|
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 bank 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 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 12 full-service retail banking
centers located in Bellevue (3), Issaquah, Kirkland (2), Monroe, Redmond,
Sammamish, Seattle (2), and Woodinville. We also have consumer loan
offices located in Orange Park, Florida and Mt. Clemens,
Michigan. 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.
OVERVIEW
For
the
third quarter and first nine months of 2007, our net income declined
significantly relative to the same periods last year, totaling $1.9 million
and
$6.4 million, down from $3.0 million and $8.4 million for the quarter and
nine
months ended September 30, 2006. Our earnings per diluted share fell
to $0.28 and $0.92, compared to $0.43 and $1.23 per diluted share in the
third
quarter and first nine months of last year, while return on average equity
(ROE)
totaled 10.42% for the quarter and 11.74% on a year-to-date basis, compared
to
18.29% and 17.74% in the prior year, respectively.
On
July
2, 2007, we announced that we had entered into a definitive merger agreement
with Washington Federal, Inc. (NASDAQ: WFSL) which provides, subject to
certain
conditions, for a merger of First Mutual with and into Washington
Federal. Our performance for the second and third quarters was
negatively impacted by expenses related to this transaction, including
third
quarter expenditures for merger-related legal and other services, a penalty
for
the cancellation of a commitment to issue $9 million in new trust preferred
securities, and retention bonuses paid to our former CFO for remaining
with the
Bank past his scheduled April 2007 retirement date.
The
primary source of revenue for each of our business lines is net interest
income. For the third quarter and first nine months of 2007, our net
interest income totaled $9.3 million and $27.5 million, down $902,000 and
$2.9
million from the levels earned in the prior year. A key driver of net
interest income is the level of our earning assets, which declined relative
to
the prior year, averaging $954 million for the quarter, down from $1,036
million
in the third quarter of last year. The drop in earning assets was due largely
to
securities sales, which reduced the size of the
portfolio
as of September 30, 2007 by nearly $75 million compared to the level at
the
September 2006 quarter-end. Also contributing to the decline in
earning assets was a substantial reduction in loan originations, which
fell from
$400 million through the first three quarters of last year to $353 million
in
the first nine months of 2007, combined with continued high levels of loan
payoffs and sales. Please see the “Net Interest Income” and “Business
Segments” sections for further discussions of net interest income and earning
assets.
A
secondary source of revenue is our noninterest income, which declined $656,000
compared to the third quarter of last year, based on a substantial reduction
in
consumer loan sales during the quarter as market demand for these loans
softened. Based on the higher levels of sales in the first half of
this year, as well as higher levels of loan servicing fee income, noninterest
income through the first nine months of the year still outpaced the prior
year
by approximately $366,000. Please see the “Noninterest Income”
section for additional discussion.
Despite
the unique expenses mentioned above, our operating expenses declined $140,000
relative to the third quarter of last year, and increased by only $314,000
on a
year-to-date basis, as reductions in occupancy and credit insurance expenses
partially offset increases in other noninterest expenses. Please
refer to the “Noninterest Expense” section for additional
information.
For
the
quarter ended September 30, 2007, our credit quality remained acceptable,
with
non-performing assets (NPAs) totaling $3.2 million, or 0.31% of total assets,
little changed compared to the similar $3.5 million, or 0.32% at the 2006
year-end. For the quarter, we reserved $449,000 in provisions for
loan losses and our reserve for loan losses, including unfunded commitments,
totaled approximately $10.2 million, which was again little changed compared
to
$10.1 million at the year-end level. The allowance for loan losses
represented 1.12% of gross loans at the quarter-end, up from 1.11% at the
2006
year-end. For additional information regarding our credit quality
please refer to the “Asset Quality” section.
RESULTS
OF OPERATIONS
Net
Income
Net
income declined nearly $1.1 million or approximately 35% for the third
quarter
of 2007 as compared to the same quarter last year, while year-to-date net
income
fell $2.0 million or 24% relative to last year. Net interest income
declined $902,000 for the quarter and $2.9 million for the first nine months
of
2007, while noninterest income fell $656,000 for the quarter but improved
$366,000 on a year-to-date basis, and noninterest expense declined $140,000
for
the quarter but increased $314,000 for the first nine months of the
year.
Net
Interest
Income
For
the
quarter and nine months ended September 30, 2007, our net interest income
declined $902,000 and $2.9 million relative to the same periods last
year. The net effects of asset and liability repricing negatively
impacted net interest income for both periods, while changes in the levels
and
mix of earning assets and funding sources positively impacted net interest
income for both the quarter and nine month periods. The following
table illustrates the impacts to our net interest income from our level
of
earning assets and rate changes on our assets and liabilities, with the
results
attributable to asset levels classified as “volume” and the effect of asset and
liability repricing labeled “rate.”
Rate/Volume
Analysis
|
|
|
Quarter
Ended
September
30, 2007 vs. September 30, 2006
Increase/(Decrease)
due to
|
|
|
Nine
Months Ended
September
30, 2007 vs. September 30, 2006
Increase/(Decrease)
due to
|
|
|
|
|
Volume
|
|
|
Rate
|
|
|
Total
|
|
|
Volume
|
|
|
Rate
|
|
|
Total
|
|
|
Interest
Income
|
|
(Dollars
in thousands)
|
|
|
Total
Investments
|
|
$
|
(715
|
)
|
|
$
|
29
|
|
|
$
|
(686
|
)
|
|
$
|
(670
|
)
|
|
$
|
37
|
|
|
$
|
(633
|
)
|
|
Total
Loans
|
|
|
(924
|
)
|
|
|
(11
|
)
|
|
|
(935
|
)
|
|
|
(1,794
|
)
|
|
|
1,386
|
|
|
|
(408
|
)
|
|
Total
Interest Income
|
|
$
|
(1,639
|
)
|
|
$
|
18
|
|
|
$
|
(1,621
|
)
|
|
$
|
(2,464
|
)
|
|
$
|
1,423
|
|
|
$
|
(1,041
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Deposits
|
|
|
(247
|
)
|
|
|
879
|
|
|
|
632
|
|
|
|
(350
|
)
|
|
|
3,816
|
|
|
|
3,466
|
|
|
FHLB
and Other
|
|
|
(1,620
|
)
|
|
|
269
|
|
|
|
(1,351
|
)
|
|
|
(3,152
|
)
|
|
|
1,591
|
|
|
|
(1,561
|
)
|
|
Total
Interest Expense
|
|
$
|
(1,867
|
)
|
|
$
|
1,148
|
|
|
$
|
(719
|
)
|
|
$
|
(3,502
|
)
|
|
$
|
5,407
|
|
|
$
|
1,905
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Interest Income
|
|
$
|
228
|
|
|
$
|
(1,130
|
)
|
|
$
|
(902
|
)
|
|
$
|
1,038
|
|
|
$
|
(3,984
|
)
|
|
$
|
(2,946
|
)
|
Earning
Asset Growth (Volume)
For
the
third quarter and first nine months of 2007, declines in our levels of
earning
assets resulted in reductions of $1.6 million and $2.5 million in interest
income relative to the same periods last year. More than offsetting
these reductions, however, were lower levels of interest expense resulting
from
the elimination of funding sources previously needed to accommodate asset
levels. Consequently, the net impacts of earning asset levels were an
improvement in third-quarter net interest income of approximately $228,000
and a
year-to-date improvement of $1.0 million compared to the first nine months
of
2006.
|
Quarter
Ending
|
Earning
Assets
|
Net
Loans (incl.LHFS)
|
Deposits
|
|
|
(Dollars
in thousands)
|
|
September
30, 2006
|
$
1,034,332
|
$
919,837
|
$
774,914
|
|
December
31, 2006
|
$
1,012,896
|
$
897,436
|
$
805,795
|
|
March
31, 2007
|
$ 995,058
|
$
881,849
|
$
771,659
|
|
June
30, 2007
|
$ 962,998
|
$
878,490
|
$
759,786
|
|
September
30, 2007
|
$ 944,195
|
$
902,669
|
$
750,675
|
As
can be
seen in the table above, our overall levels of deposits and earning assets
have
exhibited declining trends over the last several quarters, as had our loan
portfolio prior to the most recent quarter.
Driving
the decline in earning assets, the balance of our securities portfolio
(including trading, available-for-sale, and held-to-maturity securities)
totaled
approximately $25 million as of September 30, 2007, down from its year-end
2006
and second-quarter 2007 levels of $95 million and $67 million,
respectively. The portfolio contraction followed significant trading
volumes and portfolio turnover resulting from our election to early adopt
SFAS
159.
Following
the end of the first quarter, we sold several longer-maturity securities
from
the newly established trading portfolio, replaced the sold issues with
approximately $34 million in shorter-term hybrid ARM securities, and began
evaluating the potential risks and benefits of employing strategies to
hedge
against movements in the market value of the trading portfolio. In the
first
week of May, based on the earnings volatility presented by the new accounting
treatment, we elected to proceed with a plan to reduce the volatility of
the
portfolio by reselling these recently purchased securities, leaving the
portfolio at a smaller size than that at which it began the
quarter.
Based
on
our observations of the portfolio and hedge over the remainder of the second
quarter, we elected to further reduce the size of the portfolio in the
third
quarter. Consequently, in early July we sold securities with market
values totaling approximately $41 million, leaving the portfolio at
approximately its current size, and unwound the hedge position established
in
mid-May. At the present time, we do not anticipate conducting any
further securities transactions.
