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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............June 30, 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 registrant as specified in its 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 (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. August 12, 2002 4,212,575
--------------- ---------
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FIRST MUTUAL BANCSHARES, INC.
QUARTERLY REPORT ON FORM 10-Q
JUNE 30, 2002
TABLE OF CONTENTS
Page
----
PART I: FINANCIAL INFORMATION.............................................. 2
Forward-Looking Statements Disclaimer................... 2
Item 1. Financial Statements............................................. 3
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................ 15
General................................................. 15
Results of Operations .................................. 15
Net Income......................................... 15
Net Interest Income................................ 15
Other Operating Income............................. 16
Operating Expenses................................. 19
Financial Condition..................................... 20
Asset Quality........................................... 21
Portfolio Information................................... 22
Deposit Information..................................... 22
Business Segments............................................ 23
Consumer Lending........................................ 24
Commercial Lending...................................... 25
Investment Securities................................... 26
Liquidity and Capital Reserves ......................... 26
Branch Closure and Expansion............................ 27
Trust Preferred Securities Issuance..................... 28
Item 3. Quantitative and Qualitative Disclosures About Market Risk....... 28
Gap Analysis............................................ 28
Simulation Model........................................ 29
PART II: OTHER INFORMATION.................................................. 31
Item 1. Legal Proceedings................................................ 31
Item 2. Changes in Securities and Use of Proceeds........................ 31
Item 3. Defaults Upon Senior Securities.................................. 31
Item 4. Submission of Matters to a Vote of Security-Holders.............. 31
Item 5. Other Information................................................ 32
Item 6. Exhibits and Reports on Form 8-K................................. 32
SIGNATURES.................................................................. 33
CERTIFICATION............................................................... 34
1
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.
Statements containing words such as "expect", "anticipate", "suggest", "deemed",
"likely", and "considered" generally 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, 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. 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.
Consolidated Financial Statements of the Company begin on page 3.
2
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30, December 31,
2002 2001
------------ ------------
ASSETS: (Unaudited)
CASH AND CASH EQUIVALENTS:
Interest-earning deposits $ 2,375,538 $ 5,761,548
Noninterest-earning demand deposits
and cash on hand 7,225,202 8,853,755
------------ ------------
9,600,740 14,615,303
MORTGAGE-BACKED AND OTHER SECURITIES
AVAILABLE-FOR-SALE 73,362,739 45,961,301
LOANS RECEIVABLE, HELD-FOR-SALE 1,822,296 4,475,792
MORTGAGE-BACKED AND OTHER SECURITIES
HELD-TO-MATURITY 21,844,238 26,385,652
LOANS RECEIVABLE 593,088,621 570,109,616
RESERVE FOR LOAN LOSSES (7,129,196) (7,032,062)
------------ ------------
LOANS RECEIVABLE, NET 585,959,425 563,077,554
ACCRUED INTEREST RECEIVABLE 3,631,944 3,556,110
LAND, BUILDINGS AND EQUIPMENT, NET 9,476,506 8,831,022
FEDERAL HOME LOAN BANK (FHLB) STOCK, 10,115,600 9,759,300
at cost
MORTGAGE SERVICING RIGHTS 68,848 47,810
OTHER ASSETS 2,848,706 1,638,707
------------ ------------
TOTAL $718,731,042 $678,348,551
============ ============
3
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Continued)
June 30, December 31,
2002 2001
------------ ------------
(Unaudited)
LIABILITIES:
Deposits:
Investor custodial checking $ 352,703 $ 228,619
Money market deposit and
checking accounts 119,207,412 108,826,655
Regular savings 8,610,521 7,855,528
Time deposits 346,923,040 311,986,860
------------ ------------
Total deposits 475,093,676 428,897,662
Drafts payable 1,664,960 1,015,927
Accounts payable and other liabilities 3,742,343 3,446,997
Advance payments by borrowers for
taxes and insurance 1,786,444 1,662,530
FHLB advances 168,730,730 191,104,138
Other advances 250,000 250,000
Current tax liability 2,478,293 --
Trust Preferred Securities 9,000,000 --
------------ ------------
Total liabilities 662,746,446 626,377,254
STOCKHOLDERS' EQUITY:
Common stock, $1 par value-
Authorized, 10,000,000 shares
Issued and outstanding, 5,210,144
and 4,725,966 shares, respectively 5,210,144 4,725,966
Additional paid-in capital 37,487,869 31,411,296
Retained earnings 12,712,025 16,025,853
Accumulated other comprehensive income:
Unrealized income/(loss) on securities
available-for-sale, net of federal
income tax 574,558 (191,818)
------------ ------------
Total stockholders' equity 55,984,596 51,971,297
------------ ------------
TOTAL $718,731,042 $678,348,551
============ ============
4
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
Quarters ended June 30, Six Months ended June 30,
--------------------------- ---------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
(Unaudited)
INTEREST INCOME:
Loans Receivable $ 10,592,882 $ 11,780,707 $ 21,391,388 $ 23,370,297
Interest on AFS Securities 1,086,279 481,387 1,860,487 1,062,539
Interest on HTM Securities 332,123 1,032,662 697,136 2,317,683
Interest Other 159,819 148,184 308,277 301,809
------------ ------------ ------------ ------------
12,171,103 13,442,940 24,257,288 27,052,328
INTEREST EXPENSE:
Deposits 3,575,374 5,925,818 7,154,508 12,296,875
FHLB advances and other 1,895,191 2,233,276 3,896,130 4,312,542
------------ ------------ ------------ ------------
5,470,565 8,159,094 11,050,638 16,609,417
------------ ------------ ------------ ------------
Net interest income 6,700,538 5,283,846 13,206,650 10,442,911
PROVISION FOR LOAN LOSSES 85,000 50,000 135,000 265,000
------------ ------------ ------------ ------------
Net interest income, after provision
for loan losses 6,615,538 5,233,846 13,071,650 10,177,911
OTHER OPERATING INCOME:
Gain on sales of loans 205,809 410,119 457,524 1,163,681
Servicing fees, net of amortization 29,791 25,752 52,341 66,828
Gain on sales of investments 157,443 156,875 157,443 628,663
Fees on deposits 127,582 84,258 229,892 167,153
Other 227,767 191,727 515,135 413,377
------------ ------------ ------------ ------------
Total other operating income 748,392 868,731 1,412,335 2,439,702
BALANCE, carried forward 7,363,930 6,102,577 14,483,985 12,617,613
5
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(CONTINUED)
Quarters ended June 30, Six Months ended June 30,
--------------------------- ---------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
(Unaudited)
BALANCE, brought forward $ 7,363,930 $ 6,102,577 $ 14,483,985 $ 12,617,613
OPERATING EXPENSES:
Salaries and employee benefits 2,710,325 2,046,098 5,187,412 4,312,378
Occupancy 558,559 508,874 1,137,240 1,037,219
Other 1,200,124 945,102 2,286,356 1,814,058
------------ ------------ ------------ ------------
Total other operating expenses 4,469,008 3,500,074 8,611,008 7,163,655
------------ ------------ ------------ ------------
Income before Federal Income Tax and Cumulative
Effect of Adoption of New Accounting Principle 2,894,922 2,602,503 5,872,977 5,453,958
FEDERAL INCOME TAX 978,524 880,437 1,985,771 1,845,507
------------ ------------ ------------ ------------
Income before Cumulative Effect of Adoption
of New Accounting Principle 1,916,398 1,722,066 3,887,206 3,608,451
Cumulative effect of Adoption of New Accounting
Principle, net of federal income tax -- -- -- (155,247)
------------ ------------ ------------ ------------
NET INCOME $ 1,916,398 $ 1,722,066 $ 3,887,206 $ 3,453,204
============ ============ ============ ============
PER SHARE DATA:
Basic earnings per common share before Cumulative
Effect of Adoption of New Accounting Principle $ 0.37 $ 0.33 $ 0.75 $ 0.70
Cumulative Effect of Adoption of New Accounting Principle,
net of federal income tax -- -- -- (0.03)
------------ ------------ ------------ ------------
Basic earnings per common share $ 0.37 $ 0.33 $ 0.75 $ 0.67
============ ============ ============ ============
Earnings per common share before cumulative effect of
Adoption of New Accounting Principle, Assuming Dilution $ 0.36 $ 0.33 $ 0.74 $ 0.69
Cumulative Effect of Adoption of New Accounting Principle,
net of federal income tax -- -- -- (0.03)
------------ ------------ ------------ ------------
Earnings Per Common Share Assuming Dilution $ 0.36 $ 0.33 $ 0.74 $ 0.66
============ ============ ============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING 5,205,791 5,171,611 5,203,564 5,164,564
============ ============ ============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING
INCLUDING DILUTIVE STOCK OPTIONS 5,310,505 5,250,415 5,284,230 5,257,613
============ ============ ============ ============
6
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
