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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended...................... March 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number 005-57091
FIRST MUTUAL BANCSHARES, INC.
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(Exact name of registrant as specified in its charter)
WASHINGTON 91-2005970
--------------------------- --------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
400 108th Avenue N.E., Bellevue, WA 98004
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(Address of principal executive offices and zip code)
(425)453-5301
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year,
if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
(1) Yes X No
----- -----
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Title of class: As of May 14, 2001
--------------- --------------------
Common Stock, $1.00 par value 4,699,801 shares
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FIRST MUTUAL BANCSHARES, INC.
QUARTERLY REPORT ON FORM 10-Q
MARCH 31, 2001
TABLE OF CONTENTS
Page
----
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements............................................. 2
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................ 15
General....................................................... 15
Results of Operations......................................... 15
Net Interest Income........................................ 15
Other Operating Income..................................... 18
Operating Expenses......................................... 21
Net Income................................................. 21
Business Segments............................................. 22
Consumer Banking........................................... 22
Residential Lending........................................ 22
Commercial Lending......................................... 23
Financial Condition........................................... 23
Asset Quality.............................................. 24
Liquidity and Capital Reserves............................. 25
Item 3. Quantitative and Qualitative Disclosures About Market Risk....... 26
PART II: OTHER INFORMATION
Item 1. Legal Proceedings................................................ 28
Item 2. Changes in Securities............................................ 28
Item 3. Defaults Upon Senior Securities.................................. 28
Item 4. Submission of Matters to a Vote of Security-Holders.............. 28
Item 5. Other Information................................................ 29
Item 6. Exhibits and Reports on Form 8-K................................. 29
Forward-Looking Statements Disclaimer......................... 29
1
Item 1. Financial Statements
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
ASSETS
- ------ March 31, December 31,
2001 2000
------------- -------------
(Unaudited)
CASH AND CASH EQUIVALENTS:
Interest-earning deposits $ 1,614,000 $ 513,806
Noninterest-earning demand deposits
and cash on hand 3,728,752 6,485,186
------------- -------------
5,342,752 6,998,992
MORTGAGE-BACKED AND OTHER SECURITIES
AVAILABLE FOR SALE 34,222,116 38,648,017
LOANS RECEIVABLE, HELD FOR SALE 32,280,813 15,774,341
MORTGAGE-BACKED AND OTHER SECURITIES
HELD TO MATURITY 78,234,224 85,041,725
LOANS RECEIVABLE 490,136,065 480,505,472
RESERVE FOR LOAN LOSSES (6,950,576) (6,729,166)
------------- -------------
LOANS RECEIVABLE, NET 483,185,489 473,776,306
ACCRUED INTEREST RECEIVABLE 4,573,098 4,665,516
REAL ESTATE HELD FOR SALE -- 1,352,611
LAND, BUILDINGS AND EQUIPMENT, NET 7,418,700 7,423,956
FEDERAL HOME LOAN BANK (FHLB) STOCK, 7,873,600 7,749,400
at cost
MORTGAGE SERVICING RIGHTS 30,330 145,097
OTHER ASSETS 1,560,976 1,655,505
------------- -------------
TOTAL $ 654,722,098 $ 643,231,466
============= =============
2
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Continued)
March 31, December 31,
2001 2000
------------- -------------
(Unaudited)
LIABILITIES:
Deposits:
Investor custodial checking $ 934,009 $ 662,545
Money market deposit and
checking accounts 99,839,878 96,267,362
Regular savings 8,513,452 8,350,254
Time deposits 351,366,741 352,211,748
------------- -------------
Total deposits 460,654,080 457,491,909
Drafts payable 1,082,698 1,300,082
Accounts payable and other liabilities 3,176,818 3,493,118
Advance payments by borrowers for
taxes and insurance 2,667,303 1,484,132
FHLB advances 138,035,725 133,034,725
Other advances 250,000 250,000
Current Tax Liability 1,095,110 260,229
------------- -------------
Total liabilities 606,961,734 597,314,195
STOCKHOLDERS' EQUITY:
Common stock, $1 par value-
Authorized, 10,000,000 shares
Issued and outstanding, 4,697,209
and 4,671,286 shares, respectively 4,697,209 4,671,286
Additional paid-in capital 31,271,951 31,118,545
Employee Stock Ownership Plan Debt -- (97,821)
Retained earnings 11,636,846 10,140,569
Accumulated other comprehensive income:
Unrealized income on securities available for sale,
net of federal income tax 154,358 84,692
------------- -------------
Total stockholders' equity 47,760,364 45,917,271
------------- -------------
TOTAL $ 654,722,098 $ 643,231,466
============= =============
3
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
Quarters ended March 31
2001 2000
----------- -----------
(Unaudited)
INTEREST INCOME:
Loans Receivable $11,589,590 $10,251,294
Interest on AFS Securities 581,152 291,945
Interest on HTM Securities 1,285,021 1,319,367
Interest Other 153,625 128,222
----------- -----------
13,609,388 11,990,828
INTEREST EXPENSE:
Deposits 6,371,057 5,006,563
FHLB advances and other 2,079,266 1,907,423
----------- -----------
8,450,323 6,913,986
----------- -----------
Net interest income 5,159,065 5,076,842
PROVISION FOR LOAN LOSSES 215,000 130,000
----------- -----------
Net interest income, after provision
for loan losses 4,944,065 4,946,842
OTHER OPERATING INCOME:
Gain on sales of loans 753,562 121,532
Servicing fees, net of amortization 41,076 229,774
Gain on sale of investments 471,788 --
Fees on deposits 82,895 80,764
Other 221,650 190,330
----------- -----------
Total other operating income 1,570,971 622,400
BALANCE, carried forward 6,515,036 5,569,242
4
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(CONTINUED)
Quarters ended March 31
2001 2000
----------- -----------
(Unaudited)
BALANCE, brought forward $ 6,515,036 $ 5,569,242
OPERATING EXPENSES:
Salaries and employee benefits 2,266,280 1,940,888
Occupancy 528,345 427,528
Other 868,956 707,486
----------- -----------
Total other operating expenses 3,663,581 3,075,902
----------- -----------
Income before Federal Income Tax and Cumulative
Effect of Adoption of New Accounting Principle 2,851,455 2,493,340
FEDERAL INCOME TAX 965,070 846,044
----------- -----------
Income before Cumulative Effect of Adoption
of New Accounting Principle 1,886,385 1,647,296
----------- -----------
Cumulative effect of Adoption of New Accounting
Principle, net of federal income tax (155,247) --
----------- -----------
NET INCOME $ 1,731,138 $ 1,647,296
=========== ===========
PER SHARE DATA:
Basic earnings per common share before
Cumulative Effect of Adoption of New Accounting Principle $ 0.40 $ 0.35
Cumulative Effect of Adoption of New Accounting Principle,
Net of federal income tax (0.03) --
----------- -----------
Basic earnings per common share $ 0.37 $ 0.35
=========== ===========
Earnings per common share before cumulative effect
of Adoption of New Accounting Principle, Assuming Dilution $ 0.39 $ 0.35
Cumulative Effect of Adoption of New Accounting Principle,
Net of federal income tax (0.03) --
----------- -----------
Earnings Per Common Share Assuming Dilution $ 0.36 $ 0.35
=========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING 4,688,580 4,669,507
=========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING
INCLUDING DILUTIVE STOCK OPTIONS 4,786,120 4,734,291
=========== ===========
5
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
Common stock Additional
---------------------------- paid-in Retained
Shares Amount capital earnings
------------ ------------ ------------ ------------
BALANCE, JANUARY 31, 1999 4,247,275 $ 4,247,275 $ 25,848,681 $ 5,181,720
Options exercised, including tax benefit of $13,038 9,378 9,378 48,701 --
10% stock dividend 424,483 424,483 5,252,977 (5,677,460)
Retirement of shares repurchased (8,500) (8,500) (34,000) (60,031)
Repayment of ESOP debt -- -- -- --
Cash dividends declared ($.20 per share) -- -- -- (917,221)
Comprehensive income:
Net income -- -- -- 6,000,348
Other comprehensive income(loss)--Change in unrealized
loss on securities available-for-sale, net of
federal income tax -- -- -- --
------------
Total Comprehensive income -- -- -- 6,000,348
------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 1999 4,672,636 $ 4,672,636 $ 31,116,359 $ 4,527,356
============ ============ ============ ============
Options exercised, including tax benefit of $6,431 8,650 8,650 42,186 --