Through
the first three quarters of this year, we experienced declines in our income
property and residential construction loans, while balances of business
banking
loans, commercial construction, consumer, and single-family permanent loans
ended the third quarter at levels higher than those observed at the 2006
year-end. Additionally, while consumer loan balances declined during the
first
half of the year, they did so largely as a result of high loan sales volumes,
which totaled approximately $30 million for the first two quarters of the
year. Were it not for these sales, growth would likely have been
observed in this portfolio segment as well, as it was in the most recent
quarter
with sales totaling less than $6 million.
On
the
liabilities side of the balance sheet, our total deposit balances declined
$55
million, or approximately 7% in the first nine months of the year, including
$9
million in the most recent quarter. Our non-maturity deposit balances
grew more than $21 million through the first three quarters of the year,
with
more than $4 million occurring in the most recent quarter, while time deposits,
including certificates issued through brokerage services, declined $76
million,
with nearly $14 million occurring in the third quarter. Brokered
certificates of deposit accounted for approximately $36 million of the
year-to-date reduction, including $2 million in the third
quarter. The decrease in retail certificate balances occurred as we
attempted to move away from offering rates competitive with the higher
rates in
the local market. While this has resulted in some of the more rate-sensitive
depositors exiting the Bank for higher rates elsewhere, most of these funds
have
remained on our books at lower costs to the Bank.
Asset
Yields and Funding Costs (Rate)
|
Quarter
Ended
|
Net
Interest Margin
|
|
September
30, 2006
|
3.94%
|
|
December
31, 2006
|
3.78%
|
|
March
31, 2007
|
3.73%
|
|
June
30, 2007
|
3.62%
|
|
September
30, 2007
|
3.90%
|
While
the
effects of interest rate movements and repricing on our loan portfolio
negatively impacted the income earned on our loan portfolio by $11,000
for the
third quarter, repricing accounted for an additional $1.4 million in interest
income relative to last year on a year-to-date
basis. Adjustable-rate
loans, which reprice according to terms specified in our loan agreements
with
the borrowers, accounted for approximately 74% of our loan portfolio as
of
September 30, 2007, down from 80% at the 2006 year-end.
On
the
liability side of the balance sheet, however, the effects of interest rate
movements and repricing were more pronounced, increasing our interest expense
on
deposits and wholesale funding by more than $1.1 million for the quarter
and
$5.4 million on a year-to-date basis. As a result, for the third
quarter and first nine months of 2007, the net effects of rate movements
and
repricing negatively impacted our net interest income by $1.1 million and
$4.0
million relative to the same periods in the prior year, as the large volumes
of
maturing/repricing liabilities resulted in a greater increase in liability
costs
than was observed for asset yields.
Noninterest
Income
Relative
to the third quarter of last year, our noninterest income fell $656,000,
or
approximately 28%, as a result of a substantial reduction in consumer loan
sales
and resulting gains thereon. On a year-to-date basis, noninterest
income increased by approximately 6%, or $366,000 as compared to the prior
year,
based on a comparable level of loan sales and higher servicing fee
income.
SFAS
No. 157 and 159 Related Gains/(Losses)
Effective
January 1, 2007, we elected early adoption of SFAS No. 157 and 159, which
generally permit the mark-to-market of selected eligible financial
instruments. In our case, we elected to apply the standards to
certain investments held in our securities portfolio and a $9 million long
term
debenture payable (trust preferred security). With the early
adoption, we recorded total pre-tax, SFAS No. 159-related, mark-to-market
gains
of $447,000 for the first quarter. In the second quarter, however, we
experienced net SFAS No. 159-related losses totaling $211,000 resulting
primarily from adverse movements in the prices of our
securities. This net loss reflected the partial offset from a
$244,000 gain on a hedge position against those securities, which had been
established in the second week of May.
Based
on
our observations of the portfolio and hedge, we elected to further reduce
the
size of the portfolio and unwind the hedge position. Consequently, in
early July we sold securities with market values totaling approximately
$41
million and unwound the hedge position, which resulted in gains on sale
totaling
$69,000 for the quarter, bringing our year-to-date gains on securities
sales to
$185,000. With these transactions completed in mid-July, our net SFAS No.
159-related losses for the third quarter totaled $119,000, resulting in
a net
year-to-date SFAS No. 159-related gain of $117,000. At the present
time, we do not anticipate conducting any further securities
transactions.
Gains/(Losses)
on Sales of Loans
|
|
|
Quarter
Ended September 30,
|
|
|
Nine
Months Ended September 30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Gains/(Losses)
on Sales:
|
|
|
|
|
|
|
|
|
|
|
|
Consumer
|
|
$
|
238,000
|
|
|
$
|
784,000
|
|
|
$
|
1,917,000
|
|
|
$
|
1,962,000
|
|
|
Residential
|
|
|
(34,000
|
)
|
|
|
69,000
|
|
|
|
80,000
|
|
|
|
68,000
|
|
|
Commercial
|
|
|
37,000
|
|
|
|
62,000
|
|
|
|
90,000
|
|
|
|
195,000
|
|
|
Total
Gains on Loan Sales
|
|
$
|
241,000
|
|
|
$
|
915,000
|
|
|
$
|
2,087,000
|
|
|
$
|
2,225,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
Sold:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer
|
|
$
|
5,511,000
|
|
|
$
|
17,987,000
|
|
|
$
|
35,525,000
|
|
|
$
|
41,030,000
|
|
|
Residential
|
|
|
10,783,000
|
|
|
|
12,701,000
|
|
|
|
42,581,000
|
|
|
|
35,814,000
|
|
|
Commercial
|
|
|
10,244,000
|
|
|
|
6,382,000
|
|
|
|
14,300,000
|
|
|
|
11,574,000
|
|
|
Total
Loans Sold
|
|
$
|
26,538,000
|
|
|
$
|
37,070,000
|
|
|
$
|
92,406,000
|
|
|
$
|
88,418,000
|
|
Contrary
to the trend observed over the last several quarters, our third quarter
gains on
loan sales declined significantly relative to the prior year based on a
substantial reduction in sales of our consumer loans. Following sales
of $30 million in the first half of 2007, sales of consumer loan sales
totaled
less than $6 million for the third quarter due to a softening in market
demand. Based on uncertainties of the marketplace we are not offering
a forecast for anticipated loan sales at this time.
Following
an absence of commercial real estate loan sales in the first quarter of
2007, we
sold participations in commercial real estate loans during the second and
third
quarters, though gains trailed their year-ago levels. Commercial real
estate loan transactions, particularly those that are candidates for sales
of
participations to other institutions, tend to be larger-dollar credits
and
unpredictable in their timing and frequency of occurrence. As a result,
the
volumes of commercial real estate loans sold, and gains thereon, can be
expected
to vary considerably from one quarter to the next depending on the timing
of the
loan and sales transactions.
Compared
to the markets for our consumer and commercial loan sales, the market for
residential loan sales is significantly larger and more efficient. As a
result,
residential loan sales are typically sold for very modest gains or potentially
even slight losses when interest rates are rising quickly. We believe the
construction phase to be the most profitable facet of residential lending
and
the primary objective in a residential lending relationship. Following
the
construction process, our practice is to retain in our portfolio those
residential mortgages that we consider to be beneficial to the Bank, but
to sell
those that we consider less attractive assets. Included in these less attractive
assets would be those mortgages with fixed rates, which we offer for competitive
reasons. Additionally, as residential loans are typically sold servicing
released, sales do not generally result in future servicing
income.
Service
Fee Income/(Expense)
|
|
|
Quarter
Ended September 30,
|
|
|
Nine
Months Ended September 30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Consumer
Loans
|
|
$
|
428,000
|
|
|
$
|
300,000
|
|
|
$
|
1,320,000
|
|
|
$
|
930,000
|
|
|
Commercial
Loans
|
|
|
2,000
|
|
|
|
0
|
|
|
|
(59,000
|
)
|
|
|
9,000
|
|
|
Residential
Loans
|
|
|
2,000
|
|
|
|
(3,000
|
)
|
|
|
7,000
|
|
|
|
(7,000
|
)
|
|
Service
Fee Income
|
|
$
|
432,000
|
|
|
$
|
297,000
|
|
|
$
|
1,268,000
|
|
|
$
|
932,000
|
|
Our
servicing fee income rose 45% from the level earned in the third quarter
of last
year and 36% on a year-to-date basis, as income from consumer loans serviced
for
other institutions increased in response to higher levels of loan sales
in late
2006 and the first half of 2007. Servicing fee income represents the
net of servicing income received less the amortization of servicing assets,
which are recorded when we sell loans from our portfolio to other investors.
The
values of these servicing assets are determined at the time of the sale
using a
valuation model that calculates the present value of future cash flows
for the
loans sold, including cash flows related to the servicing of the loans.
The
servicing asset is recorded based on fair value. The servicing rights are
then
amortized in proportion to, and over the period of, the estimated future
servicing income.
For
the
third quarter and first nine months of 2007, service fee income earned
on
consumer loans serviced for other investors exceeded that earned in the
same
periods of the prior year by 43% and 42%. This improvement was based on
a
significant increase in the balances of consumer loans serviced, which
was in
turn a product of the increased volume of loan sales in 2006 and the first
half
of 2007.
In
the
case of commercial loans, a minimal level of servicing income was earned
during
the third quarter, while on a year-to-date basis, payoffs during the first
half
of the year of balances sold to and serviced for other institutional investors
required us to immediately write-off the related servicing assets, which
resulted in the loss presented above.
In
contrast to consumer and commercial loans, residential loans are typically
sold
servicing released, which means we no longer service those loans once they
are
sold. Consequently, we do not view these loans as a significant source
of
servicing fee income.
