Item 1. Business
General
Riverview Bancorp, Inc., a Washington corporation, is the savings and loan holding company of Riverview Community Bank (the “Bank”). At March 31, 2014, the Company had total assets of $824.5 million, total deposit accounts of $690.1 million and shareholders' equity of $98.0 million. The Company’s executive offices are located in Vancouver Washington.
The Company is subject to regulation by the Board of Governors of the Federal Reserve Systems (“Federal Reserve”). Substantially all of the Company’s business is conducted through the Bank which is regulated by the Office of the Comptroller of the Currency ("OCC"), its primary regulator, and by the Federal Deposit Insurance Corporation ("FDIC"), the insurer of its deposits. The Bank's deposits are insured by the FDIC up to applicable legal limits under the Deposit Insurance Fund ("DIF"). The Bank has been a member of the Federal Home Loan Bank of Seattle ("FHLB") since 1937.
As a progressive, community-oriented financial services company, the Company emphasizes local, personal service to residents of its primary market area. The Company considers Clark, Cowlitz, Klickitat and Skamania counties of Washington and Multnomah and Marion counties of Oregon as its primary market area. The counties of Multnomah, Clark and Skamania are part of the Portland metropolitan area as defined by the U.S. Census Bureau. The Company is engaged predominantly in the business of attracting deposits from the general public and using such funds in its primary market area to originate commercial business, commercial real estate, multi-family real estate, real estate construction, residential real estate and other consumer loans. The Company’s strategy over the past several years has been to control balance sheet growth, including the targeted reduction of residential construction related loans, in order to improve its regulatory capital ratios. The Company’s loan portfolio totaled $520.9 million at March 31, 2014 compared to $520.4 million a year ago.
Most recently, the Company’s primary focus has been on increasing commercial business loans and owner occupied commercial real estate loans with a specific focus on medical professionals and the medical industry. The Company also purchased two separate pools of automobile loans during fiscal 2014 totaling $22.1 million from another financial institution as a way to further diversify its loan portfolio and to earn a higher yield than earned on its cash or short-term investments.
The Company’s strategic plan includes targeting the commercial banking customer base in its primary market area for loan originations and deposit growth, specifically small and medium size businesses, professionals and wealth building individuals. In pursuit of these goals, the Company will seek to increase the loan portfolio consistent with its strategic plan and asset/liability and regulatory capital objectives, which includes maintaining a significant amount of commercial and commercial real estate loans in its loan portfolio. Significant portions of our new loan originations carry adjustable rates, higher yields or shorter terms and higher credit risk than traditional fixed-rate mortgages.
At March 31, 2014, checking accounts totaled $233.2 million, or 33.8% of our total deposit mix compared to $204.3 million or 30.8% a year ago. Our strategic plan also stresses increased emphasis on non-interest income, including increased fees for asset management through the Bank’s subsidiary, Riverview Asset Management Corp. (“RAMCorp”) a trust and financial services company, and deposit service charges. The strategic plan is designed to enhance earnings, reduce interest rate risk and provide a more complete range of financial services to customers and the local communities the Company serves. We believe we are well positioned to attract new customers and to increase our market share through our 18 branches, including ten in Clark County, three in the Portland metropolitan area and three lending centers, including our most recently opened full-service branch in Gresham, Oregon.
Market Area
The Company conducts operations from its home office in Vancouver and 18 branch offices located in Camas, Washougal, Stevenson, White Salmon, Battle Ground, Goldendale, Vancouver (seven branch offices) and Longview, Washington and Portland, Gresham, Wood Village and Aumsville, Oregon. RAMCorp, our trust and financial services company is located in downtown Vancouver, Washington. Riverview Mortgage, a mortgage broker division of the Bank, originates mortgage loans for various mortgage companies predominantly in the Vancouver/Portland metropolitan areas, as well as for the Bank. The Bank’s Business and Professional Banking Division, with one lending office in Vancouver and one lending office in Portland, Oregon offers commercial and business banking services. The Bank also operates a lending office for mortgage banking activities in Vancouver.
Vancouver is located in Clark County, Washington, which is just north of Portland, Oregon. Many businesses are located in the Vancouver area because of the favorable tax structure and lower energy costs in Washington as compared to Oregon. Companies located in the Vancouver area include Sharp Microelectronics, Hewlett Packard, Georgia Pacific, Underwriters Laboratory, Wafer Tech, Nautilus, Barrett Business Services, PeaceHealth and Fisher Investments, as well as several support industries. In addition to this industry base, the Columbia River Gorge Scenic Area is a source of tourism, which has helped to transform the area from its past dependence on the timber industry.
