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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, 2002
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.
--------------------------------------------
(Exact name of bank as specified in charter)
WASHINGTON 91-2005970
---------- ----------
(State of incorporation) (I.R.S. Employer Identification Number)
400 108th Avenue N.E., Bellevue, WA 98004
---------------------------------------------------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (425) 453-5301
--------------
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 has (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. May 13, 2002 5,204,062
------------ ---------
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FIRST MUTUAL BANCSHARES, INC.
QUARTERLY REPORT ON FORM 10-Q
MARCH 31, 2002
TABLE OF CONTENTS
Page
----
PART I: FINANCIAL INFORMATION.............................................. 13
Forward-Looking Statements Disclaimer............................ 13
Item 1. Financial Statements............................................. 2
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................ 14
General...................................................... 14
Results of Operations........................................ 14
Net Income................................................ 14
Net Interest Income....................................... 14
Other Operating Income.................................... 15
Operating Expenses........................................ 17
Financial Condition.......................................... 18
Asset Quality................................................ 19
Portfolio Information........................................ 19
Deposit Information.......................................... 20
Business Segments................................................ 20
Consumer Lending............................................. 21
Commercial Lending........................................... 22
Investment Securities........................................ 22
Liquidity and Capital Reserves................................... 23
Branch Closures and Expansion.................................... 24
Item 3. Quantitative and Qualitative Disclosures About Market Risk....... 24
PART II: OTHER INFORMATION................................................. 27
Item 1. Legal Proceedings................................................ 27
Item 2. Changes in Securities and Use of Proceeds........................ 27
Item 3. Defaults Upon Senior Securities.................................. 27
Item 4. Submission of Matters to a Vote of Security-Holders.............. 27
Item 5. Other Information................................................ 27
Item 6. Exhibits and Reports on Form 8-K................................. 28
SIGNATURES................................................................. 28
1
Item 1. Financial Statements
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
March 31, December 31,
2002 2001
------------ ------------
ASSETS: (Unaudited)
CASH AND CASH EQUIVALENTS:
Interest-earning deposits $ 84,019 $ 5,761,548
Noninterest-earning demand
deposits and cash on hand 6,397,441 8,853,755
------------ ------------
6,481,460 14,615,303
MORTGAGE-BACKED AND OTHER SECURITIES
AVAILABLE-FOR-SALE 64,578,716 45,961,301
LOANS RECEIVABLE, HELD-FOR-SALE 2,550,586 4,475,792
MORTGAGE-BACKED AND OTHER SECURITIES
HELD-TO-MATURITY 23,666,072 26,385,652
LOANS RECEIVABLE 572,524,600 570,109,616
RESERVE FOR LOAN LOSSES (7,065,304) (7,032,062)
------------ ------------
LOANS RECEIVABLE, NET 565,459,296 563,077,554
ACCRUED INTEREST RECEIVABLE 3,556,274 3,556,110
LAND, BUILDINGS AND EQUIPMENT, NET 9,085,107 8,831,022
FEDERAL HOME LOAN BANK (FHLB) STOCK, 9,966,600 9,759,300
at cost
MORTGAGE SERVICING RIGHTS 53,623 47,810
OTHER ASSETS 1,726,792 1,638,707
------------ ------------
TOTAL $687,124,526 $678,348,551
============ ============
2
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Continued)
March 31, December 31,
2002 2001
------------ ------------
(Unaudited)
LIABILITIES:
Deposits:
Investor custodial checking $ 202,718 $ 228,619
Money market deposit and
checking accounts 105,457,141 108,826,655
Regular savings 8,217,428 7,855,528
Time deposits 330,824,244 311,986,860
------------ ------------
Total deposits 444,701,531 428,897,662
Drafts payable 636,504 1,015,927
Accounts payable and other liabilities 2,870,340 3,446,997
Advance payments by borrowers for
taxes and insurance 2,894,164 1,662,530
FHLB advances 181,206,892 191,104,138
Other advances 250,000 250,000
Current tax liability 999,134 --
------------ ------------
Total liabilities 633,558,565 626,377,254
STOCKHOLDERS' EQUITY:
Common stock, $1 par value-
Authorized, 10,000,000 shares
Issued and outstanding, 5,204,062
and 4,725,966 shares, respectively 5,204,062 4,725,966
Additional paid-in capital 37,460,445 31,411,296
Retained earnings 11,160,424 16,025,853
Accumulated other comprehensive income:
Unrealized income/(loss) on securities
available-for-sale, net of federal income tax (258,970) (191,818)
------------ ------------
Total stockholders' equity 53,565,961 51,971,297
------------ ------------
TOTAL $687,124,526 $678,348,551
============ ============
3
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
Quarters ended March 31,
------------------------------
2002 2001
------------ ------------
(Unaudited)
INTEREST INCOME:
Loans Receivable $ 10,798,506 $ 11,589,590
Interest on AFS Securities 774,208 581,152
Interest on HTM Securities 365,013 1,285,021
Interest Other 148,458 153,625
------------ ------------
12,086,185 13,609,388
INTEREST EXPENSE:
Deposits 3,579,134 6,371,057
FHLB advances and other 2,000,939 2,079,266
------------ ------------
5,580,073 8,450,323
------------ ------------
Net interest income 6,506,112 5,159,065
PROVISION FOR LOAN LOSSES 50,000 215,000
------------ ------------
Net interest income, after provision
for loan losses 6,456,112 4,944,065
OTHER OPERATING INCOME:
Gain on sales of loans 251,715 753,562
Servicing fees, net of amortization 22,550 41,076
Gain on sales of investments -- 471,788
Fees on deposits 102,310 82,895
Other 287,368 221,650
------------ ------------
Total other operating income 663,943 1,570,971
BALANCE, carried forward 7,120,055 6,515,036
4
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(CONTINUED)
Quarters ended March 31,
-----------------------------
2002 2001
------------ ------------
(Unaudited)
BALANCE, brought forward $ 7,120,055 $ 6,515,036
OPERATING EXPENSES:
Salaries and employee benefits 2,477,087 2,266,280
Occupancy 578,681 528,345
Other 1,086,232 868,956
------------ ------------
Total other operating expenses 4,142,000 3,663,581
------------ ------------
Income before Federal Income Tax and Cumulative
Effect of Adoption of New Accounting Principle 2,978,055 2,851,455
FEDERAL INCOME TAX 1,007,247 965,070
------------ ------------
Income before Cumulative Effect of Adoption
of New Accounting Principle 1,970,808 1,886,385
Cumulative effect of Adoption of New Accounting
Principle, net of federal income tax -- (155,247)
------------ ------------
NET INCOME $ 1,970,808 $ 1,731,138
============ ============
PER SHARE DATA:
Basic earnings per common share before
Cumulative Effect of Adoption of New Accounting Principle $ 0.38 $ 0.37
Cumulative Effect of Adoption of New Accounting Principle,
Net of federal income tax -- (0.03)
------------ ------------
Basic earnings per common share $ 0.38 $ 0.34
============ ============
Earnings per common share before cumulative effect of
Adoption of New Accounting Principle, Assuming Dilution $ 0.37 $ 0.36
Cumulative Effect of Adoption of New Accounting Principle,
Net of federal income tax -- (0.03)
------------ ------------
Earnings Per Common Share Assuming Dilution $ 0.37 $ 0.33