Fees
on Deposits
Fee
income earned on deposit accounts rose by $12,000 and $32,000, both
approximately 6%, compared to the third quarter and first nine months of
last
year, based primarily on a higher level of checking account service
charges. This source of fee income has grown as we have continued our
efforts to expand our base of business and consumer checking
accounts.
Other
Noninterest Income
|
|
|
Quarter
Ended September 30,
|
|
|
Nine
Months Ended September 30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
ATM/Wire/Safe
Deposit
Fees
|
|
$
|
95,000
|
|
|
$
|
87,000
|
|
|
$
|
280,000
|
|
|
$
|
241,000
|
|
|
Late
Charges
|
|
|
92,000
|
|
|
|
73,000
|
|
|
|
236,000
|
|
|
|
189,000
|
|
|
Loan
Fee Income
|
|
|
298,000
|
|
|
|
294,000
|
|
|
|
697,000
|
|
|
|
545,000
|
|
|
Rental
Income
|
|
|
198,000
|
|
|
|
192,000
|
|
|
|
554,000
|
|
|
|
535,000
|
|
|
Miscellaneous
|
|
|
155,000
|
|
|
|
270,000
|
|
|
|
435,000
|
|
|
|
857,000
|
|
|
Other
Noninterest
Income
|
|
$
|
838,000
|
|
|
$
|
916,000
|
|
|
$
|
2,202,000
|
|
|
$
|
2,367,000
|
|
Our
noninterest income from sources other than those described earlier declined
$78,000, or 9% for the quarter and $165,000, or 7% on a year-to-date basis
relative to the same periods last year.
We
continued to observe growth in our ATM/Wire/Safe Deposit Fees, which totaled
$95,000 for the quarter and $280,000 on a year-to-date basis, representing
increases of 10% and 16% over the same periods last year. Most of
this growth is attributable to Visa and ATM fee income, which we expect
to
continue rising as checking accounts become a greater piece of our overall
deposit mix.
Late
charges earned from our loan portfolio increased 26% and 24% relative to
the
third quarter and first nine months of 2006 based on higher fees collected
from
real estate loans.
Income
received from miscellaneous sources declined significantly relative to
both the
third quarter and first nine months of last year. For the quarter,
the decline was largely a result of changes in the market values of interest
rate derivative contracts. These derivatives are utilized to hedge
interest rate risk associated with extending longer-term, fixed-rate periods
on
commercial real-estate loans, and structured such that a gain on any given
derivative is matched against a nearly identical loss on an offsetting
derivative, reflected in our miscellaneous operating expense category,
resulting
in essentially no net earnings impact to the Bank. In the third
quarter and first nine months of last year, appreciation in the market
values of
these instruments resulted in noninterest income totaling $190,000 and
$240,000
compared to $77,000 and $181,000 in the same periods this year. These
changes in the market values of the positions were largely offset by similar
levels of expense reflected in our miscellaneous operating expense
category. Accounting rules require any change in the market value of
such instruments to be reflected in the current period income.
Also
contributing to the significant year-to-date decline in miscellaneous income
was
a unique item that occurred in the second quarter of 2006, specifically
the
receipt of $400,000 in insurance proceeds from a key-man life insurance
policy.
Partially
offsetting these declines, loan fee income increased on a year-to-date
basis
compared to the prior year based on higher levels of prepayment penalties
and
non-deferred loan fees. These typically include fees collected in connection
with loan modifications or extensions, non-conversion of construction loans
to
permanent mortgages, and letters of credit originated for commercial
borrowers.
Noninterest
Expense
Noninterest
expense for the third quarter declined $140,000, or 2% relative to the
same
period last year, but increased $314,000, or slightly more than 1% on a
year-to-date basis.
Salaries
and Employee Benefits Expense
Our
personnel-related expenses remained well contained in the first nine months
of
2007, with no change observed for the third quarter relative to the prior
year
and an increase of less than 2% on a year-to-date basis.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter
Ended September 30,
|
|
|
Nine
Months Ended September 30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Salaries
|
|
$
|
2,982,000
|
|
|
$
|
3,077,000
|
|
|
$
|
9,381,000
|
|
|
$
|
9,044,000
|
|
|
Commissions
and
Incentives
|
|
|
668,000
|
|
|
|
506,000
|
|
|
|
1,857,000
|
|
|
|
1,680,000
|
|
|
Employment
Taxes
and
Insurance
|
|
|
215,000
|
|
|
|
225,000
|
|
|
|
773,000
|
|
|
|
793,000
|
|
|
Temporary
Office
Help
|
|
|
72,000
|
|
|
|
24,000
|
|
|
|
222,000
|
|
|
|
178,000
|
|
|
Benefits
|
|
|
414,000
|
|
|
|
520,000
|
|
|
|
1,244,000
|
|
|
|
1,580,000
|
|
|
Total
|
|
$
|
4,351,000
|
|
|
$
|
4,352,000
|
|
|
$
|
13,477,000
|
|
|
$
|
13,275,000
|
|
While
annual increases in staff salaries resulted in higher expense on a year-to-date
basis, regular employee salary expense actually declined from $2,583,000
in the
third quarter of last year to $2,504,000 this year based primarily on employee
attrition and non-replacement since the announcement of the Washington
Federal
acquisition.
Also
contributing to the year-to-date increase in salary expense were certain
merger-related items that impacted the second quarter. Specifically,
Directors’ compensation increased $124,000 for the second quarter as compared to
the prior year, primarily as a result of a $100,000 payment to one of our
directors for consulting services regarding the upcoming Washington Federal
acquisition.
Among
the
categories of incentive compensation, loan officer commissions increased
$51,000
for the quarter but declined $147,000 on a year-to-date basis based largely
on
loan origination volumes exceeding the prior year for the third quarter,
but
lagging for the year-to-date period. Other incentive compensation
rose $101,000 for the quarter and $370,000 through the first nine months
of the
year based primarily on retention bonuses paid to our former CFO in the
second
and third quarters for staying on past his retirement date.
Expenditures
for temporary office help increased significantly relative to the prior
year as
temporary employees were frequently used to staff positions left vacant
as a
result of employee attrition following the announcement of the Washington
Federal acquisition.
Employee
benefit expense declined significantly relative to the third quarter and
first
nine months of last year, falling $105,000 and $336,000, or 20% and 21%,
respectively. The reduction was largely attributable to a decision to forego
profit sharing contributions to our 401K and ESOP plans. Reductions
in Director and Officer insurance expense and employee insurance benefits
also
contributed to the lower level of expense.
Occupancy
Expense
Occupancy
expense declined by $101,000 and $204,000, or 10% and 7%, compared to the
third
quarter and first nine months of last year, based on reductions in depreciation
and other occupancy expenses.
|
|
|
Quarter
Ended September 30,
|
|
|
Nine
Months Ended September 30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Rent
|
|
$
|
70,000
|
|
|
$
|
64,000
|
|
|
$
|
210,000
|
|
|
$
|
222,000
|
|
|
Utilities
and
Maintenance
|
|
|
181,000
|
|
|
|
180,000
|
|
|
|
587,000
|
|
|
|
582,000
|
|
|
Depreciation
|
|
|
487,000
|
|
|
|
528,000
|
|
|
|
1,434,000
|
|
|
|
1,555,000
|
|
|
Other
Occupancy
|
|
|
199,000
|
|
|
|
266,000
|
|
|
|
656,000
|
|
|
|
732,000
|
|
|
Total
Occupancy Expense
|
|
$
|
937,000
|
|
|
$
|
1,038,000
|
|
|
$
|
2,887,000
|
|
|
$
|
3,091,000
|
|
For
the
third quarter, depreciation expense declined $41,000, or nearly 8% relative
to
the 2006 level, based primarily on reductions in furniture/fixture and
network
software depreciation expense. On a year-to-date basis, depreciation
expense was down $121,000, also nearly 8%, based on reductions in the same
categories as well as other PC and network depreciation expense.
Additionally,
the first quarter saw a $48,000 reduction in depreciation expense due to
the
correction of a booking error associated with the purchase of our Juanita
Banking Center. In that transaction, the value of the land had been
included in the cost of the building and consequently depreciated based
on the
building’s amortization schedule. As land is not depreciable, this
error was corrected upon its discovery and resulted in a one-time $40,000
credit
to depreciation for the quarter.
The
decline in other occupancy expenses for both the quarter and year-to-date
periods was attributable to a reduction in purchases of assets for less
than
$1,000, which are expensed rather than capitalized. Given the pending
Washington Federal transaction, we have largely foregone such purchases
this
year. Consequently, these purchases totaled $84,000 through the first
nine months of 2007 and only $7,000 for the most recent quarter. By
comparison, $177,000 in such purchases occurred in the first nine months
of
2006, with nearly $81,000 in the third quarter.
Credit
Insurance
Credit
insurance premium costs fell 11% in the third quarter, and 13% on a year-to-date
basis compared to the same periods in 2006. As we stated in our 2006 year-end
press release, we expected that expenditures for credit insurance would
decline
over the course of 2007. The majority of credit insurance premiums are
attributable to our sales finance loans, including both those loans retained
in
our portfolio as well as those loans serviced for other
institutions. In mid-2006, after evaluating our use of credit
insurance, we concluded that the benefits of the insurance no longer outweighed
the costs and chose to forego the insurance and assume the credit risk
on future
sales finance loan production. Those loans insured prior to August 1,
2006 remain insured under their existing policies. Additionally, some
loans originated on or after August 1, 2006 were sold to institutional
investors
with insurance placed prior to sale and remain insured under the policy
effective August 1, 2006. All other loan volumes originated on or
after August 1, 2006 have not been insured. To a much lesser extent, residential
land loans and a small percentage of the consumer and income property loan
portfolios are also insured. While these insured balances may continue
to
increase in future quarters, the premiums paid on these balances are small
relative to those paid on sales finance loans so that total premiums are
still
expected to decline.