Economic conditions in the Company’s market areas have continued to improve from the recent recessionary downturn; however, the pace of recovery has been modest and uneven and ongoing stress in the economy will likely continue to be challenging going forward. Unemployment in the Company’s market areas decreased in both Clark County, Washington and Portland, Oregon. According to the Washington State Employment Security Department, unemployment in Clark County decreased to 7.5% at March 31, 2014 compared to 10.1% at March 31, 2013. According to the Oregon Employment Department, unemployment in Portland decreased to 6.9% at March 31, 2014 compared to 7.5% at March 31, 2013. According to the Regional Multiple Listing Services (“RMLS”), residential home inventory levels in Portland, Oregon have slightly decreased to 3.1 months at March 31, 2014 compared to 3.2 months at March 31, 2013. Residential home inventory levels in Clark County have slightly increased to 4.6 months at March 31, 2014 compared to 4.4 months at March 31, 2013. According to the RMLS, closed home sales in Clark County remained constant during March 2014 compared to March 2013. Closed home sales at March 2014 in Portland decreased 4.0% compared to March 2013. Commercial real estate leasing activity in the Portland/Vancouver area has performed better than the residential real estate market; however, it is generally affected by a slow economy later than other indicators. According to Norris Beggs Simpson (a firm specializing in Pacific Northwest commercial real estate sales and management) commercial vacancy rates in Clark County, Washington and Portland, Oregon were approximately 10.38% and 14.60%, respectively, as of March 31, 2014 compared to 12.24% and 17.11%, respectively, at March 31, 2013. The Company has also seen an increase in sales activity for building lots during the past twelve months.
Lending Activities
General
. At March 31, 2014, the Company's net loans receivable totaled $520.9 million, or 63.2% of total assets at that date. The principal lending activity of the Company is the origination of loans collateralized by commercial properties and commercial business loans. A substantial portion of the Company's loan portfolio is secured by real estate, either as primary or secondary collateral, located in its primary market area. The Company’s lending activities are subject to the written, non-discriminatory, underwriting standards and loan origination procedures established by the Bank’s Board of Directors (“Board”) and management. The customary sources of loan originations are realtors, walk-in customers, referrals and existing customers. The Bank also uses commissioned loan brokers and print advertising to market its products and services.
Loans are approved at various levels of management, depending upon the amount of the loan.
Loan Portfolio Analysis
. The following table sets forth the composition of the Company's loan portfolio, excluding loans held for sale, by type of loan at the dates indicated.
|
|
At March 31,
|
|
|
|
2014
|
|
|
|
2013
|
|
|
|
2012
|
|
|
|
2011
|
|
|
|
2010
|
|
|
|
Amount
|
|
Percent
|
|
|
|
Amount
|
|
Percent
|
|
|
|
Amount
|
|
Percent
|
|
|
|
Amount
|
|
Percent
|
|
|
|
Amount
|
|
Percent
|
|
|
|
(Dollars in thousands)
|
Commercial and construction:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
$
|
71,632
|
|
13.43
|
%
|
|
$
|
71,935
|
|
13.42
|
%
|
|
$
|
87,238
|
|
12.74
|
%
|
|
$
|
85,511
|
|
12.44
|
%
|
|
$
|
108,368
|
|
14.76
|
%
|
Other real estate mortgage
|
|
324,881
|
|
60.90
|
|
|
|
355,397
|
|
66.30
|
|
|
|
434,763
|
|
63.49
|
|
|
|
461,955
|
|
67.19
|
|
|
|
459,178
|
|
62.52
|
|
Real estate construction
|
|
19,482
|
|
3.65
|
|
|
|
9,675
|
|
1.81
|
|
|
|
25,791
|
|
3.76
|
|
|
|
27,385
|
|
3.98
|
|
|
|
75,456
|
|
10.27
|
|
Total commercial and construction
|
415,995
|
|
77.98
|
|
|
|
437,007
|
|
81.53
|
|
|
|
547,792
|
|
79.99
|
|
|
|
574,851
|
|
83.61
|
|
|
|
643,002
|
|
87.55
|
|
Consumer:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate one-to-four family
|
|
93,007
|
|
17.43
|
|
|
|
97,140
|
|
18.12
|
|
|
|
134,975
|
|
19.71
|
|
|
|
110,437
|
|
16.06
|
|
|
|
88,861
|
|
12.10
|
|
Other installment
|
|
24,486
|
|
4.59
|
|
|
|
1,865
|
|
0.35
|
|
|
|
2,042
|
|
0.30
|
|
|
|
2,289
|
|
0.33
|
|
|
|
2,616
|
|
0.35
|
|
Total consumer loans
|
|
117,493
|
|
22.02
|
|
|
|
99,005
|
|
18.47
|
|
|
|
137,017
|
|
20.01
|
|
|
|
112,726
|
|
16.39
|
|
|
|
91,477
|
|
12.45
|
|
Total loans
|
|
533,488
|
|
100.00
|
%
|
|
|
536,012
|
|
100.00
|
%
|
|
|
684,809
|
|
100.00
|
%
|
|
|
687,577
|
|
100.00
|
%
|
|
|
734,479
|
|
100.00
|
%
|
Less:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for loan losses
|
|
12,551
|
|
|
|
|
|
15,643
|
|
|
|
|
|
19,921
|
|
|
|
|
|
14,968
|
|
|
|
|
|
21,642
|
|
|
|
Total loans receivable, net
|
$
|
520,937
|
|
|
|
|
$
|
520,369
|
|
|
|
|
$
|
664,888
|
|
|
|
|
$
|
672,609
|
|
|
|
|
$
|
712,837
|
|
|
|
|
|
Loan Portfolio Composition.