============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING 5,201,312 5,157,438
============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING
INCLUDING DILUTIVE STOCK OPTIONS 5,257,930 5,264,732
============ ============
5
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
Employee
Common stock Additional stock Accumulated
------------------------- paid-in Retained ownership Comprehensive
Shares Amount capital earnings plan debt Income(loss) Total
---------- ----------- ----------- ----------- ---------- --------- -----------
BALANCE, DECEMBER 31, 1999 4,672,636 4,672,636 31,116,359 4,527,356 (310,739) (668,953) 39,336,659
Options exercised, including
tax benefit of $6,431 8,650 8,650 42,186 50,836
Retirement of shares
repurchased (10,000) (10,000) (40,000) (51,874) (101,874)
Repayment of ESOP debt 212,918 212,918
Cash dividends declared
($.20 per share) (933,913) (933,913)
Comprehensive income:
Net income 6,599,000 6,599,000
Other comprehensive income
(loss)--Change in unrealized
gain on securities available-
for-sale, net of federal
income tax 753,645 753,645
----------- --------- -----------
Total Comprehensive income 6,599,000 753,645 7,352,645
---------- ----------- ----------- ----------- ---------- --------- -----------
BALANCE, DECEMBER 31, 2000 4,671,286 $ 4,671,286 $31,118,545 $10,140,569 $ (97,821) $ 84,692 $45,917,271
========== =========== =========== =========== ========== ========= ===========
Options exercised, including
tax benefit of $117,015 54,680 54,680 292,751 347,431
Repayment of ESOP debt 97,821 97,821
Cash dividends declared
($.22 per share) (1,036,847) (1,036,847)
Comprehensive income:
Net income 6,922,131 6,922,131
Other comprehensive income
(loss)--Change in unrealized
gain on securities available-
for-sale, net of federal
income tax (276,510) (276,510)
----------- --------- -----------
Total Comprehensive income 6,922,131 (276,510) 6,645,621
---------- ----------- ----------- ----------- ---------- --------- -----------
BALANCE, DECEMBER 31, 2001 4,725,966 $ 4,725,966 $31,411,296 $16,025,853 $ -- $(191,818) $51,971,297
========== =========== =========== =========== ========== ========= ===========
Options exercised, including
tax benefit of $0 5,000 5,000 17,175 22,175
10% stock dividend 473,096 473,096 6,031,974 (6,505,070)
Cash dividends declared
($.07 per share) (331,167) (331,167)
Comprehensive income:
Net income 1,970,808 1,970,808
Other comprehensive income
(loss)--Change in unrealized
gain on securities available-
for-sale, net of federal
income tax (67,152) (67,152)
----------- --------- -----------
Total Comprehensive income 1,970,808 (67,152) 1,903,656
---------- ----------- ----------- ----------- ---------- --------- -----------
BALANCE, MARCH 31, 2002 5,204,062 $ 5,204,062 $37,460,445 $11,160,424 $ -- $(258,970) $53,565,961
========== =========== =========== =========== ========== ========= ===========
6
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months ended March 31,
------------------------------
2002 2001
------------ ------------
(Unaudited)
OPERATING ACTIVITIES:
Net income $ 1,970,808 $ 1,731,138
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Provision for loan losses 50,000 215,000
Depreciation and amortization 214,297 228,352
Deferred loan origination fees, net of accretion (120,040) (217,815)
Amortization of mortgage servicing rights 11,816 2,440
Gain on sales of loans (251,715) (582,486)
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 (144,700) (124,200)
Changes in operating assets & liabilities:
Loans receivable held-for-sale 1,925,206 (16,506,472)
Accrued interest receivable (164) 92,418
Other assets (88,085) 94,529
Drafts payable (379,423) (217,384)
Accounts payable and other liabilities (577,007) (317,597)
Federal income taxes 999,134 834,881
Advance payments by borrowers for taxes and insurance 1,231,634 1,183,171
------------ ------------
Net cash provided (used) by operating activities 4,841,761 (14,065,108)
INVESTING ACTIVITIES:
Loan originations (53,079,521) (41,601,011)
Loan principal repayments 46,819,841 37,335,837
Increase in undisbursed loan proceeds 4,204,821 (5,522,010)
Principal repayments & redemptions on
mortgage-backed and other securities 4,215,045 8,092,205
Purchase of mortgage-backed securities available-for-sale (19,958,706) --
Purchase of mortgage-backed and other securities (250,000) --
Purchases of premises and equipment (462,464) (219,319)
Purchase of FHLB stock (62,600) --
Proceeds from sale of loans -- 1,021,188
Proceeds from other investments -- 430,307
Proceeds from sale of securities -- 3,317,431
Proceeds from sale of real estate held-for-sale -- 1,433,584
------------ ------------
Net cash provided (used) by investing activities (18,573,584) 4,288,212
7
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
Three months ended March 31,
------------------------------
2002 2001
------------ ------------
(Unaudited)
FINANCING ACTIVITIES:
Net increase (decrease) in deposit accounts 12,224,410 (3,154,289)
Interest credited to deposit accounts 3,579,459 6,316,460
Proceeds from advances 79,290,754 54,598,000
Repayment of advances (89,188,000) (49,597,000)
Dividends paid (330,818) (233,564)
Proceeds from exercise of stock options 22,175 93,228
Repayment of employee stock ownership plan debt -- 97,821
------------ ------------
Net cash provided by financing activities 5,597,980 8,120,656
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (8,133,843) (1,656,240)
CASH & CASH EQUIVALENTS:
Beginning of year 14,615,303 6,998,992
------------ ------------
End of quarter $ 6,481,460 $ 5,342,752
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Loans originated for mortgage banking activities $ 14,432,383 $ 27,149,499
============ ============
Loans originated for investment activities $ 53,079,521 $ 41,601,011
============ ============
Proceeds from sales of loans held-for-sale $ 16,357,588 $ 10,643,027
============ ============
Cash paid during the three months ended March 31 for:
Interest $ 5,522,864 $ 8,531,109
============ ============
Income taxes $ -- $ --
============ ============
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING ACTIVITIES:
Loans transferred to (from) real estate
held-for-sale, net $ -- $ (1,352,611)
8
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.
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, 2002, and December 31, 2001 are summarized as follows:
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
----------- ----------- ----------- -----------
MARCH 31, 2002:
Freddie Mac securities $ 5,171,437 $ 22,251 $ -- $ 5,193,688
Fannie Mae securities 59,799,657 59,386 474,015 59,385,028
----------- ----------- ----------- -----------
$64,971,094 $ 81,637 $ 474,015 $64,578,716
=========== =========== =========== ===========
DECEMBER 31, 2001:
Freddie Mac securities $ 5,276,304 $ 13,813 $ 5,779 $ 5,284,338
Fannie Mae securities 40,975,631 59,065 357,733 40,676,963
----------- ----------- ----------- -----------
$46,251,935 $ 72,878 $ 363,512 $45,961,301
=========== =========== =========== ===========
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, 2002:
Fannie Mae securities $21,168,028 $ 435,641 $ -- $21,603,669
Freddie Mac securities 1,097,043 2,188 -- 1,099,231
Municipal bonds 1,345,582 -- 13,405 1,332,177
REMICS 55,419 1,433 -- 56,852
----------- ----------- ----------- -----------
$23,666,072 $ 439,262 $ 13,405 $24,091,929
=========== =========== =========== ===========
DECEMBER 31, 2001:
Fannie Mae securities $24,068,746 $ 497,926 $ -- $24,566,672
Freddie Mac securities 1,103,892 7,459 -- 1,111,351
Municipal bonds 1,112,852 -- 1,580 1,111,272
REMICs 100,162 999 17 101,144
----------- ----------- ----------- -----------
$26,385,652 $ 506,384 $ 1,597 $26,890,439
=========== =========== =========== ===========
9
NOTE 4.