Retirement of shares repurchased (10,000) (10,000) (40,000) (51,874)
Repayment of ESOP debt -- -- -- --
Cash dividends declared ($.20 per share) -- -- -- (933,913)
Comprehensive income:
Net income -- -- -- 6,599,000
Other comprehensive income(loss)--Change in unrealized
loss on securities available-for-sale, net of
federal income tax -- -- -- --
------------
Total Comprehensive income -- -- -- 6,599,000
------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2000 4,671,286 $ 4,671,286 $ 31,118,545 $ 10,140,569
============ ============ ============ ============
Options exercised, including tax benefit of $86,101 25,923 25,923 153,406 --
Repayment of ESOP debt -- -- -- --
Cash dividends declared ($.05 per share) -- -- -- (234,861)
Comprehensive income:
Net income -- -- -- 1,731,138
Other comprehensive income(loss)--Change in unrealized
loss on securities available-for-sale, net of
federal income tax -- -- -- --
------------
Total Comprehensive income -- -- -- 1,731,138
------------ ------------ ------------ ------------
BALANCE, MARCH 31, 2001 4,697,209 $ 4,697,209 $ 31,271,951 $ 11,636,846
============ ============ ============ ============
6
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)(continued)
Employee stock Accumulated
ownership Comprehensive
plan debt Income(loss)(2) Total
------------ ------------ ------------
BALANCE, JANUARY 31, 1999 $ (603,738) $ (11,985) $ 34,661,953
Options exercised, including tax benefit of $13,038 -- -- 58,079
10% stock dividend -- -- --
Retirement of shares repurchased (102,531)
Repayment of ESOP debt 292,999 -- 292,999
Cash dividends declared ($.20 per share) -- -- (917,221)
Comprehensive income:
Net income -- -- 6,000,348
Other comprehensive income(loss)--Change in unrealized
loss on securities available-for-sale, net of
federal income tax -- (656,968) (656,968)
------------ ------------
Total Comprehensive income -- (656,968) 5,343,380
------------ ------------ ------------
BALANCE, DECEMBER 31, 1999 $ (310,739) $ (668,953) $ 39,336,659
============ ============ ============
Options exercised, including tax benefit of $6,431 -- -- 50,836
Retirement of shares repurchased -- -- (101,874)
Repayment of ESOP debt 212,918 -- 212,918
Cash dividends declared ($.20 per share) -- -- (933,913)
Comprehensive income:
Net income -- -- 6,599,000
Other comprehensive income(loss)--Change in unrealized
loss on securities available-for-sale, net of
federal income tax -- 753,645 753,645
------------ ------------
Total Comprehensive income -- 753,645 7,352,645
------------ ------------ ------------
BALANCE, DECEMBER 31, 2000 $ (97,821) $ 84,692 $ 45,917,271
============ ============ ============
Options exercised, including tax benefit of $86,101 -- -- 179,329
Repayment of ESOP debt 97,821 -- 97,821
Cash dividends declared ($.05 per share) -- -- (234,861)
Comprehensive income:
Net income -- -- 1,731,138
Other comprehensive income(loss)--Change in unrealized
loss on securities available-for-sale, net of
federal income tax -- 69,666 69,666
------------ ------------
Total Comprehensive income -- 69,666 1,800,804
------------ ------------ ------------
BALANCE, MARCH 31, 2001 $ -- $ 154,358 $ 47,760,364
============ ============ ============
7
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months ended March 31,
---------------------------------
2001 2000
------------ ------------
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,731,138 $ 1,647,296
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Provision for loan losses 215,000 130,000
Depreciation and Amortization 228,352 187,380
Deferred loan origination fees, net of accretion (217,815) (121,805)
Amortization of Mortgage servicing rights 2,440 24,351
Gain on sales of loans (582,486) (121,160)
Gain on sale of repossessed real estate (9,296) --
Gain on sale of securities available-for-sale (49,957)
Gain on sale of other investments (421,830)
FHLB stock dividends (124,200) (116,654)
Changes in operating assets & liabilities:
Loans receivable held-for-sale (16,506,472) (2,516,679)
Accrued interest receivable 92,418 (209,323)
Other assets 94,529 (154,126)
Drafts payable (217,384) (302,673)
Accounts payable and other liabilities (317,597) (1,282,423)
Federal income taxes 834,881 574,845
Advance payments by borrowers for Taxes and insurance 1,183,171 1,141,510
------------ ------------
Net cash used by operating activities (14,065,108) (1,119,461)
CASH FLOWS FROM INVESTING ACTIVITIES:
Loan originations (42,680,175) (45,534,444)
Loan principal repayments 38,415,001 24,846,243
Increase/(decrease) in undisbursed loan proceeds (5,522,010) 4,700,305
Principal repayments & redemptions on --
mortgage-backed and other securities 8,092,205 2,261,160
Purchase of mortgage-backed and other securities held-to-maturity -- (250,000)
Purchases of premises and equipment (219,319) (109,052)
Purchase of FHLB stock -- (246,046)
Proceeds from sale of Loans 1,021,188 173,963
Proceeds from other investments 430,307
Proceeds from sale of securities available-for-sale 3,317,431
Proceeds from sale of Real Estate Held-for-Sale 1,433,584 --
------------ ------------
BALANCE, net cash provided (used) by investing activities 4,288,212 (14,157,871)
8
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
Three months ended March 31,
-----------------------------------
2001 2000
------------- -------------
(Unaudited)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposit accounts (3,154,289) 20,657,504
Interest credited to deposit accounts 6,316,460 5,017,873
Proceeds from advances 54,598,000 295,848,000
Repayment of advances (49,597,000) (300,503,000)
Dividends paid (233,564) (234,057)
Proceeds from exercise of stock options 93,228 14,708
Repurchase of common stock -- (101,875)
Repayment of Employee Stock Ownership Plan debt 97,821 165,125
------------- -------------
Net cash provided by financing activities 8,120,656 20,864,278
------------- -------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS (1,656,240) 5,586,946
CASH & CASH EQUIVALENTS:
Beginning of year 6,998,992 3,864,995
------------- -------------
End of quarter $ 5,342,752 $ 9,451,941
============= =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Loans originated for mortgage banking activities $ 26,070,335 $ 11,434,050
============= =============
Loans originated for investment activities $ 42,680,175 $ 45,534,444
============= =============
Proceeds from sales of loans held-for-sale $ 9,563,863 $ 8,917,371
============= =============
Cash paid during three months ended March 31
Interest $ 8,531,109 $ 6,973,460
============= =============
Income taxes $ -- $ 212,780
============= =============
SUPPLEMENTAL DISCLOSURES OF NONCASH
INVESTING ACTIVITIES:
Loans transferred to (from) real estate
held-for-sale, net $ (1,352,611) $ --
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1.
The results of operations for the interim periods shown in this report are not
necessarily indicative of results to be expected for the fiscal year. In the
opinion of management, the information contained herein reflects all adjustments
necessary to make the results of operations for the interim periods a fair
statement of such operations. The consolidated statement of financial condition
of the company as of December 31, 2000 had been derived from the audited
consolidated statement of financial condition of the company as of that date.
NEW ACCOUNTING STANDARD RECENTLY ADOPTED: SFAS 133, Accounting for Derivative
Instruments and Hedging Activities, became effective and was adopted by the Bank
on January 1, 2001. The new accounting standard requires the mark-to-market of
all interest rate locks on loans pending sale and forward commitments into the
secondary market. The statement also permits the mark-to-market of closed loans
pending sale if certain conditions are met. The Bank elected in the first
quarter not to meet the strict conditions for mark-to-market of the saleable
closed loans, and instead only record the gains and losses on interest rate
locks and forward sale commitments.
NOTE 2.
MORTGAGE-BACKED AND OTHER SECURITIES AVAILABLE-FOR-SALE
The amortized cost and estimated fair value of securities available-for-sale at
March 31, 2001 and December 31, 2000 are summarized as follows:
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
----------- ----------- ----------- -----------
MARCH 31, 2001:
FHLMC securities $ 419,516 $ 9,575 $ -- $ 429,091
FNMA securities 31,917,659 359,712 125,759 32,151,612
GNMA securities 1,650,989 -- 9,576 1,641,413
----------- ----------- ----------- -----------
$33,988,164 $ 369,287 $ 135,335 $34,222,116
=========== =========== =========== ===========
DECEMBER 31, 2000:
FHLMC securities $ 420,698 $ 9,504 $ -- $ 430,202
FNMA securities 36,383,457 358,474 217,890 36,524,041
GNMA securities 1,713,531 -- 19,757 1,693,774
----------- ----------- ----------- -----------
$38,517,686 $ 367,978 $ 237,647 $38,648,017
=========== =========== =========== ===========
NOTE 3.