Common stock Additional Employee 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 $0 11,295 11,295 47,314 58,609
10% stock dividend 472,883 472,883 6,029,259 (6,502,142) (0)
Cash dividends declared ($.07 per share) (698,892) (698,892)
Comprehensive income:
Net income 3,887,206 3,887,206
Other comprehensive income(loss)-
Change in unrealized gain on
securities available-for-sale,
net of federal income tax 766,376 766,376
----------- ----------- -----------
Total Comprehensive income 3,887,206 766,376 4,653,582
----------- ----------- ----------- ----------- ----------- ----------- -----------
BALANCE, JUNE 30, 2002 5,210,144 $ 5,210,144 $37,487,869 $12,712,025 $ -- $ 574,558 $55,984,596
=========== =========== =========== =========== =========== =========== ===========
7
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six months ended June 30,
---------------------------
2002 2001
------------ ------------
(Unaudited)
OPERATING ACTIVITIES:
Net income $ 3,887,206 $ 3,453,204
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Provision for loan losses 135,000 265,000
Depreciation and amortization 414,912 565,073
Deferred loan origination fees, net of accretion (195,942) (336,945)
Amortization of mortgage servicing rights 21,993 5,756
Gain on sales of loans (457,523) (998,454)
Gain on sale of repossessed real estate -- (9,296)
Gain on sale of securities available-for-sale (157,443) (206,832)
Gain on sale of other investments -- (421,830)
FHLB stock dividends (293,700) (263,400)
Changes in operating assets & liabilities:
Loans receivable held-for-sale 2,653,496 (2,782,197)
Accrued interest receivable (75,834) 464,849
Other assets (1,209,999) (340,144)
Drafts payable 649,033 (765,048)
Accounts payable and other liabilities 258,439 (406,251)
Federal income taxes 2,478,293 (379,463)
Advance payments by borrowers for taxes and insurance 123,914 139,884
------------ ------------
Net cash provided (used) by operating activities 8,231,845 (2,016,094)
INVESTING ACTIVITIES:
Loan originations (123,697,916) (124,989,383)
Loan principal repayments 92,765,138 78,889,769
Increase in undisbursed loan proceeds 8,141,329 (4,296,604)
Principal repayments & redemptions on
mortgage-backed and other securities 7,440,951 29,608,027
Purchase of mortgage-backed securities available-for-sale (39,526,461) (2,996,250)
Purchase of mortgage-backed and other securities (250,000) --
Purchases of premises and equipment (1,063,189) (1,022,182)
Purchase of FHLB stock (62,600) (233,100)
Proceeds from sale of loans -- 1,146,155
Proceeds from other investments -- 430,307
Proceeds from sale of securities 10,787,110 7,717,947
Proceeds from sale of real estate held-for-sale -- 1,433,584
------------ ------------
Net cash used by investing activities (45,465,638) (14,311,730)
8
FIRST MUTUAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
Six months ended June 30,
---------------------------
2002 2001
------------ ------------
(Unaudited)
FINANCING ACTIVITIES:
Net increase (decrease) in deposit accounts 39,194,782 (13,637,066)
Interest credited to deposit accounts 7,001,231 12,317,974
Proceeds from Trust Preferred Securities 9,000,000 --
Proceeds from advances 124,158,892 139,175,000
Repayment of advances (146,532,300) (123,068,000)
Dividends paid (661,985) (468,425)
Proceeds from exercise of stock options 58,609 148,101
Repayment of employee stock ownership plan debt -- 97,821
------------ ------------
Net cash provided by financing activities 32,219,229 14,565,405
------------ ------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (5,014,564) (1,762,419)
CASH & CASH EQUIVALENTS:
Beginning of year 14,615,303 6,998,992
------------ ------------
End of quarter $ 9,600,739 $ 5,236,573
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Loans originated for mortgage banking activities $ 33,389,528 $ 53,905,686
============ ============
Loans originated for investment activities $123,697,916 $124,989,383
============ ============
Proceeds from sales of loans held-for-sale $ 36,043,024 $ 51,123,489
============ ============
Cash paid during the Six months ended June 30 for:
Interest $ 11,018,064 $ 16,733,436
============ ============
Income taxes $ 1,540,000 $ 2,029,500
============ ============
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING ACTIVITIES:
Loans securitized into securities available-for-sale $ 14,485,309 --
Loans transferred 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.
NOTE 2.
MORTGAGE-BACKED AND OTHER SECURITIES AVAILABLE-FOR-SALE
The amortized cost and estimated fair value of securities available-for-sale at
June 30, 2002, and December 31, 2001 are summarized as follows:
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
------------ ------------ ------------ ------------
JUNE 30, 2002:
Freddie Mac securities $ 5,059,229 $ 112,147 $ -- $ 5,171,376
Fannie Mae securities 67,432,967 881,284 122,888 68,191,363
------------ ------------ ------------ ------------
$ 72,492,196 $ 993,431 $ 122,888 $ 73,362,739
============ ============ ============ ============
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
------------ ------------ ------------ ------------
JUNE 30, 2002:
Fannie Mae securities $ 19,430,814 $ 683,207 $ -- $ 20,114,021
Freddie Mac securities 1,026,963 10,239 -- 1,037,202
Municipal bonds 1,342,820 -- 3,993 1,338,827
REMICS 43,641 1,106 -- 44,747
------------ ------------ ------------ ------------
$ 21,844,238 $ 694,552 $ 3,993 $ 22,534,797
============ ============ ============ ============
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
============ ============ ============ ============
10
NOTE 4.
NONPERFORMING ASSETS
The Bank had nonperforming assets as follows:
June 30, December 31,
2002 2001
------------ ------------
Nonperforming loans $ 338,451 $ 498,033
Real Estate and Repossessed assets held-for-sale 37,561 22,587
------------ ------------
Total Nonperforming Assets $ 376,012 $ 520,620
============ ============
At June 30, 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 June 30,
2002, and June 30, 2001:
Income Shares Per share
(numerator) (denominator) amount
---------------------------------------------
Quarter ended June 30, 2002
Basic EPS:
Income available to common shareholders $ 1,916,398 5,205,791 $ 0.37
============
Effect of dilutive stock options -- 104,714
------------ ------------
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised $ 1,916,398 5,310,505 $ 0.36
============ ============ ============
Six months ended June 30, 2002
Basic EPS:
Income available to common shareholders $ 3,887,206 5,203,564 $ 0.75
============
Effect of dilutive stock options -- 80,666
------------ ------------
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised $ 3,887,206 5,284,230 $ 0.74
============ ============ ============
Quarter ended June 30, 2001
Basic EPS:
Income available to common shareholders $ 1,722,066 5,171,611 $ 0.33
============
Effect of dilutive stock options -- 78,804
------------ ------------
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised $ 1,722,066 5,250,415 $ 0.33
============ ============ ============
Six months ended June 30, 2001
Basic EPS:
Income available to common shareholders $ 3,453,204 5,164,564 $ 0.67
============
Effect of dilutive stock options -- 93,049
------------ ------------
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised $ 3,453,204 5,257,613 $ 0.66
============ ============ ============
11
NOTE 6.
RATE VOLUME ANALYSIS SECOND QUARTER 2002 SIX MONTHS ENDED JUNE 30, 2002
(Dollars in thousands) VS VS
SECOND QUARTER 2001 SIX MONTHS ENDED JUNE 30, 2001
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
TOTAL TOTAL
VOLUME RATE CHANGE VOLUME RATE CHANGE
- -------------------------------------------------------------------------------- ------------------------------------
INTEREST INCOME
Investments:
Available-for-sale securities $ 580 $ 25 $ 605 $ 880 $ (82) $ 798
Held-to-maturity securities (683) (18) (701) (1,160) (461) (1,621)
Other equity investments 52 (40) 12 67 (60) 7
---------- ---------- ---------- ---------- ---------- ----------
Total investments (51) (33) (84) (213) (603) (816)
Loans:
Residential (146) (382) (528) (98) (516) (614)
Residential construction 61 (111) (50) 101 (380) (279)
Multifamily 357 (594) (237) 696 (1,197) (501)
Multifamily construction (218) (130) (348) (424) (274) (698)
Commercial real estate and Business 716 (852) (136) 1,675 (1,669) 6
Commercial real estate construction 31 (8) 23 72 (87) (15)
Consumer & Other 231 (144) 87 441 (320) 121
---------- ---------- ---------- ---------- ---------- ----------
Total loans 1,032 (2,221) (1,189) 2,463 (4,443) (1,980)
---------- ---------- ---------- ---------- ---------- ----------
Total interest income 981 (2,254) (1,273) 2,250 (5,046) (2,796)
INTEREST EXPENSE
Deposits:
Money market deposit and checking 84 (347) (263) 172 (841) (669)
Regular savings 1 (14) (13) (1) (30) (31)
Time deposits (97) (1,978) (2,075) (590) (3,853) (4,443)
---------- ---------- ---------- ---------- ---------- ----------
Total deposits (12) (2,339) (2,351) (419) (4,724) (5,143)
FHLB advances and other 472 (810) (338) 1,364 (1,780) (416)
---------- ---------- ---------- ---------- ---------- ----------
Total interest expense 460 (3,149) (2,689) 945 (6,504) (5,559)
Net interest income $ 521 $ 895 $ 1,416 $ 1,305 $ 1,458 $ 2,763
========== ========== ========== ========== ========== ==========
12
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, 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 segments.