NONPERFORMING ASSETS
The Bank had nonperforming assets as follows:
March 31, 2002 December 31, 2001
-------------- -----------------
Nonperforming loans $ 14,743 $498,033
Real Estate and Repossessed
assets Held-for-Sale 54,686 22,587
-------- --------
Total Nonperforming Assets $ 69,429 $520,620
======== ========
At March 31, 2002, and December 31, 2001, the Bank had no material 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 ending March 31,
2002, and March 31, 2001:
Income Shares Per share
(numerator) (denominator) amount
------------------------------------------
Quarter ended March 31, 2002
- ----------------------------
Basic EPS:
Income available to common shareholders $ 1,970,808 5,201,312 $ 0.38
============
Effect of dilutive stock options -- 56,618
------------ ------------
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised $ 1,970,808 5,257,930 $ 0.37
============ ============ ============
Quarter ended March 31, 2001
- ----------------------------
Basic EPS:
Income available to common shareholders $ 1,731,138 5,157,438 $ 0.34
============
Effect of dilutive stock options -- 107,294
------------ ------------
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised $ 1,731,138 5,264,732 $ 0.33
============ ============ ============
10
NOTE 6.
RATE VOLUME ANALYSIS
(Dollars in thousands)
FIRST QUARTER 2002
VS
FIRST QUARTER 2001
INCREASE (DECREASE) DUE TO
------------------------------------------
TOTAL
VOLUME RATE CHANGE
- -------------------------------------------------------------------------------------------
INTEREST INCOME
Investments:
Available-for-sale securities $ 300 $ (107) $ 193
Held-to-maturity securities (477) (443) (920)
Other equity investments 15 (20) (5)
------------ ------------ ------------
Total investments (162) (570) (732)
Loans:
Residential 48 (134) (86)
Residential construction 40 (269) (229)
Multifamily 339 (603) (264)
Multifamily construction (206) (144) (350)
Commercial real estate and Business 959 (817) 142
Commercial real estate construction 41 (79) (38)
Consumer & Other 210 (176) 34
------------ ------------ ------------
Total loans 1,431 (2,222) (791)
------------ ------------ ------------
Total interest income 1,269 (2,792) (1,523)
INTEREST EXPENSE
Deposits:
Money market deposit and checking 88 (494) (406)
Regular savings (2) (16) (18)
Time deposits (493) (1,875) (2,368)
------------ ------------ ------------
Total deposits (407) (2,385) (2,792)
FHLB advances and other 892 (970) (78)
------------ ------------ ------------
Total interest expense 485 (3,355) (2,870)
Net interest income $ 784 $ 563 $ 1,347
============ ============ ============
11
NOTE 7.
SEGMENTS
Effective January 1, 2002 management implemented a fundamental change in the way
that it views the segments within the Bank. Previously management had identified
three segments of business: consumer banking, residential lending, and
commercial lending. Management has re-evaluated the composition of the segments
and combined the consumer and residential segments as well as added an
additional segment-Investment Securities. Unlike financial accounting, there is
no comprehensive, authoritative guidance for management accounting. The
management reporting process measures the performance of the operating segments
based on the management structure of the Bank and is not necessarily comparable
with similar information for any other financial institution. The Bank's
operating segments are defined by product type and customer segments. The Bank
continues to enhance its segment reporting process methodologies. These
methodologies are based on the Bank's management reporting process, which
assigns certain balance sheet and income statement items to the responsible
operating segment. New methodologies that are now applied to the measurement of
segment profitability include:
A new funds transfer pricing system, which allocates actual net interest
income between funds users, and is based upon the funding needs and the
relative duration of the loans or securities within each segment.
The retail deposit gathering branch network income and expenses are now
allocated to the business segments based on their asset size.
In previous reports, the calculation for the provision for loan and lease
losses was not allocated to the business segmants.
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 identified as providers or users of the ancillary service, or
are allocated based on some common denominator.
Historical periods have been restated to conform to this new presentation. Under
the new structure, the reportable segments include the following:
Consumer lending includes residential and home equity lending, direct
consumer loans, and consumer dealer financing contracts. Residential
lending offers adjustable-rate, conventional, or government-insured loans
to borrowers to purchase, refinance, or build homes secured by
one-to-four-unit family dwellings. Consumer loans include lines of credit
and loans for purposes other than home ownership. Included within the
consumer 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 four units) and commercial real estate
properties, and loans to small- and medium-sized businesses for financing
inventory, accounts receivable, and equipment, among other things. The
underlying real estate collateral or business asset being financed
typically secures these loans.
The investment securities segment includes the investment securities
portfolio. Although management does not consider this to be an operating
business line, security investments are a necessary part of liquidity
management for the Bank.
These segments are managed separately because each business requires different
processes and different marketing strategies to reach the customer base that
purchases 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.
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.
Financial information for the Company's segments is shown below for March 31,
2002, 2001 and 2000:
CONSUMER COMMERCIAL SECURITY
Quarter ended March 31: LENDING LENDING INVESTMENTS TOTALS
- ----------------------- ---------- ---------- ----------- ---------
Interest income 2002 $2,889,508 $7,908,807 $1,287,870 $12,086,185
2001 2,883,339 8,704,481 2,021,568 13,609,388
2000 2,601,857 7,646,874 1,742,097 11,990,828
Interest Expense 2002 1,297,687 3,148,031 1,134,355 5,580,073
2001 1,827,651 4,843,386 1,779,286 8,450,323
2000 1,543,115 4,080,575 1,290,296 6,913,986
Net Interest Income 2002 1,591,821 4,760,776 153,515 6,506,112
2001 1,055,688 3,861,095 242,282 5,159,065
2000 1,058,742 3,566,299 451,801 5,076,842
Provision for loan losses 2002 15,455 34,545 -- 50,000
2001 66,458 148,542 -- 215,000
2000 40,183 89,817 -- 130,000
Net interest income, after 2002 1,576,366 4,726,231 153,515 6,456,112
provision for loan losses 2001 989,230 3,712,553 242,282 4,944,065
2000 1,018,559 3,476,482 451,801 4,946,842
Noninterest income 2002 316,189 323,886 23,868 663,943
2001 881,801 191,942 497,228 1,570,971
2000 437,715 158,667 26,018 622,400
Noninterest expense 2002 1,453,767 2,398,293 289,940 4,142,000
2001 1,204,058 2,132,756 326,767 3,663,581
2000 1,145,818 1,653,834 276,250 3,075,902
Income before federal income taxes 2002 438,788 2,651,824 (112,557) 2,978,055
and cumulative effect of adoption 2001 666,973 1,771,739 412,743 2,851,455
of New Accounting principle 2000 310,456 1,981,315 201,569 2,493,340
Federal income taxes 2002 149,188 901,620 (43,561) 1,007,247
2001 226,771 602,391 135,908 965,070
2000 105,555 673,647 66,842 846,044
Income before Cumulative 2002 289,600 1,750,204 (68,996) 1,970,808
Effect of Adoption of 2001 440,202 1,169,348 276,835 1,886,385
New Accounting Principle 2000 204,901 1,307,668 134,727 1,647,296
Cumulative effect of Adoption 2002 -- -- -- --
of New Accounting Principle, 2001 (155,247) -- -- (155,247)
net of federal income tax 2000 -- -- -- --
Net income 2002 289,600 1,750,204 (68,996) 1,970,808
2001 284,955 1,169,348 276,835 1,731,138
2000 204,901 1,307,668 134,727 1,647,296
Total Interest Earning assets 2002 154,780,642 418,051,179 98,295,406 671,127,227
2001 147,463,298 383,988,026 121,912,340 653,363,664
2000 133,170,280 349,687,833 115,751,691 598,609,804
12
PART I : FINANCIAL INFORMATION
FORWARD-LOOKING STATEMENTS DISCLAIMER
- -------------------------------------
This Form 10-Q, First Mutual Bancshares, Inc. contains statements concerning
future operations, trends, expectations, plans, capabilities, and prospects of
First Mutual Bancshares, Inc. and First Mutual Bank (together, the "Company")
that are forward-looking statements for the purposes of the safe harbor
provisions under the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements include statements referring to our expectations
regarding future interest rate margins, loan quality, branch office expansion,
anticipated increase/decrease in fee income, expectations related to operating
expenses, the outlook for deposit growth and funding sources, analysis of market
risks, and observations pertaining to the potential disparate movement of assets
and liabilities. 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, operations, and prospects, these
forward-looking statements are subject to numerous uncertainties and risks and
actual events, results, and developments will ultimately differ from the
expectations and may differ materially from those expressed or implied in such
forward-looking statements. Factors which could affect actual results include
economic conditions in the Company's market area and the nation as a whole,
interest rate fluctuations, the impact of competitive products, services, and
pricing, credit risk management, the ability of the Company to control its costs
and expenses, loan delinquency rates, and the legislative and regulatory changes
affecting the banking industry. There are other risks and uncertainties that
could affect the Company which are discussed from time to time in the filings
made by the Company with the Securities and Exchange Commission. 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 shall
not be responsible to update any such forward-looking statements.