MORTGAGE-BACKED AND OTHER SECURITIES HELD-TO-MATURITY
The amortized cost and estimated fair value of mortgage-backed and other
securities are summarized as follows:
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
----------- ----------- ----------- -----------
MARCH 31, 2001:
FNMA certificates $31,215,414 $ 406,022 $ 20,187 $31,601,249
FHLMC certificates 1,416,470 8,153 -- 1,424,623
U.S. government agency securities 41,671,698 205,562 6,840 41,870,420
Merrill Lynch corporate bond 2,520,336 16,664 -- 2,537,000
Municipal bonds 1,118,790 -- 1,604 1,117,186
REMICS 291,516 504 -- 292,020
----------- ----------- ----------- -----------
$78,234,224 $ 636,905 $ 28,631 $78,842,498
=========== =========== =========== ===========
DECEMBER 31, 2000:
FNMA certificates $32,858,126 $ 215,635 $ 456,516 $32,617,245
FHLMC certificates 1,528,524 18,518 -- 1,547,042
U.S. government agency securities 46,665,515 131,994 227,007 46,570,502
Merrill Lynch corporate bond 2,523,071 -- 31,246 2,491,825
Municipal bonds 1,120,707 -- 60,939 1,059,768
REMICs 345,782 1,222 914 346,090
----------- ----------- ----------- -----------
$85,041,725 $ 367,369 $ 776,622 $84,632,472
=========== =========== =========== ===========
10
NOTE 4.
NONPERFORMING ASSETS
The Company had nonperforming assets as follows.
March 31, 2001 December 31, 2000
---------- ----------
Nonperforming loans $ 847,241 $1,110,920
Real Estate and Repossessed assets Held-for-Sale -- 1,352,611
---------- ----------
Totals $ 847,241 $2,463,531
========== ==========
At March 31, 2001 and December 31, 2000, the Bank had no impaired loans as
defined under Statement of Financial Accounting Standards (SFAS) No. 114,
"Accounting by Creditors for Impairment of a Loan."
NOTE 5.
EARNINGS PER SHARE
Basic Earnings Per Share is computed by dividing net income by the
weighted-average number of shares outstanding during the year. Diluted EPS
reflects the potential dilutive effect of stock options and is computed by
dividing net income by the weighted-average number of shares outstanding during
the year, plus the dilutive common shares that would have been outstanding had
the stock options been exercised.
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations for quarters and years ending
March 31, 2001 and March 31, 2000:
Income Shares Per share
(numerator) (denominator) amount
--------------------------------------------
Quarter ended March 31, 2001
Basic EPS:
Income available to common shareholders $1,731,138 4,688,580 $ 0.37
========
Effect of dilutive stock options -- 97,540
---------- ---------
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised $1,731,138 4,786,120 $ 0.36
============================================
Quarter ended March 31, 2000
Basic EPS:
Income available to common shareholders $1,647,296 4,669,507 $ 0.35
========
Effect of dilutive stock options -- 64,784
---------- ---------
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised $1,647,296 4,734,291 $ 0.35
============================================
11
NOTE 6.
RATE VOLUME ANALYSIS FIRST QUARTER 2001
(Dollars in thousands) VS
FIRST QUARTER 2000
INCREASE (DECREASE) DUE TO
TOTAL
VOLUME RATE CHANGE
- ------------------------------------------------------------------------------------------
INTEREST INCOME
Investments:
Available-for-sale securities $ 329 $ (40) $ 289
Held-to-maturity securities 110 (144) (34)
Other equity investments 19 7 26
------- ------- -------
Total investments 458 (177) 281
Loans:
Residential (270) 27 (243)
Residential construction 208 (5) 203
Multifamily 71 203 274
Multifamily construction 232 5 237
Commercial real estate and Business 473 84 557
Commercial real estate construction 101 (44) 57
Consumer & Other 218 34 252
------- ------- -------
Total loans 1,033 304 1,337
------- ------- -------
Total interest income 1,491 127 1,618
INTEREST EXPENSE
Deposits:
Money market deposit and checking (6) (14) (20)
Regular savings (15) (5) (20)
Time deposits 637 767 1,404
------- ------- -------
Total deposits 616 748 1,364
FHLB advances and other 9 163 172
------- ------- -------
Total interest expense 625 911 1,536
Net interest income $ 866 $ (784) $ 82
=======================================
12
NOTE 7.
SEGMENTS
The Company is organized based on the products and services that it offers.
Under this organizational structure, the Company has three reportable segments:
consumer banking, residential lending, and commercial lending.
Consumer banking offers depositor banking services, home equity lending, direct
consumer loans, consumer dealer financing contracts and small business lending.
Residential lending offers conventional or government-insured loans to borrowers
to purchase, refinance, or build homes, secured by one-to-four unit family
dwellings. Embedded within the residential lending segment is a mortgage banking
operation, which sells loans in the secondary mortgage market. The mortgage
banking operation may choose to retain or sell the right to service the loans
sold(i.e., collection of principal and interest payments) depending upon market
conditions.
Commercial lending offers permanent and interim (construction) loans for
multifamily housing (over 4 units), commercial real estate properties, and loans
to small and medium-sized businesses for financing inventory, accounts
receivables, and equipment, among other things. The underlying real estate
collateral or business asset being financed typically secures
these loans.
These segments are managed separately because each business requires different
processes and different marketing strategies to reach the customer base that
buys those products and services. All three segments derive a majority of their
revenue from interest, and management relies primarily on net interest revenue
in managing these segments. No single customer provides more than 10% of the
Company's revenues.
Basis of accounting for reportable segments: Starting in 1997, the Company
adopted business unit profitability reporting, which measures the performance of
segments as self-standing business entities. As self-standing entities, the
segments have full income-allocated and cost-burdened profit and loss
statements. Except for the allocations and the funds transfer-pricing mechanism
described below, the accounting policies for the segments are the same as those
described in the Summary of Significant Accounting Policies in the Company's
annual report.
Allocations and funds transfer-pricing mechanism:
Operating income and expenses are allocated to segments whenever they can be
directly attributed to their activities. Indirect income and overhead costs are
credited or charged to the segments whenever they are specifically identifed as
providers or users of the ancillary internal service, or are allocated based on
some common denominator. For certain services, inter-segment user fees are
assessed at agreed-upon prices.
A funds transfer-pricing method has been utilized to allocate interest income
for the deposits held in the branch banks. The deposit-gathering activities
contribute to the profitability by reducing borrowing costs. The deposits are
therefore presumed to generate revenues for consumer banking through
reinvestments in low-risk securities (inferred interest-earning assets). The
interest earnings are calculated using an internal, proxy market interest rate.
The loan-producing units in the residential, commercial, and consumer segments
are also presumed to borrow money to fund their loans using an internal,
proxy-market interest rate.
Equity capital commensurate with the risk weight of segment assets has been
allocated to simulate the operating capital level required by the Bank's
regulators. The allocated capital provides the segments with interest-free
funding.
Financial information for the Company's segments is shown below for quarters
ended March 31, 2001, 2000 and 1999:
CONSUMER RESIDENTIAL COMMERCIAL
BANKING LENDING LENDING TOTALS
------- ------- ------- ------
Revenues from external customers 2001 $ 3,207,288 $ 1,218,987 $ 8,756,141 $13,182,416
2000 2,479,946 2,080,662 7,708,375 12,268,983
1999 2,098,936 2,251,623 6,201,471 10,552,030
Revenues from other segments 2001 5,006,703 93,078 506,880 5,606,661
2000 4,531,990 86,158 442,606 5,060,754
1999 4,543,186 80,802 384,194 5,008,182
Total Revenues 2001 8,213,991 1,312,065 9,263,021 18,789,077
2000 7,011,936 2,166,820 8,150,981 17,329,737
1999 6,642,122 2,332,425 6,585,665 15,560,212
Net interest revenue 2001 1,214,389 399,289 3,335,430 4,949,108
2000 1,583,035 481,689 2,935,537 5,000,261
1999 1,611,854 494,557 2,318,777 4,425,188
Income/(loss) before federal income taxes 2001 (666,403) (127,457) 2,323,195 1,529,335
2000 198,096 204,291 2,176,761 2,579,148
1999 222,561 447,861 1,561,534 2,231,956
Revenues from external customers is comprised of interest income and other
operating income. Revenues from other segments include the interest-free benefit
of allocated equity capital, the interest revenue from the inferred earning
assets on branch deposits, and inter-segment user fees and charges.