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:
Consumer lending includes residential and home equity lending, direct consumer
loans, and consumer dealer financing contracts. Residential lending offers
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 Bank'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 June 30,
2002, 2001 and 2000:
CONSUMER COMMERCIAL SECURITY
QUARTER ENDED JUNE 30: LENDING LENDING INVESTMENTS TOTALS
- ---------------------- ------- ------- ----------- ------
Interest income 2002 $ 2,874,064 $ 7,718,607 $ 1,578,432 $12,171,103
2001 3,202,322 8,577,888 1,662,730 13,442,940
2000 2,774,681 7,930,667 1,746,568 12,451,916
Interest Expense 2002 1,230,753 2,968,912 1,270,900 5,470,565
2001 1,947,901 4,666,613 1,544,580 8,159,094
2000 1,676,828 4,235,893 1,483,174 7,395,895
Net Interest Income 2002 1,643,311 4,749,695 307,532 6,700,538
2001 1,254,421 3,911,275 118,150 5,283,846
2000 1,097,853 3,694,774 263,394 5,056,021
Provision for loan losses 2002 25,993 59,007 -- 85,000
2001 15,455 34,545 -- 50,000
2000 30,910 69,090 -- 100,000
Net interest income, after provision 2002 1,617,318 4,690,688 307,532 6,615,538
for loan losses 2001 1,238,966 3,876,730 118,150 5,233,846
2000 1,066,943 3,625,684 263,394 4,956,021
Noninterest income 2002 267,253 293,826 187,313 748,392
2001 472,429 222,015 174,287 868,731
2000 185,226 128,267 26,066 339,559
Noninterest expense 2002 1,502,689 2,614,069 352,250 4,469,008
2001 1,303,342 1,992,484 204,248 3,500,074
2000 1,017,232 1,575,136 259,863 2,852,231
Income before federal income taxes 2002 381,882 2,370,445 142,595 2,894,922
2001 408,053 2,106,261 88,189 2,602,503
2000 234,937 2,178,815 29,597 2,443,349
Federal income taxes 2002 129,840 805,951 42,733 978,524
2001 138,738 716,129 25,570 880,437
2000 79,879 740,797 6,947 827,623
Net income 2002 252,042 1,564,494 99,862 1,916,398
2001 269,315 1,390,132 62,619 1,722,066
2000 155,058 1,438,018 22,650 1,615,726
Total Interest Earning assets 2002 160,233,123 434,946,950 107,698,115 702,878,188
(Ending period balances) 2001 151,434,161 405,300,361 97,800,475 654,534,997
2000 138,863,542 352,736,595 118,078,354 609,678,491
13
NOTE 7.
SEGMENTS (CONTINUED)
CONSUMER COMMERCIAL SECURITY
YEAR-TO-DATE ENDED JUNE 30: LENDING LENDING INVESTMENTS TOTALS
- --------------------------- ------- ------- ----------- ------
Interest income 2002 $ 5,763,572 $ 15,627,414 $ 2,866,302 $ 24,257,288
2001 6,085,660 17,282,370 3,684,298 27,052,328
2000 5,376,539 15,577,540 3,488,665 24,442,744
Interest Expense 2002 2,528,440 6,116,943 2,405,254 11,050,637
2001 3,775,551 9,509,999 3,323,866 16,609,416
2000 3,219,943 8,316,468 2,773,470 14,309,881
Net Interest Income 2002 3,235,132 9,510,471 461,048 13,206,651
2001 2,310,109 7,772,371 360,432 10,442,912
2000 2,156,596 7,261,072 715,195 10,132,863
Provision for loan losses 2002 41,448 93,552 -- 135,000
2001 81,913 183,087 -- 265,000
2000 71,093 158,907 -- 230,000
Net interest income, after provision 2002 3,193,684 9,416,919 461,048 13,071,651
for loan losses 2001 2,228,196 7,589,284 360,432 10,177,912
2000 2,085,503 7,102,165 715,195 9,902,863
Noninterest income 2002 583,442 617,712 211,181 1,412,335
2001 1,354,230 413,958 671,514 2,439,702
2000 622,942 286,934 52,083 961,959
Noninterest expense 2002 2,956,456 5,012,362 642,189 8,611,007
2001 2,507,400 4,125,240 531,015 7,163,655
2000 2,163,050 3,228,970 536,113 5,928,133
Income before federal income taxes 2002 820,670 5,022,269 30,040 5,872,979
and cumulative effect of adoption 2001 1,075,026 3,878,002 500,931 5,453,959
of New Accounting principle 2000 545,395 4,160,129 231,165 4,936,689
Federal income taxes 2002 279,028 1,707,571 (828) 1,985,771
2001 365,509 1,318,520 161,478 1,845,507
2000 185,434 1,414,444 73,789 1,673,667
Income before Cumulative Effect of 2002 541,642 3,314,698 30,868 3,887,206
Adoption of New Accounting Principle 2001 709,517 2,559,482 339,453 3,608,452
2000 359,961 2,745,685 157,376 3,263,022
Cumulative effect of Adoption of New 2002 -- -- -- --
Accounting Principle, net of federal 2001 (155,247) -- -- (155,247)
income tax 2000 -- -- -- --
Net income 2002 541,642 3,314,698 30,868 3,887,206
2001 554,270 2,559,482 339,453 3,453,204
2000 359,961 2,745,685 157,376 3,263,022
Total Interest Earning assets (Averages) 2002 153,146,576 424,580,671 105,565,733 683,292,980
2001 149,448,730 394,644,194 109,856,408 653,949,332
2000 136,016,911 351,212,214 116,915,023 604,144,148
NOTE 8.
TRUST PREFERRED SECURITIES ISSUANCE
During the second quarter of 2002 the Financial Holding Company formed a
subsidiary whose sole purpose was to issue $9.0 million in Trust Preferred
Securities through a pool sponsored by Bear Stearns & Co. Inc., Regional
Advisor's Alliance and other brokers. Under the terms of the transaction the
Trust Preferred Securities will have a maturity of 30 years and are redeemable
after five years with certain exceptions. The floating-rate securities have a
5.52% interest rate, which will reset quarterly at the three-month LIBOR rate
plus 3.65%. The Trust Preferred Securities will be recorded as a liability on
the Statement of Financial Condition, but are expected to qualify as Tier 1
capital for regulatory capital purposes. The proceeds from the offering will be
used to fund the stock repurchase of approximately 20% of the shares
outstanding.
In connection with the Trust Preferred Securities issuance, the Bank entered
into a swap agreement with the Federal Home Loan Bank of Seattle (FHLB) in order
to fix the interest rate on the issuance. Under the terms of the swap agreement,
the Bank receives the equivalent of three-month LIBOR and pays the FHLB a fixed
rate of interest equal to the five-year swap curve, as of the trade date, based
upon the notional value of the contract. This transaction is intended to be a
highly effective cash flow hedge as defined by FAS No. 133, ACCOUNTING FOR
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES.
14
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
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 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.
On June 20, 2002 the Company formed a new subsidiary, First Mutual Capital Trust
I, for the sole purpose of issuing $9,000,000 in Trust Preferred Securities
through a pool sponsored by Bear Stearns & Co. Inc., Regional Advisor's
Alliance, and other brokers. The Company owns 100% or 279 common shares
($279,000) in the trust subsidiary. The transaction was completed on June 27,
2002. The proceeds of the offering will be used to fund a stock repurchase of
approximately 20% of the shares outstanding in a private transaction.
RESULTS OF OPERATIONS
- ---------------------
Net Income
----------
Net income increased 11.8%, from $1.7 million in the second quarter of 2001 to
$1.9 in the same period of 2002. The improvement in net income is a reflection
of a significant decrease in interest expense, which was partially offset by a
28% rise in operating expenses.