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 accounting
principles generally accepted in the United States of America ("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 2001 financial statements to
conform to the 2002 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. Year 2001 Annual Report on Form 10-K to the
Securities and Exchange Commission. Interim results are not necessarily
indicative of results for a full year.
13
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
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First Mutual Bancshares, Inc. (the "Company"), a Washington corporation, is a
financial holding company owning all of the equity of its wholly owned
subsidiary, First Mutual Bank. The Company is subject to regulation by the
Federal Reserve Bank of San Francisco. This discussion refers to the
consolidated statements of the Company and the Bank and therefore the references
to "Bank" in this discussion refer to both entities.
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 (2), Redmond, Seattle (2),
Issaquah, and Monroe. The Bank also has income property loan production offices
located in Bellingham and Tacoma, Washington and a consumer loan office located
in Jacksonville, Florida. The Bank ceased its retail banking operations in its
Bellingham Branch facility effective March 29, 2002. The Bellingham location,
which is located 88 miles north of Bellevue, proved difficult to support, as it
required additional advertising buys to reach that marketplace. 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
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Net Income
- ----------
Net income increased 13.8%, from $1.7 million in the first quarter of 2001 to
nearly $2.0 in the same period of 2002. The improvement in net income is a
reflection of a higher net interest margin.
Net Interest Income
-------------------
Net interest income after provision for loan losses increased $1.5 million, or
30.6%, in the first quarter of 2002 as contrasted with the same quarter in 2001.
The net interest margin generally has improved, both on a sequential quarter
basis, and on the quarter-over-quarter comparison.
Quarters Ended Net Interest Margin
- -------------- -------------------
March 31, 2001 3.28%
June 30, 2001 3.31%
September 30, 2001 3.23%
December 31, 2001 3.50%
March 31, 2002 3.94%
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The net interest margin has jumped in the last two quarters because of a sharp
drop in interest expense. Interest costs fell from 4.14% in the fourth quarter
of 2001 to 3.57% this quarter. Interest expense in the third quarter of 2001 was
5.01%. Since the third quarter of 2001, interest costs have dropped 144 basis
points, or 28.7%. Interest income has also fallen during the same period, from
7.94% in the third quarter of last year to 7.16%, a decline of 78 basis points,
or 9.8%. Thus, while interest expense has declined 28.7%, interest income has
only decreased 9.8%.
The drop in interest expense in the last few quarters is principally due to the
repricing of time deposits. Approximately one-half of the Bank's time deposits
matured in the fourth quarter of 2001. The Bank does not expect any significant
further improvement in the net interest margin in the remainder of the year.
The provision for loan losses decreased from $215,000 in the first quarter of
2001 to $50,000 in the like period in 2002. 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.
The loan portfolio increased in the first quarter by $2.4 million. Most of the
loan growth occurred in residential and consumer loans, which are considered to
be less of a credit risk than commercial real estate and business banking loans.
Also influencing the level of loan loss reserves is the current status of the
local economy. The northwest economy is in the midst of a recession that is
deeper than that of the nation as a whole. While many economists feel that the
national economy has begun to recover, that is not true in Washington and
Oregon.
Particularly affecting the reserve for loan loss is the loan portfolio's actual
performance, which has improved in the last quarter. As of quarter-end March
2002 the Bank's non-performing assets to total assets was 0.01% (0.08% as of
December 31, 2001). That number compares to the national ratios of 0.66% for
savings institutions and 0.92% for commercial banks as of December 31, 2001. For
the past five years the Bank's NPA's to total assets ratio has been considerably
less than that of either the FDIC-insured savings institutions or the commercial
banks, reflecting the Bank's conservative underwriting practices and proactive
approach to delinquent loans. In addition, the Bank's loan loss reserves to net
charge-offs ratios, which emphasizes the relative level of reserves to that of
the actual losses experienced, have generally been significantly higher than
that of the Bank's FDIC designated peer group. This ratio is reflected in the
Uniform Bank Performance Report (UBPR). The Bank's average loan loss reserves to
net charge-offs for the years 1997 through 2001 was 103.61% as compared to an
average for the peer group of 33.04%.
In summary, the Bank's provision for loan loss reserves is based on historical
credit analysis and an assessment of local and national economic conditions, and
it appears to be reasonable in light of the Bank's favorable non-performing
asset status and historically low net charge-offs.
Other Operating Income
----------------------
Other operating income decreased to $664,000 in the first quarter of 2002 as
compared to $1,571,000 in the same quarter in 2001. The 58% decrease was mainly
attributable to a decline in the gain on sales of loans and investments.
15
GAIN ON SALES OF LOANS. Gain on sales of loans totaled $252,000 for the quarter
as compared to $754,000 for the first quarter ended March 31, 2001. Several
factors contributed to that change. Gain on sales 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).
Last year the Bank concluded its strategic sale of bulk servicing rights. That
sale resulted in a pre-tax gain of $891,000. The Bank was concerned that a
refinance boom would erode the value of the servicing portfolio. In fact, a
refinance boom did occur last year, which would have been very detrimental to
the servicing portfolio had the Bank not previously sold that portfolio. There
were no comparable bulk servicing sales this year.
Contributing to the gain on sales of loans was the slight increase in the
capitalization of mortgage servicing rights (MSRs). Pursuant to Statement of
Financial Accounting Standards (SFAS) No. 140, ACCOUNTING FOR TRANSFERS AND
SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES, the Bank is
required to capitalize internally generated servicing rights. The amount of MSRs
capitalized and recognized in income totaled $18,000 for the first quarter of
2002 as compared to $13,000 for the like quarter in 2001.
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 gains in the first quarter of 2002
amounted to $232,000 on total loan sales of $16.4 million, compared to losses of
$178,000 on total loan sales of $10.6 million in first quarter 2001. Benefiting
gain on sales of loan revenue this year was the sale of home improvement loans.
The Bank recognized $154,000 in pre-tax income in 2002 as compared to $51,000 in
the same period last year. The Bank does not anticipate any further increase in
loan sale gains of home improvement loans. That is, the amount realized in the
first quarter of 2002 should be representative of the other three quarters this
year. Also contributing to income this year was the pre-tax gain on sale of
loans in the secondary market. Gains totaled $78,000, as opposed to a loss of
$228,000 in the first quarter of 2001. Last year was hit hard by pair-off
losses, on custom construction loans, which totaled $296,000. The Bank has since
changed the manner in which it manages the custom loan portfolio.
The fourth and final piece of the gain on sales of loans total is the
mark-to-market of all interest rate locks on loans pending sale and forward
commitments into the secondary market pursuant to SFAS No. 133, ACCOUNTING FOR
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. 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
income statement for 2001. There was no comparable figure for 2002.
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
for the first quarter of 2001 as compared to a gain of $2,000 this year.
