout the state of Oregon and in adjoining areas of
Washington State. These services primarily include attracting deposits from the
general public and using such funds, together with other borrowings, to invest
in various real estate loans, consumer and commercial loans, investment
securities and mortgage-backed and related securities.
Use of Estimates in the Presentation of the Financial Statements
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
assumptions. These assumptions result in estimates 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.
Cash Equivalents
For purposes of the Consolidated Statements of Cash Flows, the Company considers
cash and due from banks, interest-bearing deposits held at domestic banks,
federal funds sold, and security resale agreements to be cash and cash
equivalents, all of which mature within 90 days.
Investment Securities
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 115,
Accounting for Certain Investments in Debt and Equity Securities, investment
securities held to maturity are stated at amortized cost only if the Company has
the positive intent and the ability to hold the securities to maturity.
Securities available for sale, including mutual funds, and trading securities
are stated at fair value. Unrealized gains and losses from available for sale
securities are excluded from earnings and reported (net of tax) as a net amount
in a separate component of shareholders' equity until realized. Realized gains
and losses on the sale of securities, recognized on a specific identification
basis, and valuation adjustments of trading account securities are included in
non- interest income or expense. 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 the value has
occurred.
Stock Investments
The Company holds stock in the Federal Home Loan Bank of Seattle ("FHLB of
Seattle"). This investment is carried at historical cost.
Loans
Loans held for investment are stated at the principal amount outstanding, net of
deferred loan fees and unearned income. Loan origination fees, commitment fees
and certain direct loan origination costs are capitalized and recognized as a
yield adjustment over the lives of the loans using the level yield method.
Unearned discounts are accreted to income over the average lives of the related
loans using the level yield method, adjusted for estimated prepayments.
Interest income is recorded as earned. Management ceases to accrue interest
income on any loan that becomes 90 days or more delinquent and reverses all
interest accrued up to that time. Thereafter, interest income is accrued only if
and when, in management's opinion, projected cash proceeds are deemed sufficient
to repay both principal and interest. All loans for which interest is not being
accrued are referred to as loans on non accrual status.
Allowance for Loan Losses
The allowance for loan losses is established to absorb known and inherent losses
in the loan portfolio. Allowances for losses on specific problem real estate
loans are charged to earnings when it is determined that the value of these
loans is impaired. In addition to specific reserves, the Company also maintains
general provisions for loan losses based on evaluating known and inherent risks
in the loan portfolio, including management's continuing analysis of the factors
underlying the quality of the loan portfolio. These factors include changes in
the size and composition of the loan portfolio, geographic concentrations,
actual loan loss experience, current economic conditions, detailed analysis of
individual loans for which full collectibility may not be assured, and
determination of the existence and realizable value of the collateral and
guarantees securing the loans. The allowance is an estimate based upon factors
and trends identified by management at the time financial statements are
prepared. The ultimate recovery of loans is susceptible to future market factors
beyond the Company's control, which may result in losses or recoveries differing
significantly from those provided in the consolidated financial statements. In
addition, various regulatory agencies, as an integral part of their examination
process, periodically review the Company's allowance on loans.
Delinquent interest on loans past due 90 days or more is charged off or an
allowance established by a charge to income equal to all interest previously
accrued. Interest is subsequently recognized only to the extent cash payments
are received until delinquent interest is paid in full and, in management's
judgment, the borrower's ability to make periodic interest and principal
payments is back to normal, in which case the loan is returned to accrual
status.
Real Estate Owned
Property acquired through foreclosure or deed in lieu of foreclosure is carried
at the lower of estimated fair value, less estimated costs to sell, or the
balance of the loan on the property at date of acquisition, not to exceed net
realizable value. Costs excluding interest, relating to the improvement of
property are capitalized, whereas those relating to acquiring and holding the
property are charged to expense.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is generally computed on the straight-line basis over the estimated
useful lives of the various classes of assets from their respective dates of
acquisition. Estimated useful lives range up to 30 years for buildings, up to
the lease term for leasehold improvements, three years for automobiles, and
three to 15 years for furniture and equipment.
Mortgage Servicing
Fees earned for servicing loans are reported as income when the related mortgage
loan payments are collected. Loan servicing costs are charged to expense as
incurred.
The Company accounts for mortgage servicing rights ("MSR") in accordance with
SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities. SFAS No. 140 requires the Company to allocate the
total cost of all mortgage loans sold, whether
originated or purchased, to the MSR and the loans (without MSR) based on their
relative fair values if it is practicable to estimate those fair values.
MSR are capitalized at their allocated carrying value and amortized in
proportion to, and over the period of, estimated future net servicing income.
The Company assesses impairment of the MSR based on the fair value of those
rights. For purposes of measuring impairment, the MSR are stratified based on
interest rate characteristics (fixed-rate and adjustable-rate), as well as by
coupon rate. In order to determine the fair value of the MSR, the Company uses a
model that estimates the present value of expected future cash flows.
Assumptions used in the model include market discount rates and anticipated
prepayment speeds. In addition, the Company uses market comparables for
estimates of the cost of servicing, inflation rates and ancillary income.
Impairment allowances of $193,443 and $180,739 were recorded at September 30,
2003 and 2002. Future interest rate decreases could have a negative impact on
the recorded MSR.
Intangible Assets
In conjunction with branch acquisitions, the Company has recorded intangible
assets, including core deposit intangible and other intangible assets. Core
deposit intangibles are amortized over the estimated average remaining life of
the deposit base acquired. Other intangible assets are amortized over a period
no greater than the estimated remaining life of the long term assets acquired.
Because other intangible assets were recorded in conjunction with a purchase of
branches, they were accounted for in accordance with SFAS No. 72, Accounting for
Certain Acquisitions of Bank and Thrift Institutions. In October 2002, the
Financial Accounting Standards Board ("FASB") issued SFAS No. 147, Acquisitions
of Certain Financial Institutions, which requires such intangible assets to be
accounted for under the provisions of SFAS No. 141, Business Combinations, and
SFAS No. 142, Goodwill and Other Intangible Assets. Under this guidance, other
intangible assets will be evaluated for impairment but will no longer be
amortized. The Company adopted SFAS No. 147 as of October 1, 2002. Expense
related to amortization of other intangibles totaled $1.1 million for the year
ended September 30, 2002. There was no amortization expense in the year ended
September 30, 2001 because the transaction to which the intangible assets relate
happened in mid- September 2001 and no expense was recorded. Due to the adoption
of SFAS No. 147, no such amortization expense was recorded in fiscal year 2003.
Mandatorily Redeemable Preferred Securities
The Company adopted SFAS No. 150, Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity, as of July 1, 2003.
Adoption of this statement resulted in the reclassification of the mandatorily
redeemable preferred securities from a separate classification between
liabilities and equity to inclusion within liabilities. Restatement of prior
periods was not permitted, so these securities are included in liabilities
during the current period and in mezzanine equity for the previous years. In
addition, expense related to these securities was recorded as interest expense
for the period from July 1, 2003 to September 30, 2003 but is included in other
expense for all prior periods.
Income Taxes
The Company accounts for income taxes using the asset and liability method of
accounting for income taxes. Under this method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled.
Employee Stock Ownership Plan
The Company sponsors an Employee Stock Ownership Plan ("ESOP"). The ESOP is
accounted for in accordance with the American Institute of Certified Public
Accountants ("AICPA") Statement of Position 93-6, Employer's Accounting for
Employee Stock Ownership Plans. Accordingly, the shares held by the ESOP are
reported as unearned shares issued to the employee stock ownership plan in the
balance sheets. The plan authorizes release of the shares over a ten-year
period, of which four years are remaining. As shares are released from
collateral, compensation expense is recorded equal to the then current market
price of the shares, and the shares become outstanding for earnings per share
calculations.
Management Recognition and Development Plan
The Company sponsors a Management Recognition and Development Plan ("MRDP"). The
MRDP is accounted for in accordance with SFAS No. 123, Accounting for
Stock-Based Compensation. The plan authorizes the grant of common stock shares
to certain officers and directors, which vest over a five-year period in equal
installments. The Company recognizes compensation expense in the amount of the
fair value of the common stock in accordance with the vesting schedule during
the years in which the shares are payable. When the MRDP awards are allocated,
the common stock shares become common stock equivalents for earnings per share
calculations. Compensation expense related to the MRDP for the years ended
September 30, 2003, 2002 and 2001 was $219,285, $311,259 and $1.2 million,
respectively.
Stock Based Compensation
The Company accounts for stock option grants using the intrinsic value method as
prescribed in Accounting Principles Board ("APB") Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations. Under the intrinsic
value based method, compensation cost for stock options is measured as the
excess, if any, of the quoted market price of stock at grant date over the
amount an employee must pay to acquire the stock. Stock options granted by the
Company have no intrinsic value at the grant date and, under APB No. 25, there
is no compensation expense to be recorded.
SFAS No. 123, Accounting for Stock-Based Compensation, encourages, but does not
require, companies to record compensation cost for stock-based employee
compensation plans at fair value. The fair value approach measures compensation
costs based on factors such as the term of the option, the market price at grant
date, and the option exercise price, with expense recognized over the vesting
period.
As discussed above, the Company continues to account for its stock-based awards
using the intrinsic value method in accordance with APB Opinion No. 25,
Accounting for Stock Issued to Employees
and its related interpretations. Accordingly, no compensation expense has been
recognized in the financial statements for employee stock arrangements.
SFAS No. 123, Accounting for Stock-Based Compensation 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 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 weighted average grant-date fair value of options granted during fiscal
years 2003, 2002, and 2001 was $2.71, $1.63, $2.03, respectively. The Company's
calculations are based on a multiple option valuation approach and forfeitures
are recognized as they occur. Had compensation cost for these awards been
determined under SFAS No. 123, the Company's net earnings and earnings per share
would have been reduced to the following pro forma amounts:
Year ended September 30,
2003 2002 2001
----------------------------------------------------
Net earnings:
As reported $2,396,823 $6,788,776 $7,571,002
Pro forma 2,321,998 6,662,157 7,457,552
Earnings per common share - basic
As reported $0.37 $1.06 $1.14
Pro forma $0.35 $1.04 $1.13
Earnings per common share - fully
diluted:
As reported $0.36 $1.05 $1.13
Pro forma $0.34 $1.03 $1.11
The Company's calculations were made using the Black-Scholes option pricing
model with the following weighted average assumptions:
2003 2002 2001
Grant Grant Grant
--------- ------- ------
Risk free interest rates 2.98% 3.69% 5.09%
Expected dividend 3.09% 4.03% 4.33%
Expected lives, in years 7.5 3.5 3.3
Expected volatility 21.51% 20.29% 28.73%
Recently Issued Accounting Pronouncements
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure. SFAS No. 148 amends SFAS No. 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition for an entity that voluntarily changes to the fair value based method
of accounting for stock-based employee compensation. The Company has adopted
this statement and has elected to continue to account for stock-based
compensation under the guidance in APB Opinion No. 25.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, for certain
decisions made by the FASB and to incorporate clarifications of the definition
of a derivative. This Statement is effective for contracts entered into or
modified after June 30, 2003. Management does not expect that the provisions of
SFAS No. 149 will impact the Company's results of operations or financial
condition.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities. This Interpretation requires a variable interest
entity to be consolidated by the primary beneficiary of that entity. The
consolidation requirements of this interpretation apply immediately to variable
interest entities created after January 31, 2003, and will apply to existing
entities for the first fiscal year or interim period beginning after December
15, 2003. Certain disclosure requirements apply in all financial statements
issued after January 31, 2003, regardless of when the variable interest entity
was established. The Company is currently evaluating the impact of the
interpretation on its financial statements and, except for the possible effects
related to the issuance of its trust preferred securities, and any related
regulatory effects, does not currently believe the interpretation will have a
material impact on the results of operations or financial condition of the
Company.
(2) Acquisition
On September 7, 2001, the Company completed the acquisition of 13 branches from
Washington Mutual. These branches are located along the Oregon coast and in
northeastern Oregon, complementing and expanding the existing branch network.
The transaction, which was accounted for as a purchase in accordance with SFAS
No. 72, Accounting for Certain Acquisitions of Bank and Thrift Institutions,
included acquisition of $179.3 million in loans and assumption of $423.5 million
in deposit liabilities. Income and expense related to the transaction and
operation of the branches for the period from September 7, 2001 to September 30,
2001 are reflected in the statement of earnings. As a result of this
transaction, the Company recorded core deposit intangible of $15.0 million which
will be amortized over the estimated life of the deposit base. The Company also
recorded other intangible assets of $24.1 million related to the transaction.
(3) Cash and Due from Banks
The Company is required to maintain an average reserve balance with the Federal
Reserve Bank, or maintain such reserve balance in the form of cash. The amount
of this required reserve balance was approximately $4.3 million and $4.0 million
at September 30, 2003 and 2002, respectively, and was met by holding cash and
maintaining an average balance with the Federal Reserve Bank in excess of this
amount.