Net Interest Income
-------------------
Net interest income increased $1.4 million, or 26.8%, in the second quarter of
2002 as contrasted with the same quarter in 2001. Year-to-date net interest
income has increased $2.8 million, or 26.5%, rising from $10.4 million for the
first half of 2001 to $13.2 million for the same period this year. Net interest
income improved as a result of both a decrease in the rates paid on
interest-bearing liabilities and an increase in earning-assets. The net positive
impact from the decrease in interest rates totaled $895,000 for the second
quarter this year. Additionally the continued increase in interest-earning
assets contributed $521,000 for the quarter. Year-to-date the change in interest
rates provided $1.5 million to net income and the rise in interest-earning
assets amounted to $1.3 million, for a total change of $2.8 million.
The net interest margin (as illustrated below) increased over the prior year as
a result of the cost of funds dropping faster than the yield on earning assets.
The cost of funds, as measured by the ratio of interest expense/average earning
assets, has declined from 5.11% at June 30, 2001, to its current rate of 3.21%
- -- a drop of 1.9%. The yield on earning assets, as measured by the ratio of
interest income/average earning assets, also fell, but at a much slower pace,
from 8.42% a year ago to 7.15%, a decrease of 1.27%. While the funding costs
have declined 37% over the last year, the yield on loans and investments has
only dropped 15%.
15
Quarter Ended Net Interest Margin
- ------------- -------------------
June 30, 2001 3.31%
September 30, 2001 3.23%
December 31, 2001 3.50%
March 31, 2002 3.94%
June 30, 2002 3.94%
The Bank is currently positively gapped (more one-year assets than liabilities)
by 15%, which means that rising rates would improve the net interest margin,
while falling rates would be adverse. The Bank's simulation model, however,
suggests that the negative impact from a change in rates is not as dramatic as
the Gap report might indicate. The latest simulation model report shows a .06%
decrease in net interest income if interest rates rise 200 basis points, and a
2.08% decline if rates fall by the same amount.
The provision for loan losses increased from $50,000 in the second quarter of
2001 to $85,000 in the like period in 2002. Year-to-date the provision for loan
losses totaled $135,000 as compared to $265,000 for the first six months of
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.
Other Operating Income
----------------------
Other operating income consisted of the following:
Three Months Six Months
Ended June 30 Ended June 30
----------------------------- -----------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
SFAS 133 Gain $ 29,000 $ 185,000 $ 31,000 $ 272,000
Secondary Market Fees/(Costs) 152,000 96,000 384,000 (81,000)
Mortgage Servicing Rights 25,000 100,000 43,000 114,000
Sale of Servicing Rights 0 29,000 0 859,000
------------ ------------ ------------ ------------
GAIN ON SALES OF LOANS: $ 206,000 $ 410,000 $ 458,000 $ 1,164,000
SERVICING FEES $ 30,000 $ 26,000 $ 52,000 $ 67,000
GAIN ON SALE OF INVESTMENTS $ 157,000 $ 157,000 $ 157,000 $ 629,000
FEES ON DEPOSITS $ 127,000 $ 84,000 $ 230,000 $ 167,000
OTHER INCOME:
Miscellaneous Loan Fees 76,000 16,000 199,000 44,000
Late Charges 30,000 23,000 52,000 47,000
Official Check Income 34,000 29,000 65,000 55,000
Other 88,000 124,000 199,000 267,000
------------ ------------ ------------ ------------
SUBTOTAL $ 228,000 $ 192,000 $ 515,000 $ 413,000
------------ ------------ ------------ ------------
============ ============ ============ ============
TOTAL $ 748,000 $ 869,000 $ 1,412,000 $ 2,440,000
============ ============ ============ ============
16
Other operating income decreased to $748,000 in the second quarter of 2002 as
compared to $869,000 in the same quarter in 2001. Year-to-date other operating
income also declined from $2.4 million to $1.4 million. The 14% drop for the
quarter and the 42% drop for the first six months of the year were mainly
attributable to declines in the gain on sales of loans.
GAIN ON SALES OF LOANS. Gain on sales of loans totaled $206,000 for the quarter
as compared to $410,000 for the second quarter ended June 30, 2001. Year-to-date
gain on sales of loans declined $706,000 from $1,164,000 at the end of June last
year to $458,000 this year. A number of factors contributed to the change: the
mark-to-market of interest rate locks on loans pending sale and forward sale
commitments into the secondary market (pursuant to SFAS No. 133), secondary
market fees, capitalization of mortgage servicing rights, and sale of servicing
rights.
SFAS No. 133 is the accounting guidance applicable to derivative financial
instruments. This standard requires that all interest rate locks on loans
pending sale and forward sale commitments, which are considered to be
derivatives, be marked to market. In the second quarter of last year, because of
a favorable rate movement for forward loan commitments, the mark-to-market gain
was $207,000. The mark-to-market gain for the same period this year was $12,000.
The Bank does not currently have any outstanding forward commitments, nor does
it expect to acquire any significant amount in the forthcoming quarter. As a
result, the Bank does not anticipate any material gains or losses in the third
quarter from the mark-to-market of forward loan commitments. Year-to-date the
SFAS 133 impact is similar to the second quarter results. For the first six
months of 2001, the mark-to-market net gain on forward loan commitments and
interest rate locks totaled $272,000 as compared to a net gain of $31,000 for
the like period in 2002.
Secondary market fees are the cash gains or losses from the sale of loans into
the secondary market. Cash gains in the second quarter of 2002 amounted to
$152,000 on loan sales of $19.7 million, compared to $96,000 on sales of $42.7
million in the same quarter of 2001. Year-to-date the gain in 2002 is $384,000
on loan sales of $36.0 million compared to a loss of $81,000 on sales of $53.4
million last year. Included in secondary marketing fees are pair-off fees.
Pair-off fees, which are a routine secondary marketing activity, are the
resulting gain or loss incurred when a forward loan commitment position is
settled. The resulting gain or loss is largely dependent upon the movement of
mortgage rates. Pair-off losses tied to the hedging activities of residential
loans being held-for-sale totaled $41,000 for the second quarter of 2002 as
compared to $24,000 for the same period last year. For the first six months of
2002, pair-off losses amounted to $67,000 compared to $320,000 for 2001. In
2001, during a period when the Bank was more active in its mortgage banking
activities, rates fell throughout the year making the hedging of interest rates
more difficult. Currently the Bank does not have any outstanding forward loan
commitments and does not anticipate acquiring any significant amounts. As a
result, the Bank does not anticipate any material gains or losses associated
with pair-off fees during the third quarter. Benefiting secondary market fees
this year was the sale of home improvement loans. The Bank recognized $110,000
in pre-tax income in the second quarter of 2002 and $264,000 year-to-date as
compared to $69,000 in the same period last year and $120,000 for the first six
months of 2001.
Another area affected by accounting guidance is loans sold with the servicing
rights retained. 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 mortgage servicing rights (MSR's). The Bank sold $10.6 million in
loans with retained servicing rights and recorded gains of $100,000 during the
second quarter of 2001; those figures compare to $25,000 in gains on $7.9
million in loan sales in the like quarter of this year. Year-to-date capitalized
mortgage servicing rights totaled $43,000 as compared to $114,000 for the like
period in 2001. The comparative loan sales for loans with retained servicing
rights were $15.7 million for the first six months of 2002 and $14.2 million for
the first and second quarters of 2001. Also affecting gains on servicing rights
is the periodic analysis of the calculation used to determine the capitalization
value for the internally generated MSR's. Based on a recent assessment, the
value used to capitalize an MSR has declined approximately 10 basis points from
the valuation used in year 2001.
17
The fourth and final piece of the gain on sales of loans total is the gains
realized from the sale of servicing rights. Gains realized from the sale of
servicing rights totaled $29,000 for the second quarter of 2001 and $859,000 for
the first six months of last year. There were no comparable gains this year.
Last year the Bank executed a bulk sale of $78 million in servicing rights. A
pending sale of $20 million in servicing rights will be settled in the third
quarter. The estimated gain from that sale is $227,000.
SERVICING FEES, NET OF AMORTIZATION. Servicing fees have increased $4,000, or
15.7%, for the second quarter of 2002 as compared to the like quarter last year,
due to an increase in the mortgage servicing portfolio. The servicing portfolio
totaled $65.5 million at June 30, 2002, as compared to $46.7 million a year ago.
Year-to-date servicing fee income amounted to $52,000 for the first six months
of 2002 and $67,000 for the like period last year. The year-to-date servicing
fee income last year benefited from sub-servicing fees on the $78 million sale.
That arrangement was concluded in March 2001. The Bank is preparing to sell the
servicing rights underlying approximately $20 million in loans during the third
quarter of 2002. As a result, the amount of income from this source is
anticipated to decline for the second half of the year.