Contributing to last year's gain of $90,000 were two factors: the refinance boom
and a greater focus last year on the Bank's mortgage banking activity. With a
refinance boom comes an increase in the amount of conforming fixed rate loans
that the Bank sells in the secondary market. These loans, since they are
held-for-sale, fall under
16
the SFAS 133 rules, thus the rate locks and any forward commitments that are
associated with these loans must be marked-to-market for financial reporting
purposes. As more of these loans are originated, as occurs during a period of
declining interest rates, the amount of gain or loss recognized tends to vary
significantly from period to period. Management has attempted to mitigate the
volatility that the Bank has experienced in the past year by emphasizing
portfolio lending over mortgage banking thus minimizing the amount of loans that
fall under the mark-to-market rules of SFAS 133. The amount of gain or loss will
still fluctuate from period to period as the Bank continues to participate in
the mortgage banking arena but the relative dollar amount should be reduced with
the passing of the refinance boom and the renewed emphasis on portfolio lending.
SERVICING FEES, NET OF AMORTIZATION. Servicing fees have decreased $18,000 or
43.9% as compared to March 31, 2001. Servicing fee income for the first quarter
of 2002 totaled $23,000 as compared to $41,000 for the like period in 2001. The
servicing portfolio totaled $48.5 million at March 31, 2002 as compared to $44.6
million a year ago. The servicing fee income has decreased from a year ago even
though the servicing portfolio of loans has increased slightly due to the bulk
sale of mortgage servicing rights that occurred during the first quarter of
2001. This sale took effect in January 2001 but the Bank continued to
sub-service the loans for the purchaser, for which the Bank collected a fee,
until the end of March 2001 when the records were actually transferred. It is
anticipated that the level of service fee income will remain flat throughout the
remainder of 2002.
GAIN ON SALES OF INVESTMENTS. Gain on sales of investment securities
held-for-sale totaled $472,000 in the first quarter of 2001. There were no
comparable gains in the first quarter of 2002. Last year the Bank, along with
the other limited partners, sold its interest in an ATM network. The pre-tax
gain amounted to $422,000. The Bank also recognized a pre-tax gain of $50,000 on
the sale of $3.3 million of investment securities.
FEE INCOME ON DEPOSITS. Fee income from deposits are up $19,000, or 23.4%, on a
quarter-to-quarter comparison, and in the last two years has risen $32,000, or
75.6%. The Bank is optimistic that it can continue to increase fee income at a
solid pace, although probably not as rapidly as has occurred in the last two
years.
OTHER INCOME. Other income increased 29.3% from $222,000 in the first quarter of
2001 to $287,000 this year. Most of that gain was attributable to loan
prepayment fees that rose from $25,000 for the first quarter last year to
$101,000 for the like period in 2002. Although prepayment and extension fee
income has been strong in the last few quarters, management continues to feel
that this level of prepayment fee income is not sustainable.
Operating Expenses
------------------
Salaries and employee benefits costs rose $211,000, or 9.3%. Salaries increased
$325,000, or 22.7%, from $1.4 million in the first quarter of 2001 to $1.8
million. In addition, loan officer commissions were up $31,000 from $166,000
last year. Partially offsetting those costs was a decline in staff bonus expense
of $259,000.
Compensation expense was affected by a 14% increase in staff, from 130 full-time
equivalent employees at March 31, 2001, to 148 this year. The Bank opened the
Juanita branch, and added a
17
dozen employees in the Business Banking and Sales Finance Departments. In
addition, annual salary increases of 4% added to compensation costs.
Loan officer commissions were up 19% on a quarter-to-quarter comparison.
Although total loan originations were approximately the same for both periods,
the originations of business banking and sales finance loans increased
substantially from $7.2 million in the first quarter of last year to $16.7
million in 2002. Commission expense for those two areas, as a result of the
increased loan originations, rose over seven fold.
In the first quarter last year the bank accrued a staff performance bonus of
$250,000. Because of disappointing earnings growth in subsequent quarters, that
bonus accrual was reversed in the third quarter. There was no comparable accrual
this year.
Occupancy expense rose $50,000, or 10% on a quarter-to-quarter basis. Adding to
occupancy expense was the opening of the Juanita branch last summer, and the
expansion of leased space at the Bellevue Headquarters.
Other operating expenses increased $217,000, or 25%, from $869,000 in the first
quarter of 2001 to $1,086,000 in the same period of this year. The largest
element was legal expense, which increased $87,000. Most of the increase in the
legal cost was due to routine corporate matters such as the resolution of
non-performing loans, property leases, loan agreements, etc.
FINANCIAL CONDITION
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ASSETS. Assets increased 1.3% from $678,349,000 at year-end 2001 to $687,125,000
as of March 31, 2002. The change in assets is principally the result of an
increase in the investment securities portfolio offset somewhat by a decrease in
cash and cash equivalents.
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, 2002, the balance of the unrealized loss, net of federal income taxes,
was $259,000, which compares to an unrealized loss at year-end 2001 of $192,000.
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) increased $15.9 million or 22.0% from
December 31, 2001, to the end of the first quarter 2002. During the quarter
$20.3 million (par value) in securities were purchased and $1.0 million (par
value) matured. This addition to the securities portfolio has helped to increase
assets during a period of rather flat loan growth.
LOANS. Net loans receivable, including loans held-for-sale, rose from
$567,553,000 at year-end 2001, to $568,010,000, an increase of $457,000 in three
months. The loan growth has been flat due to the increase in loan prepayments in
the income property loan portfolio coupled with a decline in new loan
originations. The Bank is hopeful that loan originations will increase from the
level experienced in the first quarter and that loan payoffs, which averaged a
26.6%
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annualized prepayment rate in the first quarter, will decline to a more normal
rate in the remainder of 2002.
LIABILITIES. Deposits increased $15.8 million, or 3.7%, in the first three
months of 2002 totaling $445 million as compared to $429 million at year-end
2001. This increase in deposits was used to fund the asset growth in the
securities portfolio as well as to pay down the FHLB borrowings.
The FHLB advances decreased from $191 million at year-end 2001 to $181 million
as of the end of the first quarter. As of March 31, 2002, the Bank had the
capacity to borrow up to a total of $274.8 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
$50,000 in the first quarter of 2002.
Non-performing assets were 0.01% of total assets in the first quarter, down from
0.13% in the like quarter of 2001.
Non-performing assets fell from $521,000 at year-end 2001 to $69,000 at March
31, 2002. Repossessed assets totaled $54,000 at quarter-end and non-performing
loans decreased from $498,000 at year-end 2001 to $15,000 at March 31, 2002.
Total non-performing assets are comprised of 15 items. Noted below is a summary
of the Bank's exposure to non-performing loans and repossessed assets:
Amount
------
Two home improvement loans - The Bank is hopeful that it
will collect all, or substantially all, of the amount due $ 15,000
Repossessed assets - 13 consumer loans 54,000
------
Total non-performing assets $ 69,000
==========
Portfolio Information
---------------------
The commercial real estate portfolio comprises 64% of the Bank's portfolio. Not
only is that sector the largest, but it is also considered by many to represent
a greater risk to asset quality than other types of loans, such as residential
loans.
The average loan size (excluding construction loans) in the commercial real
estate portfolio was $668,200 as of March 31, 2002, with an average
loan-to-value ratio of 65%. At quarter-end, only one of these commercial loans
was delinquent for 30 days or more (0.22%). Small individual investors or their
limited liability companies typically own the properties securing these loans.
The portfolio is split between residential use (multifamily or mobile home
parks) and commercial use. At quarter-end, the breakdown was 52% residential and
48% commercial.
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Management believes that the commercial loans in the income property portfolio
are largely well diversified, secured by small retail shopping centers, office
buildings, warehouses, mini-storage facilities, restaurants and gas stations, as
well as other properties classified as general commercial use.