(4) Investments and Mortgage-backed Securities
Amortized cost and approximate fair value of securities available for sale and
held to maturity are summarized by type and maturity as follows:
September 30, 2003
-----------------------------------------------------------------------
Amortized Gross Unrealized Fair
cost Gains Losses value
---------- ---------- ---------- ----------
INVESTMENT SECURITIES AVAILABLE-FOR-SALE
State and municipal obligations
Maturing within one year $485,036 $4,188 $-- $489,224
Maturing after five years through
ten years 2,181,683 78,185 1,876 2,257,992
Maturing after ten years 39,575,738 2,295,049 33,389 41,837,398
FHLB obligations
Maturing after one year through
five years 10,000,000 87,500 -- 10.087,500
Corporate obligations
Maturing within one year 11,860,320 156,958 -- 12,017,278
Maturing after one year through
five years 39,680,212 953,949 -- 40,634,161
Maturing after ten years 19,841,738 -- 1,659,238 18,182,500
Federal agency preferred stock
Maturing after ten years 15,169,995 263,116 -- 15,433,111
---------- ---------- ---------- ----------
$138,794,722 $3,838,945 $1,694,503 $140,939,164
========== ========== ========== ==========
September 30, 2002
-----------------------------------------------------------------------
Amortized Gross Unrealized Fair
cost Gains Losses value
---------- ---------- ---------- ----------
INVESTMENT SECURITIES AVAILABLE-FOR-SALE
State and municipal obligations
Maturing within one year $100,000 $565 $-- $100,565
Maturing after one year through
five years 485,300 12,929 -- 498,229
Maturing after five years through
ten years 790,110 56,682 -- 846,792
Maturing after ten years 38,202,338 2,381,961 4,044 40,580,255
Corporate obligations
Maturing within one year 17,890,090 -- 55,225 17,834,865
Maturing after one year through
five years 23,922,805 489,819 14,498 24,398,126
Maturing after ten years 19,834,958 -- 2,644,508 17,190,450
Federal agency preferred stock
Maturing after ten years 18,715,244 -- 622,474 18,092,770
---------- ---------- ---------- ----------
$119,940,845 $2,941,956 $3,340,749 $119,542,052
========== ========== ========== ==========
September 30, 2003
-----------------------------------------------------------------------
Amortized Gross Unrealized Fair
cost Gains Losses value
---------- ---------- ---------- ----------
MORTGAGE-BACKED AND RELATED SECURITIES AVAILABLE-FOR-SALE
CMO's maturing after one year
through five years $7,147,206 $95,116 $ -- $7,242,322
FHLMC maturing after one year
through five years 1,726,836 34,426 -- 1,761,262
FNMA maturing after five years
through ten years 5,688,474 216,480 -- 5,904,954
CMO's maturing after five years
through ten years 40,619,858 842,027 -- 41,461,885
FHLMC maturing after five years
through ten years 3,287,704 61,530 -- 3,349,234
FNMA maturing after ten years 253,431,224 1,608,103 420,377 254,618,950
FHLMC maturing after ten years 122,306,799 310,664 1,540,051 121,077,412
GNMA maturing after ten years 8,809,464 36,581 70,730 8,775,315
CMO's maturing after ten years 235,870,852 1,500,660 843,331 236,528,181
---------- ---------- ---------- ----------
$678,888,417 $4,705,587 $2,874,489 $680,719,515
========== ========== =========== ==========
September 30, 2002
-----------------------------------------------------------------------
Amortized Gross Unrealized Fair
cost Gains Losses value
---------- ---------- ---------- ----------
MORTGAGE-BACKED AND RELATED SECURITIES AVAILABLE-FOR-SALE
CMO's maturing after one year
through five years $2,944,195 $26,810 $ -- $2,971,005
FHLMC maturing after one year
through five years 11,520,162 237,265 -- 11,757,427
FNMA maturing after five years
through ten years 12,634,495 231,613 -- 12,866,108
CMO's maturing after five years
through ten years 133,151,422 4,006,978 -- 137,158,400
FHLMC maturing after five year
through ten years 7,182,143 83,445 -- 7,265,588
FNMA maturing after ten years 116,232,557 1,134,165 -- 117,366,722
FHLMC maturing after ten years 37,902,266 425,289 2,515 38,325,040
GNMA maturing after ten years 24,346,010 247,888 346 24,593,552
CMO's maturing after ten years 294,391,472 4,108,891 8,041 298,492,322
---------- ---------- ---------- ------------
$640,304,722 $10,502,344 $10,902 $650,796,164
========== ========== ========== ============
Expected maturities of mortgage-backed and related securities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
At September 30, 2003 and 2002, the Company pledged securities totaling $585.9
million and $40.5 million, respectively, to secure certain public deposits and
for other purposes as required or permitted by law. The increase from 2002 to
2003 resulted from pledging investment securities to collateralize FHLB of
Seattle borrowings in replacement of collateralization with mortgage loans under
a blanket pledge.
(5) Loans receivable
September 30,
---------------------------------------------
2003 2002
----------------- -----------------
Real estate loans
Permanent residential one- to four-family $195,784,922 $339,403,368
Multi-family residential 32,029,946 21,595,322
Construction 16,650,269 15,223,441
Agricultural 9,382,520 4,888,861
Commercial 125,725,721 91,703,262
Land 8,081,601 4,164,394
----------------- -----------------
Total real estate loans 387,654,979 476,978,648
Non-real estate loans
Savings account 1,293,776 1,261,448
Home improvement and home equity 112,248,154 65,092,250
Other consumer 16,072,833 16,926,304
Commercial 57,975,073 62,102,347
---------------- -----------------
Total non-real estate loans 187,589,836 145,382,349
---------------- -----------------
Total loans 575,244,815 622,360,997
Less
Undisbursed portion of loans 7,540,747 3,609,164
Deferred loan fees 3,218,917 3,911,361
Allowance for loan losses 6,933,749 7,375,812
----------------- -----------------
$557,551,402 $607,464,660
================= =================
The weighted average interest rate on loans at September 30, 2003 and 2002 was
6.39% and 7.36%, respectively.
Included in loans receivable are $4.0 million of loans held for sale. All these
loans are one- to four-family mortgage loans. In the aggregate there was no
lower of cost or market adjustment required; fair value approximates cost.
Aggregate loans to officers and directors, all of which were current, consist of
the following (in thousands):
Year Ended September 30,
--------------------------------------------------------------
2003 2002 2001
----------- -------------- -----------
Beginning balance $3,220 $2,990 $2,089
Originations 6,006 1,018 1,227
Principal repayments (1,716) (788) (326)
----------- -------------- -----------
Ending balance $7,510 $3,220 $2,990
=========== ============== ===========
The significant increase in originations for 2003 relates to refinancing
activity and to the election of a new director in January 2003 who had existing
loans with the Company.
Activity in the allowance for loan losses is summarized as follows:
Year Ended September 30,
-----------------------------------------------------------
2003 2002 2001
----------- -------------- --------------
Balance, beginning of year $7,375,812 $7,950,680 $4,082,265
Charge offs (507,130) (747,092) (90,173)
Recoveries 65,067 16,224 42,406
Additions -- 156,000 387,000
Acquisitions -- -- 3,761,024
Allowance reclassified with loan securitization -- -- (231,842)
----------- -------------- --------------
Balance, end of year $6,933,749 $7,375,812 $7,950,680
======== ======== ========
At September 30, 2003 and 2002, impaired loans totaled $104,424 and $200,000,
respectively. At September 30, 2003, loan loss reserves specifically allocated
to these loans totaled $1,512. There were no specifically allocated loan loss
reserves related to these loans at September 30, 2002. The average investment in
impaired loans for the years ended September 30, 2003 and 2002 was $157,847 and
$43,590, respectively.
(6) Premises and Equipment
Premises and equipment consist of the following:
September 30,
--------------------------------------
2003 2002
----------- ------------
Land $ 4,879,451 $ 4,872,673
Office buildings and construction in progress 18,696,847 17,766,655
Furniture, fixtures and equipment 10,711,875 9,559,681
Automobiles 30,324 20,928
Less accumulated depreciation (10,987,451) (8,809,090)
------------ ------------
$23,331,046 $23,410,847
=========== ===========
Depreciation expense was $2.2 million, $2.0 million, and $1.2 million for the
years ended September 30, 2003, 2002, and 2001, respectively.
(7) Accrued Interest Receivable
The following is a summary of accrued interest receivable:
September 30,
--------------------------------------
2003 2002
----------- -----------
Loans receivable $ 2,954,233 $ 3,578,678
Mortgage-backed and related securities 2,622,224 3,028,121
Investment securities 1,587,676 1,570,154
Federal funds sold and securities purchased
under agreements to resell 57 61
------------ ------------
$ 7,164,190 $ 8,177,014
=========== ============
(8) Mortgage Servicing Rights ("MSR")
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The unpaid principal balance of mortgage loans
serviced for others was $72.9 million and $140.3 million at September 30, 2003
and 2002, respectively. The mortgage servicing rights are included in other
assets in the consolidated balance sheets.
During the quarter ended March 31, 2001, the Company sold $190.3 million in
seasoned fixed-rate single- family loans to Fannie Mae. The mortgages were
aggregated into 14 pools and securitized with the resulting MBS being retained
by the Company, and classified as available for sale, and subsequently sold. The
loans were sold with servicing retained by the Company.
The fair value of MSR was determined using a discounted cash flow model, which
incorporates the expected life of the loans, estimated costs to service the
loans, servicing fees to be received, and other factors. Mortgage servicing
rights were valued at $1.7 million. The key assumptions used to initially value
the MSR recorded in 2001 included a constant prepayment rate ("CPR") of 20%, an
average life of 6.3 years and a discount rate of 10%. The Company pays a
guarantee fee to FNMA as part of the securitization and servicing of the loans,
thus transferring all credit risk to FNMA. The final resulting basis in the MBS
recorded was $185.9 million. As of September 30, 2001, all the resulting MBS had
been sold with a gain of $5.4 million.
The balance of the Company's originated MSR as of September 30, 2003, 2002, and
2001, and changes during the periods then ended, were as follows:
Year Ended September 30,
-------------------------------------------------
2003 2002 2001
--------------- ------------- -------------
Balance, beginning of year $1,035,660 $1,596,930 $95,420
Additions for loans securitized -- -- 1,653,830
Additions for other loans sold -- -- 54,693
Amortization of servicing rights for loans securitized (597,397) (327,542) (167,857)
Amortization of servicing rights for other loans sold (39,896) (52,989) (39,156)
Valuation allowance (12,704) (180,739) --
--------------- ------------- -------------
Balance, end of year $385,663 $1,035,660 $1,596,930
======== ========== ==========
The changes in the Company's valuation allowance for impairment of MSR are as
follows for the periods indicated:
Year Ended September 30,
------------------------------------------
2003 2002 2001
---------- ---------- ------
Balance, beginning of year ($180,739) $-- $--
Additions for impairment (12,704) (180,739) --
_________ ________ _____
Balance, end of year ($193,443) ($180,739) $--
========= ======== =====
The Company evaluates MSR for impairment by stratifying MSR based on the
predominant risk characteristics of the underlying financial assets. At
September 30, 2003 and 2002, the fair values of the Company's MSR were $385,663
and $1,045,964 respectively, which were estimated using a discount rate of 8.5%
and Public Securities Association prepayment assumptions (PSA) ranging from 152
to 513 and from 217 to 679, respectively.
At September 30, 2003, the key economic assumptions and the sensitivity of the
current value for MSR to immediate 10% and 20% adverse changes in those
assumptions were as follows:
Year Ended
September 30, 2003
------------------
Fair value of capitalized MSR $385,663
PSA 152 to 513
Impact on fair value of 10% adverse change (19,342)
Impact on fair value of 20% adverse change (36,663)
Future cash flows discounted at 8.50%
Impact on fair value of 10% adverse change (7,774)
Impact on fair value of 20% adverse change (15,238)
These sensitivities are hypothetical and should be used with caution. As the
amounts indicate, changes in fair value based on a change in assumptions
generally cannot be extrapolated because the relationship of the change in
assumption to the change in fair value may not be linear. Also, in this table,
the effect of a variation in a particular assumption on the fair value of the
retained interest is calculated without changing any other assumption. In
reality, however, changes in one factor may result in changes in another, which
might magnify or counteract the sensitivities.
(9) Goodwill and Intangible Assets
On October 1, 2002, the Company adopted SFAS No. 147, Acquisitions of Certain
Financial Institutions, which requires certain intangible assets to be accounted
for under the provisions of SFAS No. 141, Business Combinations, and SFAS No.
142, Goodwill and Other Intangible Assets, which statements were also adopted on
October 1, 2002. In accordance with these standards, goodwill and other
intangible assets with indefinite lives are no longer being amortized but
instead will be tested for impairment at least annually. Upon adoption of SFAS
No. 147, $22.9 million of intangible assets related to prior branch acquisitions
were reclassified to goodwill and amortization of these assets ceased. Expense
related to amortization of goodwill totaled $1.6 million for the year ended
September 30, 2002. A similar expense is not being recorded in fiscal year 2003.
Core deposit intangibles will continue to be amortized based on the estimated
lives of the underlying deposits.
The following table summarizes selected information about intangible assets:
Gross Carrying Amount Accumulated Amortization
- --------------------------------- -------------------------------------------- --------------------------------------------
Intangible assets September 30, 2003 September 30, 2002 September 30, 2003 September 30, 2002
carrying value
- --------------------------------- --------------------- ---------------------- ----------------------- --------------------
Core deposit intangible $28,376,467 $28,376,467 $14,598,767 $10,950,393
Mortgage servicing rights (included
in Other Assets) 1,820,823 1,820,823 1,241,717 604,424
--------------------- ---------------------- ----------------------- --------------------
Total $30,197,290 $30,197,290 $15,840,484 $11,554,817
===================== ====================== ======================= ====================
Amortization expense
Year ended September 30,
--------------------------------------------
Intangible assets amortization 2003 2002
- --------------------------------- --------------------- ----------------------
Core deposit intangible $3,648,374 $3,895,043
Mortgage servicing rights 637,293 380,531
--------------------- ----------------------
Total $4,285,667 $4,275,574
===================== ======================
Estimated amortization expense for
core deposit intangible and MSR
For year ended 9/30/2004 $3,611,358
For year ended 9/30/2005 $3,306,403
For year ended 9/30/2006 $1,648,489
For year ended 9/30/2007 $1,527,914
For year ended 9/30/2008 $1,258,079
(10) Deposit Liabilities
The following is a summary of deposit liabilities:
September 30,
---------------------------------------------------------
2003 2002
------------------------- -------------------------
Amount Percent Amount Percent
---------- ---------- ---------- ----------
Checking accounts, non-interest
bearing $161,450,712 15.1% $142,772,746 12.5%
---------- ---------- ---------- ----------
Interest-bearing checking 136,557,381 12.8 125,866,951 11.0
---------- ---------- ---------- ----------
Passbook and statement savings 93,311,065 8.7 86,000,755 7.5
---------- ---------- ---------- ----------
Money market deposits 326,630,686 30.6 330,646,410 29.0
---------- ---------- ---------- ----------
Certificates of deposit
Less than 4% 195,245,851 18.3 241,617,671 21.1
4.00% to 5.99% 79,480,745 7.4 110,380,428 9.7
6.00% to 7.99% 75,047,388 7.0 104,395,224 9.1
8.00% to 9.99% 339,202 0.1 325,812 0.1
-------------- --------- -------------- ---------
350,113,186 32.8 456,719,135 40.0
-------------- --------- -------------- ---------
$1,068,063,030 100.0% $1,142,005,997 100.0%
============== ========= ============== =========
The following is a summary of interest expense on deposits:
Year Ended September 30,
------------------------------------------
2003 2002 2001
---------- ---------- ----------
Interest-bearing checking $175,549 $ 906,544 $ 812,210
Passbook and statement savings 384,216 930,450 1,066,607
Money market 3,366,528 6,376,625 6,332,507
Certificates of deposit 14,331,577 21,691,878 22,199,640
---------- ---------- ----------
18,257,870 29,905,497 30,410,964
Less early withdrawal
penalties 84,399 122,898 106,693
---------- ---------- ----------
Net interest on deposits $18,173,471 $29,782,599 $30,304,271
=========== =========== ===========
At September 30, 2003, maturities of certificates of deposit were as follows:
Within 1 year $201,289,820
1 year to 3 years 82,522,403
3 years to 5 years 31,837,173
Thereafter 34,463,790
------------
$350,113,186
============
Weighted average interest rates at September 30, 2003 and 2002 were as follows:
2003 2002
---------- ----------
Interest-bearing checking 0.19% 0.44%
Passbook and statement savings 0.25% 0.75%
Money market 0.88% 1.44%
Certificates of deposit 3.34% 4.00%
Weighted average rate for all deposits 1.66% 2.42%
Deposits in excess of $100,000 totaled $296.3 million and $297.8 million at
September 30, 2003 and 2002, respectively. Deposits in excess of $100,000 are
not insured by the Federal Deposit Insurance Corporation ("FDIC").