GAIN ON SALES OF INVESTMENTS. Gain on sales of investment securities,
held-for-sale, were the same, at $157,000, in the second quarter for both years.
Gains this year included a delayed payment of $26,000 on a limited partnership
interest sold last year and $131,000 from the sale of $10.7 million of security
investments. Last year in the second quarter, gains amounted to $157,000 on $4.8
million in security sales. Year-to-date the gains totaled $157,000 for this year
and $629,000 in 2001. 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.
Total security sales last year amounted to $207,000 on $8.2 million of
investment securities.
In the third quarter, security sales totaling $15.2 million have settled.
Pre-tax gains on those sales are estimated to be $129,000.
FEE INCOME ON DEPOSITS. Fee income from deposits is up $43,000, or 51%, on a
quarter-to-quarter comparison. Virtually all of that increase came from improved
fee income on checking accounts. Year-to-date income is up 38% as compared to
the prior year, with checking account fees accounting for most of that
improvement. The Bank expects fee income from this source to continue to show an
increase, although not at the rate experienced in the last two years.
OTHER INCOME. Other income totaled $228,000 compared to $192,000 in the second
quarter of last year. For the first six months of 2002, other income amounted to
$515,000 as compared to $413,000 for the like period the previous year. The rise
in other income is mainly due to an increase in miscellaneous loan fees, late
charges, and fees derived from the issuance of official checks.
Miscellaneous loan fees increased $23,000 during the second quarter of 2002 as
compared to the same quarter a year ago. The year-to-date figures have risen as
well, from $194,000 for the first half of 2001 to $283,000 for the like period
in 2002. The increase was mainly attributable to loan prepayment fees and
brokered loan fees. Loan prepayment fees contributed $41,000 for the quarter and
$142,000 year-to-date. There was no comparable figure for the second quarter of
2001, although for the first six months of 2001, these fees amounted to $25,000.
Brokered loan fees increased $18,000 on a quarterly comparison and $38,000
year-to-date. Late charges have also increased on a quarterly and year-to-date
basis. Second quarter late fees rose $7,000 on a quarter-to-quarter comparison
and $5,000 on a year-to-date comparative basis. Over the past year the loan
portfolio has grown $62 million. Income from the issuance of official checks has
continued to rise. Last year the Bank changed vendors that provide official
check services to the Bank. The Bank shares in the interest earned on the
outstanding check balances. By changing vendors the amount of fee income earned
increased $5,000 for the quarter and $9,000 on a year-to-date comparison.
18
Operating Expenses
------------------
Operating expenses consisted of the following:
Three Months Six Months
Ended June 30, Ended June 30,
----------------------------- -----------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
SALARIES AND BENEFITS $ 2,710,000 $ 2,046,000 $ 5,188,000 $ 4,312,000
OCCUPANCY $ 559,000 $ 509,000 1,137,000 1,037,000
OTHER EXPENSES:
Marketing/Investor Relations 249,000 136,000 367,000 253,000
Outside Services 63,000 41,000 150,000 78,000
Legal Fees 125,000 110,000 260,000 158,000
Other 763,000 658,000 $ 1,509,000 $ 1,325,000
------------ ------------ ------------ ------------
SUBTOTAL $ 1,200,000 $ 945,000 $ 2,286,000 $ 1,814,000
------------ ------------ ------------ ------------
TOTAL $ 4,469,000 $ 3,500,000 $ 8,611,000 $ 7,163,000
============ ============ ============ ============
Salaries and employee benefits costs rose $664,000, or 32%, for the second
quarter of 2002 as compared to the previous year. A number of factors have
contributed to that increase to include a rise in loan officer commission
expense, a growth in base compensation, and an annual salary increase.
Loan officer commissions were up 42% on a quarter-to-quarter comparison even
though overall loan originations have decreased for the quarter by 19%. The bulk
of the increase in commissions for the quarter came from the Business Banking
area. The commission structure in this area is not strictly based on loan
volume; there are other factors involved to include funds acquisition.
For the quarter, base compensation including payroll taxes increased 36%, or
$514,000, compared to second quarter last year. This jump is due in part to the
4% annual salary increase that occurred in December 2001 and the rise in the
number of employees at the Bank. The staffing levels at the Bank grew from 139
employees at June 30, 2001, to 160 this year. Over half of those new employees
were recruited to the Bank to support the Business Banking and Consumer Lending
activities. In addition to an increased number of employees, compensation
expense rose as a result of more experienced individuals being added to the
staff. That is, the new employees were generally highly skilled individuals,
commanding greater levels of compensation.
Year-to-date salaries and employee benefits costs have also increased over last
year by $875,000, or 20%. Like the results for the second quarter, increases in
staffing over the past year coupled with higher loan officer commissions
contributed to the rise. Partially offsetting the rise for the first six months
was the incentive bonus that was accrued during the first quarter of last year.
As was mentioned earlier, 21 new employees have been hired since June 30, 2001.
This coupled with the fact that the cost per employee is higher than normal due
to their skills and experience has had a significant impact on the Bank's
compensation and benefits expense.
Last year during the first quarter the Bank accrued a staff incentive bonus of
$250,000 that was later reversed during the third quarter when it was apparent
that the pre-set goals were not going to be met for the year. For the current
year there have been no accruals of this nature.
19
Occupancy expense rose $50,000, or 9.8% on a quarter-to-quarter basis;
year-to-date the increase totaled $100,000, or 9.6%. 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 $255,000, or 27%, from $945,000 in the second
quarter of 2001 to $1.2 million in the same period of this year. Year-to-date
other expenses have increased $472,000, or 26% over the first half of 2001. The
largest elements were marketing/investor relations, outside services, and legal
expense.
Marketing/investor relations expenses increased $112,000 quarter-over-quarter
and $114,000 on a year-to-date comparison. A marketing director has recently
joined the Bank, and more emphasis is now being placed on brand and product
development.
Outside services for the second quarter of 2002 totaled $63,000 and $150,000 for
the first six months of the year. The totals for 2001 for the like periods were
$41,000 and $78,000, respectively. The increase for both second quarter and the
first six months of the year is principally due to the engagement of several
consultants. The Bank contracted with a compensation consultant to review its
compensation plans, and with a second consultant to review and make
recommendations regarding the residential loan area. The expenses associated
with those engagements totaled $27,000 for the second quarter of 2002 and
$72,000 year-to-date. There were no comparable expenses in the first six months
of 2001. The Bank expects consulting expense to moderate in the third and fourth
quarters.
FINANCIAL CONDITION
- -------------------
Assets. Assets increased 6.0% from $678,349,000 at year-end 2001 to $718,731,000
as of June 30, 2002. The change in assets is principally the result of an
increase in both the investment securities and the loan portfolios.
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
June 30, 2002, the balance of the unrealized gain, net of federal income taxes,
was $575,000, 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 $22.9 million, or 31.6%, from
December 31, 2001, to the end of the second quarter 2002. During the quarter
$14.5 million (par value) in loans were securitized, $5 million (par value) were
purchased and $10.7 million (par value) were sold. An additional $15.2 million
in securities have been sold in the third quarter.
Loans. Net loans receivable, including loans held-for-sale, rose from
$567,553,000 at year-end 2001, to $587,782,000, an increase of $20.2 million in
six months. Loan originations have jumped $22 million, or 33%, in the second
quarter as compared to the first quarter of this year. Loan payoffs have also
moved favorably since the first quarter, decreasing 41%. During the first
quarter annualized loan prepayments averaged 26.5%, declining in the second
quarter to an annualized rate of 15.8%. Year-to-date the Bank's annualized
prepayment rate is 21.2%. Although the trend on a sequential quarterly basis is
encouraging, it is premature to draw any conclusion from that data. On a
month-to-month basis loan originations and prepayments are very volatile and can
range widely. Management would not be surprised to see the trend established in
the first half of the year reverse itself.
20
Liabilities. Deposits increased $46.2 million, or 10.8%, in the first six months
of 2002, totaling $475 million as compared to $429 million at year-end 2001.
This increase in deposits was used to fund the asset growth in the securities
and loan portfolios as well as to pay down the Federal Home Loan Bank of Seattle
(FHLB) borrowings.
FHLB advances decreased from $191 million at year-end 2001 to $169 million at
the end of the second quarter. As of June 30, 2002, the Bank had the capacity to
borrow up to a total of $287.5 million in FHLB advances, subject to sufficient
collateral to support those advances.
Nine million dollars in Trust Preferred Securities were issued during the
quarter through a pooled trust program sponsored by Bear Stearns Co., Inc.,
Regional Advisor's Alliance, and other brokers. The proceeds of this issuance
have been used to repurchase approximately 20% of the outstanding shares of the
Bank during the third quarter of 2002.
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
$85,000 in the second quarter of 2002, bringing the total loan loss reserve to
$7.1 million. Over the past year the reserve balance has increased $147,000.