To diversify its risk and to continue serving its customers, the Bank sells
participation interests in some loans to other financial institutions. About 8%
of commercial real estate loan balances originated by the Bank have been sold in
this manner. The Bank continues to service the customer's loan and is paid a
servicing fee by the participant. Likewise, the bank occasionally buys an
interest in loans originated by other lenders. About $19 million, or 6% of the
portfolio has been purchased in this manner.
Deposit Information
-------------------
The number of business checking accounts increased from 575 at March 31, 2001,
to 769 at March 31, 2002, a gain of 194 accounts, or 34%. Consumer checking
accounts also increased, from 3,718 in first quarter 2001 to 4,100 this year, a
growth in the number of accounts of 382, or 10%.
The mix of deposits as of March 31, 2002 is as follows:
Time Deposits 74%
Checking 7%
Money Market Accounts 17%
Statement Savings 2%
BUSINESS SEGMENTS
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Effective January 1, 2002 management implemented a fundamental change in the way
that it views the segments within the Bank. Previously management had identified
three segments of business: consumer banking, residential lending, and
commercial lending. Management has re-evaluated the composition of the segments
and combined the consumer and residential segments as well as added an
additional segment - Investment Securities. Unlike financial accounting, there
is no comprehensive, authoritative guidance for management accounting. The
management reporting process measures the performance of the operating segments
based on the management structure of the Bank and is not necessarily comparable
with similar information for any other financial institution. The Bank's
operating segments are defined by product type and customer segments. The Bank
continues to enhance its segment reporting process methodologies. These
methodologies are based on the Bank's management reporting process, which
assigns certain balance sheet and income statement items to the responsible
operating segment. New methodologies that are now applied to the measurement of
segment profitability include:
o A new funds transfer pricing system, which allocates actual net
interest income between funds users, and is based upon the funding
needs and the relative duration of the loans or securities within
each segment
o The retail deposit gathering branch network income and expenses are
now allocated to the business segments based on their asset size.
20
o In previous reports, the calculation for the provision for loan and
lease losses was not allocated to the business segments.
o 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 identified as providers or users of the
ancillary internal service, or are allocated based on some common
denominator.
Historical periods have been restated to conform to this new presentation. Under
the new structure, the reportable segments include the following:
o Consumer lending includes residential and home equity lending,
direct consumer loans, and consumer dealer financing contracts.
Residential lending offers adjustable-rate, conventional or
government-insured loans to borrowers to purchase, refinance, or
build homes secured by one-to-four-unit family dwellings. Consumer
loans include lines of credit and loans for purposes other than home
ownership. Included within the consumer 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.
o Commercial lending offers permanent and interim construction loans
for multifamily housing (over four units) and commercial real estate
properties, and loans to small- and medium-sized businesses for
financing inventory, accounts receivable, and equipment, among other
things. The underlying real estate collateral or business asset
being financed typically secures these loans.
o The investment securities segment includes the investment securities
portfolio. Although management does not consider this to be an
operating business line, security investments are a necessary part
of liquidity management for the Bank.
These segments are managed separately because each business unit requires
different processes and different marketing strategies to reach the customer
base that purchases 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.
Consumer Lending
----------------
Net income for the consumer lending segment increased slightly from $285,000 in
the first quarter of 2001 to $290,000 in the same quarter in 2002. The increase
in net income was a result of the increase in the net interest income which was
somewhat offset by the drop in noninterest income.
Net interest income, after provision for loan loss, was up $587,000, increasing
from $989,000 in the first quarter of 2001 to $1.6 million this year. The
majority of this improvement was due to the drop in interest expense. Interest
expense decreased $530,000 as compared to the first quarter of 2001 due to the
dramatic decline in interest rates over the past year.
21
Non-interest income declined from $882,000 in the three months ending March 2001
to $316,000 in the same quarter this year. The bulk sale of servicing rights
that occurred in the first quarter of last year, and which was partially offset
by the adoption of SFAS 133, contributed to the change. During the first quarter
of 2001 the Bank concluded its strategic sale of bulk servicing rights. There
were no comparable sales for the first quarter of 2002. Additionally the Bank
adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities. At January 1, 2001, the loss realized from the adoption of the
standard amounted to a loss of $155,000 net of tax that is shown on the face of
the income statement. There was no comparable entry for the first quarter of
2002. Please see the section titled "Gain on Sale of Loans" under "Other
Operating Income" for more information.
Commercial Lending
------------------
Net income for this business segment rose $581,000, or 50%, from $1,169,000 in
the first quarter of 2001 to $1,750,000 in the like period of 2002. Net interest
revenue, after provision for loan losses, grew $1,014,000 while other operating
income and operating expense increased $132,000 and $266,000 respectively.
Net interest revenue, like the consumer segment, benefited from a dramatic
decline in interest rates over the past year. Interest income declined 9.1%
while interest expense for this segment dropped by 35%, or $1,700,000. At the
same time, assets continued to increase. Interest-earning assets totaled $418
million at March 31, 2002 as compared to $384 million a year ago.
Other operating income rose $132,000, or 68.7% as compared to first quarter last
year. This increase was mainly due to the rise in loan prepayment and extension
fees that the Bank has seen increase as rates have fallen. Loan prepayment fee
income for this segment amounted to $101,000 for the first quarter of 2002
compared to $25,000 for the like period last year.
Operating expenses increased 12.5% in the first quarter of 2002 as compared to
the like quarter in 2001. Non-interest expense increased primarily due to the
growth in compensation expense resulting from the Bank's focus on expansion of
the Business Banking and Community Business Banking departments over the past
year. Also contributing to the escalation of the operating expenses was the
normal annual salary adjustments that occurred in December 2001. As a result,
the first quarter of 2002 realizes the full impact of the salary adjustments for
the full three months.
Investment Securities
---------------------
Net income dropped sharply for the investment securities segment, from $277,000
in the first quarter of 2001 to a loss of $69,000 in 2002. This segment was
affected by a decrease in both net interest income and noninterest income,
partially offset by a decline in operating expenses.
Net interest income fell for this business segment, from $242,000 in the first
quarter of 2001 to $154,000 this year. The reason for the drop is two-fold: a
decrease in the size of the securities portfolio and a decline in the overall
net interest margin. The securities portfolio totaled $121.9 million at March
31, 2001, dropping $23.6 million to $98.3 million at the end of the first
quarter of 2002. During 2001 the securities portfolio declined 41.9% due to the
sale, redemption by the issuer of the security before maturity (call), and
maturity of several securities. At the same time interest rates were on the
decline with the Federal Reserve's Open Market Committee (FOMC) lowering rates
eleven times throughout the year resulting in lower yields on the new securities
22
that were purchased. The net interest margin declined from 0.79% at the end of
the first quarter in 2001 to 0.62% at the end of March 2002. During the first
quarter of 2002 $20.3 million in securities were purchased and $1 million
matured.
Non-interest income fell dramatically from $497,000 in the first three months of
2001 to $24,000 in the same period this year. During the first quarter of 2001
the Bank, along with the other limited partners, sold its interest in an ATM
network. The pre-tax gain amounted to $422,000. The Bank also recognized a
pre-tax gain of $50,000 on the sale of $3.3 million of investment securities.
There were no comparable gains for the first quarter of this year. At the
present time, the Bank doesn't anticipate any security sales this year.
Operating expenses declined by $37,000 to $290,000 in the first quarter this
year. This decline is largely due to the manner in which the branch operating
expenses are allocated to each segment. The amount of branch noninterest expense
allocated to each segment is based on the balance of the earning assets. At
March 31, 2001 the earning assets balance for the investment securities segment
totaled $121.9 million as compared to $98.3 million at the end of the first
quarter of 2002. Since the balance in the earning assets decreased, the amount
of noninterest expense allocated to this segment also decreased.