Other
Noninterest Expense
Other
noninterest expense remained unchanged relative to the third quarter of
2006 as
reductions in some categories offset increases in others. On a
year-to-date basis, other noninterest expense rose $494,000, or 9%, due
to a
number of unique and/or merger-related items in the second quarter of the
year.
|
|
|
Quarter
Ended September 30,
|
|
|
Nine
Months Ended September 30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Marketing
and
Investor
Relations
|
|
$
|
185,000
|
|
|
$
|
211,000
|
|
|
$
|
641,000
|
|
|
$
|
730,000
|
|
|
Outside
Services
|
|
|
220,000
|
|
|
|
193,000
|
|
|
|
747,000
|
|
|
|
616,000
|
|
|
Information
Systems
|
|
|
299,000
|
|
|
|
244,000
|
|
|
|
798,000
|
|
|
|
674,000
|
|
|
Taxes
|
|
|
169,000
|
|
|
|
205,000
|
|
|
|
525,000
|
|
|
|
509,000
|
|
|
Legal
|
|
|
203,000
|
|
|
|
115,000
|
|
|
|
567,000
|
|
|
|
420,000
|
|
|
Other
|
|
|
844,000
|
|
|
|
948,000
|
|
|
|
2,737,000
|
|
|
|
2,572,000
|
|
|
Total
|
|
$
|
1,920,000
|
|
|
$
|
1,916,000
|
|
|
$
|
6,015,000
|
|
|
$
|
5,521,000
|
|
Expenditures
on outside services increased nearly $27,000 in the third quarter, and
more
significantly $130,000 through the first nine months of 2007 as compared
to the
same periods in the prior year. Included in the third quarter
expenses were a $55,000 fee for the cancellation of a commitment to issue
$9
million in trust preferred securities and $29,000 in due diligence related
expenses. Both of these expenses were incurred as a result of the
pending Washington Federal transaction.
Legal
fees grew by $88,000 for the quarter and $147,000 on a year-to-date
basis. Our legal expense has exceeded its historical norm over the
last two quarters, also based largely upon expenses related to the Washington
Federal transaction.
Partially
offsetting the overall increase in other noninterest expenses, our marketing
and
investor relations costs declined $26,000 for the quarter and $90,000 on
a
year-to-date basis relative to the same periods last year.
Other
miscellaneous operating expenses declined $104,000 for the third quarter,
or 11%
relative to the same quarter last year, but remained nearly $166,000, or
6%,
above last year’s level on a year-to-date basis. Compared to the
prior year, charitable contributions declined $42,000 for the quarter,
but
increased $139,000 for the year-to-date period as a result of a $188,000
contribution to a local performing arts organization in the second
quarter. We had originally expected to make this contribution in
several installments over time, but given the pending merger with Washington
Federal, we elected to go ahead and lump-sum the remaining
contribution. Similarly, recruiting expenses declined $1,000 for the
quarter, but increased $217,000 for the year-to-date period. The
unusually high level of recruiting expense in the first half of the year
resulted from the use of employment services in connection with our search
for a
new CFO, as well as the hiring of a new business banking officer, income
property lending officer and production assistant, treasury management
officer,
as well as various other personnel including accounting and information
systems
staff.
Among
other items included in this category, lower levels of expense associated
with
the marking-to-market of interest rate derivatives reduced our other noninterest
expense for both the quarter and year-to-date periods. As previously
noted, however, these derivatives are structured such that a loss on any
given
derivative is matched against a nearly identical gain on an offsetting
derivative, reflected in our miscellaneous noninterest income
category. Consequently, the lower level of expense was nearly matched
by the previously mentioned lower level of noninterest income, resulting
in
essentially no net earnings impact to the Bank.
FINANCIAL
CONDITION
Assets
Because
of a decline in the securities portfolio balances, our assets totaled $1.017
billion at September 30, 2007, down from $1.029 billion at the start of
the
quarter and representing a decline of approximately 6% from the $1.079
billion
2006 year-end level. The reduction in the securities portfolio was an
indirect result of our decision to elect early adoption of SFAS
159.
Securities
The
balance of our securities portfolio (including trading, available-for-sale,
and
held-to-maturity securities) totaled approximately $25 million as of September
30, 2007, down from its year-end and second-quarter 2007 levels of $95
million
and nearly $67 million.
Following
the end of the first quarter, we sold several longer-maturity securities
from
the newly established trading portfolio, replaced the sold issues with
approximately $34 million in shorter-term hybrid ARM securities, and began
evaluating the potential risks and benefits of employing strategies to
hedge
against movements in the market value of the trading portfolio. In the
first
week of May, we elected to proceed with a plan to reduce the volatility
of the
portfolio by reselling our recently purchased securities in the secondary
market
and utilizing an interest rate swap to partially hedge against movements
in the
market value of the remaining trading portfolio. Based on our
observations of the portfolio and hedge over the remainder of the quarter,
we
elected to further reduce the size of the portfolio and unwind the hedge
position. Consequently, in early July we sold additional securities
with market values totaling approximately $41 million and unwound the hedge
position. These securities were seasoned hybrid ARM securities and
two FHLB agency bullet securities that had been moved from the
available-for-sale or held-to-maturity category to the trading portfolio
at the
time of our SFAS 159 adoption. At the present time, we do not
anticipate conducting any further significant securities
transactions.
Any
investment security purchased is classified in one of the following categories:
1) trading, 2) available-for-sale, or 3) held-to-maturity. Prior to our
early
adoption of SFAS 159, the majority of the securities in our present portfolio
had been classified as available-for-sale, while no securities were classified
in the trading category. Available-for-sale securities are reviewed regularly,
and any unrealized gains or losses are recorded in comprehensive income
in the
shareholders’ equity account. In contrast, any change in market value of trading
securities during the period is reflected in current period income. Generally,
falling interest rates will increase the market values of securities, thus
enhancing the amounts recorded as gains or reducing losses, while rising
rates
will have the opposite effect. The passage of time partially counteracts
these
interest rate effects, as the unrealized gain or loss on a given security
will
gradually decline to zero as the security approaches its maturity
date.
Loans
Loans
receivable, excluding loans held-for-sale, grew by nearly $13 million for
the
quarter, but still ended September at a level $14 million less than at
the start
of the year. While loan originations in the most recent quarter
exceeded those of the prior year, totaling $129 million, up from $120 million
at
the end of the third quarter last year, originations have typically lagged
2006
this year, totaling $353 million through the first nine months of 2007
compared
to $400 million through the first three quarters of 2006. In addition
to the decline in originations, the loan portfolio was impacted by a combination
of continued high prepayment speeds and significant volumes of loan
sales.
|
Portfolio
Composition
|
|
September
30, 2007
|
|
|
June
30, 2007
|
|
|
December
31, 2006
|
|
|
|
|
(Dollars
in thousands)
|
|
|
Single
Family Residential
|
|
$
|
265,705
|
|
|
$
|
261,699
|
|
|
$
|
254,374
|
|
|
Income
Property
|
|
|
217,488
|
|
|
|
220,056
|
|
|
|
248,100
|
|
|
Business
Banking
|
|
|
168,986
|
|
|
|
164,151
|
|
|
|
144,771
|
|
|
Commercial
Construction
|
|
|
54,291
|
|
|
|
47,864
|
|
|
|
47,153
|
|
|
Single
Family Construction
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Spec
Construction
|
|
|
27,469
|
|
|
|
29,146
|
|
|
|
31,315
|
|
|
Custom
Construction
|
|
|
47,683
|
|
|
|
49,129
|
|
|
|
70,541
|
|
|
Consumer
|
|
|
98,043
|
|
|
|
94,813
|
|
|
|
97,177
|
|
|
Total
|
|
$
|
879,665
|
|
|
$
|
866,858
|
|
|
$
|
893,431
|
|
While
our
total loan portfolio experienced a decline since the last year-end, respectable
growth occurred in our business banking loan portfolio, which has been
very
successful in building earning assets in recent years. More modest
loan growth was also observed in our residential lending permanent loan
portfolio. The single family residential loans held in our portfolio
are typically non-conforming loans that do not meet the requirements for
resale
in the secondary market, but generally offer higher yields than conforming
residential mortgages and are still considered eligible collateral for
borrowing
from the FHLB. Additionally, while consumer loan balances rose only minimally
relative to the year-end, they did so despite loan sales totaling nearly
$36
million in the first nine months of the year. Were it not for these
sales, substantial growth would likely have been observed in this portfolio
segment as well.
Income
property loans, which consist of mortgages on investor-owned commercial
real
estate and multifamily properties, have demonstrated a gradual downward
trend in
recent years. This decline has been largely the result of lower
originations of loans, along with a high level of prepayments, which we
attribute to a combination of increased competition from other lenders,
including conduit programs, and a flat-to-inverted yield curve. The
flattening of the yield curve reduced the rate differential between short-
and
long-term financing costs and provided a financial incentive for borrowers
to
select longer-term, fixed-rate loans as opposed to short-term or adjustable-rate
financing. As we have historically been an originator of short-term
and adjustable-rate loans, this has impacted us in two ways. First,
as prospective buyers sought loans with terms that fell outside of our
typical
underwriting structures, our originations of permanent multifamily and
commercial real estate loans declined. Second, with the yield curve
providing borrowers with a financial incentive to refinance adjustable-rate
loans, which make up the majority of our loan portfolio, with longer-term,
fixed-rate debt, the prepayment rates on our income property portfolio
remained
at relatively high levels. Increased competition among lenders in our
local market accelerated both the decline in new loans as well as portfolio
payoffs, as the competition frequently resulted in lenders offering prospective
borrowers new loan commitments or existing borrowers the opportunity to
refinance at lower margins than we would consider appropriate for the risks
presented by the credits.