The key considerations that led to the increase in the reserves for loan losses
included the growth in the loan portfolio, concern about the economy of the
Northwest, and the continued, relative to peer institutions, low level of
non-performing assets.
Since year-end 2001 the net loan portfolio (excluding loans held-for-sale) has
grown by $22.9 million. Most of that growth occurred in the residential and
consumer loan portfolios, which are generally considered to be a lower risk than
commercial real estate and Business Banking loans.
The local Northwest economy continues to exhibit stress. Housing permits in the
first quarter were down 27% compared to a year ago, and Washington and Oregon
continue to lead the nation in unemployment statistics. Although the Bank's loan
portfolio has yet to be significantly affected by the economic downturn, there
remains the potential risk at a later date.
Partially offsetting the impact of the growth in loan portfolios and the local
economy is the performance of the loan portfolio. As of quarter-end June 30,
2002, the Bank's non-performing assets to total assets was 0.05%, which compares
to 0.15% as of June 30, 2001. Those numbers compare to the national ratios of
0.68% for savings institutions and 0.97% for commercial banks as of March 31,
2002. For the past five years the Bank's NPA's to total assets has been
considerably less than that of either FDIC-insured savings institutions or
commercial banks.
In summary, the Bank's provision for loan loss reserves is based on historical
credit analysis and an assessment of the local and national economic conditions,
and it appears to be reasonable in light of the current conditions.
Non-performing assets improved to $376,000, or 0.05% of total assets, at
quarter-end 2002 compared to $968,000, or 0.15% of assets, at June 30, 2001.
21
Noted below is a summary of the Bank's exposure to non-performing loans and
repossessed assets:
Amount
-----------
Business Banking loan - possible loss of $16,000 $ 40,000
Residential loan, Eastern WA - no loss anticipated 48,000
Residential loan, Puget Sound area - no loss anticipated 175,000
Three consumer loans - possible loss of $35,000 35,000
Five consumer loans - no loss anticipated 28,000
A consumer loan - paid current and reinstated 12,000
Total repossessed assets 38,000
-----------
Total non-performing assets $ 376,000
===========
The Bank has 14 pieces of property that it has repossessed, and includes items
such as motorcycles, spas, and personal watercraft. The properties are
held-for-sale on consignment, typically with a dealer that specializes in that
type of property.
PORTFOLIO INFORMATION
- ---------------------
The commercial real estate portfolio comprises 69% 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 $688,235 as of June 30, 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 (0.19%). Small individual investors or their limited
liability companies as well as business owners 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 46% residential and 54% commercial.
The loans in the commercial real estate portfolio are 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 5% of the
portfolio, has been purchased in this manner.
DEPOSIT INFORMATION
- -------------------
The number of business checking accounts increased from 614 at June 30, 2001, to
812 at June 30, 2002, a gain of 198 accounts, or 32%. Consumer checking accounts
also increased, from 3,813 in second quarter of 2001 to 4,247 this year, a
growth in the number of accounts of 434, or 11%.
22
The mix of deposits as of June 30, 2002 is as follows:
Time Deposits 72%
Checking 9%
Money Market Accounts 17%
Statement Savings 2%
BUSINESS 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:
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.
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:
CONSUMER LENDING - Consumer lending includes residential and home equity
lending, direct consumer loans, and consumer dealer financing contracts.
Residential lending offers 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.
23
COMMERCIAL LENDING - 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.
INVESTMENT SECURITIES - 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 Bank's revenues.
CONSUMER LENDING
- ----------------
Net income for the consumer lending segment declined from $269,000 in the second
quarter of 2001 to $252,000 in the same quarter in 2002. The decrease in net
income was the result of a drop in non-interest income coupled with an
escalation in operating expense, both of which were partially offset by an
improvement in net interest income.
Net interest income, after provision for loan losses, was up $378,000,
increasing from $1.2 million in the second quarter of 2001 to $1.6 million this
year. Most of this amelioration was due to the drop in interest expense, which
decreased $717,000 as compared to the second quarter of 2001.
Non-interest income declined from $472,000 in the three months ending June 30,
2001, to $267,000 in the same quarter this year. The decrease was mainly
attributable to the gains that were realized last year from the mark-to-market
of forward commitments and interest rate locks as a result of a favorable
movement in interest rates during the second quarter of 2001. Gains related to
the mark-to-market of forward commitments totaled $207,000 for the second
quarter of 2001 as compared to $12,000 for the same quarter this year. The Bank
does not currently have any outstanding forward commitments, nor does it expect
to acquire any significant amount in the forthcoming quarter. As a result, the
Bank does not anticipate any material gains or losses in the third quarter from
the mark-to-market of forward loan commitments. Also affecting non-interest
income were the gains from the capitalization of internally generated mortgage
servicing rights, which dropped from $92,000 to $1,000 due to a decline in the
amount of loans sold servicing retained. Loans sold with the servicing rights
retained by the Bank for the second quarter 2002 totaled $112,000 as compared to
$6.3 million for the same quarter last year.
Non-interest expense increased $199,000, or 15.3%, for the quarter as compared
to the second quarter of 2001. The rise was principally due to compensation and
legal expense. Compensation expense for this segment increased $100,000 for the
second quarter of 2002 as compared to the same quarter last year, largely as a
result of the opening of the Sales Finance Office in Jacksonville, FL (eastern
division) mid-year 2001 and the expansion and addition of new staff to the
western division. Legal expense related to the expansion of the Sales Finance
Division totaled $70,000 for the second quarter of 2002, up from $31,000 the
comparable quarter last year. The Bank expects legal costs directly related to
this area to decline in the second half of this year.
The year-to-date results are similar to the quarterly results. Net income
declined $13,000, from $554,000 in the six months ending June 30, 2001, to
$542,000 in 2002.
24
Net interest income after provision for loan losses for the first half of 2002
jumped $965,000, or 43% over the same period last year. The decline in interest
expense from $3.8 million for the period ended June 30, 2001, to $2.5 million
for the same period this year was the primary reason for the rise. With interest
rates on the decline over the past year, the Bank was able to significantly
reduce its interest expense Bank-wide.
Non-interest income declined $771,000, from $1,354,000 for the first six months
of 2001 to $583,000 in 2002. The change in non-interest income is largely
attributable to a $78 million bulk sale of servicing rights in the first quarter
of last year. The pre-tax gain from that sale totaled $891,000. There were no
comparable sales this year.
Non-interest expense, year-to-date, increased to $3.0 million for the first two
quarters of 2002 as compared to $2.5 million for the like period last year. The
$500,000 rise, similar to the results for the quarter, was associated with
compensation and legal expenses. The Sales Finance Department's expansion into
Florida added $161,000 in additional compensation costs this year. Also, legal
expenses related to the expansion of the Sales Finance Department escalated in
the first six months of 2002 to $82,000 as compared to $32,000 for the like
period last year.
COMMERCIAL LENDING
- ------------------
Net income for this business segment rose $174,000, or 13%, from $1,390,000 in
the second quarter of 2001 to $1,564,000 in the same quarter of 2002. Net
interest revenue after provision for loan loss grew $814,000 due to a
substantial decrease in interest expense. Offsetting the net interest revenue
increase was a rise in non-interest expense.
Net interest revenue, like the consumer segment, benefited from a dramatic
decline in interest rates over the past year. Interest income declined 10.0%
while interest expense for this segment dropped by 36%, or $1.7 million. At the
same time, assets continued to increase. Interest-earning assets totaled $435
million at June 30, 2002, as compared to $405 million a year ago.
Other operating income rose $72,000, or 32%, as contrasted with the second
quarter last year. This increase was mainly due to the rise in miscellaneous
loan fees such as loan prepayment and broker fees. Miscellaneous loan fees for
this segment amounted to $102,000 for the second quarter of 2002 compared to
$76,000 for the same period last year.
Operating expenses increased 31.2%, or $622,000, in the second quarter of 2002
as compared to the like quarter in 2001. Non-interest expense rose primarily
because of the growth in compensation costs resulting from the Bank's focus on
expansion of the Business Banking and Community Business Banking departments
over the past year. In addition, the commission plans in a number of areas have
been updated and as a result commission expense has increased. With the
increased staff in these areas, compensation expense is likely to rise over the
second half of 2002.
The trends, year-to-date, appear to be relatively similar to the results for the
quarter. Net income for the first six months of the year rose to $755,000, or
30% as compared to last year. Like the quarterly results, interest expense
decreased substantially, non-interest income declined, and operating expenses
increased.
Net interest income after provision for loan losses increased from $7.6 million
to $9.4 million, or $1.8 million. The decline in interest expense had the
largest impact, decreasing $3.4 million, or 36%. Declining interest rates again
benefited this segment.