Liquidity and Capital Reserves
- ------------------------------
The net cash, as reported in the Statement of Cash Flows, decreased by $8.1
million in the first three months of 2002. Cash flows from principal repayments
on loans and securities and the net increase in deposits did not keep pace with
the cash outflows for loan originations, purchases of securities and repayments
of FHLB advances. The more significant cash inflows and outflows are described
below.
Loan and security principal repayments contributed to the cash inflows. During
the quarter loan principal repayments totaled $46.8 million while principal
repayments and redemptions on mortgage-backed and other securities amounted to
$4.2 million. In addition, net deposits rose $15.8 million, mainly due to the
acquisition of approximately $17.0 million in brokered deposits. Offsetting the
cash inflows was a greater cash outflow due to the following activities.
Cash inflows were used mainly to fund loan originations, which amounted to $53.1
million during the first quarter of 2002 and the purchase of four
mortgage-backed securities, classified as available-for-sale totaling $20.0
million. The Bank was also able to reduce its FHLB borrowing balance by $9.9
million during the period.
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 26.4%, 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 million.
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.
23
At March 31, 2002, the Bank exceeded the capital levels required to meet the
definition of a well-capitalized institution:
For Capital "Well Capitalized"
Actual Adequacy Minimum Minimum Ratio
------ ---------------- ----------------
Total capital(to risk-weighted assets):
First Mutual Bancshares, Inc. 11.81% 8.00% 10.00%
First Mutual Bank 11.77 8.00 10.00
Tier I capital(to risk-weighted assets):
First Mutual Bancshares, Inc. 10.56 4.00 6.00
First Mutual Bank 10.51 4.00 6.00
Tier I capital(to average assets):
First Mutual Bancshares, Inc. 7.91 4.00 5.00
First Mutual Bank 7.84 4.00 5.00
The Bank declared a 10% stock dividend to be issued May 8, 2002, to shareholders
of record April 17, 2002. This 10% stock dividend increased the number of shares
outstanding by 472,883 shares. Additionally the Bank recently increased its cash
divided that is paid quarterly to $0.07 per share from $0.05 per share. This
$0.02 increase resulted in an additional $114,000 cash distribution per quarter.
Branch Closures and Expansion
- -----------------------------
As was noted earlier, the Bellingham Branch was closed effective March 29, 2002.
A branch site has been acquired to replace the existing Ballard Branch with an
anticipated opening during the third quarter of 2002. A site has also been
acquired in Woodinville for construction of an additional branch site expected
to begin operations during 2003. In addition, negotiations are currently taking
place for one other de novo branch site, located on the east side of Lake
Washington, which is the Bank's primary focus for enlarging the branch
franchise.
The Bank reviews the utilization of its properties on a regular basis and
believes that it has adequate facilities for current operations. The Bank may
open new branches from time-to-time, and on a selective basis, depending on the
availability of capital resources, the locations potential for growth and
profitability, and if the business model for the branch is favorable.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following table shows the maturity or period to repricing of the Company's
consolidated portfolio of securities available-for-sale and held-to-maturity
(dollars in thousands):
Available-for-sale at March 31, 2002
-----------------------------------------------------------------------------------
Over One to Over Three to Over Five to
One Year or Less Three Years Five Years Ten Years
---------------- ---------------- ---------------- ----------------
Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average
AVAILABLE-FOR-SALE: Value Yield Value Yield Value Yield Value Yield
- ------------------- ------- ----- ------- ----- ------- ----- ------- -----
US Government Treasury and agency obligations $ -- 0.00% $ -- 0.00% $ -- 0.00% $ -- 0.00%
Municipal Bonds -- 0.00% -- 0.00% -- 0.00% -- 0.00%
Corporate Bonds -- 0.00% -- 0.00% -- 0.00% -- 0.00%
Mortgage backed securities:
Ginnie Mae -- 0.00% -- 0.00% -- 0.00% -- 0.00%
Freddie Mac 370 6.46% -- 0.00% -- 0.00% 4,824 5.50%
Fannie Mae 781 6.37% -- 0.00% -- 0.00% 38,745 5.44%
------- ----- ------- ----- ------- ----- ------- -----
Total mortgage-backed securities 1,151 6.40% -- 0.00% -- 0.00% 43,569 5.44%
CMO's -- 0.00% -- 0.00% -- 0.00% -- 0.00%
Other - Stock -- 0.00% -- 0.00% -- 0.00% -- 0.00%
------- ----- ------- ----- ------- ----- ------- -----
Total securities available-for-sale --
Carrying Value $ 1,151 6.40% $ -- 0.00% $ -- 0.00% $43,569 5.44%
------- ----- ------- ----- ------- ----- ------- -----
Total securities available-for-sale --
Amortized Cost $ 1,117 6.40% $ -- 0.00% $ -- 0.00% $43,639 5.44%
------- ----- ------- ----- ------- ----- ------- -----
Available-for-sale at March 31, 2002
-------------------------------------------------------------
Over Ten to
Twenty Years Over Twenty Years Total
---------------- ---------------- ----------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
AVAILABLE-FOR-SALE: Value Yield Value Yield Value Yield
- ------------------- ------- ----- ------- ----- ------- -----
US Government Treasury and agency obligations $ -- 0.00% $ -- 0.00% $ -- 0.00%
Municipal Bonds -- 0.00% -- 0.00% -- 0.00%
Corporate Bonds -- 0.00% -- 0.00% -- 0.00%
Mortgage backed securities:
Ginnie Mae -- 0.00% -- 0.00% -- 0.00%
Freddie Mac -- 0.00% -- 0.00% 5,194 5.57%
Fannie Mae 11,753 5.56% 8,106 6.04% 59,385 5.56%
------- ----- ------- ----- ------- -----
Total mortgage-backed securities 11,753 5.56% 8,106 6.04% 64,579 5.56%
CMO's -- 0.00% -- 0.00% -- 0.00%
Other - Stock -- 0.00% -- 0.00% -- 0.00%
------- ----- ------- ----- ------- -----
Total securities available-for-sale --
Carrying Value $11,753 5.56% $ 8,106 6.04% 64,579 5.56%
------- ----- ------- ----- ------- -----
Total securities available-for-sale --
Amortized Cost $12,044 5.56% $ 8,171 6.04% 64,971 5.56%
------- ----- ------- ----- ------- -----
Held-to-Maturity at March 31, 2002
-----------------------------------------------------------------------------------
Over One to Over Three to Over Five to
One Year or Less Three Years Five Years Ten Years
---------------- ---------------- ---------------- ----------------
Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average
HELD-TO-MATURITY: Value Yield Value Yield Value Yield Value Yield
- ----------------- ------- ----- ------- ----- ------- ----- ------- -----
US Government Treasury and agency obligations $ -- 0.00% $ -- 0.00% $ -- 0.00% $ -- 0.00%
Municipal Bonds -- 0.00% -- 0.00% -- 0.00% -- 0.00%
Corporate Bonds -- 0.00% -- 0.00% -- 0.00% -- 0.00%
Mortgage backed securities:
Ginnie Mae -- 0.00% -- 0.00% -- 0.00% -- 0.00%
Freddie Mac 1,097 6.97% -- 0.00% -- 0.00% -- 0.00%
Fannie Mae 3,804 7.07% 443 5.70% 13,911 5.64% 2,832 5.50%
------- ----- ------- ----- ------- ----- ------- -----
Total mortgage-backed securities 4,901 7.04% 443 5.70% 13,911 5.64% 2,832 5.50%
CMO's -- 0.00% -- 0.00% -- 0.00% -- 0.00%
Other - Stock -- 0.00% -- 0.00% -- 0.00% -- 0.00%
------- ----- ------- ----- ------- ----- ------- -----
Total securities held-to-maturity --
Carrying Value $ 4,901 7.04% $ 443 5.70% $13,911 5.64% $ 2,832 5.50%
------- ----- ------- ----- ------- ----- ------- -----
Total securities held-to-maturity --
Fair Market Value $ 5,041 7.04% $ 451 5.70% $14,168 5.64% $ 2,860 5.50%
------- ----- ------- ----- ------- ----- ------- -----
Held-to-Maturity at March 31, 2002
-------------------------------------------------------------
Over Ten to
Twenty Years Over Twenty Years Total
---------------- ---------------- ----------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
HELD-TO-MATURITY: Value Yield Value Yield Value Yield
- ----------------- ------- ----- ------- ----- ------- -----
US Government Treasury and agency obligations $ -- 0.00% $ -- 0.00% $ -- 0.00%
Municipal Bonds 220 5.38% 1,126 6.16% 1,346 6.03%
Corporate Bonds -- 0.00% -- 0.00% -- 0.00%
Mortgage backed securities:
Ginnie Mae -- 0.00% -- 0.00% -- 0.00%
Freddie Mac -- 0.00% -- 0.00% 1,097 6.97%
Fannie Mae -- 0.00% 178 7.50% 21,168 5.90%
------- ----- ------- ----- ------- -----
Total mortgage-backed securities -- 0.00% 178 7.50% 22,265 5.95%
CMO's -- 0.00% 55 6.50% 55 6.50%
Other - Stock -- 0.00% -- 0.00% -- 0.00%
------- ----- ------- ----- ------- -----
Total securities held-to-maturity --
Carrying Value $ 220 5.38% $ 1,359 6.35% 23,666 5.96%
------- ----- ------- ----- ------- -----
Total securities held-to-maturity --
Fair Market Value $ 207 5.38% $ 1,365 6.35% 24,092 5.96%
------- ----- ------- ----- ------- -----
24
Market risk is defined as the sensitivity of income and capital from changes in
interest rates, foreign currency exchange rates, commodity prices, and other
relevant market rates or prices. The primary market risk to which we are exposed
to is interest rate 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 expense incurred 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.