(11) Advances from FHLB
As a member of the FHLB of Seattle, the Association maintains a credit line that
is a percentage of its total regulatory assets, subject to collateralization
requirements. At September 30, 2003, the credit line was 40% of total assets of
the Association. Advances are collateralized in the aggregate, as provided for
in the Advances, Security and Deposit Agreements with the FHLB of Seattle, by
certain mortgages or deeds of trust, and securities of the U.S. Government and
agencies thereof. At September 30, 2003 the minimum book value of eligible
collateral for these borrowings was $382.0 million.
Scheduled maturities of advances from the FHLB were as follows:
September 30, 2003 September 30, 2002
--------------------------------------------------- -----------------------------------------------------
Range of Weighted Range of Weighted
interest average interest average
Amount rates interest rate Amount rates interest rate
-------------- -------------- -------------- -------------- -------------- -------------
Due within one year $130,000,000 1.18% - 2.48% 1.26% $31,250,000 1.91% - 2.20% 2.09%
After one but within
five years 60,000,000 2.22% - 4.77% 4.22% 16,000,000 2.48% - 3.58% 3.06%
After five but within
ten years 118,000,000 5.35% - 7.05% 6.23% 158,000,000 4.77% - 7.05% 5.86%
-------------- --------------
$308,000,000 $205,250,000
============ ==============
Financial data pertaining to the weighted average cost, the level of FHLB
advances and the related interest expense are as follows:
Year Ended September 30,
-----------------------------------------------------------------
2003 2002 2001
-------------- -------------- --------------
Weighted average interest rate at end of year 3.74% 5.07% 5.73%
Weighted daily average interest rate during the year 4.71% 5.71% 5.90%
Daily average FHLB advances $231,255,753 $168,332,740 $170,520,548
Maximum FHLB advances at any month end 369,000,000 205,250,000 173,000,000
Interest expense during the year 10,885,897 9,608,659 10,065,991
(12) Short Term Borrowings
The Company had short term borrowings of zero and $1.7 million at September 30,
2003 and 2002, respectively. At September 30, 2003, the borrowings consisted of
one unsecured line of credit with Key Bank that has been paid off. The interest
rate of this line is the prime rate, which was 4.00% at September 30, 2003. At
September 30, 2002, the borrowings consisted of one unsecured line of credit
with Key Bank that was fully disbursed. The interest rate on this line was the
prime rate, which was 4.75% at September 30, 2002. The Company also had an
unused line of credit totaling $15.0 million with U.S. National Bank of Oregon
at September 30, 2003 and 2002. The Company is in compliance with all debt
covenants imposed by the lenders.
Financial data pertaining to the weighted average cost, the level of short term
borrowings and securities sold under agreements to repurchase, and the related
interest expense are as follows:
Year Ended September 30,
----------------------------------------------
2003 2002 2001
--------------- --------------- ----------
Weighted average interest rate at end of year --% 4.75% 5.58%
Weighted daily average interest rate
during the year 4.43% 4.32% 8.22%
Daily average of short term borrowings $1,215,616 $1,704,521 $3,265,205
Maximum short term borrowings at
any month end 1,700,000 1,700,000 6,400,000
Interest expense during the year 53,870 73,690 268,447
(13) Taxes on Income
The following is a summary of income tax expense:
Year Ended September 30,
---------------------------------------------------------------
2003 2002 2001
--------------- -------------- ------------
Current Taxes
Federal $911,119 $4,306,047 $3,560,966
State 332,482 987,105 835,250
Current tax provision 1,243,601 5,284,152 4,396,216
Deferred Taxes
Federal (555,734) (1,684,353) (564,904)
State (110,971) (340,065) (114,052)
Deferred tax benefit (666,705) (2,024,418) (678,956)
---------- ----------- ----------
Provision for income taxes $576,896 $3,259,734 $3,717,260
========= ========== ==========
An analysis of income tax expense, setting forth the reasons for the variation
from the "expected" federal corporate income tax rate and the effective rate
provided, is as follows:
Year Ended September 30,
---------------------------------------------
2003 2002 2001
------------ --------- ---------
Federal income taxes computed at
statutory rate 35.0% 35.0% 35.0%
Tax effect of:
State income taxes, net of federal
income tax benefit 4.6 4.2 4.2
Nondeductible ESOP compensation
expense 13.2 1.8 1.1
Deductible MRDP compensation
expense (2.8) -- --
Interest income on municipal securities (22.7) (5.7) (4.1)
Dividends received deduction (4.0) (2.0) (0.7)
Other (3.9) (0.9) (2.6)
------ ---- -----
Income tax expense included in the
statement of earnings 19.4% 32.4% 32.9%
===== ==== ====
Deferred income taxes at September 30, 2003 and 2002 reflect the impact of
temporary differences between amounts of assets and liabilities for financial
reporting purposes and such amounts as measured by tax laws.
The tax effects of temporary differences which give rise to a significant
portion of deferred tax assets and deferred tax liabilities are as follows:
September 30,
-------------------------------------
2003 2002
------------ ------------
DEFERRED TAX ASSETS
Allowance for losses on loans $1,527,439 $1,679,909
Pension liability 365,013 330,929
Unearned ESOP shares 276,812 353,036
Core deposit premium 2,954,461 2,264,290
Basis difference in fixed assets 831,215 788,381
Other 78,818 --
------------ -----------
Total gross deferred tax assets 6,033,758 5,416,545
DEFERRED TAX LIABILITIES
FHLB stock dividends 2,169,847 1,834,035
Capitalized loan servicing income 151,527 360,498
Unrealized gain on securities
available for sale 1,510,705 3,135,399
Deferred loan fees 485,179 485,179
Branch acquisition costs 241,928 241,928
Tax bad debt reserve in excess of base-
year reserve 226,534 475,116
Other 423,194 350,946
------------ -----------
Total gross deferred tax liabilities 5,208,914 6,883,101
------------ -----------
Net deferred tax asset (liability) $824,844 ($1,466,556)
============ ============
The Company has qualified under provisions of the Internal Revenue Code to
compute federal income taxes after deductions of additions to the bad debt
reserves. At September 30, 2003, the Company had a taxable temporary difference
of approximately $10.5 million that arose before 1988 (base-year amount). In
accordance with SFAS No. 109, Accounting for Income Taxes, a deferred tax
liability has not been recognized for the temporary difference. Management does
not expect this temporary difference to reverse in the foreseeable future.
(14) Mandatorily Redeemable Preferred Securities
In July 2001, the Company issued $15 million of mandatorily redeemable preferred
securities through a subsidiary grantor trust. The Trust holds debt instruments
of the parent company purchased with the proceeds of the securities issuance.
The capital qualifying securities bear interest at a floating rate indexed to
six-month LIBOR and mature in July 2031. At September 30, 2003 and 2002, the
interest rate was 4.90% and 5.61%, respectively. The Company has the right to
redeem the securities after five years at a premium, and after ten years at par.
In April 2002, the Company issued $13 million of mandatorily redeemable
preferred securities through a subsidiary grantor trust. The Trust holds debt
instruments of the parent company purchased with the proceeds of the securities
issuance. The capital qualifying securities bear interest at a floating rate
indexed to six-month LIBOR and mature in April 2032. At September 30, 2003 and
2002, the interest rate was 4.99% and 6.02%, respectively. The Company has the
right to redeem the securities at a premium up to five years from issuance, and
after five years at par.
Certain changes in tax law or Office of Thrift Supervision regulations regarding
the treatment of the capital securities as core capital could result in early
redemption, at par, or a shortening in the maturity of the securities.
(15) Commitments and Contingencies
In the ordinary course of business, the Company has various outstanding
commitments and contingencies that are not reflected in the accompanying
consolidated financial statements. In addition, the Company is a defendant in
certain claims and legal actions arising in the ordinary course of business. In
the opinion of management, after consultation with legal counsel, the ultimate
disposition of these matters is not expected to have a material adverse effect
on the consolidated financial condition of the Company.
The Company is party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing need 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 45 day agreements to lend to a customer subject to the Company's
usual terms and conditions.
At September 30, 2003, loan commitments amounted to approximately $45.1 million
comprised of $24.8 million in variable rate loans ranging from 1.99% to 17.00%
and $20.3 million in fixed rate loans ranging from 3.00% to 12.50%. At September
30, 2003, the Company had $5.9 million in commitments to sell loans.
The Company originates residential real estate loans secured by residential,
multi-family and commercial properties as well as consumer and commercial
business loans. Substantially all of the Company's lending portfolio resides in
the state of Oregon. An economic downturn in this area would likely have a
negative impact on the Company's results of operations depending on the severity
of the downturn.
(16) Shareholders' Equity
The Company's Articles of Incorporation authorize the issuance of 500,000 shares
of preferred stock, having a par value of $.01 per share, in series and to fix
and state the powers, designations, preferences and relative rights of the
shares of such series, and the qualifications, limitations and restrictions
thereof.
(17) Earnings Per Share
Earnings per share ("EPS") is computed in accordance with SFAS No. 128, Earnings
per Share. Shares held by the Company's ESOP that are committed for release are
considered contingently issuable shares and are included in the computation of
basic EPS. Diluted EPS is computed using the treasury stock method, giving
effect to potential additional common shares that were outstanding during the
period. Potential dilutive common shares include shares awarded but not released
under the Company's MRDP, and stock options granted under the Stock Option Plan.
Following is a summary of the effect of dilutive securities on weighted average
number of shares (denominator) for the basic and diluted EPS calculations. There
are no resulting adjustments to net earnings.
For the Year Ended September 30,
--------------------------------------------------------
2003 2002 2001
----------------- ------------------ ---------------
Weighted average common
shares outstanding - basic 6,562,515 6,411,351 6,627,200
----------------- ------------------ ---------------
Effect of dilutive securities on number of shares:
MRDP shares 4,264 8,108 9,252
Stock options 176,441 76,039 65,593
----------------- ------------------ -----------------
Total dilutive securities 180,705 84,147 74,845
----------------- ------------------ -----------------
Weighted average common shares
outstanding - with dilution 6,743,220 6,495,498 6,702,045
================= ================= ===============
(18) Employee Benefit Plans
Employee Retirement Plan As of September 30, 2001, the Company terminated its
participation in a multiple-employer trusteed pension plan ("Plan") covering all
employees with at least one year of service and which paid direct pensions to
certain retired employees. Benefits were based on years of service with the
Company and salary excluding bonuses, fees, commissions, etc. Participants were
vested in their accrued benefits after five years of service. Pension expense of
$452,592 was incurred during the year ended September 30, 2001. Separate
actuarial valuations, including computed value of vested benefits, were not made
with respect to each contributing employer, nor are the plan assets so
segregated by the trustee. As part of the termination of the plan, early
retirement was offered to certain long-time employees of the Company. The
Company recorded expense of $378,887 in the year ended September 30, 2001
related to these retirements.
Effective October 1, 2001, the Company implemented a 401(k) plan for all
employees. The Company matches 50% of the employee contributions up to a maximum
of 6% the employee's compensation. Expense of $251,093 and $451,649 was recorded
in the years ended September 30, 2003 and 2002, respectively, related to this
plan.
Postretirement Benefit Plan
The Company had an unfunded postretirement benefit plan for certain retirees and
all currently active employees who retired with at least ten years of service.
The plan provided for payment of all or a portion of the Medicare Supplement
premium for qualified retirees and their spouses. This plan was revised
effective October 1, 2001 to limit benefits to those already retired and
discontinue the benefit for current employees. The table below reflects the
result of this change on the actuarial valuation of the plan.
Information related to the years ended September 30, 2003, 2002, and 2001 is
presented below.
Year Ended September 30,
----------------------------------------------
2003 2002 2001
----------- ------------- -----------
Change in benefit obligation
Benefit obligation at beginning of year $237,399 $401,461 $324,279
Service cost -- -- 27,386
Interest cost 13,811 13,121 25,852
Actuarial changes -- (166,365) 35,109
Benefits paid (14,428) (10,818) (11,165)
-------- -------- --------
Benefit obligation at end of year $236,782 $237,399 $401,461
======== ======== ========
2003 2002 2001
---------- ------------- ----------
Components of net periodic benefit cost
Service cost $ -- $ -- $27,386
Interest cost 13,811 13,121 25,852
Recognition of changes in actuarial
assumptions, prior service cost, benefit
changes, and actuarial gains and losses -- -- 9,475
---------- -------- -------
Net periodic benefit cost $13,811 $13,121 $62,713
========== ======== =======
For measurement of the net periodic cost of the post retirement benefit plan, a
5.0% annual increase in the medical care trend rate was assumed. The assumed
discount rate was 6.0% for 2003 and 2002 and 7.5% for 2001.
If the assumed medical trend rates were increased by 1%, the September 30, 2003
benefit obligation would increase from $236,782 to $267,862 and the net periodic
benefit cost for the year ended September 30, 2003 would increase from $13,811
to $31,770.
Director Deferred Compensation Plan/Supplemental Executive Retirement Plan
The Company also had an unfunded supplemental benefits plan to provide members
of the Board of Directors with supplemental retirement benefits. Supplemental
benefits are based on monthly fees approved by the Compensation Committee of the
Board. In 2003, a similar plan was created to provide benefits to certain
employees. In addition, the Directors Deferred Compensation Plan was rolled into
a new but substantially similar supplemental retirement plan. The projected
benefit obligation of the combined plans was $929,022, $516,170 and $942,148 for
the years ended September 30, 2003, 2002 and 2001, respectively. Pension costs
recognized for the years ended September 30, 2003, 2002, and 2001 were $424,654,
zero, and $71,052, respectively.