Servicing
Assets
Servicing
assets represent the deferred servicing rights generated from sales of
loans
that are sold servicing retained, reduced by the amortization and prepayments
of
those loans, as well as any impairment charges that may occur. While our
servicing assets have not and do not represent a significant percentage
of our
total assets, this area has grown with high volumes of loan sales.
|
Servicing
Assets
|
|
September
30, 2007
|
|
|
June
30, 2007
|
|
|
December
31, 2006
|
|
|
Commercial
|
|
$
|
123,000
|
|
|
$
|
114,000
|
|
|
$
|
224,000
|
|
|
Residential
|
|
|
66,000
|
|
|
|
72,000
|
|
|
|
63,000
|
|
|
Consumer
|
|
|
4,537,000
|
|
|
|
4,798,000
|
|
|
|
3,724,000
|
|
|
Total
|
|
$
|
4,726,000
|
|
|
$
|
4,984,000
|
|
|
$
|
4,011,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan
Balances Serviced for Others
|
|
$
|
161,580,000
|
|
|
$
|
154,199,000
|
|
|
$
|
155,025,000
|
|
As
a
result of the nearly $36 million in loan sales for the first nine months
of the
year, our servicing assets related to consumer loans increased significantly
relative to the year-end level. However, due to the substantial
reduction in loan sale volumes in the third quarter combined with high
payoff
rates and rapid amortization of these servicing assets, the consumer loan
servicing asset declined relative to the previous quarter-end.
Servicing
assets related to commercial loans increased modestly during the third
quarter
as deferred servicing rights related to participations sold during the
quarter
slightly exceeded the amortization of existing servicing assets. On a
year-to-date basis, commercial servicing assets declined as some existing
commercial loan pools were paid off in the first half of 2007. These
payoffs required us to immediately write off the remaining servicing assets
associated with these credits.
Residential
loans are generally sold servicing released. Consequently, no
servicing assets are recognized following the vast majority of residential
loan
sales.
Deposits
and Borrowings
Through
the first nine months of the year, our total deposit balances declined
$55
million, or approximately 7%, including $9 million in the most recent
quarter. Our non-maturity deposit balances grew more than $21 million
through the first three quarters of the year, with more than $4 million
occurring in the most recent quarter, while time deposits, including
certificates issued through brokerage services, declined $76 million, with
nearly $14 million occurring in the third quarter. Brokered
certificates of deposit accounted for approximately $36 million of the
year-to-date reduction, including $2 million in the third quarter.
The
growth of checking and money market accounts typically helps us reduce
our
overall cost of funds. Consequently, we consider the growth of these types
of
accounts to be an important part of our funding strategy. To encourage
this
growth, we actively monitor the products and rates offered by our competition
in
the local market and develop new products and/or offer aggressive rates
to
attract new balances in the most cost-effective manner possible.
The
decrease in retail certificate balances occurred as we attempted to move
away
from offering rates competitive with the higher rates in the local market.
While
this has resulted in some of the more rate-sensitive depositors exiting
the Bank
for higher rates elsewhere, most of those deposits have remained on our
books at
significantly lower costs to the Bank.
Our
preferred supplemental funding mechanism is borrowing funds from the Federal
Home Loan Bank of Seattle (FHLB). We experienced a modest decrease in
our FHLB advances to $159 million at the end of the third quarter, compared
to
$163 million at the end of the second quarter of 2007 and $172 million
at the
2006 year-end. As of September 30, 2007, we had the authority to
borrow up to approximately $407 million from the FHLB, subject to maintaining
a
sufficient level of eligible collateral.
ASSET
QUALITY
Provision
and Reserve for Loan Loss and Loan Commitments Liability
The
provision for loan losses reflects the amount deemed appropriate to produce
an
adequate reserve for probable loan losses inherent in the risk characteristics
of the loan portfolio. In determining the appropriate reserve
balance, we consider the current and historical performance of the loan
portfolio, the amount and type of new loans added to the portfolio, our
level of
non-performing loans, the amount of loans charged off, and the economic
conditions in which we currently operate.
The
provisions for the third quarter and first nine months of 2007 totaled
$449,000
and $687,000 compared to provisions of $267,000 and $473,000 in the same
periods
last year. The increase in the provision for the quarter was prompted
by the growth in our loan portfolio over the course of the quarter, a reduced
volume of consumer loan sales, and the downgrade of a borrowing relationship
in
our Income Property portfolio during the third quarter. Information
we received subsequent to the end of the third quarter has necessitated
a
further downgrade of this relationship’s risk rating, and is consequently
expected to increase our reserve requirement for the fourth
quarter. Please see the “Subsequent Events” section for further
information.
Nonperforming
assets, both in terms of balances and as a percentage of total assets,
were
little changed from the $3.5 million and 0.32% observed at the 2006 year-end,
totaling $3.2 million and 0.31% at the end of the third
quarter. While this level of nonperforming assets remains at the high
end of our historical experience, it remains below industry
standards. Noted below are the ratios from 1998 and the comparative
industry ratios.
|
Year
|
First
Mutual Bank
|
FDIC
Insured Commercial Banks
|
|
1998
|
0.07%
|
0.65%
|
|
1999
|
0.06%
|
0.63%
|
|
2000
|
0.38%
|
0.74%
|
|
2001
|
0.08%
|
0.92%
|
|
2002
|
0.28%
|
0.94%
|
|
2003
|
0.06%
|
0.77%
|
|
2004
|
0.10%
|
0.55%
|
|
2005
|
0.08%
|
0.48%
|
|
2006
|
0.32%
|
0.51%
|
|
Third
Quarter 2007
|
0.31%
|
N/A
|
Including
a $198,000 liability for unfunded commitments, our reserve for loan losses
totaled approximately $10.2 million at September 30, 2007, little changed
from
$10.1 million at the 2006 year-end. At this level, the allowance for
loan losses represented 1.12% of gross loans at the end of the quarter,
compared
to 1.11% at the 2006 year-end.
Non-Performing
Assets
Our
exposure to non-performing assets as of September 30, 2007 was:
|
Two
single-family residential loans in the Oregon market. No
anticipated
loss.
|
|
$
|
1,451,000
|
|
|
One
mobile-home park loan in Oregon. No anticipated
loss.
|
|
|
732,000
|
|
|
Two
single-family residential loans in Washington. No anticipated
loss.
|
|
|
320,000
|
|
|
One
custom construction loan in the Oregon market. Impairment
charges
taken
in 2006. No further losses anticipated
|
|
|
240,000
|
|
|
One
land loan in Western Washington. No anticipated
loss.
|
|
|
151,000
|
|
|
Thirty
consumer loans. Full recovery expected from insurance
claims.
|
|
|
138,000
|
|
|
One
lease pool. Possible loss of $52,000.
|
|
|
52,000
|
|
|
Eighteen
consumer loans. Possible loss of $34,000.
|
|
|
34,000
|
|
|
Six
consumer loans. No anticipated loss.
|
|
|
26,000
|
|
|
One
multifamily loan with an impairment balance of
$1,000.
|
|
|
11,000
|
|
|
Six
insured consumer loans that have exceeded the credit
insurance
limit. Possible
loss of $10,000.
|
|
|
10,000
|
|
|
One
commercial line of credit possible loss of $4,000.
|
|
|
4,000
|
|
|
Total
Non-Performing Assets
|
|
$
|
3,169,000
|
|
BUSINESS
SEGMENTS
Beginning
January 1, 2007, we changed the presentation of our Business Segments to
more
accurately reflect the way these segments are managed within the
Bank. Prior to 2007, we recognized four business
segments: 1) Consumer Lending, 2) Residential Lending, 3) Business
Banking Lending, and 4) Income Property Lending. All other
departments, including our Banking Centers and investment portfolio were
assumed
to support these business lines. Consequently, all income generated
and expenses incurred at these support centers were allocated to the four
business segments, resulting in no net income or loss at any department
except
the four lending units.