Non-interest income increased $204,000 to $618,000 from $414,000 for the second
half of 2001. The increase is mainly attributable to the rise in miscellaneous
loan fees, which totaled $184,000 for the second half of 2002 as compared to
$119,000 for the like period in 2001.
25
Operating expenses increased $887,000, or 22%, during the six-month period ended
June 30, 2002, as compared to the same period last year. Escalating compensation
costs associated with the expansion of the Business Banking and Community
Business Banking areas contributed significantly to the increase.
INVESTMENT SECURITIES
- ---------------------
Net income increased for the investment securities segment, from $63,000 in the
second quarter of 2001 to $100,000 in 2002. This segment was affected by an
increase in net interest income, which was partially offset by a rise in
non-interest expense.
Net interest income jumped for this business segment, from $118,000 in the
second quarter of 2001 to $308,000 for the like quarter this year. The reason
for the increase is due to a significant decline in interest expense. Interest
expense totaled $1.5 million in the second quarter of 2001, declining $274,000,
or 17.7% as compared to the same quarter of this year. Additionally, the
securities portfolio increased from $97.8 million at June 30, 2001, to $108
million at the end of the second quarter of 2002.
Non-interest income increased from $174,000 in the three months ending June 30,
2001, to $187,000 in the same period this year. During the second quarter of
2002 the portion of the branch fee income that was allocated to this segment
rose due to an overall increase in fees from checking accounts.
Operating expenses jumped by $148,000 to $352,000 in the second quarter this
year. This increase is largely due to the manner in which the branch operating
expenses and the holding company expenses are allocated to each segment. The
amount of branch operating expense allocated to each segment is based on the
balance of the earning assets. At June 30, 2001, the earning assets balance for
the investment securities segment totaled $97.8 million as compared to $107.7
million at the end of the second quarter of 2002.
The year-to-date results for 2002 showed a decline of $309,000, or 91%, over the
comparable period last year. Although net interest income increased $101,000,
benefiting from a drop in interest expense of $919,000, it was more than offset
by a decline in non-interest income and a rise in operating expense.
Non-interest income for the first six months of 2002 totaled $211,000 as
compared to $672,000 last year. In the first quarter of 2001 the Bank, along
with other limited partners, sold its interest in an ATM network. The pre-tax
gain amounted to $422,000. There was no comparable sale this year. In addition,
gains from security sales in the first half of 2001 totaled $207,000 as compared
to $131,000 this year.
Operating expense rose $111,000, or 21%, on a year-to-year basis, due to the
allocation of increased overhead costs.
LIQUIDITY AND CAPITAL RESERVES
- ------------------------------
The net cash, as reported in the Statement of Cash Flows, decreased by $5.0
million in the first six months of 2002. Cash flows from principal repayments on
loans and securities, the net increase in deposits, and the issuance of Trust
Preferred Securities were offset by cash outflows for loan originations,
purchases of securities and repayments of FHLB advances.
Loan and security principal repayments contributed to the cash inflows. During
the first half of 2002, loan principal repayments totaled $92.8 million while
principal repayments and redemptions on mortgage-backed and other securities
amounted to $7.4 million. In addition, net deposits rose $46.2 million. Included
in the increase in deposits is the acquisition of approximately $17.0 million in
brokered deposits during the first quarter of 2002. During the second quarter
the Financial Holding Company formed First Mutual Capital Trust I in order to
issue Trust Preferred Securities. The $9.0 million issuance also contributed to
the inflow of cash. Offsetting the cash inflows was a greater cash outflow due
to the following activities.
26
Cash inflows were used mainly to fund loan originations, which amounted to
$123.7 million during the first half of 2002, and purchase mortgage-backed
securities, totaling $39.5 million. The Bank was also able to reduce its FHLB
borrowing balance by $22.4 million during the period.
In the third quarter this year the Bank plans to repurchase 1,019,000 shares of
its outstanding stock, at a cost of $15,798,000. Funding at the Holding Company
for that transaction will come from the $9 million of Trust Preferred
Securities, and a dividend from the subsidiary, First Mutual Bank.
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 23.5%, 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. At June
30, 2002, the Bank exceeded the capital levels required to meet the definition
of a well-capitalized institution:
For Capital "Well
Adequacy Capitalized"
Actual Minimum Minimum Ratio
------ ------- -------------
Total capital (to risk-weighted assets):
First Mutual Bancshares, Inc. 13.49% 8.00% 10.00%
First Mutual Bank 11.74 8.00 10.00
Tier I capital (to risk-weighted assets):
First Mutual Bancshares, Inc. 12.24 4.00 6.00
First Mutual Bank 10.49 4.00 6.00
Tier I capital (to average assets):
First Mutual Bancshares, Inc. 9.12 4.00 5.00
First Mutual Bank 7.82 4.00 5.00
The capital levels in the second quarter increased principally because of the
issuance of $9 million in Trust Preferred Securities. In the third quarter, as a
result of the share repurchase, capital will decrease by $15,798,000. The effect
of that repurchase, using the June 30, 2002 capital and asset structure, would
have been to reduce "total capital to risk-adjusted assets" from 13.49% to
10.49%, "Tier I capital to risk-adjusted assets" from 12.24% to 9.24%, and "Tier
I capital to average assets" from 9.12% to 6.88%. The actual capital ratio at
the end of the third quarter will depend on the size and mix of assets, and the
growth in retained earnings.
BRANCH CLOSURE AND EXPANSION
- ----------------------------
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.
27
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.
TRUST PREFERRED SECURITIES ISSUANCE
- -----------------------------------
During the second quarter of 2002 the Financial Holding Company formed a
subsidiary whose sole purpose was to issue $9.0 million in Trust Preferred
Securities through a pool sponsored by Bear Stearns & Co. Inc., Regional
Advisor's Alliance and other brokers. Under the terms of the transaction the
Trust Preferred Securities will have a maturity of 30 years and are redeemable
after five years with certain exceptions. The floating-rate securities have a
5.52% interest rate, which will reset quarterly at the three-month LIBOR rate
plus 3.65%. The Trust Preferred Securities will be recorded as a liability on
the Statement of Financial Condition, but are expected to qualify as Tier I
capital for regulatory capital purposes. The proceeds from the offering will be
used to fund the stock repurchase of approximately 20% of the shares
outstanding.
In connection with the Trust Preferred Securities issuance, the Bank entered
into a swap agreement with the Federal Home Loan Bank of Seattle (FHLB) in order
to fix the interest rate on the issuance. Under the terms of the swap agreement,
the Bank receives the equivalent of three-month LIBOR and pays the FHLB a fixed
rate of interest equal to the five-year swap curve, as of the trade date, based
upon the notional value of the contract. This transaction is intended to be a
highly effective cash flow hedge as defined by FAS No. 133, ACCOUNTING FOR
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following table sets forth certain information regarding carrying values and
percentage of total carrying values of the Company's consolidated portfolio of
securities classified as available-for-sale and held-to-maturity (in thousands).