Stock Option Plan
In February 1996, the Board of Directors adopted a Stock Option Plan ("Stock
Plan") for the benefit of certain employees and directors. The Stock Plan was
approved by the Company's shareholders on April 9, 1996. The maximum number of
common shares which may be issued under the Stock Plan is 1,223,313 shares with
a maximum term of ten years for each option from the date of grant. The initial
awards were granted on April 9, 1996 at the fair value of the common stock on
that date ($13.125). All initial awards vest in equal installments over a five
year period from the grant date and expire during April 2006. Unvested options
become immediately exercisable in the event of death or disability.
Option activity under the Stock Plan is as follows:
Weighted
Number of Average
Shares Exercise Price
-------------- ---------------------
Outstanding, September 30, 2000 916,258 $13.314
Granted 207,500 $12.412
Exercised (244,662) $13.125
Canceled -- --
-------------- --------------
Outstanding, September 30, 2001 879,096 $13.154
Granted 40,000 $12.900
Exercised (19,572) $13.125
Canceled (19,573) $13,125
-------------- -------------
Outstanding, September 30, 2002 879,951 $13.144
Granted 23,243 16.85
Exercised (252,254) 13.14
Canceled (12,000) 13.50
-------------- -------------
Outstanding, September 30, 2003 638,940 $13.28
============== =============
At September 30, 2003, 6,781 shares were available for future grants under the
Stock Plan.
Additional information regarding options outstanding as of September 30, 2003 is
as follows:
Weighted Avg.
Range of Options Options Remaining
Exercise Prices Outstanding Exercisable Contractual Life
- ------------------- ----------- ------------- ----------------
$16.846 23,243 -- 10
$12.70 - $13.100 40,000 24,000 8.3
$11.625 - $13.144 180,500 140,000 7.3
$20.577 23,243 23,243 4.1
$13.125 371,954 371,954 2.5
--------- ----------
638,940 559,197
========= =========
(19) Employee Stock Ownership Plan
As part of the stock conversion consummated on October 4, 1995, the Company
established an ESOP for all employees that are age 21 or older and have
completed two years of service with the Company. The ESOP borrowed $9,786,500
from the Company and used the funds to purchase 978,650 shares of the common
stock of the Company issued in the conversion which would be distributed over a
ten year period. The loan will be repaid principally from the Company's
discretionary contributions to the ESOP over a period of ten years. The loan had
an outstanding balance of $2.0 million and $2.9 million at September 30, 2003
and 2002, respectively, and an interest rate of 8.75%. The loan obligation of
the ESOP is considered unearned compensation and, as such, recorded as a
reduction of the Company's shareholders' equity. Both the loan obligation and
the unearned compensation are reduced by the amount of loan repayments made by
the ESOP. Shares purchased with the loan proceeds are held in a suspense account
for allocation among participants as the loan is repaid.
Contributions to the ESOP and shares released from the suspense account are
allocated among participants on the basis of compensation in the year of
allocation. Benefits are fully vested at all times under the ESOP. Forfeitures
are reallocated to remaining plan participants and may reduce the Company's
contributions. Benefits may be payable on retirement, death, disability, or
separation from service. Since the Company's annual contributions are
discretionary, benefits payable under the ESOP cannot be estimated. Compensation
expense is recognized to the extent of the fair value of shares committed to be
released. The Company recorded compensation expense under the ESOP of $1.7
million, $1.4 million, and $1.4 million for the years ended September 30, 2003,
2002 and 2001, respectively, and approximately 98,000 shares were allocated
among the participants in each of those years.
In conjunction with the Sterling Merger, it is the Company's intention to
terminate the ESOP. In furtherance of that goal, the Plan has been amended and
an IRS determination letter has been requested. Unallocated shares in the ESOP
will be used to pay off the loan balance and any remaining shares will be
distributed to participants.
(20) Fair Value of Financial Instruments
Financial instruments have been construed to generally mean cash or a contract
that implies an obligation to deliver cash or another financial instrument to
another entity.
September 30, 2003 September 30, 2002
---------------------------------- ------------------------------
Carrying Fair Carrying Fair
amount value amount value
-------------- ----------- ------------ -----------
Financial Assets
Cash and due from banks $39,266,748 $39,266,748 $38,444,500 $38,444,500
Interest earning deposits with banks 5,838,016 5,838,016 5,762,373 5,762,373
Federal funds sold and
securities purchased under
agreements to resell 2,200,000 2,200,000 1,584,540 1,584,540
Investment securities
available for sale 140,939,164 140,939,164 119,542,052 119,542,052
Mortgage-backed and related
securities available for sale 680,719,515 680,719,515 650,796,164 650,796,164
Loans receivable, net 557,551,402 572,055,851 607,464,660 649,490,130
FHLB stock 17,190,400 17,190,400 13,510,400 13,510,400
Mortgage servicing rights 385,663 385,663 1,035,660 1,035,660
Financial Liabilities
Deposit liabilities 1,068,063,030 1,081,804,238 1,142,005,997 1,155,611,434
FHLB advances 308,000,000 320,259,942 205,250,000 218,125,349
Short term borrowings -- -- 1,700,000 1,700,000
Mandatorily redeemable preferred securities 27,338,107 27,338,107 27,205,507 27,205,507
Fair value estimates, methods, and assumptions are set forth below :
Investments and Mortgage-Backed Securities - Fair values were based on quoted
market rates and dealer quotes.
Loans Receivable - Loans were priced using a discounted cash flow method. The
discount rate was the rate currently offered on similar products.
No adjustment was made to the entry-value interest rates for changes in credit
of performing loans for which there are not known credit concerns. Management
believes that the risk factor embedded in the entry-value interest rates, along
with the general reserves applicable to the loan portfolio for which there are
no known credit concerns, result in a fair valuation of such loans on an
entry-value basis.
Deposits - The fair value of deposits with no stated maturity such as
non-interest-bearing demand deposits, savings, NOW accounts and money market
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 of FHLB advances was based on
the discounted cash flow method. The discount rate was estimated using rates
currently available from FHLB.
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 September 30, 2003 and 2002. 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.
(21) Regulatory Capital Requirements
The Company is not subject to any regulatory capital requirements. The
Association, however, 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 action by regulators that, if undertaken, could have a
direct material effect on the Association's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Association must meet specific capital guidelines that involve quantitative
measures of the Association's assets, liabilities, and certain off-balance sheet
items as calculated under regulatory accounting practices. The Association'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 Association to maintain minimum amounts and ratios of total and Tier
I capital to risk-weighted assets, of Tier I capital to total assets, and
tangible capital to tangible assets (set forth in the table below). Management
believes that the Association meets all capital adequacy requirements to which
it is subject as of September 30, 2003.
As of September 30, 2003, the most recent notification from the OTS categorized
the Association as "well capitalized" under the regulatory framework for prompt
corrective action. To be categorized as "well-capitalized," the Association must
maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios
as set forth in the table. There are no conditions or events since that
notification that management believes have changed the institution's category.
At periodic intervals, the OTS and FDIC routinely examine the Association as
part of their legally prescribed oversight of the thrift industry. Based on
these examinations, the regulators can direct that the Association'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 Association's 2003 financial statements. In view of the
uncertain regulatory environment in which the Association now operates, the
extent, if any, to which a forthcoming regulatory examination may ultimately
result in adjustments to the 2003 financial statements cannot be presently
determined.
The Association's actual and required minimum capital ratios are presented in
the following table:
Categorized as "Well
Capitalized" Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provision
---------------------------- ------------------------- ---------------------------
Amount Ratio Amount Ratio Amount Ratio
------------- ------- ----------- ------- ------------- -------
As of September 30, 2003
Total Capital: $105,782,022 12.7% $66,467,920 8.0% $83,084,900 10.0%
(To Risk Weighted Assets)
Tier I Capital: 98,947,473 11.9% N/A N/A 49,850,940 6.0%
(To Risk Weighted Assets)
Tier I Capital: 98,947,473 6.6% 59,601,418 4.0% 74,501,773 5.0%
(To Total Assets)
Tangible Capital: 98,947,473 6.6% 22,350,532 1.5% N/A N/A
(To Tangible Assets)
As of September 30, 2002
Total Capital: $102,759,108 14.0% $58,696,528 8.0% $73,370,660 10.0%
(To Risk Weighted Assets)
Tier I Capital: 95,497,095 13.0% N/A N/A 44,022,396 6.0%
(To Risk Weighted Assets)
Tier I Capital: 95,497,095 6.6% 58,297,476 4.0% 72,871,846 5.0%
(To Total Assets)
Tangible Capital: 95,497,095 6.6% 21,861,554 1.5% N/A N/A
(To Tangible Assets)
The following table is a reconciliation of the Association's capital, calculated
according to generally accepted accounting principles, to regulatory tangible
and risk-based capital:
September 30, 2003 September 30, 2002
------------------ -------------------
Association's equity $138,061,967 $142,052,659
Unrealized securities losses (2,463,879) (6,256,574)
Core deposit intangible and goodwill (36,650,615) (40,298,990)
----------------- ------------------
Tangible capital 98,947,473 95,497,095
General valuation allowances 6,834,549 7,262,013
----------------- ------------------
Total capital $105,782,022 $102,759,108
================= ==================
(22) Parent Company Financial Information
Condensed financial information as of September 30, 2003 and 2002 and for each
of the three years in the period ended September 30, 2003, for Klamath First
Bancorp, Inc. is presented and should be read in conjunction with the
consolidated financial statements and the notes thereto:
BALANCE SHEETS
September 30,
------------------------------------
2003 2002
------------- ------------
Assets
Cash and cash equivalents $7,677,155 $5,608,620
Investment and mortgage-backed securities 142,507 149,077
Investment in wholly-owned subsidiary 138,061,967 142,052,659
Deferred tax asset -- 310,718
Other assets 3,189,312 2,157,987
------------ ------------
Total assets $149,070,941 $150,279,061
============ ============
Liabilities
Short-term borrowings $-- $1,700,000
Mandatorily redeemable preferred securities 27,338,107 27,205,507
Deferred tax Liability 585 --
Other liabilities 1,396,792 1,435,518
Total liabilities 28,735,484 30,341,025
Shareholders' equity
Common stock 69,826 67,440
Additional paid-in capital 34,330,667 30,282,059
Retained earnings 88,676,785 93,522,778
Unearned ESOP shares at cost (1,956,480) (2,935,130)
Unearned MRDP shares at cost (785,340) (999,111)
Tax benefit of stock options 541,867 311,251
Total shareholders' equity 120,335,458 119,938,036
------------ ------------
Total liabilities and shareholders' equity $149,070,941 $150,279,061
=========== ===========
STATEMENTS OF EARNINGS
Year Ended September 30,
--------------------------------------------------------
2003 2002 2001
----------- ----------- ----------
Equity in undistributed income of subsidiary $3,927,889 $7,868,854 $8,271,234
Total interest income 413,498 560,127 730,727
Total interest expense 1,672,998 74,650 268,185
Non-interest income 44 11,972 --
Non-interest expense 1,318,095 2,315,762 1,641,346
Earnings before income taxes 1,350,338 6,050,541 7,092,430
Income tax benefit (1,046,485) (738,235) (478,572)
----------- ---------- ----------
Net earnings $2,396,823 $6,788,776 $7,571,002
=========== ========== ==========
STATEMENTS OF CASH FLOWS
Year Ended September 30,
---------------------------------------------------------
2003 2002 2001
------------ ---------- -----------
Net cash flows from operating activities $3,299,747 $3,200,786 $8,229,769
Cash flows from investing activities
Investment in subsidiary (139,890) (10,264,911) (10,306,546)
Maturity of investment and mortgage- backed securities 6,882 533,743 683,893
Sale of investment and mortgage-backed securities -- 782,597 --
----------- ---------- ----------
Net cash flows used in investing activities (133,008) (8,948,571) (9,622,653)
Cash flows from financing activities
Cost of ESOP shares released 978,650 978,380 979,740
Proceeds from short-term borrowings -- 1,900,000 3,400,000
Repayments of short-term borrowings (1,700,000) (1,900,000) (4,700,000)
Issuance of mandatorily redeemable preferred securities 132,600 12,651,823 14,553,684
Stock repurchase and retirement (232,760) (4,750,847) (7,399,423)
Stock options exercised 3,313,399 369,588 3,211,189
Dividends paid (3,590,093) (3,530,528) (3,746,304)
Net cash flows provided by (used in) financing activities (1,098,204) 5,718,416 6,298,886
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents 2,068,535 (29,369) 4,906,002
Cash and cash equivalents beginning of year 5,608,620 5,637,989 731,987
---------- ---------- ----------
Cash and cash equivalents end of year $7,677,155 $5,608,620 $5,637,989
========== ========== ==========
Note 23 Subsequent events
Sale of Branches
On December 12, 2003, the Company's wholly-owned subsidiary, Klamath First
Federal Savings and Loan Association, successfully completed the sale of seven
branches located in northeastern Oregon to the Bank of Eastern Oregon. The seven
branches are located in the towns of Burns, Condon, Fossil, Heppner, John Day,
Prairie City, and Moro. The sale included deposit accounts of approximately $65
million, the fixed assets and branch locations. The transaction resulted in a
pretax gain of approximately $3.4 million.
Sterling Merger
On July 15, 2003, the Company announced that it had entered into an Agreement
and Plan of Merger ("the Sterling Merger") with Sterling Financial Corporation,
Inc., a Washington corporation ("Sterling"). The Company will be merged with and
into Sterling, with Sterling being the surviving corporation in the merger. The
Company's wholly-owned subsidiary, Klamath First Federal Savings and Loan
Association, will be merged with and into Sterling's wholly-owned subsidiary,
Sterling Savings Bank, with Sterling Savings Bank being the surviving
institution.
Under the terms of the Sterling Merger, each share of Klamath First Bancorp,
Inc. common stock will be converted into 0.77 shares of Sterling common stock
subject to certain conditions.
On December 11, 2003, the merger was approved by a vote of the stockholders of
both the Company and Sterling. All necessary regulatory approvals had previously
been received. The transaction is expected to close on January 2, 2004.