13
NOTE 7.
SEGMENTS (CONTINUED)
Reconciliations of segment data to the Company consolidated financial statements
are shown in the table below. The amounts for the segments will differ from the
actual consolidated financial statements due to the use of internal, proxy
market interest rates, and various methods for allocating costs.
The provision for loan losses and the reserve for loan losses have not been
allocated to the segments. Total segment assets include inferred
interest-earning assets on branch deposits, which are essentially the same
assets from the lending segments, but credited with a proportional interest
yield.
FOR QUARTERS ENDED MARCH 31,
-----------------------------------------------------
2001 2000 1999
---- ---- ----
TOTAL REVENUES
Segment total revenues $ 18,789,077 $ 17,329,737 $ 15,560,212
Back out or add back:
Revenues from other segments (5,606,661) (5,060,754) (5,008,182)
Revenues of administrative departments netted against
overhead costs and reallocated as net costs 1,997,943 344,245 265,113
-----------------------------------------------------
Consolidated total revenues $ 15,180,359 $ 12,613,228 $ 10,817,143
NET INTEREST REVENUE
Segment net interest revenue $ 4,949,108 $ 5,000,261 $ 4,425,188
Back out or add back:
Difference between actual interest expense
and intersegment funding allocation (113,035) (67,949) (73,938)
Interest revenues of administrative departments netted
against overhead costs and reallocated as net costs 322,992 144,530 191,381
-----------------------------------------------------
Consolidated net interest revenue $ 5,159,065 $ 5,076,842 $ 4,542,631
INCOME BEFORE FEDERAL INCOME TAXES
Segment pre-tax income $ 1,529,335 $ 2,579,148 $ 2,231,956
Back out or add back:
Unallocated loan losses (215,000) (130,000) (150,000)
Unallocated net expenses of administrative departments -- -- (789,582)
Difference between actual total funding cost
and total intersegment funding allocation 1,537,120 44,192 870,287
-----------------------------------------------------
Consolidated pre-tax income $ 2,851,455 $ 2,493,340 $ 2,162,661
TOTAL ASSETS AS OF MARCH 31:
SEGMENT TOTAL ASSETS $ 981,467,751 $ 891,816,331 $ 790,486,777
Back out or add back:
Inferred intersegment interest earning assets on branch deposits (320,581,675) (293,355,798) (264,686,850)
Unallocated reserve for loan loss (6,950,576) (6,420,054) (5,699,677)
Unallocated nonearning assets of administrative
departments 786,598 11,898,808 $ 5,417,359
-----------------------------------------------------
Consolidated total assets $ 654,722,098 $ 603,939,287 $ 525,517,609
=====================================================
14
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
In the opinion of management, the accompanying consolidated statements of
financial condition and related interim consolidated statements of income,
comprehensive income, stockholders' equity and cash flows reflect all
adjustments (which include reclassifications and normal recurring adjustments)
that are necessary for a fair presentation in conformity with generally accepted
accounting principles ("GAAP"). The preparation of financial statements in
conformity with GAAP requires management to make estimates and assumptions that
affect amounts reported in the financial statements. Changes in these estimates
and assumptions are considered reasonably possible and may have a material
impact on the financial statements.
Certain reclassifications have been made to the 2000 financial statements to
conform to the 2001 presentation. All significant intercompany transactions and
balances have been eliminated.
The information included in this Form 10-Q should be read in conjunction with
First Mutual Bancshares, Inc. Annual Report on Form 10-K to the Securities and
Exchange Commission. Interim results are not necessarily indicative of results
for a full year.
Consolidated Financial Statements of the Company begin on page 2.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
- -------
First Mutual Bancshares, Inc. (the "Company"), a Washington corporation, is a
holding company owning all of the equity of its wholly owned subsidiary, First
Mutual Bank (formerly First Mutual Savings Bank). On June 11, 2000, First Mutual
Bancshares, Inc.'s election to become a financial holding company was approved
by the Federal Reserve Bank of San Francisco. First Mutual Bancshares is also
referred to as the "Bank" in this report.
First Mutual Bank (the "Bank") is a Washington-chartered savings bank subject to
regulation by the State of Washington Department of Financial Institutions and
the Federal Deposit Insurance Corporation ("FDIC"). The Bank conducts business
from its headquarters in Bellevue, Washington, and has ten full-service
facilities located in Bellevue (3), Kirkland, Redmond, Seattle (2), Issaquah,
Bellingham, and Monroe, Washington, and has an income property loan production
office located in Tacoma, Washington. The Bank's business consists mainly of
attracting deposits from the general public as well as wholesale funding
sources, and investing those funds primarily in real estate loans, small and
mid-sized business loans, and consumer loans. In addition to portfolio lending,
the Bank conducts a mortgage banking operation.
RESULTS OF OPERATIONS
- ---------------------
Net Interest Income
-------------------
Net interest income increased $82,000, or 1.6%, in the first quarter of 2001 as
contrasted with the same quarter in 2000. The net interest margin for the
quarter was 3.28%, which compares to
15
3.37%, 3.44%, 3.41%, and 3.52% for the quarters ended December 31, 2000,
September 30, 2000, June 30, 2000, and March 31, 2000 respectively.
Net interest income improved principally as a result of an increase in earning
assets, which contributed $866,000 in the first quarter. Interest-earning assets
grew from $588,548,000 at March 31, 2000, to $637,410,000 at quarter-end March
2001. Offsetting the benefit from greater-earning assets was the negative impact
of $784,000 from a change in interest rates. The unfavorable change in the net
interest margin is attributable to a greater relative increase in interest
expense as compared to the percentage increase for interest income. Interest
expense, as measured by the ratio of interest expense/average-earning assets,
rose from 4.79% in the first quarter of 2000 to 5.37% in the same period in
2001. Interest income, as measured by the ratio of interest
income/average-earning assets, also grew, rising from 8.30% in the first quarter
of 2000 to 8.65% in 2001. Thus, even though the interest income ratio increased
0.35%, the rise of 0.58% in the interest expense ratio was significantly
greater.
There are several factors that have greatly affected the Bank's net interest
margin - a divergence in key indices and the Bank's "gap" position.
A systematic problem that has arisen is the drifting apart of the two principal
indices that govern rates for assets and liabilities. Most of the Bank's assets
are adjustable-rate loans that reprice annually based on the one-year Constant
Maturity Treasury (CMT) index, which tracks the movement of Treasury bills. Time
deposits, which are the majority of the Bank's one-year repricing liabilities,
are largely influenced by competition in the local market. Although there is no
direct measure for rates paid on time deposits, it has been the Bank's
experience that there is a strong relationship between bank deposit rates and
the London Interbank Offering Rate (LIBOR). We believe this relationship is most
likely because financial institutions must ultimately compete with the broader
markets for funds.
The movement of these two indices has put considerable pressure on the net
interest margin. In 1996 the comparison of the CMT to the LIBOR showed a range,
on a trailing-average-12-month basis, of 19-25 basis points. That is, LIBOR
tended to be about 19-25 basis points (B.P.) higher than the CMT at any given
month that year. Over the last five years, that relationship has gradually
widened.
Year Trailing-Average-12-Month Variance
---- ----------------------------------
1996 19-25 B.P.
1997 27-45 B.P.
1998 46-49 B.P.
1999 51-72 B.P.
2000 72-85 B.P.
1st Qtr. 2001 67-73 B.P.
In addition to the downward drift of the CMT in comparison to the one-year
LIBOR, the margins obtained over the CMT index have deteriorated due to stiff
competition. In essence, the Bank's cost of funds has drifted higher than the
index it has historically used over which loans are priced.
To mitigate this problem, the Bank is taking steps to select indices for its
assets that more closely approximate the repricing profile of its liabilities.
In addition, 65% of the Bank's commercial
16
real estate loans have a floor of 7.5% or greater. Based on current rates, many
of those loans are approaching those floors.