At June 30,
------------------------------------------------------------------------
2002 2001
---------------------------------- ----------------------------------
AVAILABLE-FOR-SALE: Carrying Value Percent of Total Carrying Value Percent of Total
- ------------------- ---------------------------------- ----------------------------------
Mortgage backed securities:
Ginnie Mae $ -- 0% $ 1,547 6%
Freddie Mac 5,172 7% 373 1%
Fannie Mae (includes FNMA stock) 68,191 93% 26,416 93%
---------------------------------- ----------------------------------
Total mortgage-backed securities 73,363 100% 28,336 100%
---------------------------------- ----------------------------------
TOTAL SECURITIES AVAILABLE-FOR-SALE $ 73,363 100% $ 28,336 100%
---------------------------------------------------------------------------------- ----------------------------------
At June 30,
------------------------------------------------------------------------
2002 2001
---------------------------------- ----------------------------------
HELD-TO-MATURITY: Carrying Value Percent of Total Carrying Value Percent of Total
- ----------------- ---------------------------------- ----------------------------------
US Government Treasury and agency obligations $ -- 0% $ 26,670 44%
Municipal Bonds 1,343 6% 1,117 2%
Corporate Bonds -- 0% 2,517 4%
Mortgage backed securities:
Freddie Mac 1,027 5% 1,410 2%
Fannie Mae 19,430 89% 29,228 48%
---------------------------------- ----------------------------------
Total mortgage-backed securities 20,457 94% 30,638 50%
CMO's 44 0% 230 0%
---------------------------------- ----------------------------------
TOTAL SECURITIES HELD-TO-MATURITY $ 21,844 100% $ 61,172 100%
---------------------------------------------------------------------------------- ----------------------------------
ESTIMATED MARKET VALUE $ 22,535 $ 61,851
----------------------------------------------------------- -----------
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 June 30, 2002
- -------------------------------------------------------------------------------------------------------------------------------
Over One to Over Three to
One Year or Less Three Years Five Years
- -------------------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
- -------------------------------------------------------------------------------------------------------------------------------
AVAILABLE-FOR-SALE:
Mortgage backed securities:
Freddie Mac $ 368 6.46% $ -- 0.00% $ -- 0.00%
Fannie Mae 755 6.10% -- 0.00% -- 0.00%
----- ----- ----- ----- ----- -----
Total mortgage-backed securities 1,123 6.22% -- 0.00% -- 0.00%
----------------------------------------------------------------------
Total securities available-for-sale -- Carrying Value $ 1,123 6.22% $ -- 0.00% $ -- 0.00%
======================================================================
Total securities available-for-sale -- Amortized Cost $ 1,088 6.22% $ -- 0.00% $ -- 0.00%
=====================================================================
Available-for-sale at June 30, 2002
- -------------------------------------------------------------------------------------------------------------------------------
Over Five to Over Ten to
Ten Years Twenty Years Over Twenty Years
- -------------------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
- -------------------------------------------------------------------------------------------------------------------------------
AVAILABLE-FOR-SALE:
Mortgage backed securities:
Freddie Mac $ 4,804 5.50% $ -- 0.00% $ -- 0.00%
Fannie Mae 33,812 5.51% 16,703 5.77% 16,921 5.94%
------- ----- ------- ----- ------- -----
Total mortgage-backed securities 38,616 5.51% 16,703 5.77% 16,921 5.94%
----------------------------------------------------------------------
Total securities available-for-sale -- Carrying Value $38,616 5.51% $16,703 5.77% $16,921 5.94%
======================================================================
Total securities available-for-sale -- Amortized Cost $37,950 5.51% $16,657 5.77% $16,797 5.93%
======================================================================
Available-for-sale at June 30, 2002
- -------------------------------------------------------------------------------
Total
- -------------------------------------------------------------------------------
Weighted
Carrying Average
Value Yield
- -------------------------------------------------------------------------------
AVAILABLE-FOR-SALE:
Mortgage backed securities:
Freddie Mac $ 5,172 5.57%
Fannie Mae 68,191 5.68%
------- -----
Total mortgage-backed securities 73,363 5.68%
----------------------
Total securities available-for-sale -- Carrying Value $ 73,363 5.68%
======================
Total securities available-for-sale -- Amortized Cost $ 72,492 5.68%
======================
Held-to-Maturity at June 30, 2002
- -------------------------------------------------------------------------------------------------------------------------------
Over One to Over Three to
One Year or Less Three Years Five Years
- -------------------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
- -------------------------------------------------------------------------------------------------------------------------------
HELD-TO-MATURITY:
Municipal Bonds $ -- 0.00% $ -- 0.00% $ -- 0.00%
Mortgage backed securities:
Freddie Mac 1,027 4.99% -- 0.00% -- 0.00%
Fannie Mae 3,881 6.68% 73 6.50% 12,686 5.63%
------ ----- --- ----- ------- -----
Total mortgage-backed securities 4,908 6.33% 73 6.50% 12,686 5.63%
CMO's -- 0.00% -- 0.00% -- 0.00%
----------------------------------------------------------------------
Total securities held-to-maturity -- Carrying Value $ 4,908 6.33% $ 73 6.50% $ 12,686 5.63%
======================================================================
Total securities held-to-maturity -- Fair Market Value $ 5,081 6.34% $ 75 6.50% $ 13,116 5.63%
======================================================================
Held-to-Maturity at June 30, 2002
- -------------------------------------------------------------------------------------------------------------------------------
Over Five to Over Ten to
Ten Years Twenty Years Over Twenty Years
- -------------------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
- -------------------------------------------------------------------------------------------------------------------------------
HELD-TO-MATURITY:
Municipal Bonds $ -- 0.00% $ 220 5.38% $ 1,123 6.16%
Mortgage backed securities:
Freddie Mac -- 0.00% -- 0.00% -- 0.00%
Fannie Mae 2,613 5.50% -- 0.00% 177 7.50%
------ ----- ---- ----- ---- -----
Total mortgage-backed securities 2,613 5.50% -- 0.00% 177 7.50%
CMO's -- 0.00% 44 6.50% -- 0.00%
----------------------------------------------------------------------
Total securities held-to-maturity -- Carrying Value $ 2,613 5.50% $ 264 5.56% $ 1,300 6.34%
======================================================================
Total securities held-to-maturity -- Fair Market Value $ 2,695 5.50% $ 261 5.57% $ 1,307 6.35%
======================================================================
Held-to-Maturity at June 30, 2002
- -------------------------------------------------------------------------------
Total
- -------------------------------------------------------------------------------
Weighted
Carrying Average
Value Yield
- -------------------------------------------------------------------------------
HELD-TO-MATURITY:
Municipal Bonds $ 1,343 6.03%
Mortgage backed securities:
Freddie Mac 1,027 4.99%
Fannie Mae 19,430 5.84%
------- -----
Total mortgage-backed securities 20,457 5.80%
CMO's 44 6.50%
----------------------
Total securities held-to-maturity -- Carrying Value $ 21,844 5.81%
======================
Total securities held-to-maturity -- Fair Market Value $ 22,535 5.82%
======================
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
28
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. 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 Bank has discontinued the use of the rate shock model to measure simulated
changes in its net interest income and the economic value of equity. Management
believes that the rate ramp model produces more meaningful results that more
closely track actual Bank performance. The difference between the two models is
the assumption regarding the timing of the interest rate increases or decreases.
The rate shock model assumes rates immediately rise or fall 100, 200, or 300
basis points, whereas the rate ramp assumes a steady increase over a 12-month
period. All numbers presented from this point forward will reflect the results
of the rate ramp model.
The Bank's simulation model and its gap analysis results for the periods ending
June 30, 2002, and December 31, 2001, are presented below.
ONE-YEAR INTEREST RATE SENSITIVE GAP
------------------------------------
(in thousands)
June 30, December 31,
2002 2001
------------ ------------
One-year repricing assets $ 538,840 $ 506,458
One-year repricing liabilities 432,742 413,279
------------ ------------
One-year gap $ 106,098 $ 93,179
------------ ------------
Total assets $ 718,731 $ 678,349
============ ============
One year interest rate sensitive
gap as a percent of assets 14.8% 13.7%
29
FIRST MUTUAL BANCSHARES, INC.
RATE RAMP ESTIMATES
Net Interest Income and Net Market Value
June 30, 2002 December 31, 2001
Percentage Change Percentage Change
- --------------------------------------------------------------------------------
Gradual Net Net Net Net
Change in Interest Market Interest Market
Interest Rates Income Value Income Value
- -------------- -------- ------- -------- -------
+300 2 % (17) % (1) % (15) %
+200 0 (13) (1) (12)
+100 0 (6) 0 (5)
-100 (1) 1 (1) (2)
-200 (2) 1 (3) (7)
-300 (4) (3) (7) (13)
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
15.3% 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.
30
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
At June 30, 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 AND USE OF PROCEEDS
(a) On July 12, 2002, the Company issued a $9 million Floating Rate Junior
Subordinated Deferrable Interest Debenture due June 30, 2032, to a
business trust subsidiary which issued $9 million in Trust Preferred
Securities based upon this Debenture and a guarantee from the Company.
Interest is payable quarterly at a rate of 3.65% above the three-month
LIBOR rate. The Debenture matures on June 30, 2032, and may be
redeemed on or after June 30, 2007, or if certain conditions are met.
The Debenture and Trust Preferred Securities provide that we have the
right to elect to defer the payment of interest on the Debenture and
Trust Preferred Securities for up to an aggregate of 20 quarterly
periods; however, if the Company should defer the payment of interest
or default on the payment of interest on the Debenture, we may not
declare or pay any dividends on our common stock during any such
period. We paid a placement fee of $270,000 plus certain expenses to
SAMCO Capital Markets in connection with the placement of the Trust
Preferred Securities. The issuance of the Debenture and the Trust
Preferred Securities were exempt from registration under the
Securities Act pursuant to Section 4(2) there under. We will utilize
the proceeds of the Debenture in connection with our repurchase of
approximately 20% of our common stock from MGN Group LLC, as described
in our 8-K filed June 3, 2002.
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
31
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(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, incorporated by reference to the Report on Form 10-Q
filed with the SEC on May 13, 2002.
(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.
(99) Certification of CEO and CFO.
(b) Reports on Form 8-K
8-K filed June 3, 2002 attaching press release announcing stock
repurchase agreement
32
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: August 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 - Chief Financial Officer
(Principal Financial Officer)
33