Consolidated Supplemental Data
Selected Quarterly Financial Data
(unaudited)
Year Ended September 30, 2003
-----------------------------------------------------------
December March June September
------------ ---------- --------- ---------
(In thousands, except per share data)
Total interest income $19,227 $17,771 $17,347 $16,946
Total interest expense 8,230 7,348 6,820 7,126
------ ------ ------ ------
Net interest income 10,997 10,423 10,527 9,820
Provision for loan losses -- -- -- --
------ ------ ------ ------
Net interest income after provision 10,997 10,423 10,527 9,820
Non-interest income 3,941 4,176 4,853 4,135
Non-interest expense 12,167 13,249 17,409 13,073
------ ------ ------ ------
Earnings/loss before income taxes 2,771 1,350 (2,029) 882
Provision (benefit) for income tax 885 388 (667) (29)
------ ------ ------ ------
Net earnings (loss) $1,886 $962 ($1,362) $911
====== ====== ====== ======
Net earnings (loss) per share - basic $0.29 $0.15 ($0.20) $0.14
Net earnings (loss) per share - fully diluted $0.29 $0.14 ($0.20) $0.13
Year Ended September 30, 2002
----------------------------------------------------------
December March June September
----------- ----------- ---------- ----------
(In thousands, except per share data)
Total interest income $22,995 $21,922 $21,530 $20,846
Total interest expense 11,719 9,897 9,208 8,707
------ ------ ------ ------
Net interest income 11,276 12,025 12,322 12,139
Provision for loan losses 153 3 -- --
------ ------ ------ ------
Net interest income after provision 11,123 12,022 12,322 12,139
Non-interest income 2,282 2,921 3,054 4,356
Non-interest expense 12,129 12,396 12,404 13,241
------ ------ ------ ------
Earnings before income taxes 1,276 2,547 2,972 3,254
Provision for income tax 454 876 1,044 886
------ ------ ------ ------
Net earnings $822 $1,671 $1,928 $2,368
Net earnings per share - basic $0.13 $0.26 $0.30 $0.37
Net earnings per share - fully diluted $0.13 $0.26 $0.30 $0.36
Klamath First Bancorp, Inc.
Corporate Information
Corporate Common Stock
Headquarters Traded over-the-counter/
540 Main Street Nasdaq National Market
Klamath Falls, OR 97601 Nasdaq Symbol: KFBI
541-882-3444
Form 10-K
Independent Information
Auditors Available without charge
Deloitte & Touche LLP to shareholders of record
Suite 3900 upon written request to:
111 SW Fifth Avenue Marshall Alexander
Portland, OR 97204-3698 Executive Vice President -
503-222-1341 Chief Financial Officer
Klamath First Bancorp, Inc.
Corporate Counsel 540 Main Street
Craig M Moore Klamath Falls, OR 97601
540 Main Street
Klamath Falls, OR 97601 Because the merger of Klamath
541-882-3444 First Bancorp, Inc. is expected
to be completed during the first
Special Counsel calendar quarter of 2004, no
Breyer & Associates PC annual meeting has been scheduled
8180 Greensboro Drive
Suite 785
McLean, Virginia 22102
703-883-1100
Transfer Agent
Registrar & Transfer Co.
10 Commerce Drive
Cranford, NJ 07016-3572
800-866-1340
(b) Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
There have been no changes in or disagreements with Accountants on
accounting and financial disclosure during the year ended September
30, 2003.
45
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)-14(c)
of the Securities Exchange Act of 1934 (the "Act")) was carried out under the
supervision and with the participation of the Company's Chief Executive Officer,
Chief Financial Officer and several other members of the Company's senior
management within the 90 day period preceding the filing of this annual report.
Based on such evaluation, the Company's Chief Executive Officer and Chief
Financial Officer have concluded that the Company's disclosure controls and
procedures are effective in ensuring that the information required to be
disclosed by the Company in reports it files or submits under the Act is (i)
accumulated and communicated to the Company's management (including the Chief
Executive Officer and Chief Financial Officer) in a timely manner, and (ii)
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms.
(b) Changes in Internal Controls: There have not been any changes in the
Company's internal control over financial reporting (as defined in Section 13(a)
- - 15(f) and 15d - 15(f) of the Act) during the year ended September 30, 2003
that have materially affected, or are reasonably likely to materially affect,
the Company's internal control over financial reporting.
PART III
Item 10. Directors and Executive Officers of the Registrant
The Company's Board of Directors consists of eight directors as required by
the Company's Bylaws. The Company's Bylaws also provide that the directors will
be elected for three-year staggered terms with approximately one-third of the
directors elected each year. The following table sets forth ceratin information
regarding the directors of the Company.
Year First
Elected or
Name Age (1) Principal Occupation During Last Five Years Appointed (2)
- ----------------------- ------- ----------------------------------------------------------- -------------
Rodney N. Murray 75 Chairman of the Board; owner and operator, Rod Murray 1976
Ranch, Klamath Falls, Oregon; former owner and operator,
Klamath Falls Creamery/Crater Lake Dairy Products.
Kermit K. Houser 60 President and Chief Executive Officer of the Company and 2000
The Association, November 2000 to present. Prior to joining
the Company, employed by Bank of America, 1983-2000,
in various positions, including senior vice president and
manager for commercial banking, executive vice president
and senior credit officer, and most recently, senior vice
president and market executive for Bank of America's
South Valley commercial banking in Fresno, California.
Bernard Z. Agrons 81 Retired; former State Representative, Oregon State 1974
Legislature, 1983-1991; former Vice President for the
Eastern Region, Weyerhaeuser Company, until 1981.
Timothy A. Bailey 57 Executive Director, KMSB Foundation; Member, Oregon 1993
State Bar; former Senior Vice President, Klamath
Operations for Regence Blue Cross/Blue Shield of Oregon.
Donald N. Bauhofer 52 Founder and President, the Pennbrook Company (real 2002
estate development), Bend, Oregon; Founder and Chief
Executive Officer, Pennbrook Homes, Inc. and Praxis
Medical Group; Co-owner, Arrowood Development, LLC;
Co-Owner and Director, Pacific Education Corporation.
James D. Bocchi 79 Retired; former President and Chief Executive Officer of 1983
the Association, 1984-1994; employed by the Association,
1950-1994.
William C. Dalton 72 Retired; former owner of W.C. Dalton Company (farming). 1972
Dianne E. Spires 49 Certified Public Accountant; Partner, Rusth, Spires & 1997
Menefee, LLP, Klamath Falls, Oregon.
_________________________
<FN>
(1) As of September 30, 2003
(2) Includes service on the Board of Directors of the Association
</FN>
46
MEETINGS AND COMMITTEES OF THE BOARD OF DIRECTORS
The Boards of Directors of the Company and the Association conduct their
business through meetings of the Boards and through their committees. During the
year ended September 30, 2003, the Board of Directors of the Company held 12
regular meetings and six special meetings, and took one action by written
consent. The Board of Directors of the Association held 12 regular meetings,
eight special meetings, and took one action by written consent. No director of
the Company or the Association attended fewer than 75% of the total meetings of
the Boards and committees on which such person served during this period.
The Boards of Directors of the Company and the Association have established
various committees, including Executive, Audit, Compensation and Nominating
Committees.
The Executive Committee consists of Messrs. Bocchi, Dalton, Houser and
Murray. The Executive Committee has the power and authority to act on behalf of
the Board of Directors on matters between regularly scheduled Board meetings
unless specific Board of Directors' action is otherwise required. The Executive
Committee met six times during the year ended September 30, 2003.
The Audit Committee consists of Messrs. Agrons, Dalton and Murray and Ms.
Spires. The Audit Committee reviews the internal auditors' reports and results
of their examination prior to review by and with the entire Board of Directors
and retains and establishes the scope of engagement of the Company's independent
auditors. The Audit Committee met five times during the year ended September 30,
2003, and took one action by written consent. For additional information
regarding the Audit Committee, see "Audit Committee Matters" below.
The Compensation Committee, consisting of Messrs. Bailey, Agrons and
Bauhofer, and Ms. Spires, reviews and recommends compensation arrangements for
management and other personnel. The Compensation Committee met five times during
the year ended September 30, 2003.
The Nominating Committee, consisting of the Company's full Board of
Directors, selects the nominees for election as directors. During the year ended
September 30, 2003, the Nominating Committee met once to nominate the nominees
for directors at the annual Shareholders' Meeting.
DIRECTORS' COMPENSATION
Fees. The Company and the Association each pay fees to its directors, and
each director of the Company is a director of the Association. Each director of
the Company receives a quarterly fee of $1,000, except that the Chairman of the
Board receives a quarterly fee of $1,250. Each director of the Association other
than the Chairman of the Board receives an annual retainer of $10,900 and a fee
of $1,550 per month for attendance at regular Board meetings. In addition to the
annual retainer, the Chairman of the Board of the Association also receives a
fee of $1,950 per month for attendance at regular Board meetings. Mr. Houser,
President, Chief Executive Officer and a director of the Company and the
Association, does not receive any fees for attending Board meetings of the
Company and the Association. The Company and the Association paid total fees to
directors of $234,717 for the fiscal year ended September 30, 2003, $16,800 was
paid to one director emeritus and $18,600 was paid to the surviving spouse of a
former director.
47
Supplemental Benefit Plan. The Association also maintains an unfunded
supplemental benefit plan to provide retirement benefits to members of the Board
of Directors. Payments are based on directors' fees paid by the Association and
continue for a period of five years following a director's retirement, except
for directors who served at January 1, 1992, who receive this fee for life.
Payments under this plan have been waived by all current directors, with
payments under the plan only being made to one director emeritus and the
surviving spouse of a former director.
Effective January 1, 2003, the Company established new director fee
continuation agreements to provide retirement benefits to members of the Board
of Directors. The agreements provide that the normal retirement age is 68, but
permit retirement as early as age 55 with a cut-back in retirement benefits.
Payments vest over a period of up to nine years, and are payable after
retirement for life. The maximum initial retirement benefit at normal retirement
is $36,084 per year, with subsequent cost of living adjustments of two percent
per year. Directors fully vested under the prior plan are fully vested under the
new agreements. The agreements also provide for full vesting in the event of
termination as a director, other than for cause, subsequent to a change in
control.
The Company has entered into fee continuation agreements with directors Rodney
N. Murray, Bernard Z. Agrons, Timothy A. Bailey, James D. Bocchi, Donald N.
Bauhofer, William C. Dalton, and Dianne E. Spires which entitle each of the
directors to payment of retirement benefits if the director suffers a
termination of service, whether voluntary or involuntary, except for cause.
Upon a change of control, if a director subsequently suffers a termination of
service, voluntary or involuntary, except for cause, then the director shall be
paid director retirement benefits of $2,834 per month, commencing at age 65 and
continuing until the death of the director. Alternatively, the director may
elect to receive a reduced early retirement benefit as specified in the fee
continuation agreement, as of the date selected for early retirement. However,
if the director dies before 60 monthly payments have been made, such monthly
payments will continue until a total of 60 monthly payments have been made, or
until the death of the director's surviving spouse, whichever occurs earlier.
Monthly payments increase by two percent at the end of each calendar year.
Pursuant to the terms of the proposed merger, directors who are at least age 65
on the effective date of the merger shall be entitled to normal retirement age
benefits, as defined in the fee continuation agreement, if those benefits would
be greater than the benefits that would be received under the change of control
provision.
Assuming the service of Company's directors is terminated in 2004 and their
retirement payments begin at or after the directors reach age 65, the increase
in initial annual benefits for Messrs. Murray, Agrons, Bocchi, Dalton, Bailey,
Bauhofer, and Ms. Spires would be $2,076, $2,076, $2,076, $2,076, $23,184,
$26,792 and $23,184, respectively, as a result of the merger being deemed a
change in control under the director fee continuation agreements.
Section 16(a) Compliance. Section 16(a) of the Exchange Act requires the
Company's executive officers and directors, and persons who own more than 10% of
any registered class of the Company's equity securities, to file reports of
ownership and changes in ownership with the SEC. Executive officers, directors
and greater than 10% stockholders are required by regulation to furnish the
Company with copies of all Section 16(a) forms they file.
Based solely on its review of the copies of such forms it has received and
written representations provided to the Company by the above referenced persons,
the Company believes that, during the fiscal year ended September 30, 2003, all
filing requirements applicable to its reporting officers, directors and greater
than 10% stockholders were complied with properly and timely, except that
Bernard Z. Agrons filed a Form 4 to report the sale of shares during 1999 for
payment taxes on vested shares under the Company's Management Development and
Recognition Plan of 1996 and to report a small gift of shares that occurred
during 2001, which transactions had not been previously reported.
AUDIT COMMITTEE MATTERS
Audit Committee Charter. The Audit Committee operates pursuant to a written
charter approved by the Company's Board of Directors. The Audit Committee
reports to the Board of Directors and is responsible for overseeing and
monitoring financial accounting and reporting, the system of internal controls
established by management and the audit process of the Company. The Audit
Committee Charter sets out the responsibilities, authority and specific duties
of the Audit Committee. The Charter specifies, among other things, the structure
and membership requirements of the Audit Committee, as well as the relationship
of the Audit Committee to the independent accountants, the internal audit
department and management of the Company.
A copy of the Audit Committee Charter is attached and filed as Exhibit
99 to this Form 10-K report.
Report of the Audit Committee. The Audit Committee reports as follows with
respect to the Company's audited financial statements for the year ended
September 30, 2003:
The Audit Committee has completed its review and discussion of the
Company's 2003 audited financial statements with management;
The Audit Committee has discussed with the independent auditors,
Deloitte & Touche LLP, the matters required to be discussed by
Statement on Auditing Standards ("SAS") No. 61, Communication with
Audit Committees, as amended by SAS No. 90, Audit Committee
Communications, including, matters related to the conduct of the audit
of the Company's financial statements;
The Audit Committee has received written disclosures, as required by
Independence Standards Board Standard No. 1, Independence Discussions
with Audit Committee, indicating all relationships, if any, between
the independent auditor and its related entities and the Company and
its related entities which, in the auditor's professional judgment,
reasonably may be thought to bear on the auditors' independence, and
the letter from the independent auditors confirming that, in its
professional judgment, it is independent from the Company and its
related entities, and has discussed with the auditors the auditors'
independence from the Company; and
The Audit Committee has, based on its review and discussions with
management of the Company's 2003 audited financial statements and
discussions with the independent auditors, recommended to the Board of
Directors that the Company's audited financial statements for the year
ended September 30, 2003 be included in the Company's Annual Report on
Form 10-K.