Gap is the relationship between one-year repricing assets and liabilities and
also impacts the net interest margin. A negative gap means that more liabilities
are repriced in the next 12 months than assets, which is favorable in a
declining interest rate environment. A positive gap position means that more
assets will reprice than liabilities, which is favorable in a rising interest
rate environment.
Noted below are the gap positions for the last six quarters:
December 31, 1999 (15.3%)
March 31, 2000 (23.5%)
June 30, 2000 (11.6%)
September 30, 2000 2.7%
December 31, 2000 (3.7%)
March 31, 2001 8.4%
The one-year positive gap at March 31, 2001, if segmented into shorter periods,
provides further information. For the 0-3 month period, gap is +16.23%; the 4-6
month period is +5.18%; and the 7-12 month timeline is a negative (13.04%). The
cumulative sum of all three periods is a positive 8.37% gap. A degree of
skepticism needs to be applied to those figures because the results are based on
the assumption that loan prepayment rates will range as high as 52% per year.
Although that was the loan prepayment environment at the end of the first
quarter, prepayment rates and assumptions can change quickly.
The present outlook for the net interest margin for the next quarter is not
encouraging. The issue of diverging indices for assets and liabilities is not
likely to be resolved in the intermediate future. In addition, the Bank is
currently asset sensitive, particularly so, in the next three months, when it
appears that the Federal Reserve Bank may continue to cut rates.
The provision for loan losses increased from $130,000 in the first quarter of
2000 to $215,000 in the like period in 2001. The provision for loan losses
reflects the amount deemed appropriate to produce an adequate reserve for
possible loan losses inherent in the risk characteristics of the Bank's loan
portfolio. In determining the appropriate reserve balance, the Bank takes into
consideration the local and national economic outlook and the historical
performance of the loan portfolio.
Of interest to the Bank is the mix of its loan portfolio. Currently, 17.6% of
the portfolio is residential loans, including loans held for sale, and the
remaining 82.4% is composed of commercial, construction, and consumer loans. The
residential figure of 17.6% compares, according to the fourth quarter 2000
Federal Deposit Insurance Corporation (FDIC) Quarterly Banking Profile (latest
available data), to 69.1% for the FDIC-insured savings institutions and 24.0%
for the FDIC-insured commercial banks. Management's assessment of this
information is that its loan portfolio is more closely related to that of a
commercial bank.
The Bank's loan loss reserves to total loans ratio was 1.33% at March 31, 2001.
The comparable ratios for FDIC-insured savings institutions and commercial
banks, as of December 31, 2000, were .88% and 1.68%, respectively. Although the
Bank's loan mix is similar to that of a commercial bank, and therefore arguably
its ratio of loan loss reserves to total loans should
17
correspond to the national average, management believes that the Bank's current
ratio of non-performing loans to assets warrants favorable consideration. As of
quarter-end March 2001 the Bank's non-performing assets to total assets was
0.13%. That number compares to the national ratios of 0.56% for savings
institutions and 0.74% for commercial banks as of December 31, 2000.
In summary, the Bank's provision for loan loss reserves is based on historical
credit analysis, analysis of the portfolio, an assessment of local and national
economic conditions, and it appears to be reasonable in light of the national
ratios for comparable loan portfolios when tempered by the Bank's favorable
non-performing asset status.
Other Operating Income
----------------------
Other operating income increased to $1,571,000 in the first quarter of 2001 as
compared to $622,000 in the same quarter in 2000. The 153% increase was mainly
attributable to a bulk sale of mortgage servicing rights as well as the sale of
the Bank's limited partnership interest in TransAlliance. Partially offsetting
the increase was the implementation of Statement of Financial Accounting
Standard No. 133 (SFAS 133), ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES, which became effective January 1, 2001.
GAIN ON SALES OF LOANS. Gain on sales of loans totaled $518,000 for the quarter
as compared to $122,000 for the first quarter ended March 31, 2000. Gain on sale
of loans is composed of four elements: sale of servicing rights, capitalization
of mortgage servicing rights, secondary market fees, and the mark-to-market of
all interest rate locks on loans pending sale and forward sale commitments into
the secondary market (pursuant to SFAS No. 133).
The majority of the gain was attributable to a bulk sale of servicing rights of
$78 million, which resulted in a pre-tax gain of $891,000. The bulk sale in the
first quarter concludes the strategic liquidation of the Bank's residential
servicing portfolio. An earlier sale in fourth quarter of 2000 totaled $51
million of servicing rights. As recently as December 1996, the Bank's servicing
portfolio totaled $371 million. In the intervening years, the Bank has
systematically reduced that portfolio to today's level of $45 million. The
remaining servicing portfolio is largely made up of income property loans, which
are not readily saleable.
Offsetting the gain on sales of loans was the decrease in the capitalization of
mortgage servicing rights (MSRs). Pursuant to Statement of Financial Accounting
Standards (SFAS) No. 125, ACCOUNTING FOR TRANSFERS OF SERVICING OF FINANCIAL
ASSETS AND EXTINGUISHMENT OF LIABILITIES, the Bank is required to capitalize
internally generated servicing rights. The amount of MSRs capitalized and
recognized in income totaled $13,000 for the first quarter of 2001 as compared
to $66,000 for the like quarter in 2000. The reason for the decrease is twofold,
both loan sales and interest rates have fallen.
The amount of loan sales, related to the capitalization of the MSRs, in the
first quarter of 2001 amounted to $3,638,000 as compared to $6,164,000 in the
first quarter of 2000. The amount of servicing rights that are capitalized is
directly related to the amount of loan sale activity. As loan sales decrease,
the amount of MSRs that are capitalized and recognized into income, generally
decline as well and vice versa. In addition to the drop in loan sales, treasury
rates have also been on the decline.
18
At March 31, 2000 the One-Year Treasury rate was 6.39%, dropping to 4.13% as of
March 31, 2001. This is a 226 basis point drop in one year, which is
significant. As rates decline the value of the MSRs decrease due to the lower
interest income that is collected over the life of the loan. The present value
of this income stream is used to value the MSRs. As interest rates decline the
amount of capitalized MSRs will decrease as well.
Secondary market fees, is the third piece that is included in the gain on sales
of loans. Secondary market fees are the cash gains or losses from the sale of
loans into the secondary market. Cash losses in first quarter 2001 amounted to
$178,000 on total loan sales of $9.6 million, an increase of 345% over losses of
$40,000 on total loan sales of $9.0 million in first quarter 2000. The types of
loans that are in the loans held-for-sale inventory (pipeline) have impacted the
secondary market gains and losses significantly. In the past, the majority of
the loans in the pipeline have been for existing homes, which tend to close
within a thirty- to sixty-day window. However, in the last twelve months, the
Banks portfolio of custom construction loans has more than doubled. Due to the
nature of these loans, they tend to stay in the pipeline for six to twelve
months. At March 31, 2000, total custom construction loans included in loans
held-for-sale equaled $3 million in contrast to $14 million at March 31, 2001,
an $11 million increase. The difficulty with custom construction loans, is that
the forward commitments that hedge these loans only have a term of thirty to
ninety days, and thus must be settled (paired-off) with the mortgage secondary
market broker every one to three months. Since interest rates were principally
on the decline during the past year, losses were recorded on the pair-offs
during the construction phase of these homes. As these construction projects
come to an end, and the homes are completed, these mortgages should be sold at a
gain, assuming rates remain flat or continue to decline. Pair-off losses totaled
$296,000 for the first quarter of 2001 as compared to a loss of $3,000 for the
like period last year. Pair-off fees are a routine secondary market activity;
however, whether the pair-off results in a gain or loss is largely dependent on
the movement of mortgage rates. When rates decline, losses occur in pair-offs,
and vice versa in a rising interest rate environment.
The fourth and final piece of the gain on sales of loans total is new this year.
SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES,
became effective on January 1, 2001. The new accounting standard requires the
mark-to-market of all interest rate locks on loans pending sale and forward
commitments into the secondary market. The statement also permits the
mark-to-market of closed loans pending sale if certain conditions are met. The
Bank elected in the first quarter not to meet the strict conditions for
mark-to-market of the saleable closed loans, and instead only record the gains
and losses on interest rate locks and forward sale commitments. At January 1,
2001, the gain realized from interest rate locks was not particularly
significant at $8,500 before tax. The losses on forward commitments, however,
totaled $244,000. The net of those two items, tax effected, amounted to a loss
of $155,000 which has been presented as an adoption of a new accounting
principle on the face of the statement of income.