To
better
reflect how we manage the Bank, we have changed our business segments as
follows:
|
·
|
Established
a “Retail Banking” segment which includes our banking centers and direct
consumer lending. The Home Equity Lines of Credit (HELOC’s) and
other consumer lending originated through the Banking Centers,
which were
previously included in the “Consumer Lending” segment, are included in
this segment. The “Retail Banking” segment does not include
Sales Finance lending. This segment also includes Community
Business Banking (small business lending) which had been previously
included in the “Business Banking”
segment.
|
|
·
|
Isolated
our Investment Securities activities as a separate business segment
so
that any changes in the investment portfolio’s market value or level of
earning assets do not distort the reported operating results
of our other
business segments.
|
In
moving
the banking centers, our primary source of funds generation, from an allocated
overhead category to an operating segment, it became necessary to implement
a
new process for transferring funds from our funds-generating operations
to the
users of such funds. The objective of the funds transfer process is
to isolate the true profit contribution of each side of the
balance
sheet. Prior to 2007, the profitability of the funds-generating
operations, such as the banking centers, was defined as break-even with
the
lending segments collectively compensating the funds-generating operations
such
that this result was achieved. Under the new methodology, the rates
at which funds are transferred between the generators and users of funds
are
based on market rates of interest. The profitability of the business
segments, including retail banking, then varies depending on the actual
rates
earned on assets and paid on liabilities as well as expenses incurred in
the
segments’ operations. To assist in tracking and evaluating the
profitability of such funds transfers, we now utilize four line items in
determining each segment’s net interest income:
|
·
|
Interest
Income – This represents the actual interest received from the segment’s
loans or securities.
|
|
·
|
Interest
Income on Funding Sources – This represents the interest income received
from selling funding sources generated by the segment (i.e. deposits
or
FHLB advances) to a centralized treasury function. The interest
rate paid to the segment is based on the point on the FHLB rate
curve for
advances of a duration comparable to the segment’s funding
source.
|
|
·
|
Funding
Costs – This represents the interest paid to the centralized treasury
function by each business segment for the funding sources necessary
to
support earning asset balances. Again, the interest rate
charged to the segment is based on the point on the FHLB rate
curve for
advances of a duration comparable to the segment’s earning
assets.
|
|
·
|
Interest
Expense – This represents the actual interest paid on the segment’s
liabilities (i.e. deposits or FHLB
advances).
|
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
reportable segments include the following:
|
·
|
Retail
Banking – Retail Banking is the segment primarily responsible for the
generation of funding sources, specifically our consumer and
small
business deposit accounts. In addition to our banking centers,
the segment includes our direct consumer and Community Business
Banking
(small business) lending
departments.
|
|
·
|
Sales
Finance Lending – Sales Finance generates indirect unsecured consumer
loans in connection with home improvement projects. A large
percentage of this segment’s loan volume is sold into the secondary market
on a servicing-retained basis, meaning we continue to process
payments and
service the loan following the
sale.
|
|
·
|
Residential
Lending - Residential Lending offers loans to borrowers to purchase,
refinance, or build homes secured by one-to-four-unit family
dwellings. This segment also sells loans into the secondary
market. We 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.
|
|
·
|
Business
Banking Lending – Business Banking offers a full range of banking services
to middle-market size businesses including deposit and cash management
products, loans for financing receivables, inventory, and equipment
as
well as permanent and interim construction loans for commercial
real
estate. The underlying real estate collateral or business asset
being financed typically secures these
loans.
|
|
·
|
Income
Property Lending – Income Property Lending offers permanent and interim
construction loans for multifamily housing (over four units)
and
commercial real estate properties. The underlying real estate
collateral being financed typically secures these
loans.
|
|
·
|
Investment
and Treasury - The Investment and Treasury segment includes the
investment
securities portfolio, FHLB stock, and interest-earning cash
balances. Although management does not consider this to be an
operating business line, security investments represent 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 the products and services. The segments derive a majority
of their revenue from interest income, and we rely primarily on net interest
revenue in managing these segments. No single customer provides more
than 10% of the Bank’s revenues.
Retail
Banking
|
|
Quarter
Ended
|
|
Nine
Months Ended
|
|
|
Net
Income/(Loss)
|
Return
on
Equity
|
|
Net
Income/(Loss)
|
Return
on
Equity
|
|
Sept.
30, 2005
|
76,000
|
2.04%
|
|
(609,000)
|
(5.74%)
|
|
Sept.
30, 2006
|
124,000
|
3.51%
|
|
1,191,000
|
11.69%
|
|
Sept.
30, 2007
|
(242,000)
|
(5.92%)
|
|
(571,000)
|
(4.80%)
|
Third
quarter and year-to-date net income for our Retail Banking segment declined
$366,000 and $1.8 million relative to the prior year based on a sharp reduction
in net interest income, as rates paid on deposits continued to increase
while
market rates of interest, and thus the rates at which the retail operations
are
credited for their deposits, remained comparatively stable over the last
several
quarters.
As
our
Retail Banking segment includes our banking centers, the majority of this
segment’s income is received from selling funding sources, specifically deposits
generated and serviced in the banking centers, to lending units in need
of
funding to support earning asset balances. This income appears in the
accompanying notes to our financial statements as “Treasury Income and Interest
Income on Funding Sources”. The line labeled “Funding
Costs” represents the expense paid by the users of these funds to
support their earning asset balances.
Relative
to the third quarter of last year, the segment’s transferable funding sources
(deposit balances) remained virtually unchanged totaling slightly less
than $668
million at the quarter-end. Combined with the movements in market
rates of interest, at which these funds are transferred to our lending
units,
the Retail segment’s interest income from funding sources declined $35,000 from
its third quarter 2006 level. Year-to-date results were slightly
better, with income from funding sources rising $746,000, or nearly 3%,
compared
to the first nine months of
2006. Other
interest income for the segment, which consists of interest received on
home
equity, personal, and small business loans and lines, totaled $928,000
for the
quarter, up 4% from the same period last year.
By
comparison, the interest paid on deposits rose more than $824,000 for the
quarter and $3.3 million on a year-to-date basis, as competition in the
local
marketplace continued to keep retail deposit rates high. As a result,
the segment’s net interest income declined $836,000 relative to the third
quarter and $2.5 million compared to the first nine months of last
year.
Both
noninterest income and noninterest expense for the segment were relatively
little changed relative to the prior year. Noninterest income
declined $75,000 compared to the first nine months of last year, while
noninterest expense increased $318,000, or approximately 3% relative to
the
first three quarters of 2006. The increase in operating expense was
attributable to both growth among ordinary expenses, such as salary expense,
which increases each year as a result of annual increases in staff salaries,
as
well as allocations of the unusual expenses incurred in the quarter, which
were
described in the “Noninterest Expense” section. These expenses, which
were allocated to the various business segments, included legal and other
fees
related to the Washington Federal transaction, as well as retention bonuses
to
our CFO for remaining with the Bank past his retirement date, again related
to
the Washington Federal transaction.
Sales
Finance
|
|
Quarter
Ended
|
|
Nine
Months Ended
|
|
|
Net
Income/(Loss)
|
Return
on
Equity
|
|
Net
Income/(Loss)
|
Return
on
Equity
|
|
Sept.
30, 2005
|
141,000
|
9.27%
|
|
652,000
|
16.18%
|
|
Sept.
30, 2006
|
448,000
|
31.52%
|
|
1,070,000
|
25.31%
|
|
Sept.
30, 2007
|
94,000
|
5.54%
|
|
483,000
|
11.08%
|
Net
income for our Sales Finance segment declined $354,000, or approximately
79%,
from the level earned in the third quarter of 2006, and $587,000, or nearly
55%,
compared to the first nine months of last year based primarily on a reduction
in
net interest income and increase in the segment’s loan loss
provision.
While
the
Sales Finance segment’s quarter-end earning assets showed modest growth relative
to the prior year, up 4% to nearly $81 million, the average level through
the
first three quarters of the year declined significantly relative to 2006
based
on a substantial increase in the level of loan sales relative to prior
years. While less than $6 million in loans were sold in the most
recent quarter, sales for the first half of this year totaled $30
million.
With
these sales, the segment’s net interest income declined $570,000, or 19%
compared to the first nine months of 2006, but showed signs of recovery
with the
reduced sales in the third quarter, exceeding the third quarter 2006 net
interest income by $29,000. With the segment’s third quarter loan
loss provision increasing $169,000 relative to the prior year, net interest
income after the loan loss provision declined $140,000, or 15%. On a
year-to-date basis, the segment’s loan loss provision increased $650,000
relative to the prior year, with net interest income after provision down
$1.2
million, or 41%. The increase in the loan loss provision relative to
the prior year was related to the insured loan pools for years 2002-2003
and
2003-2004 reaching their 10% coverage limits. In relation to probable
losses inherent in those pools, the segment’s loan loss provision was
increased.
While
the
increased loan sales prior to the most recent quarter negatively impacted
the
segment’s net interest income, they contributed to improvements in noninterest
income in the first half of the year. For the most recent quarter,
however, the segment’s noninterest income declined $411,000 relative to the
prior year based on the significant reduction in loan sales. Besides
gains on sales, loan sale transactions also result in additional service
fee
income on an ongoing basis after loans are sold. The segment’s
servicing fee income increased from $300,000 and $930,000 in the third
quarter
and first nine months of 2006 to $428,000 and $1.3 million this
year.
The
segment’s noninterest expense remained well contained relative to the third
quarter of last year, declining $20,000 compared to the third quarter of
2006,
and $9,000 on a year-to-date basis. The improvement was partly
attributable to a reduction in credit insurance premiums. As we stated
in our
2006 year-end press release, after evaluating our use of credit insurance,
we
concluded that the benefits of the insurance no longer outweighed the costs
and
chose to forego the insurance and assume the credit risk on future sales
finance
loan production. Consequently, it was our expectation that
expenditures for credit insurance would decline in 2007. Those loans
insured prior to August 1, 2006 remain insured under their existing policies,
and some loans originated on or after August 1, 2006 were sold to institutional
investors with insurance placed prior to sale and remain insured under
the
policy effective August 1, 2006.
Residential
Lending
|
|
Quarter
Ended
|
|
Nine
Months Ended
|
|
|
Net
Income/(Loss)
|
Return
on
Equity
|
|
Net
Income/(Loss)
|
Return
on
Equity
|
|
Sept.
30, 2005
|
821,000
|
28.78%
|
|
2,244,000
|
28.84%
|
|
Sept.
30, 2006
|
1,089,000
|
35.80%
|
|
2,382,000
|
27.96%
|
|
Sept.
30, 2007
|
721,000
|
21.95%
|
|
2,153,000
|
21.90%
|
The
Residential Lending segment’s net income for the third quarter totaled $721,000,
representing a 34% decline relative to the same period last year, based
primarily on a reduction in the segment’s net interest income. On a
year-to-date basis, net income fell nearly 10% also as a result of a reduction
in the segment’s net interest income.