Audit Committee consisting of:
Bernard Z. Agrons, Chairman
William C. Dalton
Rodney N. Murray
Dianne E. Spires
Independence and Other Matters. Each member of the Audit Committee is
"independent," as defined, in the case of the Company, under the Nasdaq Stock
Market Rules. The Audit Committee members do not have any relationship to the
48
Company that may interfere with the exercise of their independence from
management and the Company. None of the Audit Committee members are current
officers or employees of the Company or its affiliates. Dianne E. Spires, CPA,
has been designated as the Audit Committee's financial expert.
Item 11. Executive Compensation
Summary Compensation Table. The following table shows the compensation paid
during the last three fiscal years to the Company's Chief Executive Officer and
the four highest paid executive officers of the Company who received salary and
incentive compensation in excess of $100,000 during the fiscal year ended
September 30, 2003.
Annual Long-Term
Compensation (1) Compensation Awards
--------------------------- ---------------------------
Restricted Number of All Other
Name and Position Year Salary Bonus Stock Awards Options (3) Compensation (4)
(2)
- ---------------------------- ----- -------- ------- ------------ ----------- ----------------
Kermit K. Houser (5) 2003 $200,000 $60,000 $ --- --- $32,291
President and Chief 2002 200,000 $60,000 --- --- 6,000
Executive Officer and 2001 175,000 -- 232,500 100,000
Director
Marshall J. Alexander 2003 $136,050 $30,000 $ --- --- $31,772
Executive Vice President 2002 $114,600 $30,000 --- --- 26,652
and Chief Financial Officer 2001 104,220 -- 147,481 20,000 34,132
Ben A. Gay (6) 2003 $136,050 $30,000 $ --- --- $5,555
Executive Vice President 2002 $114,600 -- --- --- 2,865
and Chief Credit Officer 2001 $2,571 -- 143,383 20,000 --
49
Walter F. Dodrill (7) 2003 $126,642 $22,500 $ --- --- $3,519
Senior Vice President 2002 $88,794 -- 131,000 20,000 1,628
Business Banking 2001 -- -- --- --- --
Craig M Moore 2003 $140,166 $25,000 $ --- --- $27,335
Senior Vice President, 2002 95,000 $20,000 --- --- 20,123
Chief Auditor, General 2001 81,583 -- 65,315 15,000 16,377
Counsel and Secretary
<FN>
(1) All compensation is paid by the Association. Excludes (1) All
compensation is paid by the Association. Excludes certain additional
benefits which did not exceed the lesser of $50,000 or 10% of salary
and bonus.
(2) Represents the total value of the award of shares of (2)Represents the
toal value of the award of shares of restricted Common Stock on the
award date, pursuant to the MRDP. Mr. Houser was awarded 20,000 shares
on November 15, 2000, Mr. Alexander was awarded 11,290 shares on April
1, 2001, Mr. Gay was awarded 11,290 shares on September 24, 2001, Mr.
Dodrill was awarded 10,000 shares on January 2, 2002, and Mr. Moore
was awarded 5,000 shares on April 1, 2001. Dividends are paid on such
awards if and when declared and paid by the Company on the Common
Stock. The restricted MRDP shares awarded to Messrs. Houser, Alexander
and Gay vest ratably over a two-year period and those awarded to Mr.
Dodrill and Mr. Moore vest ratably over a five-year period. At
September 30, 2003, the number and value of the aggregate restricted
stockholdings were: Mr. Dodrill 8,000 shares worth $171,920; and Mr.
Moore, 3,000 shares worth $64,470.
(3) Represents the total number of shares granted under the Klamath (3)
Represents the toal number of shares granted under the Klamath First
Bancorp, Inc. 1996 Stock Option Plan ("Option Plan").
(4) Represents the cost to the Company of awards under the ESOP and (4)
Represents the cost to the Company of awards under the ESOP and
employer matching contributions to the Klamath First 401(k) Plan.
Messrs. Gay and Dodrill are not ESOP participants. Mr. Houser became a
participant in the ESOP on 4/1/2003 and received his first allocation
as of 9/30/2003.
(5) Mr. Houser was appointed to his position effective November 15, 2000.
(6) Mr. Gay was hired on September 24, 2001 and was appointed to his
position effective October 5, 2001.
(7) Mr. Dodrill was appointed to his position effective January 2, 2002.
</FN>
Option Exercise/Value Table. The following information is provided for
Messrs. Houser, Alexander, Gay, Dodrill and Moore.
Value of
Unexercised Options In-the-Money Options
at Fiscal Year End at Fiscal Year End (1)
Shares
Acquired on Value
Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
Kermit K. Houser 0 $0 100,000 - $986,500 -
Marshall J. Alexander 0 $0 127,651 - $1,069,041 -
Ben A. Gay 0 $0 20,000 - $175,800 -
Walter F. Dodrill 0 $0 4,000 16,000 $33,560 $134,240
Craig M Moore 0 $0 6,000 9,000 $50,562 $75,853
<FN>
(1) Value of unexercised in-the-money options equals market value of shares
covered by in-the-money options on September 30, 2003 less the option
exercise price. Options are in-the-money if the market value of the shares
covered by the options is greater than the option exercise price.
</FN>
50
Employment Agreements. The Company and the Association (collectively,
"Employers") have entered into two-year employment agreements ("Employment
Agreements") with Messrs. Houser, Alexander, Gay, Dodrill and Moore
(individually, "Executive" and collectively, "Executives").
Under the Employment Agreements, the current annual salary levels for
Messrs. Houser, Alexander, Gay, Dodrill and Moore are $200,000, $138,000,
$138,000, $119,000 and $117,000, respectively, which amounts will be paid by the
Association and which may be increased at the discretion of the Board of
Directors or an authorized committee of the Board. In addition, Mr. Moore's
monthly compensation was increased by $8,333 monthly for six months beginning
July 1, 2003 for the extra services he has provided to the Company and
Association to facilitate the transactions contemplated under the Agreement and
Plan of Merger by and between the Company and Sterling Financial Corporation
dated July 14, 2003 (the "Merger Agreement"). On each anniversary of the
commencement date of the Employment Agreements, the term of each agreement may
be extended for an additional year at the discretion of the Board of Directors.
The current term for Mr. Houser's Employment Agreement expires on November 14,
2004, the current term for Mr. Dodrill's Employment Agreement expires on January
2, 2005, and the current terms of the Employment Agreements for Messrs.
Alexander, Gay and Moore expire on September 30, 2004. The Employment Agreements
are terminable by the Employers for just cause at anytime or upon the occurrence
of certain events specified by federal regulations. Under the Employment
Agreements, the Executives may receive bonuses at the discretion of the Board.
The Employment Agreements were amended on July 14, 2003 in connection with
the Merger Agreement which entitle the Executives to severance payments or
liquidated damages upon a change of control. The proposed merger between
Sterling and Klamath will constitute a change of control for the purpose of the
employment agreements.
Upon the earlier of completion of the merger, or December 31, 2003 if the
closing conditions under the merger agreement have been satisfied or waived by
that date, the named Executives will be entitled to receive a cash severance
amount as well as continued life, medical, dental and disability insurance
coverage for a period of 36 months, with the exception of Walter F. Dodrill, who
will not be entitled to receive continuing insurance coverage, and will receive
cash in the amount of $12,588 in lieu thereof, which is included in his
severance payment described below.
The severance amounts to be paid to Messrs. Houser, Alexander, Gay,
Dodrill, and Moore will be approximately $405,750, $281,750, $281,750, $196,838,
and $131,250, respectively, under their employment agreements as a result of the
merger being constituting a change in control. The Association has purchased
long-term care insurance for Messrs. Alexander, Gay and Moore, and the employer
costs of such insurance shall reduce their respective cash severance amounts.
If the merger is not consummated, the amendment is not effective and the
regular change in control provisions of the Employment Agreements will still be
effective. The agreements without the amendment provide for severance payments
and other benefits in the event of involuntary termination of employment in
connection with any change in control of the Employers. Severance payments also
will be provided on a similar basis in connection with a voluntary termination
of employment where, subsequent to a change in control, the Executives are
assigned duties inconsistent with their respective position, responsibilities
and status immediately prior to such change in control. The term "change in
control" is defined in the Employment Agreements as any time during the period
of employment when (a) a person other than the Company purchases shares of
Common Stock pursuant to a tender or exchange offer for such shares, (b) any
person (as such term is used in Sections 13(d) and 14(d)(2) of the Exchange Act)
is or becomes the beneficial owner, directly or indirectly, of securities of the
Company representing 25% or more of the combined voting power of the Company's
then outstanding securities, (c) the membership of the Board of Directors
changes as the result of a contested election, or (d) stockholders of the
Company approve a merger, consolidation, sale or disposition of all or
substantially all of the Company's assets, or a plan of partial or complete
liquidation.
The maximum value of the severance benefits without the amendments to the
Employment Agreements is 2.00 or 1.50 times the Executive's average annual
compensation during the five-year period preceding the effective date of the
change in control (the "base amount"). Agreements for Messrs. Houser, Alexander
and Gay are at the 2.00 times rate, while Messrs. Dodrill and Moore are at the
1.50 times rate. Such amounts will be paid in a lump sum within ten business
days following the termination of employment.
Section 280G of the Internal Revenue Code of 1986, as amended ("Code"),
provides that certain severance payments which equal or exceed three times the
base amount of the individual are deemed to be "excess parachute payments" if
they are contingent upon a change in control. Individuals receiving excess
parachute payments are subject to a 20% excise tax on the amount of such excess
payments, and the Employers would not be entitled to deduct the amount of such
excess payments.
The Employment Agreements restrict an Executive's right to compete against
the Employers for a period of one year from the date of termination of the
agreement if the Executive voluntarily terminates employment, except in the
event of a change in control.
Salary Continuation Agreements. The Association ("Employer") has entered
into Executive Salary Continuation Agreements as supplemental executive
retirement plans ("SERP Agreements") with Messrs. Houser, Alexander, Gay,
Dodrill and Moore (individually, "Executive" and collectively, "Executives").
Under the SERP Agreements, the Executives are entitled to receive a normal
retirement benefit at age 62 (age 65 for Mr. Houser) that provides a
continuation of salary for life, and annual increases of two percent. The salary
continuation benefits are on individual vesting schedules that generally
accelerate the closer each executive becomes to retirement age while still
employed with the Association. The SERP Agreements also provide for full vesting
in the event of employment termination within two years following a change in
control. The amount of normal retirement benefit with no break in service was
based on: 60% of projected salary assuming 4% annual increases until normal
retirement for Messrs. Houser, Alexander and Gay; 40% of projected salary
assuming 4% annual increases until normal retirement for Mr. Dodrill; and 50% of
projected salary assuming 4% annual increases until normal retirement for Mr.
Moore. The annual benefits payable upon a normal retirement age for Messrs.
Houser, Alexander, Gay, Dodrill and Moore are $161,642, $149,209, $104,446,
$88,223, and $132,982, respectively.
In the event an Executive's employment with Klamath is terminated in
connection with a change in control prior to age 62 (or age 65 in the case of
Mr. Houser), the Executive shall be entitled to receive an enhanced annual
benefit under his or her salary continuation agreement, which shall be paid
beginning no sooner than when the Executive attains age 55 and no later than
when the executive attains age 62 (with the exception of Mr. Houser, whose
benefits will commence no later than age 65). In general, the enhanced annual
benefit payable is reduced if installment payments commence prior to age 62 (age
65 for Mr. Houser). Upon the commencement of payments, the installments will be
payable until the executive's death and will increase by two percent per year.
In lieu of the benefit (including the enhanced benefits described above)
provided under the salary continuation agreement of Messrs. Dodrill and Moore,
the Association has the right at any time during calendar year 2003 to make a
single lump sum cash payment to the Executives in complete satisfaction of all
of its obligations under their salary continuation agreements. Upon payment by
the Association to the Executives of such single lump sum cash payment, their
salary continuation agreements will terminate and no longer be effective. If the
closing conditions under the Merger Agreement are satisfied or waived on or
before December 31, 2003, the Association intends to make cash payments in full
satisfaction of its obligations under those salary continuation agreements.
Assuming such cash payments are made pursuant to the salary continuation
agreements, the cash-out amounts required to be made to Messrs. Dodrill and
Moore would be approximately $582,214 and $606,309, respectively. The salary
continuation agreements which Klamath has entered into with Messrs. Houser,
Alexander and Gay do not provide for a cash-out option. However, they will
receive an enhanced annual benefit on or after the later of their termination of
employment or age 55 as a result of the merger constituting a change in control.
Assuming that retirement payments begin at the normal retirement date, the
increase in initial annual benefits for Messrs. Houser, Alexander and Gay will
be $102,863, $109,167, and $69,631 respectively.
Joint Beneficiary Agreements. The Association ("Employer") has entered into
Joint Beneficiary Agreements ("JB Agreements") with respect to bank-owned life
insurance policies insuring each of Messrs. Houser, Alexander, Gay, Dodrill and
Moore (individually, "Executive" and collectively, "Executives"). The JB
Agreements provide generally for three levels of death benefits. The maximum
benefit is paid if death occurs while employed, after normal retirement with no
break in service, or after termination pursuant to a change in control. The
maximum death benefits for Messrs. Houser, Alexander, Gay, Dodrill and Moore are
$1,616,420, $1,492,090, $1,044,460, $882,230, and $1,329,820, respectively. The
middle benefit, which increases in value with the length of the Executive's
service, is provided if the Executive is not employed by the Association at the
time of death, and the termination was not for cause. The middle level of death
benefit is on individual vesting schedules that generally accelerate the closer
each Executive becomes to retirement age while still employed with the
Association. The vesting schedule provides a minimum $100,000 death benefit. The
lowest benefit is $25,000 in the event the executive is not employed by the
Association due to a termination for cause. The death benefit is reduced 30% and
70% from the original benefit if death occurs after attaining age 70 and age 80,
respectively.
The approval of the Merger Agreement by the Company shareholders
constitutes a change in control under the JB Agreements. Messrs. Houser,
Alexander, Gay and Moore will become fully vested in the death benefits as a
result of the merger between the Company and Sterling Financial Corporation. Mr.