Market losses on forward commitments occur when interest rates for mortgage
loans decline. Just the opposite happens when rates increase. Offsetting the
losses on the forward commitments is an unrealized mark-to-market gain of
$441,000 on loans held for sale. The gain on those closed loans will not be
recorded until the loans are actually sold and delivered to the secondary
market.
During the quarter, after the initial adoption of SFAS 133 on January 1, 2001,
the net change in rate locks and forward commitments totaled a gain of $90,000.
19
Servicing fees have decreased $189,000 or 82.2% as compared to March 31, 2000.
Servicing fee income for first quarter 2001 totaled $41,000 as compared to
$230,000 for the like period in 2000. The servicing portfolio totaled $44.6
million at March 31, 2001 as compared to $184.7 million a year ago. The sale of
servicing rights in the last few years has eroded the balance of that portfolio.
Management has been concerned for a number of years about the potential for loss
from the early prepayment of loans held in the servicing portfolio. Because of
this, the strategic decision was made to significantly reduce the size of the
portfolio. Therefore, servicing fee income in future quarters will be materially
less than in the past few years.
Gain on sale of investment securities held-for-sale totaled $472,000 in the
first quarter. There were no comparable gains in 2000. These gains are made up
of two items: the sale of a limited partnership interest and the sale of $3.3
million in investment securities.
The Bank sold its interest in the TransAlliance Limited Partnership. The Limited
Partnership's business activities principally encompassed the operation of
automated teller machines. The General Partner, Electronic Data Systems (EDS),
purchased the Bank's ownership along with that of the other limited partners.
The pre-tax gain from that sale amounted to $422,000. The future impact from the
sale of that asset is the loss of dividend income. Dividend income, which was
variable, totaled $112,000 in year 2000, and $17,000 in 1999.
Investment securities, with a principle balance of $3.3 million, were sold with
a pre-tax gain of $50,000. Those securities were 30-year fixed-rate instruments,
and were liquidated to improve the Bank's asset/liability position. Those
proceeds were used to fund short-term loans held-for-sale.
Fee income from deposits rose a mere $2,000 or 2.5% in the first quarter of 2001
on a quarter-to-quarter comparison. In the aggregate, this increase appears
insignificant but broken down, two components have changed substantially,
non-sufficient funds (NSF) fees and non-FDIC insured investment sales fees. The
Bank made two strategic decisions last year in regards to deposit fee income.
The first decision was to discontinue offering non-FDIC insured investments to
customers and secondly, a new program was launched to increase deposit fee
income through NSF fees. The results of these two changes are as follows:
non-FDIC insured investment fee income decreased 93% on a quarter-to-quarter
basis or $12,000 and NSF fee income has increased $13,000 or 30% as compared to
first quarter 2000.
Loan prepayment fee income has increased considerably as compared to first
quarter of 2000. At March 31, 2000, loan prepayment fee income totaled $2,000
which compares with $25,000 for the same time period in 2001. These prepayment
penalties relate to two loans, one of which was an income property loan that
accounted for the majority of the increase and the other was a business banking
loan that paid off prior to its scheduled maturity.
Non-deferred loan fees have increased 90% to $86,000 from $45,000 for the first
quarter of 2000. These fees predominately consist of short-term extension fees
on construction loans. As can be seen from the table below, loans originated for
mortgage banking activities have increased significantly, contributing to the
recognition of loan fees that are not deferred.
Loans Originated for
Mortgage Banking Activities
---------------------------
Year 2001 Year 2000
--------- ---------
First Quarter $31,954,000 $11,633,000
20
Offsetting the increases in both prepayment fees and non-deferred loan fees was
the decrease in brokered loan fees. During first quarter 2000, total broker fee
income amounted to $46,000 resulting from 21 loans that were brokered out. Those
figures compare with one brokered loan in the first quarter of 2001 for fee
income of $2,600. The reason for this dramatic decrease was due to a change in
the loan officer's compensation plan to discourage this type of activity. The
Bank is able to realize more favorable returns on loans that are sold servicing
released in the secondary market as opposed to brokering them out to another
institution.
Also included in Other Operating Income are the dividends received from the
TransAlliance partnership interest. As was mentioned earlier, the sale of the
TransAlliance Limited Partnership eliminates any future dividends. Dividends
received in the first quarter of 2000 amounted to $22,000 as compared to $0 for
the same period this year.
Operating Expenses
------------------
Salaries and employee benefits increased from $1,941,000 in the three months
ending March 2000 to $2,266,000 this year, an increase of 16.8%. Several factors
contributed to that rise in expenses. The largest impact was from promotions and
annual salary increases, which rose 8.5% year-over-year. Also impacting
operating expenses was the doubling of the Business Banking Department's staff
in the first quarter. The additional salary and benefit costs of the Kirkland
Branch, which opened last summer, also contributed to the rise in operating
expenses.
Occupancy expense rose $101,000 or 23.6% on a quarter-to-quarter basis. A
significant portion, $65,000, of that increase is attributable to the new
Kirkland Office and the expansion of the Consumer Loan Department at the
Bellevue headquarters.
Other operating expenses jumped $162,000, or 22.9%, from $707,000 in the first
quarter of 2000 to $869,000 in the like period of this year. A number of items
contributed to the rise in costs, of which the most notable line items were
recruiting expense, office supplies, postage, and B&O tax. Recruiting expense
this year was $30,000, as compared to $8,000 in year 2000. The expansion of the
Business Banking Department accounted for most of these costs. Office supplies
and postage, which increased from $25,000 and $17,000, respectively, in the
first quarter of last year, to $50,000 and $40,000 this year, are largely a
reflection of the residential refinance activity. B&O tax is up $27,000, or
37.6% on a quarter-to-quarter comparison, principally as a result of the gains
realized from the sale of servicing and the TransAlliance Limited Partnership.
Net Income
----------
Net income after adoption of the new accounting principle increased 5.1%, from
$1,647,000 in the first quarter of 2000 to $1,731,000 in the same period of
2001. The improvement in net income is a reflection of higher net interest
income before provision for loan loss and a significant increase in non-interest
income.
21
BUSINESS SEGMENTS
- -----------------
The Bank has identified three segments of business for the purposes of
management reporting. The amounts for the segments are different from the actual
consolidated financial statements due to the various methods for allocating
costs and the inferring of interest-earning assets. The management accounting
process measures the performance of the business segments based on the
management structure of the Bank and is not necessarily comparable with similar
information for any other financial institution.
Consumer Banking
----------------
Income before taxes for the consumer banking segment fell from $198,000 in the
first quarter of 2000 to a loss of $666,000 in the same quarter in 2001. The
decline in income before taxes was largely the result of a drop in net interest
income and an increase in operating expenses.
Net interest income was down $369,000, falling from $1,583,000 in the first
quarter of 2000 to $1,214,000 this year. The net interest margin also declined
from 1.49% in 2000 to 1.02% in 2001. Although average assets increased $50.2
million, or 11.8%, on a quarter-to-quarter comparison, the favorable impact from
that growth was insufficient to offset the compression in the net interest
margin.
Non-interest income increased from $154,000 in the three months ending March
2000 to $205,000 in the same quarter this year. Contributing to the growth in
non-interest income was the rise in deposit fee income and the commissions
received on the Bank's official check program. Deposit fee income (excluding fee
income associated with non-FDIC insured investment products) has increased 22%
this year compared to first quarter of 2000. The Bank has placed a greater
emphasis on improving fee income from deposit accounts. The commission income
that the Bank receives on a quarterly basis from its official check provider has
increased 68% over first quarter of last year. There are a number of factors
involved in calculating the Bank's commission such as the average dollar amount
of outstanding items, the average time it takes the items to clear the issuing
bank, and the investment rate. The commission that the Bank received in first
quarter of 2000 and 2001 was based on the average rate and balances outstanding
for the previous fourth quarter. On a quarter-to-quarter basis the average rate
increased 98 basis points from 5.04% during fourth quarter 1999 to 6.02% for
fourth quarter of 2000. The average investable balance also increased 41%.