While
the
Residential segment has been one of the largest contributors to our earning
asset growth in recent years, the segment’s earning assets dropped substantially
relative to their level as of September 30, 2006, falling $19 million,
or
approximately 6%, as a slowdown in residential lending resulted in a substantial
reduction in both the number of loans originated and the portfolio balances.
Based on the reduction in assets, net interest income earned on the portfolio
declined $519,000, or approximately 22% relative to the third quarter of
last
year. For the year-to-date period, interest income and funding costs
each declined by approximately 3%, with net interest income before the
provision
for loan losses falling nearly 8%. While the segment’s third quarter
provision for loan losses rose $91,000 compared to the same quarter last
year,
its year-to-date provision declined by $47,000 based on recoveries of $103,000
in the second quarter.
For
the
quarter, the Residential Lending segment’s noninterest income fell $17,000
compared to the prior year, as additional loan fee income largely offset
a
reduction in gains on loan sales. On a year-to-date basis,
noninterest income rose $124,000, based primarily on the additional loan
fee
income, which increased relative to the prior year based on a higher level
of
fees collected in
connection
with loan modifications or extensions, and non-conversion of construction
loans
to permanent mortgages. Gains on residential loan sales fluctuate
from quarter to quarter, and typically result in modest gains or even slight
losses when interest rates are rising quickly. We believe the
construction phase to be the most profitable facet of residential lending
and
the primary objective in a residential lending
relationship. Following the construction process, our practice is to
retain in our portfolio those residential mortgages that we consider to
be
beneficial to the Bank, but to sell those that we consider less attractive
assets.
The
Residential segment’s noninterest expense declined $77,000, or 7% for the
quarter, and rose only $54,000, or less than 2% through the first nine
months of
the year.
Business
Banking Lending
|
|
Quarter
Ended
|
|
Nine
Months Ended
|
|
|
Net
Income/(Loss)
|
Return
on
Equity
|
|
Net
Income/(Loss)
|
Return
on
Equity
|
|
Sept.
30, 2005
|
262,000
|
13.56%
|
|
832,000
|
15.52%
|
|
Sept.
30, 2006
|
351,000
|
13.08%
|
|
790,000
|
11.42%
|
|
Sept.
30, 2007
|
252,000
|
7.17%
|
|
925,000
|
9.49%
|
With
earning assets totaling more than $169 million at the end of the third
quarter,
an increase of 19% over the prior year level, Business Banking’s interest income
grew $333,000 and $1.6 million, or 11% and 20% over the levels earned in
the
third quarter and first nine months of 2006. Additionally, with
deposit growth of $34 million, or approximately 86%, compared to September
30,
2006, income credited for funding sources rose $200,000 for the quarter
and
$836,000 year-to-date compared to the prior year. Partially
offsetting these improvements, however, were an additional $185,000 and
$1.3
million in funding costs for the quarter and nine months, respectively.
Taking
all of these into account, the Business Banking segment’s third quarter and nine
month net interest income after provision for loan losses rose $29,000
and
$339,000, or 2% and 9%, respectively, over the same periods last
year.
For
the
quarter and nine months ended September 30, 2007, the Business Banking
segment’s
noninterest income declined $92,000 and $246,000 relative to prior year
levels. This reduction was largely attributable to changes in the
valuations of interest rate derivatives utilized by the segment to hedge
interest rate risk on longer-term, fixed-rate commercial real estate
loans. These derivatives were structured such that a gain on any
given derivative would be matched against a comparable loss on a second,
corresponding derivative, resulting in minimal net impact to the Bank’s
earnings. In the third quarter and first nine months of last year,
appreciation in the market values of these instruments resulted in additions
to
noninterest income of $238,000 and $188,000 compared to $108,000 and $2,000
in
the same periods this year. These were largely offset by similar
levels of expense reflected in our miscellaneous operating expense
category. Accounting rules require any change in the market value of
such instruments to be reflected in the current period income.
Including
the corresponding reduction in noninterest expense attributable to the
changes
in derivative values, changes in the segment’s noninterest expense were rather
modest, increasing $83,000 and declining $112,000 relative to the third
quarter
and first nine months of 2006. Also worth noting is that under the
new method of presenting our business segments, the Business Banking segment
no
longer faces significant increases in allocated overhead expenses as a
result of
deposit growth. Under the previous method of segmenting our business
lines, our banking
centers
were deemed to be overhead cost centers rather than an operating segment,
and
consequently all income and expenses associated with the banking centers
was
allocated among the four lending units. Consequently, the Business
Banking segment’s deposit growth in prior years resulted in increasing
allocations of banking center-related expense, which frequently negated
the
benefit of the additional deposits. With the banking centers now
included in the Retail Banking segment, the Business Banking and other
lending
segments are no longer subject to allocations of banking center
expense. Similarly, the lending segments no longer receive the
benefit of funds generated by the banking centers at below-market rates
of
interest. The segment results for 2005 and 2006 have been restated to
reflect this methodology consistently throughout the three years presented
here.
Income
Property Lending
|
|
Quarter
Ended
|
|
Nine
Months Ended
|
|
|
Net
Income/(Loss)
|
Return
on
Equity
|
|
Net
Income/(Loss)
|
Return
on
Equity
|
|
Sept.
30, 2005
|
1,141,000
|
18.92%
|
|
3,900,000
|
21.62%
|
|
Sept.
30, 2006
|
1,211,000
|
20.98%
|
|
3,194,000
|
19.43%
|
|
Sept.
30, 2007
|
1,177,000
|
19.38%
|
|
3,412,000
|
19.01%
|
The
Income Property segment’s third quarter net income declined $34,000, or 3%
relative to the same quarter last year, based on flat net interest income,
falling noninterest income, and rising noninterest expense. On a
year-to-date basis, net income rose $218,000, or 7%, as growth in net interest
income was more than sufficient to offset the falling noninterest income
and
rising noninterest expense over that timeframe.
Compared
to the prior year, the segment’s net interest income after provision for loan
losses grew $577,000 for nine months ended September 30 as a result of
interest
income from earning assets falling by a lesser amount than did interest
expense
on funding sources. The provision for loan loss declined $12,000 and
$152,000 compared to the third quarter and first nine months of 2006, due
in
large part to continued declines in portfolio balances.
The
Income Property segment’s decrease in earning assets during the first three
quarters of 2007 continued a trend observed over the last couple of years,
and
is primarily a product of declining originations of permanent multifamily
and
commercial real estate loans, combined with a high level of prepayments
on the
loan portfolio, which we attribute to a combination of increased competition
from other lenders and the flat yield curve. Increased competition
from conduit lenders as well as lenders in our local market accelerated
both the
drop in new volumes as well as portfolio payoffs, as the competition frequently
resulted in lenders offering prospective borrowers new loan commitments,
or
existing borrowers the opportunity to refinance, at unusually low
margins. The flat yield curve, which has resulted from a number of
increases in short-term interest rates, has reduced the rate differential
between short- and long-term financing costs and provided a financial incentive
for borrowers to select longer-term, fixed-rate loans as opposed to
adjustable-rate financing. As we have historically been an originator
of short-term and adjustable-rate loans, this impacted us in two
ways. First, as prospective borrowers sought loans with terms that
fell outside of our typical underwriting structures, our originations of
permanent multifamily and commercial real estate loans
declined. Second, with the yield curve providing borrowers with a
financial incentive to refinance adjustable-rate loans, which make up the
majority of our loan portfolio, with longer-term, fixed-rate debt, the
prepayment rates on our Income Property portfolio remained at relatively
high
levels.
Noninterest
income for the Income Property segment declined $13,000 and $182,000 relative
to
the third quarter and first nine months of last year, with the year-to-date
reduction based on the combination of an unusual event last year and a
negative
impact from servicing asset write-offs this year. In the second
quarter of 2006, the segment recognized an unusually high level of noninterest
income as a result of an allocation of insurance proceeds received from
a
key-man life insurance policy. Additionally, the year-to-date results
were negatively impacted by payoffs earlier this year of loan participation
balances sold to and serviced for other institutional investors. As
these loans were paid off, we were forced to immediately write-off the
related
servicing assets, which negatively impacted noninterest income.
The
segment’s noninterest expense increased modestly, rising $31,000 for the quarter
and $70,000 on a year-to-date basis compared to the same periods in
2006. As noted above, the Income Property segment has seen its
earning asset balances decline over the last couple of years, and as a
result,
the segment has become a smaller component of our overall asset
mix. Consequently, for a number of different administrative and
overhead expenses that we allocate out to the business segments, such as
accounting and information systems related costs, the percentages allocated
to
other business lines has tended to increase, thus reducing the percentage
allocated to the Income Property segment.
Investment
and Treasury
|
|
Quarter
Ended
|
|
Nine
Months Ended
|
|
|
Net
Income/(Loss)
|
Return
on
Equity
|
|
Net
Income/(Loss)
|
Return
on
Equity
|
|
Sept.
30, 2005
|
288,000
|
53.48%
|
|
812,000
|
49.19%
|
|
Sept.
30, 2006
|
(222,000)
|
(51.51%)
|
|
(200,000)
|
(15.30%)
|
|
Sept.
30, 2007
|
(60,000)
|
(36.04%)
|
|
12,000
|
1.21%
|
The
Investment and Treasury segment includes our investment securities portfolio
on
the asset side and on the liability side our FHLB advances and certificates
of
deposit issued through brokerage services. While management does not
consider this to be an operating business line, our security investments
and
wholesale borrowings represent a necessary part of liquidity management,
and
their impact on our operations has been recognized as its own segment so
as not
to distort the results of our other business lines.