Dodrill is expected to remain employed by Sterling Financial Corporation after
the merger, so will remain subject to his individual vesting schedule unless
subsequently terminated within two years of employment or for cause. Even so,
assuming death at a normal life expectancy before age 80, but after age 70, the
increase in death benefit resulting from a termination in connection with the
change in control as compared to the benefit available for a termination during
2004 other than for cause (absent a change in control) for Messrs. Houser,
Alexander, Gay, Dodrill and Moore are $543,701, $644,046, $382, 969, $517,561,
and $830,874, respectively.
COMPENSATION COMMITTEE MATTERS
Notwithstanding anything to the contrary set forth in any of the Company 's
previous filings under the Securities Act of 1933, as amended, or the Exchange
Act that might incorporate future filings, including this Proxy Statement, in
whole or in part, the following Report of the Compensation Committee and
Performance Graph shall not be incorporated by reference into any such filings.
Report of the Compensation Committee. Under rules established by the SEC,
the Company is required to provide certain data and information in regard to the
compensation and benefits provided to the Company's Chief Executive Officer and
other executive officers of the Company and the Association. The disclosure
requirements for the Chief Executive officer and other executive officers
include the use of tables and a report explaining the rationale and
considerations that led to the fundamental executive compensation decisions
affecting those individuals. Insofar as no separate compensation is currently
payable by the company, the Compensation Committee of the Association (the
"Committee"), at the direction of the Board of Directors of the Company, has
prepared the following report for inclusion in this proxy statement.
The Compensation Committee's duties are to recommend and administer
policies that govern executive compensation for the Company and the Association.
The Compensation Committee evaluates executive performance, compensation
policies and salaries and makes recommendations to the Board of Directors
concerning the compensation of each named executive officer and other executive
officers. The Board of Directors reviews the Compensation Committee's
recommendations and establishes compensation levels for the coming year.
The executive compensation policy of the Company and the Association is
designed to establish an appropriate relationship between executive pay and the
Company's and the Association's annual and long-term performance, long- term
growth objectives, and their ability to attract and retain qualified executive
officers. The principles underlying the program are:
To attract and retain key executives who are vital to the long-term success
of the Company and the Association and who are of the highest caliber;
To provide compensation levels competitive with those offered throughout
the financial industry and consistent with the Company's and the
Association's level of performance;
To motivate executives to enhance long-term stockholder value by building
their personal ownership in the Company; and
To integrate the compensation program with the Company's and the
Association's annual and long-term strategic planning and performance
measurement processes.
The Compensation Committee also considers a variety of subjective and
objective factors in determining the compensation package for individual
executives, including (i) the performance of the Company and the Association as
a whole with emphasis on annual and long-term performance, (ii) the
responsibilities assigned to each executive, and (iii) the performance of each
executive of assigned responsibilities as measured by the progress of the
Company and the Association during the year.
The Compensation Committee considers compensation survey prepared by
various sources. Most recently, the Compensation Committee used a survey
prepared by RSM McGladrey, Inc., which included proxy searches and the results
of surveys by Watson Wyatt & Company and Business & Legal Reports, Inc.
Although the Compensation Committee did not establish executive
compensation levels only on the basis of whether specific financial goals had
been achieved by the Company and the Association, the Compensation Committee
(and the Board of Directors) considered the overall profitability of the Company
and the Association when making their decisions. The Compensation Committee
believes that management
52
compensation levels, as a whole, appropriately reflect the application of the
Company's and Association's executive compensation policy and the progress of
the Company and the Association.
The compensation for the Company's President and Chief Executive Officer,
Kermit K. Houser, was $200,000. The Compensation Committee believes Mr. Houser's
salary is appropriate based on Company performance and competitive salary
surveys.
The Committee also recommends to the Board of Directors the amount of fees
paid for service on the Board. The Committee did not recommend a change in Board
fees during the fiscal year ended September 30, 2003. However, as described
previously, new director fee continuation agreements to provide retirement
benefits for board members were established during the fiscal year.
Compensation Committee consisting of:
Timothy A. Bailey, Chairman
Bernard Z. Agrons
Donald N. Bauhofer
Dianne E. Spires
Compensation Committee Interlocks and Insider Participation. No members of
the Compensation Committee were officers or employees of the Company or any of
its subsidiaries during the year, were formerly Company officers, or had any
relationship otherwise requiring disclosure.
Reference is made to the cover page of this report for information
regarding compliance with Section 16(a) of the Exchange Act.
Code of Ethics
The Company has adopted a Code of Conduct which is attached as Exhibit 14.
The Code of Conduct is distributed to all employees and is published on the
Company's website, www.klamathfirst.com.
Performance Table. The following table compares the cumulative total
stockholder return on the Company's Common Stock with the cumulative total
return on the Nasdaq Index (U.S. Companies) and with the SNL $1 Billion to $5
Billion Thrift Index. Total return assumes the reinvestment of all dividends.
Period Ending
---------------------------------------------------------------------------
Index 09/30/98 09/30/99 09/30/00 09/30/01 09/30/02 09/30/03
- --------------------------------------------------------------------------------------------------------------------
Klamath First Bancorp, Inc. 100.00 74.91 78.32 87.20 100.85 147.24
NASDAQ - Total US 100.00 162.62 217.87 89.20 70.04 107.27
SNL $1B-$5B Thrift Index 100.00 102.04 108.95 153.43 208.85 287.55
53
Item 12. Security Ownership of Certain Beneficial Owners and Management
Equity Compensation Plan Information. The following table summarizes share
and exercise price information about the Corporations' equity compensation
plans as of September 30, 2003.
(c)
Number of securities
(a) (b) remaining available
Number of securities Weighted-average for future issuance
to be issued upon exercise price under equity
exercise of of outstanding compensation plans
outstanding options, options, warrants (excluding securities
Plan category warrants and rights and rights reflected in column (a))
- ------------------------------------------ ------------------------ ------------------------- --------------------
Equity compensation plans approved
by security holders:
Option............................... 638,940 $13.275 6,781
Restricted stock plan................ -- -- 27,735
Equity compensation plans not approved
by security holders: N/A N/A N/A
------------------------ ------------------------- --------------------
Total 638,940 $13.275 34,516
======================== ========================= ===================
(a) and (b) Security Ownership of Certain Beneficial Owners and Security
Ownership of Management
Persons and groups who beneficially own in excess of 5% of the outstanding
shares of the Company's Common Stock are required to file certain reports with
the Securities and Exchange Commission ("SEC"), and provide a copy to the
Company, disclosing such ownership pursuant to the Securities Exchange Act of
1934, as amended ("Exchange Act"). Based solely upon the receipt of such
reports, other than as set forth in the following table, management knows of no
person who owned more than 5% of the outstanding shares of Common Stock as of
the Record Date for the special shareholders meeting to vote on the merger
agreement between the Company and Sterling Financial Corporation. In addition,
the following table sets forth, as of October 13, 2003, information as to the
shares of Klamath Common Stock beneficially owned by each director and named
executive officer, and by all executive officers and directors of the Company as
a group.
55
Beneficial Owner Amount and Nature of Percent of
Beneficial Ownership (1) Common Stock
Outstanding
- ------------------------------------------------ -------------------------- -------------
Beneficial owners of more than 5%
Tontine Financial Partneres, L.P. (2) 582,200 8.34%
Tontine Management, L.L.C.
Tontine Overseas Associates, L.L.C.
Mr. Jeffrey L. Gendell
55 Railroad Ave., 3rd Floor
Greenwich, CT 06830
Dimensional Fund Advisors, Inc. (3) 542,900 7.78%
1299 Ocean Avenue, 11th Floor
Santa Monica, CA 90401
Bryn Mawr Capital Management, Inc. (4) 468,361 6.71%
One Town Place, Suite 200
Bryn Mawr, PA 19010-3495
Directors and Named Executive Officers (5)
Rodney N. Murray 94,129 (6) 1.35%
Kermit K. Houser 116,455 (7) 1.67%
Bernard Z. Agrons 68,495 (8) **
Timothy A. Bailey 70,298 (9) 1.01%
Donald A. Bauhofer 6,116 (10) **
James D. Bocchi 78,616 (11) 1.13%
William C. Dalton 41,570 (12) **
Dianne E. Spires 29,409 (13) **
Marshall J. Alexander 177,963 (14) 2.55%
Ben A. Gay 27,175 (15) **
Craig M Moore 14,711 (16) **
Walter F. Dodrill 13,127 (17) **
All executive officers and directors as a group 794,524 (18) 11.27%
** Less than one percent of shares outstanding.
<FN>
(1) In accordance with Rule 13d-3 under the Securities Exchange Act of 1934, a
person is deemed to be the beneficial owner, for purposes of this table, of
any shares of Klamath common stock if he or she has voting and/or
investment power with respect such security or has a right to acquire,
through the exercise of outstanding options or otherwise, beneficial
ownership at any time within 60-days from the record date. The table
includes shares owned by spouses or other immediate family members in
trust, shares held in retirement accounts or funds for the benefit of the
named individuals, and other forms of ownership, over which shares the
persons named in the table may possess voting and/or investment power. The
table excludes shares from ESOP allocation as of 9/30/2003, and options
that are expected to vest on or about 1/2/2004 in connection with the
pending merger with Sterling Financial Corporation.
(2) Based on an amended Schedule 13G dated January 6, 2003 and filed with the
SEC on January 8, 2003. According to this filing, Tontine Financial
Partners, L.P., Tontine Management, L.L.C., Tontine Overseas Associates,
L.L.C. and Mr. Gendell have shared voting power and shared dispositive
power with respect to these shares.
(3) Based on an amended Schedule 13G dated December 31, 2002 and filed with the
SEC on February 12, 2003. According to this filing, Dimensional Fund
Advisors, Inc., an investment advisor registered under the Investment
Advisors Act of 1940, has sole voting power and sole dispositive power with
respect to these shares.
(4) Based on a Schedule 13G dated December 31, 2002 and filed with the SEC on
February 12, 2003. According to this filing, an investment advisor in
accordance with Section 240.13d-1(b)(1)(ii)(f) of Exchange Act, and has
sole voting and dispositive power with respect to these shares.
(5) Under SEC regulations, the term "named executive officer(s)" is defined to
include the chief executive officer, regardless of compensation level, and
the four most highly compensated executive officers, other than the chief
57
executive officer, whose total annual salary and bonus for the last
completed fiscal year exceeded $100,000. Messrs. Houser, Alexander, Gay,
Moore and Dodrill were the Company's "named executive officers" for the
fiscal year ended 9/30/2003.
(6) Includes 61,167 shares underlying stock options exercisable within 60 days
of 10/13/2003.
(7) Includes 100,000 shares underlying stock option exercisable within 60 days
of 10/13/2003.
(8) Includes 45,670 shares underlying stock options exercisable within 60 days
of 10/13/2003.
(9) Includes 45,670 shares underlying stock options exercisable within 60 days
of 10/13/2003.
(10) Includes unvested restricted shares issued unde Klamath's Management
Recognition and Development Plan ("MRDP"). Participants in the MRDP
exercise all rights incidental to ownership, including voting rights.
(11) Includes 45,670 shares underlying stock options exercisable within 60 days
of 10/13/2003.
(12) Includes 30,670 shares underlying stock options exercisable within 60 days
of 10/13/2003.
(13) Includes 23,243 shares underlying stock options exercisable within 60 days
of 10/13/2003. Excludes shares held in trusts for which Ms. Spires is a
death beneficiary and for which she is not the named fiduciary.
(14) Includes 127,651 shares underlying stock option exercisable within 60 days
of 10/13/2003.
(15) Includes 20,000 shares underlying stock options exercisable within 60 days
of 10/13/2003.
(16) Includes 6,000 shares underlying stock options exercisable within 60 days
of 10/13/2003. Includes unvested shares in Klamath's MRDP. Participants in
the MRDP exercise all rights incidental to ownership, including voting
rights.
(17) Includes 4,000 shares underlying stock options exercisable within 60 days
of 10/13/2003. Includes unvested shares in Klamath's MRDP. Participants in
the MRDP exercise all rights incidental to ownership, including voting
rights.
(18) Includes 533,527 shares underlying stock options exercisable within 60 days
of 10/13/2003.
</FN>
(c) Changes in Control
Other than the Company's merger agreement with Sterling Financial
Corporation, as previously described, the Company is not aware of any
arrangements, including any pledge by any person of securities of the Company,
the operation of which may at a subsequent date result in a change in control of
the Company.
ITEM 13. Certain Relationships and Related Transactions with the Association
The Association has followed the policy of granting loans to its officers,
directors and employees. Loans to such persons are made in the ordinary course
of business on substantially the same terms, including interest rate and
collateral, as those prevailing at the time for comparable transactions with
other persons (unless the loan or extension of credit is made under a benefit
program generally available to all other employees and does not give preference
to any insider over any other employee), and, in the opinion of management, do
not involve more than the normal risk of collectability or present other
unfavorable features. At September 30, 2003, loans to directors and executive
officers (excluding available lines of credit) totaled approximately $7.75
million.
58
ITEM 14. Principal Accounting Fees and Services
Audit Fees. Deloitte & Touche, LLP has served as the Company's principal
accountant during the last two fiscal years. The aggregate fees billed to the
Company for professional services rendered for the audit of the Company's
financial statements for fiscal year 2002 and the reviews of the financial
statements included in the Company's Quarterly Reports on Form 10-Q for that
year, including travel expenses, were approximately $228,000. The aggregate fees
billed to the Company for professional services rendered for the audit of the
Company's financial statements for fiscal year 2003 and the reviews of the
financial statements included in the Company's Quarterly Reports on Form 10-Q
for that year, including travel expenses, were approximately $250,000.
Audit-Related Fees. During the fiscal year ended September 30, 2002,
aggregate audit-related fees billed to the Company by Deloitte & Touche, LLP
were approximately $7,000. These fees were paid for the audit of the Company's
Employee Stock Ownership Plan. During the fiscal year ended September 30, 2003,
aggregate fees billed to the Company by Deloitte & Touche, LLP were
approximately $20,000. These fees were paid for audits of the Company's
Employee Stock Ownership Plan and 401(k) Plan.
Tax Fees. The Company's principal accountant, Deloitte & Touche, LLP did
not bill any fees for tax services during the fiscal years ended September 30,
2002 and September 30, 2003.
All Other Fees. The aggregate fees billed to the Company by Deloitte &
Touche, LLP for other services were approximately $50,000 for fiscal year ended
September 30, 2003. The services were rendered for work related to the merger by
and between the Company and Sterling Financial Corporation, including some
consultation regarding executive compensation plans, in fiscal year 2003. There
were no fees billed for other services during the fiscal year ended September
30, 2002.