Operating expenses increased from $1,520,000 in the first quarter of 2000 to
$2,092,000 or 38% for the like quarter this year. The jump in operating expenses
is due to the costs related to the new Kirkland branch, which opened last summer
as well as the addition off the new Community Business Banking Department that
began in January 2001. Normal annual salary adjustments also contributed to the
increase in operating expenses.
Residential Lending
-------------------
Income before taxes dropped sharply for the residential lending segment, from
$204,000 in the first quarter of 2000 to a loss of $127,000 in 2001. This
segment was affected by a decrease in both net-interest and non-interest income,
partially offset by a decline in operating expenses.
Net interest income fell for this business segment, from $482,000 in the first
quarter of 2000 to $399,000 this year. The net interest margin also decreased on
a quarter-to-quarter comparison,
22
from 1.80% to 1.56%. The same trends that were discussed earlier regarding the
divergence in the CMT and LIBOR indices as well as the Bank's "gap" position
also apply to the residential lending segment.
Non-interest income fell dramatically from $243,000 in the first three months of
2000 to a negative $348,000 in the same period this year. The major contributors
to this decline are the adoption of FAS 133 as well as the secondary market
losses, both of which were discussed previously. (Please see subheading "Other
Operating Income - Gain on Sales of Loans" for a more complete discussion).
Operating expenses declined from $520,000 in the first quarter of 2000 to
$179,000 this year. This sharp decline is largely due to the manner in which
operating expenses are accounted for in the segment. It has been the practice of
the Bank to net operating expenses against the income generated from the Custom
Construction Department. In the past, the activities associated with that
department were not as significant as they are today. On a quarter-to-quarter
comparison, loan origination's for these types of loans have jumped 57%. Income
from the Custom Construction Department is up sharply, and has thus materially
offset operating costs for the Residential Segment.
Commercial Lending
------------------
Income before taxes for this business segment rose $146,000, or 6.7%, from
$2,177,000 in the first quarter of 2000 to $2,323,000 in the like period of
2001. Net interest revenue grew $399,000, while operating expenses increased
$247,000.
Net interest revenue benefited from a 12.6% increase in average assets. Average
assets rose from $342 million in the first quarter of 2000 to $385 million this
year. Also of importance to this segment is the slight increase in the net
interest margin, which rose from 3.43% in the first quarter of 2000 to 3.46% in
the like period of 2001.
Operating expenses increased 30.0% in the first quarter of 2001 as compared to
the like quarter in 2000. Non-interest expense increased primarily due to the
increase in recruiting expense associated with expanding the Business Banking
Department over the first quarter. Also contributing to the escalation of the
operating expenses was the normal annual salary adjustments that occurred in
December 2000. As a result, the first quarter of 2001 realizes the full impact
of the salary adjustments for the full three months.
FINANCIAL CONDITION
- -------------------
ASSETS. Assets increased 1.8% from $643,231,000 at year-end 2000 to $654,722,000
as of March 31, 2001. The change in assets is principally the result of an
increase in the loan portfolio and loans held-for-sale categories.
LOANS. Net loans receivable rose from $473,776,000 at year-end 2000, to
$483,185,000, an increase of 2.0% in three months. The growth in loan balances
is largely due to an increase in commercial real estate loans, in particular,
multi-family and income property permanent portfolio loans. The Bank purchased
$3.7 million in commercial loans during the quarter and is expecting to purchase
approximately $10 million in loan balances in the second quarter of 2001 to
augment its current loan portfolio.
23
Loans held-for-sale increased from $15,774,000 at year-end 2000 to $32,281,000,
as of March 31, 2001. The rise in loans held-for-sale, of $16.5 million since
year-end 2000, reflects the increase in mortgage banking activity due to the
recent decline in interest rates.
MORTGAGE SERVICING RIGHTS. As was discussed under the sub-heading "Other
Operating Income," the Bank has sold the majority of its mortgage servicing
rights. The balance of the mortgage servicing rights asset at year-end 2000
totaled $145,000 as compared to $30,000 as of March 31, 2001. The last sale took
place during January 2001. As a result of the sale, the amount of fee income
that the Bank recognizes from the servicing rights will decrease substantially
in future periods. Please see the discussion regarding this issue on page 18
under the sub-heading "Other Operating Income."
SECURITIES. The Bank classifies investment securities in one of the following
categories: 1) trading, 2) available-for-sale, or 3) held-to-maturity.
Securities classified as available-for-sale are reviewed regularly and any
unrealized gains or losses are recorded in the shareholders' equity account. At
March 31, 2001, the balance of the unrealized gain, net of federal income taxes,
was $154,000, which compares to an unrealized gain at year-end 2000 of $85,000.
Generally, falling interest rates will increase the amount recorded as
unrealized gain, and rising rates will decrease any unrealized gains, as the
market value of securities inversely adjusts to the change in interest rates.
Security investments (securities available-for-sale and mortgage-backed and
other securities held-to-maturity) dropped $11.2 million or 9.1% from December
31, 2000, to the end of the first quarter 2001. During the quarter three of the
Banks securities were called and as mentioned previously, the Bank sold two of
its mortgage-backed securities. Also contributing to the decline in securities
was the recording of normal principal payments.
LIABILITIES. Deposits increased $3,162,000, or 0.7%, in the first three months
of 2001 totaling $461 million as compared to $457 million at year-end 2000.
The FHLB advances increased slightly from $133 million at year-end 2000 to $138
million as of the end of the first quarter. As of March 31, 2001, the Bank had
the capacity to borrow up to a total of $262 million in FHLB advances, subject
to sufficient collateral to support those advances.
Asset Quality
-------------
PROVISION AND RESERVE FOR LOAN LOSSES. The Bank analyzes a number of factors in
determining the provision for loan losses, such as current and historical
economic conditions, non-accrual asset trends, and historical loan loss
experience. The results of that analysis indicated the need for a provision of
$215,000 in the first quarter of 2001.
Non-performing assets were .13% of total assets in the first quarter, down from
.16% in the like quarter of 2000.
Non-performing assets fell from $2,464,000 at year-end 2000 to $847,000 at March
31, 2001. There were no repossessed assets at quarter-end and nonperforming
loans decreased from $1,111,000 at year-end 2000 to $847,000 at March 31, 2001.
The nonperforming loans are comprised of five items, of which one of these loans
has subsequently been paid in full. Noted below is a summary of the Bank's
exposure, by loan:
24
Amount
------
Business Banking Loan, Puget Sound area
(charged off in April) $ 12,000
Sales Finance Loan, Portland, OR
(charged off in April) 5,000
Sales Finance Loan, Portland, OR
(paid off in full) 2,000
Residential Loan, Puget Sound area
(anticipate the loan to be brought current in Q2) 308,000
Lot loans, Western, OR
(Bank does not expect a loss, although the period
of recovery is anticipated to be lengthy) 520,000
----------
Total $ 847,000
==========
At year-end 2000, one of the properties that the Bank included in its real
estate held-for-sale was a residential construction property located in Western
Oregon. This property was subsequently sold during the first quarter of 2001
with a claim pending for $75,000 against a title company. During the second
quarter of 2001 the Bank collected on this claim in full.
Liquidity and Capital Reserves
------------------------------
The net cash, as reported in the Statement of Cash Flows, decreased by $1.7
million in the first three months of 2001. Cash flows from the sale of
investments, loan repayments, and FHLB borrowings were offset by the Bank's
dramatic increase in its loans held-for-sale during the first quarter of 2001.
The net cash flows from the sale of investments, redemption of securities and
principal repayments on securities totaled $12 million. Loan principal
repayments and FHLB advances contributed $38 million and $5 million
respectively. That cash was principally used to fund the loan portfolio, which
increased $26 million since year-end 2000. Loan's held-for-sale increased from
$15.8 million at year-end 2000 to $32.3 million at March 31, 2001. The sudden
increase was due to the decline in interest rates resulting in a rise in
refinance activity.
The Bank's long-term liquidity objective is to fund growth through consumer
deposits. Whenever that source is inadequate to meet the Bank's asset growth
requirements, FHLB advances are normally accessed. The current ratio of FHLB
advances to assets is 21.1%, which is below the Bank's credit limit of 40% of
assets. Other sources of liquidity include the sale of loans into the secondary
market, net income after the payment of dividends, and reverse repurchase
agreement credit lines of $50,000,000.