For
the
third quarter and first nine months of 2007, the segment posted net interest
losses of $21,000 and $436,000, compared to losses of $373,000 and $299,000
in
the third quarter and first nine months of last year. Generally, the
cost of funding the securities portfolio exceeded its yield, while the
FHLB
advances and brokered deposits originated by the segment were “sold” to the
lending units at rates exceeding the cost of those funding
sources. In the second and third quarters of 2007, however, the
funding sources became modestly unprofitable, contributing to the net interest
loss.
Noninterest
income for the segment, which had been virtually nonexistent prior to this
year,
totaled a loss of $80,000 and income of $483,000 for the third quarter
and first
nine months of 2007, largely as a result of our early adoption of SFAS
157 and
159, effective January 1, 2007. SFAS 159, which was issued in February
2007,
generally permits the mark-to-market of selected eligible financial
instruments. In the case of our early adoption, SFAS 159-related
gains on affected instruments totaled $117,000 through the first nine months
of
the year. Additionally, we
recognized
$69,000 in gains on securities sales during the third quarter, bringing
the
year-to-date total to $185,000.
The
segment’s noninterest expense is virtually immaterial, totaling $19,000 for the
third quarter and $75,000 for the first nine months of 2007, both slightly
less
than the prior year levels, and represents allocations of accounting and
administrative overhead costs associated with the management of the
portfolio.
LIQUIDITY
Our
primary sources of liquidity are loan and security sales and repayments,
deposits, and wholesale funds. A secondary source of liquidity is cash
from
operations, which, though not a significant source of liquidity, is a consistent
source based upon the quality of our earnings. Our principal uses of liquidity
are the origination and acquisition of loans and securities, and to a lesser
extent, purchases of facilities and equipment.
|
|
|
Quarter
Ended September 30,
|
|
|
Nine
Months Ended September 30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
|
|
(Dollars
in thousands)
|
|
|
Loan
Originations (disbursed)
|
|
$
|
(129,000
|
)
|
|
$
|
(120,000
|
)
|
|
$
|
(353,000
|
)
|
|
$
|
(400,000
|
)
|
|
Decrease
in Undisbursed Loan
Proceeds
|
|
|
(3,000
|
)
|
|
|
(13,000
|
)
|
|
|
(20,000
|
)
|
|
|
(15,000
|
)
|
|
Security
Purchases
|
|
|
0
|
|
|
|
0
|
|
|
|
(42,000
|
)
|
|
|
(7,000
|
)
|
|
Total
Originations and Purchases
|
|
$
|
(132,000
|
)
|
|
$
|
(133,000
|
)
|
|
$
|
(415,000
|
)
|
|
$
|
(422,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan
and Security Repayments
|
|
$
|
74,000
|
|
|
$
|
100,000
|
|
|
$
|
279,000
|
|
|
$
|
317,000
|
|
|
Sales
of Securities
|
|
|
40,000
|
|
|
|
0
|
|
|
|
98,000
|
|
|
|
0
|
|
|
Sales
of Loans
|
|
|
27,000
|
|
|
|
37,000
|
|
|
|
92,000
|
|
|
|
88,000
|
|
|
Total
Repayments and Sales
|
|
$
|
141,000
|
|
|
$
|
137,000
|
|
|
$
|
469,000
|
|
|
$
|
405,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Difference
|
|
$
|
9,000
|
|
|
$
|
4,000
|
|
|
$
|
54,000
|
|
|
$
|
(17,000
|
)
|
Loan
and
security sales and repayments, our primary sources of funding, are heavily
influenced by trends in mortgage rates. When rates trend downward, our
prepayment speeds typically increase as borrowers refinance their loans
at lower
interest rates. Conversely, as rates move upwards, prepayments will generally
tend to slow, as fewer borrowers will have a financial incentive to refinance
their loans. The loan portfolio, excluding loans sold into the secondary
market
and spec construction loans, experienced an annualized prepayment rate
of nearly
35% in the first nine months of 2007, comparable to the 37% and 39% rates
observed for the first nine months of 2006 and fiscal year 2006,
respectively.
We
believe the flat-to-inverted shape of the yield curve that has persisted
since
mid-2005 to the present time likely contributed to the continued high level
of
prepayments, as the rate differential between short- and long-term financing
diminished and reduced the financial incentive for borrowers to use
shorter-term, adjustable-rate financing rather than longer-term fixed rate
loans. This, in turn, provides borrowers holding short-term or adjustable-rate
loans, which represent the majority of our loan portfolio, with an incentive
to
refinance with long-term fixed-rate loans.
Our
preferred method of funding the net difference between originations/purchases
and repayments/sales is with deposits. To the extent that deposit growth
is
insufficient to fully fund the difference, we may rely on wholesale funding
sources including, but not limited to FHLB advances, brokered certificates
of
deposit, and reverse repurchase agreements. During the third quarter and
first
nine months of 2006 and 2007, changes in funds from deposits and borrowings
were
as follows:
|
|
|
Quarter
Ended Sept. 30,
|
|
|
Nine
Months Ended Sept. 30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Deposits
|
|
$
|
(9,000
|
)
|
|
$
|
15,000
|
|
|
$
|
(55,000
|
)
|
|
$
|
14,000
|
|
|
Borrowings
|
|
|
(4,000
|
)
|
|
|
(31,000
|
)
|
|
|
(13,000
|
)
|
|
|
(8,000
|
)
|
|
Total
|
|
$
|
(13,000
|
)
|
|
$
|
16,000
|
|
|
$
|
(68,000
|
)
|
|
$
|
6,000
|
|
Through
the first nine months of the year, our total deposit balances declined
$55
million, or approximately 7%, including $9 million in the most recent
quarter. Our non-maturity deposit balances grew more than $21 million
through the first three quarters of the year, with more than $4 million
occurring in the most recent quarter, while time deposits, including
certificates issued through brokerage services, declined $76 million, with
nearly $14 million occurring in the third quarter. Brokered
certificates of deposit accounted for approximately $36 million of the
year-to-date reduction, including $2 million in the third quarter.
Our
other
major source of liquidity is wholesale funds, which include borrowings
from the
FHLB, brokered deposits, reverse repurchase agreements, and a revolving
line of
credit at the Holding Company level. The most utilized wholesale funding
source
is FHLB advances, which totaled $159 million at the end of the third quarter,
down from $172 million at the 2006 year-end. Our credit line with the FHLB
is
reviewed annually, and our maximum allowable borrowing level, subject to
sufficient collateral, is currently set at 40% of assets, or $407 million
based
on assets as of September 30, 2007.
We
had
brokered deposits outstanding totaling $11 million as of the end of the
third
quarter, down from $47 million as of the 2006 year-end. In
anticipation of the closing of the Washington Federal transaction, we elected
to
replace $8 million in brokered deposits, which matured shortly before the
quarter-end, with short-term FHLB advances. Our internal policy limits
restrict
our total usage of brokered certificates to no more than 10% of total
deposits.
Reverse
repurchase lines are lines of credit collateralized by securities. We currently
have lines totaling $35 million, of which the full amount is currently
available. There has been no usage of these lines in the previous three
years.
The risks associated with these lines are the withdrawal of the line based
on
the credit standing of the Bank and the potential lack of sufficient collateral
to support the lines.
An
additional source of liquidity has been our cash from operations, which,
though
not a significant source of liquidity, we consider to be a consistent source
based upon our earnings. On a very limited basis it can be viewed as cash
from
operations adjusted for items such as provision for loan loss and depreciation.
See the “Consolidated Statements of Cash Flows” in the financial statements
section of this filing for a calculation of net cash provided by operating
activities.
In
addition to using liquidity to fund loans and securities, we routinely
invest in
facilities and equipment. In the first nine months of 2007 we invested
$1.3
million in these assets, down from $3.4 million in the same period in 2006,
as
most of our major capital projects were completed by the end of last
year.
CAPITAL
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 September 30, 2007, we exceeded the capital levels
required to meet the definition of a well-capitalized institution:
|
|
Actual
|
Minimum
for
Capital
Adequacy
Purposes
|
Minimum
to be
Categorized
as “Well
Capitalized”
Under
Prompt
Corrective
Action
Provisions
|
|
Total
capital (to risk-weighted assets):
|
|
|
|
|
First
Mutual Bancshares, Inc.
|
11.48%
|
8.00%
|
N/A
|
|
First
Mutual Bank
|
11.66
|
8.00
|
10.00%
|
|
|
|
|
|
|
Tier
I capital (to risk-weighted assets):
|
|
|
|
|
First
Mutual Bancshares, Inc.
|
10.23
|
4.00
|
N/A
|
|
First
Mutual Bank
|
10.41
|
4.00
|
6.00
|
|
|
|
|
|
|
Tier
I capital (to average assets):
|
|
|
|
|
First
Mutual Bancshares, Inc.
|
8.33
|
4.00
|
N/A
|
|
First
Mutual Bank
|
8.49
|
4.00
|
5.00
|
SUBSEQUENT
EVENTS
Subsequent
to the quarter end, we received unexpected information regarding a borrowing
relationship in our Income Property portfolio. While this
relationship had been subject to a downgrade during the third quarter,
the
information we received subsequent to the quarter end necessitated a further
downgrade of the relationship’s risk rating. The loans involved
totaled $6,692,000 at September 30, 2007. Subsequent to quarter end
they were downgraded from “other loans especially mentioned” to
“substandard”. The additional downgrade is expected to increase our
reserve requirement for the fourth quarter.