The Company's policies provide that management has no authority to engage
the primary accountant for any services without the prior approval of the Audit
Committee. Consents are documented in minutes of the Audit Committee meetings or
in separate written unanimous consents in lieu of an Audit Committee meeting,
which provide the purpose of the engagement and any dollar limitations relating
to the services. The Audit Committee has pre- approved all services rendered
during fiscal year 2003.
59
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Exhibits
3.1(a) Articles of Incorporation of the Registrant*
3.1(b) Bylaws of the Registrant*
10.1(a) Employment Agreement for Kermit K. Houser filed as Exhibit
10(a).1 to Klamath's amended report on Form 10-Q/A filed
August 15, 2003 for the period ended June 30, 2003 and
incorporated by reference herein.
10.1(b) First Amendment to Employment Agreement for Kermit K. Houser
filed as Exhibit 10(a).2 to Klamath's amended report on Form
10-Q/A filed August 15, 2003 for the period ended June 30,
2003 and incorporated by reference herein.
10.1(c) Salary Continuation Agreement for Kermit K. Houser filed as
Exhibit 10(a).3 to Klamath's amended report on Form 10-Q/A
filed August 15, 2003 for the period ended June 30, 2003 and
incorporated by reference herein.
10.2(a) Employment Agreement for Marshall J. Alexander filed as
Exhibit 10(b).1 to Klamath's amended report on Form 10-Q/A
filed August 15, 2003 for the period ended June 30, 2003 and
incorporated by reference herein.
10.2(b) First Amendment to Employment Agreement for Marshall J.
Alexander filed as Exhibit 10(b).2 to Klamath's amended
report on Form 10-Q/A filed August 15, 2003 for the period
ended June 30, 2003 and incorporated by reference herein.
10.2(c) Salary Continuation Agreement for Marshall J. Alexander
filed as Exhibit 10(b).3 to Klamath's amended report on Form
10-Q/A filed August 15, 2003 for the period ended June 30,
2003 and incorporated by reference herein.
10.3(a) Employment Agreement for Ben A. Gay filed as Exhibit 10(c).1
to Klamath's amended report on Form 10-Q/A filed August 15,
2003 for the period ended June 30, 2003 and incorporated by
reference herein.
10.3(b) First Amendment to Employment Agreement for Ben A. Gay filed
as Exhibit 10(c).2 to Klamath's amended report on Form
10-Q/A filed August 15, 2003 for the period ended June 30,
2003 and incorporated by reference herein.
10.3(c) Salary Continuation Agreement for Ben A. Gay filed as
Exhibit 10(c).3 to Klamath's amended report on Form 10-Q/A
filed August 15, 2003 for the period ended June 30, 2003 and
incorporated by reference herein.
10.4(a) Employment Agreement for Frank X. Hernandez filed as Exhibit
10(d).1 to Klamath's amended report on Form 10-Q/A filed
August 15, 2003 for the period ended June 30, 2003 and
incorporated by reference herein.
10.4(b) First Amendment to Employment Agreement for Frank X.
Hernandez filed as Exhibit 10(d).2 to Klamath's amended
report on Form 10-Q/A filed August 15, 2003 for the period
ended June 30, 2003 and incorporated by reference herein.
10.4(c) Salary Continuation Agreement for Frank X. Hernandez filed
as Exhibit 10(d).3 to Klamath's amended report on Form
10-Q/A filed August 15, 2003 for the period ended June 30,
2003 and incorporated by reference herein.
10.4(d) First Amendment to Salary Continuation Agreement for Frank
X. Hernandez filed as Exhibit 10(d).4 to Klamath's amended
report on Form 10-Q/A filed August 15, 2003 for the period
ended June 30, 2003 and incorporated by reference herein.
10.5(a) Employment Agreement for Craig M Moore filed as Exhibit
10(e).1 to Klamath's amended report on Form 10-Q/A filed
August 15, 2003 for the period ended June 30, 2003 and
incorporated by reference herein.
10.5(b) First Amendment to Employment Agreement for Craig M Moore
filed as Exhibit 10(e).2 to Klamath's amended report on Form
10-Q/A filed August 15, 2003 for the period ended June 30,
2003 and incorporated by reference herein.
10.5(c) Salary Continuation Agreement for Craig M Moore filed as
Exhibit 10(e).3 to Klamath's amended report on Form 10-Q/A
filed August 15, 2003 for the period ended June 30, 2003 and
incorporated by reference herein.
10.5(d) First Amendment to Salary Continuation Agreement for Craig M
Moore filed as Exhibit 10(e).4 to Klamath's amended report
on Form 10-Q/A filed August 15, 2003 for the period ended
June 30, 2003 and incorporated by reference herein.
10.6(a) Employment Agreement for James E. Essany filed as Exhibit
10(f).1 to Klamath's amended report on Form 10-Q/A filed
August 15, 2003 for the period ended June 30, 2003 and
incorporated by reference herein.
10.6(b) First Amendment to Employment Agreement for James E. Essany
filed as Exhibit 10(f).2 to Klamath's amended report on Form
10-Q/A filed August 15, 2003 for the period ended June 30,
2003 and incorporated by reference herein.
10.6(c) Salary Continuation Agreement for James E. Essany filed as
Exhibit 10(f).3 to Klamath's amended report on Form 10-Q/A
filed August 15, 2003 for the period ended June 30, 2003 and
incorporated by reference herein.
10.6(d) First Amendment to Salary Continuation Agreement for James
E. Essany filed as Exhibit 10(f).4 to Klamath's amended
report on Form 10-Q/A filed August 15, 2003 for the period
ended June 30, 2003 and incorporated by reference herein.
10.7(a) Employment Agreement for Walter F. Dodrill filed as Exhibit
10(g).1 to Klamath's amended report on Form 10-Q/A filed
August 15, 2003 for the period ended June 30, 2003 and
incorporated by reference herein.
10.7(b) First Amendment to Employment Agreement for Walter F.
Dodrill filed as Exhibit 10(g).2 to Klamath's amended report
on Form 10-Q/A filed August 15, 2003 for the period ended
June 30, 2003 and incorporated by reference herein.
10.7(c) Salary Continuation Agreement for Walter F. Dodrill filed as
Exhibit 10(g).3 to Klamath's amended report on Form 10-Q/A
filed August 15, 2003 for the period ended June 30, 2003 and
incorporated by reference herein.
10.7(d) First Amendment to Salary Continuation Agreement for Walter
F. Dodrill filed as Exhibit 10(g).4 to Klamath's amended
report on Form 10-Q/A filed August 15, 2003 for the period
ended June 30, 2003 and incorporated by reference herein.
10.7(e) Second Amendment to Employment Agreement for Walter F.
Dodrill filed herewith.
10.8(a) Employment Agreement for Nina G. Drake filed as Exhibit
10(h).1 to Klamath's amended report on Form 10-Q/A filed
August 15, 2003 for the period ended June 30, 2003 and
incorporated by reference herein.
10.8(b) First Amendment to Employment Agreement for Nina G. Drake
filed as Exhibit 10(h).2 to Klamath's amended report on Form
10-Q/A filed August 15, 2003 for the period ended June 30,
2003 and incorporated by reference herein.
10.8(c) Salary Continuation Agreement for Nina G. Drake filed as
Exhibit 10(h).3 to Klamath's amended report on Form 10-Q/A
filed August 15, 2003 for the period ended June 30, 2003 and
incorporated by reference herein.
10.8(d) First Amendment to Salary Continuation Agreement for Nina G.
Drake filed as Exhibit 10(h).4 to Klamath's amended report
on Form 10-Q/A filed August 15, 2003 for the period ended
June 30, 2003 and incorporated by reference herein.
10.9(a) Employment Agreement for Jeffery D. Schlenker filed as
Exhibit 10(i).1 to Klamath's amended report on Form 10-Q/A
filed August 15, 2003 for the period ended June 30, 2003 and
incorporated by reference herein.
10.9(b) First Amendment to Employment Agreement for Jeffery D.
Schlenker filed as Exhibit 10(i).2 to Klamath's amended
report on Form 10-Q/A filed August 15, 2003 for the period
ended June 30, 2003 and incorporated by reference herein.
10.9(c) Salary Continuation Agreement for Jeffery D. Schlenker filed
as Exhibit 10(i).3 to Klamath's amended report on Form
10-Q/A filed August 15, 2003 for the period ended June 30,
2003 and incorporated by reference herein.
10.9(d) First Amendment to Salary Continuation Agreement for Jeffery
D. Schlenker filed as Exhibit 10(i).4 to Klamath's amended
report on Form 10-Q/A filed August 15, 2003 for the period
ended June 30, 2003 and incorporated by reference herein.
10.9(e) Second Amendment to Employment Agreement for Jeffrey D.
Schlenker filed herewith.
10.10(a) Director Fee Continuation Agreement for Rodney N. Murray
filed as Exhibit 10(j).1 to Klamath's amended report on Form
10-Q/A filed August 15, 2003 for the period ended June 30,
2003 and incorporated by reference herein.
10.10(b) Director Fee Continuation Agreement for Bernard Z. Agrons
filed as Exhibit 10(j).2 to Klamath's amended report on Form
10-Q/A filed August 15, 2003 for the period ended June 30,
2003 and incorporated by reference herein.
10.10(c) Director Fee Continuation Agreement for Timothy A. Bailey
filed as Exhibit 10(j).3 to Klamath's amended report on Form
10-Q/A filed August 15, 2003 for the period ended June 30,
2003 and incorporated by reference herein.
10.10(d) Director Fee Continuation Agreement for James D. Bocchi
filed as Exhibit 10(j).5 to Klamath's amended report on Form
10-Q/A filed August 15, 2003 for the period ended June 30,
2003 and incorporated by reference herein.
10.10(e) Director Fee Continuation Agreement for Donald N. Bauhofer
filed as Exhibit 10(j).5 to Klamath's amended report on Form
10-Q/A filed August 15, 2003 for the period ended June 30,
2003 and incorporated by reference herein.
10.10(f) Director Fee Continuation Agreement for William C. Dalton
filed as Exhibit 10(j).6 to Klamath's amended report on Form
10-Q/A filed August 15, 2003 for the period ended June 30,
2003 and incorporated by reference herein.
10.10(g) Director Fee Continuation Agreement for Dianne E. Spires
filed as Exhibit 10(j).7 to Klamath's amended report on Form
10-Q/A filed August 15, 2003 for the period ended June 30,
2003 and incorporated by reference herein.
10.11(a) Joint Beneficiary Agreement for Kermit K. Houser filed as
Exhibit 10(a).4 to Klamath's amended report on Form 10-Q/A
filed September 11, 2003 for the period ended June 30, 2003
and incorporated by reference herein.
10.11(b) Joint Beneficiary Agreement for Marshall J. Alexander filed
as Exhibit 10(b).4 to Klamath's amended report on Form
10-Q/A filed September 11, 2003 for the period ended June
30, 2003 and incorporated by reference herein.
10.11(c) Joint Beneficiary Agreement for Ben A. Gay filed as Exhibit
10(c).4 to Klamath's amended report on Form 10-Q/A filed
September 11, 2003 for the period ended June 30, 2003 and
incorporated by reference herein.
10.11(d) Joint Beneficiary Agreement for Frank X. Hernandez filed as
Exhibit 10(d).5 to Klamath's amended report on Form 10-Q/A
filed September 11, 2003 for the period ended June 30, 2003
and incorporated by reference herein.
10.11(e) Joint Beneficiary Agreement for Craig M Moore filed as
Exhibit 10(e).5 to Klamath's amended report on Form 10-Q/A
filed September 11, 2003 for the period ended June 30, 2003
and incorporated by reference herein.
10.11(f) Joint Beneficiary Agreement for James E. Essany filed as
Exhibit 10(f).e to Klamath's amended report on Form 10-Q/A
filed September 11, 2003 for the period ended June 30, 2003
and incorporated by reference herein.
10.11(g) Joint Beneficiary Agreement for Walter F. Dodrill filed as
Exhibit 10(g).5 to Klamath's amended report on Form 10-Q/A
filed September 11, 2003 for the period ended June 30, 2003
and incorporated by reference herein.
10.11(h) Joint Beneficiary Agreement for Nina G. Drake filed as
Exhibit 10(h).5 to Klamath's amended report on Form 10-Q/A
filed September 11, 2003 for the period ended June 30, 2003
and incorporated by reference herein.
10.11(i) Joint Beneficiary Agreement for Jeffrey D. Schlenker filed
as Exhibit 10(i).5 to Klamath's amended report on Form
10-Q/A filed September 11, 2003 for the period ended June
30, 2003 and incorporated by reference herein.
10.12 1996 Stock Option Plan**
10.13 1996 Management Recognition and Development Plan**
14 Code of Ethics
21 Subsidiaries of the Registrant
23 Consent of Deloitte & Touche LLP with respect to financial
statements of the Registrant
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
99 Audit Committee Charter
___________________
* Incorporated by reference to the Registrant's Registration Statement on
Form S-1, filed on June 19, 1995.
** Incorporated by reference to the Registrant's Definitive Proxy Statement
for the 1996 Annual Meeting of Shareholders.
(b) Reports on Form 8-K
The following Current Reports on Form 8-K were filed during the
quarter ended September 30, 2003.
60
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.
KLAMATH FIRST BANCORP, INC.
Date: December 29, 2003 By: /s/ Kermit K. Houser
Kermit K. Houser
President and Chief Executive Officer
Pursuant to 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.
SIGNATURES TITLE DATE
/s/ Kermit K. Houser President, Chief Executive December 29, 2003
Kermit K. Houser Officer and Director
(Principal Executive Officer)
/s/ Marshall J. Alexander Executive Vice President and December 29, 2003
Marshall J. Alexander Chief Financial Officer
(Principal Financial
and Accounting Officer)
/s/ Rodney N. Murray Chairman of the Board December 29, 2003
Rodney N. Murray of Directors
/s/ Bernard Z. Agrons Director December 29, 2003
Bernard Z. Agrons
/s/ Timothy A. Bailey Director December 29, 2003
Timothy A. Bailey
/s/ James D. Bocchi Director December 29, 2003
James D. Bocchi
/s/ William C. Dalton Director December 29, 2003
William C. Dalton
/s/ Dianne E. Spires Director December 29, 2003
Dianne E. Spires
/s/ Donald N. Bauhofer Director December 29, 2003
Donald N. Bauhofer