The FDIC's statutory framework for capital requirements establishes five
categories of capital strength, ranging from a high of well capitalized to a low
of critically under-capitalized. An institution's category depends upon its
capital level in relation to relevant capital measures, including a risk-based
capital measure, a leverage capital measure, and certain other factors. At March
31, 2001, the Bank exceeded the capital levels required to meet the definition
of a well-capitalized institution:
25
For Capital "Well Capitalized"
Actual Adequacy Minimum Minimum Ratio
------ ---------------- -------------
Total capital (to risk-weighted assets):
First Mutual Bancshares, Inc. 11.54% 8.00% 10.00%
First Mutual Bank 11.51 8.00 10.00
Tier I capital (to risk-weighted assets):
First Mutual Bancshares, Inc. 10.29 4.00 6.00
First Mutual Bank 10.26 4.00 6.00
Tier I capital (to average assets):
First Mutual Bancshares, Inc. 7.34 4.00 5.00
First Mutual Bank 7.32 4.00 5.00
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Bank's profitability is dependent to a large extent on its net interest
income, which is the difference between the interest received from its
interest-earning assets and the interest paid on its interest-bearing
liabilities. The Bank's objectives in its asset/liability management are to
utilize its capital effectively, to provide adequate liquidity, and to enhance
net interest income, without taking unreasonable risks subjecting the Bank
unduly to interest rate fluctuations.
Assumptions regarding interest rate risk are inherent in all financial
institutions. Interest rate risk is the risk to earnings or capital resulting
from adverse movements in interest rates. Interest rate sensitivity is the
relationship between market interest rates and net interest income due to the
repricing characteristics of assets and liabilities. The Bank monitors interest
rate sensitivity by examining its one-year and longer gap positions on a regular
basis. Gap analysis and an income simulation model are used to manage interest
rate risk.
The Bank utilizes an income simulation model that calculates the result of a
100, 200, 300, etc. basis point shock in regards to the net interest income as
well as the effect on the net portfolio value of the Bank. The model
incorporates beginning of the period rate, balance, and maturity data, using
various levels of aggregation of that data, as well as certain assumptions
concerning the maturity, repricing, amortization, and prepayment characteristics
of loans and other interest-earning assets and the repricing withdrawal of
deposits and other interest-bearing liabilities. The Bank updates and prepares
simulation modeling monthly for review by ALCO (Asset Liability Committee),
senior management, and the Board of Directors. The Bank believes that the data
and assumptions are realistic representations of its portfolio and possible
outcomes under the various interest rate scenarios. Nonetheless, the interest
rate sensitivity of the Bank's net interest income and net market value of
equity could vary substantially if different assumptions were used or if actual
experience differs from the assumptions used.
The results of the Company's income simulation and gap analysis for the periods
ended March 31, 2001 and December 31, 2000 are presented below. The gap analysis
indicates that the Company is currently asset sensitive, meaning that the assets
are repricing and/or maturing at a faster pace
26
than liabilities. An asset sensitive institution will typically benefit in a
rising interest rate environment, as net interest income tends to increase. This
is supported by the results of the income simulation model. Conversely, in a
declining interest rate environment, the net interest income is expected to
decrease.
RATE SHOCK ESTIMATES
Net Interest Income and Market Value
March 31, 2001 December 31, 2000
Percentage Change Percentage Change
- ------------------------------------------------------------------------------------------------
Immediate Net Net Net Net
Change in Interest Market Interest Market
Interest Rates Income Value Income Value
- ------------------------------------------------------------------------------------------------
+400 15% (15)% (1)% (28)%
+300 13 (10) 0 (20)
+200 10 (4) 1 (12)
+100 6 (1) 1 (5)
-100 (6) (1) (3) 2
-200 (13) (8) (5) 1
-300 (21) (14) (10) (4)
-400 (28) (19) (14) (7)
- ------------------------------------------------------------------------------------------------
ONE-YEAR INTEREST RATE SENSITIVE GAP
------------------------------------
(in thousands)
March 31, 2001 December 31, 2000
-------------- -----------------
One-year repricing assets $ 505,282 $ 423,956
One-year repricing liabilities 450,522 447,992
One-year gap 54,760 (24,036)
--------- ---------
Total assets $ 654,338 $ 643,231
========= =========
Interest rate sensitivity gap as a
percent of assets 8.4% (3.7%)
The Rate Shock results for the March 31, 2001 simulation run indicate that if an
immediate increase of 200 basis points in interest rates occurred, the Company's
net interest income would increase by 10%. Conversely, if prevailing interest
rates were to decline by 200 basis points, net interest income would decrease by
13%. Both the rise and decline in rate scenarios result in a decrease in the
market value of the Bank. This situation has occurred in large part in the first
quarter of 2001 due to the sudden increase in fixed rate loans in the loans
held-for-sale category. Although these loans are fixed rate in nature, it is the
intent of the Bank to sell these loans in the secondary market. The Bank has
taken the position to liquidate these loans within a thirty-to-ninety day
period.
27
The aggressive decline in rates during the first quarter 2001 is something that
has not been seen since early 1992. Such a steep decline will cause short-term
volatility in portfolio values and interest rate risk. It remains management's
strategy to maintain a portfolio primarily consisting of adjustable rate
instruments. In doing so, adverse fluctuations in economic conditions that
effect the Company's interest income and portfolio value should be short lived.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
First Mutual Bancshares, Inc. has certain litigations and
negotiations in progress resulting from activities arising from normal
operations. In the opinion of management, none of these matters is likely to
have a material adverse effect on the Company's financial position.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
The Annual Meeting of Shareholders of First Mutual Bancshares, Inc. was held on
April 26, 2001. The results of votes on the matters presented at the Meeting are
as follows:
1. The following individuals were elected as directors for the term
noted:
28
Director Votes For Votes Withheld Term
- -------- --------- -------------- ----
Janine Florence 4,501,627 96,907 1 year
Victor E. Parker 4,505,183 93,351 1 year
F. Kemper Freeeman, Jr. 4,502,689 95,845 1 year
James J. Doud, Jr. 4,505,246 93,288 2 years
Robert C. Wallace 4,501,480 97,054 2 years
Richard S. Sprague 4,504,933 93,601 2 years
Mary Case Dunnam 4,505,083 93,451 3 years
John R. Valaas 4,489,911 108,623 3 years
George W. Rowley, Jr. 4,493,466 105,068 3 years
H. Scott Wallace 4,488,047 110,487 3 years
2. The proposal to amend the First Mutual Bancshares, Inc. Articles of
Incorporation with respect to "Blank Check" Preferred Stock received
the following votes:
Number of Shares Number of Shares Number of Shares
FOR AGAINST ABSTAINING
--- ------- ----------
3,409,758 433,448 180,629
3. The proposal to amend the First Mutual Bancshares, Inc., Articles of
Incorporation to provide for a classified board received the
following votes:
Number of Shares Number of Shares Number of Shares
FOR AGAINST ABSTAINING
--- ------- ----------
3,414,979 442,477 166,380
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
None.
FORWARD-LOOKING STATEMENTS DISCLAIMER
- -------------------------------------
In this Form 10-Q, First Mutual Bancshares, Inc. has included certain
"forward-looking statements" concerning its future operations. It is the
Company's desire to take advantage of the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995. This statement is for the
express purpose of availing the Company of the protections of such safe harbor
with respect to all forward-looking statements contained in this Form 10-Q.
Sentences containing words such as "may," "will," "expect," "anticipate,"
"believe," "estimate," "optimistic," "hopeful," "should," "projected," or
similar words may constitute forward-looking statements. Although the Company
believes that the expectations expressed in these forward-looking statements are
based on reasonable assumptions within the bounds of its knowledge of its
business and operations, it is possible that actual results may differ
materially from these expectations. Factors which could affect actual results
include interest rate trends, the general state of the economy in the Company's
market area and the country as a whole, the impact of competitive products,
services and pricing, the ability of the Company to control costs and expenses,
loan delinquency rates, and legislative,
29
regulatory and accounting changes affecting the banking and financial services
industry. These risks and uncertainties should be considered in evaluating the
forward-looking statements and undue reliance should not be placed on such
statements. The Company and the Bank disclaim any obligations publicly to
announce future events or developments which affect the forward-looking
statements herein.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 14, 2001 FIRST MUTUAL BANCSHARES, INC.
/s/ John R. Valaas
-------------------------------------
John R. Valaas
President and Chief Executive Officer
/s/ Roger A. Mandery
-------------------------------------
Roger A. Mandery
Executive Vice President
(Principal Financial Officer)
30