Gap Analysis
The interest rate sensitive gap is defined as the difference between
interest-earning assets and interest-bearing liabilities anticipated to mature
or reprice during the same period. The gap analysis quantifies the mismatch
between these assets and liabilities in like time periods. Certain shortcomings
are inherent in gap analysis. For example, some assets and liabilities may have
similar maturities or repricing characteristics but they may react differently
to changes in interest rates. Assets such as adjustable rate mortgage loans may
have features that limit the effect that changes in interest rates have on the
asset in the short-term and/or over the life of the loan. Due to the limitations
of the gap analysis, these features are not taken into consideration.
Additionally, in the event of a change in interest rates, prepayment and early
withdrawal penalties would likely deviate significantly from those assumed in
the gap calculation. As a result, the Bank utilizes the gap report as a
complement to its simulation model.
Simulation Model
The Bank's simulation model calculates the change to net interest income and the
net market value of equity based upon increases and decreases of 100-, 200-, and
300-basis point movements in interest rates. The model is based on a number of
assumptions such as the maturity, repricing, amortization, and prepayment
characteristics of loans and other interest-earning assets and the repricing of
deposits and other interest-bearing liabilities. The Bank runs the rate ramp (a
monthly pro rata increase/decrease over a one year period) simulation model
monthly for review by the ALCO (Asset Liability Committee), senior management,
and the Board of Directors, and the rate shock (an instantaneous
increase/decrease) model quarterly. 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.
25
The Bank's simulation model and its gap analysis results for the periods ending
March 31, 2002, and December 31, 2001 are presented below.
ONE-YEAR INTEREST RATE SENSITIVE GAP
------------------------------------
(in thousands)
March 31, 2002 December 31, 2001
-------------- -----------------
One-year repricing assets $509,432 $506,458
One-year repricing liabilities 428,754 413,279
------- -------
One-year gap $ 80,678 $ 93,179
--------- ---------
Total assets $687,124 $678,349
======== ========
One Year Interest Rate Sensitive
GAP as a Percent of Assets 11.7% 13.7%
FIRST MUTUAL BANCSHARES, INC.
RATE SHOCK ESTIMATES
Net Interest Income and Net Market Value
March 31, 2002 December 31, 2001
Percentage Percentage
Change Change
- -------------------------------------------------------------------------------
Immediate Net Net Net Net
Change in Interest Market Interest Market
Interest Rates Income Value Income Value
- -------------- ------------ ----------------- ------------ --------------------
+300 8% (21)% 3% (19)%
+200 6 (15) 0 (14)
+100 3 (8) 0 (6)
-100 (2) (1) (3) (2)
-200 (7) (5) (9) (8)
-300 (15) (8) (23) (15)
- -------------------------------------------------------------------------------
Gap results indicate that the Bank is asset sensitive, that is more assets will
mature or reprice than liabilities within the next year. Model simulation
results for the period further indicate results typically associated with an
asset sensitive institution; in that the Bank's net interest income is projected
to increase by a greater magnitude in a rising rate environment. Market value
analysis goes beyond simulating earnings for a specified time period to
generating principal and interest cash flows for the entire life of all assets
and liabilities. These cash flows are then discounted back to the present.
Significant factors contributing to the market value simulation results are the
Bank's fixed-rate loans and securities. These assets comprise approximately
17.5% of the Bank's total rate sensitive assets. In a simulated shift in the
yield curve, both rising and declining, the market values associated with these
assets typically tend to decline. This is also referred to as negative
convexity. As interest rates rise, the cash flows on these assets will typically
decline, as borrowers are less likely to refinance or prepay their loans. The
result of this is that there is less cash reinvested at current (higher) market
rates. The opposite effect occurs as rates decline, cash flows tend to increase
as borrowers refinance their existing mortgage to a lower rate and the cash
received must be reinvested at current (lower) market interest rates.
The sensitivity analysis does not necessarily represent a forecast for the Bank.
There are numerous assumptions inherent in the simulation model as well as in
the gap report. Some of these assumptions include the nature and timing of
interest rate levels, including yield curve shape, prepayments on loans and
securities, deposit decay rates, pricing decisions on loans and deposits, and
reinvestment/replacement of asset and liability cash flows. Customer
preferences, and competitor and economic influences are impossible to predict;
therefore, the Bank cannot make any assurances as to the outcome of these
analyses.
26
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
At March 31, 2002, we were not engaged in any legal proceedings, which in the
opinion of management, after consultation with our legal counsel, would be
material to our financial condition either individually or in the aggregate.
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 25, 2002. The results of votes on the matter presented at the Meeting are
as follows:
1. The following individuals were elected as directors for the term
noted:
Votes Votes
Director Votes For Withheld Abstained Term
- -------- ------------------- -------- --------- ----
Janine Florence 4,640,938 6,012 84,016 3 years
Victor E. Parker 4,640,938 6,012 84,016 3 years
F. Kemper Freeman, Jr. 4,634,685 12,265 84,016 3 years
The terms of the Class II and III directors expire at the Annual Meeting of
Shareholders for 2003 and 2004, respectively.
CLASS II DIRECTORS, term expires in 2003
- ----------------------------------------
James J. Doud, Jr.
Richard S. Sprague
Robert C. Wallace
CLASS III DIRECTORS, term expires in 2004
- -----------------------------------------
Mary Case Dunnam
George W. Rowley, Jr.
John R. Valaas
ITEM 5. OTHER INFORMATION
None.
27
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(3.1) Articles of Incorporation, Incorporated by reference to the
Report on Form 8-K filed with the SEC on November 10, 1999.
(3.2) Amendment to Articles of Incorporation effective May 16,
2001.
(3.3) Bylaws, Incorporated by reference to the Report on Form 8-K
filed with the SEC on November 10, 1999.
(11) Statement regarding computation of per share earnings.
Reference is made to the Company's Consolidated Statements
of Income attached hereto as part of Item I Financial
Statements, which are incorporated herein by reference.
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 13, 2002 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)
28