The following tables set forth the composition of the Company's commercial and construction loan portfolio based on loan purpose at the dates indicated.
|
|
Commercial
|
|
|
Other
Real Estate
Mortgage
|
|
|
Real Estate
Construction
|
|
|
Commercial & Construction
Total
|
|
March 31, 2014
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
$
|
71,632
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
71,632
|
|
Commercial construction
|
|
|
-
|
|
|
|
-
|
|
|
|
15,618
|
|
|
|
15,618
|
|
Office buildings
|
|
|
-
|
|
|
|
77,476
|
|
|
|
-
|
|
|
|
77,476
|
|
Warehouse/industrial
|
|
|
-
|
|
|
|
45,632
|
|
|
|
-
|
|
|
|
45,632
|
|
Retail/shopping centers/strip malls
|
|
|
-
|
|
|
|
63,049
|
|
|
|
-
|
|
|
|
63,049
|
|
Assisted living facilities
|
|
|
-
|
|
|
|
7,585
|
|
|
|
-
|
|
|
|
7,585
|
|
Single purpose facilities
|
|
|
-
|
|
|
|
93,766
|
|
|
|
-
|
|
|
|
93,766
|
|
Land
|
|
|
-
|
|
|
|
16,245
|
|
|
|
-
|
|
|
|
16,245
|
|
Multi-family
|
|
|
-
|
|
|
|
21,128
|
|
|
|
-
|
|
|
|
21,128
|
|
One-to-four family construction
|
|
|
-
|
|
|
|
-
|
|
|
|
3,864
|
|
|
|
3,864
|
|
Total
|
|
$
|
71,632
|
|
|
$
|
324,881
|
|
|
$
|
19,482
|
|
|
$
|
415,995
|
|
March 31, 2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
$
|
71,935
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
71,935
|
|
Commercial construction
|
|
|
-
|
|
|
|
-
|
|
|
|
5,719
|
|
|
|
5,719
|
|
Office buildings
|
|
|
-
|
|
|
|
86,751
|
|
|
|
-
|
|
|
|
86,751
|
|
Warehouse/industrial
|
|
|
-
|
|
|
|
41,124
|
|
|
|
-
|
|
|
|
41,124
|
|
Retail/shopping centers/strip malls
|
|
|
-
|
|
|
|
67,472
|
|
|
|
-
|
|
|
|
67,472
|
|
Assisted living facilities
|
|
|
-
|
|
|
|
13,146
|
|
|
|
-
|
|
|
|
13,146
|
|
Single purpose facilities
|
|
|
-
|
|
|
|
89,198
|
|
|
|
-
|
|
|
|
89,198
|
|
Land
|
|
|
-
|
|
|
|
23,404
|
|
|
|
-
|
|
|
|
23,404
|
|
Multi-family
|
|
|
-
|
|
|
|
34,302
|
|
|
|
-
|
|
|
|
34,302
|
|
One-to-four family construction
|
|
|
-
|
|
|
|
-
|
|
|
|
3,956
|
|
|
|
3,956
|
|
Total
|
|
$
|
71,935
|
|
|
$
|
355,397
|
|
|
$
|
9,675
|
|
|
$
|
437,007
|
|
Commercial Business Lending.
At March 31, 2014, the commercial business loan portfolio totaled $71.6 million or 13.4% of total loans. Commercial business loans are typically secured by business equipment, accounts receivable, inventory or other property. The Company’s commercial business loans may be structured as term loans or as lines of credit. Commercial term loans are generally made to finance the purchase of assets and usually have maturities of five years or less. Commercial lines of credit are typically made for the purpose of providing working capital and usually have a term of one year or less. Lines of credit are made at variable rates of interest equal to a negotiated margin above an index rate and term loans are at either a variable or fixed rate. The Company also generally obtains personal guarantees from financially capable parties based on a review of personal financial statements.
Commercial lending involves risks that are different from those associated with residential and commercial real estate lending. Commercial business loans are primarily made based on the cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The borrower’s cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Although commercial business loans are often collateralized by equipment, inventory, accounts receivable or other business assets, the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use, among other things. Accordingly, the repayment of commercial business loans depends primarily on the cash flow and credit worthiness of the borrower and secondarily on the underlying collateral provided by the borrower.
Other Real Estate Mortgage Lending.
At March 31, 2014, the other real estate lending portfolio totaled $324.9 million, or 60.9% of total loans. The Company originates other real estate loans including office buildings, warehouse/industrial, retail, assisted living facilities and single-purpose facilities (collectively “commercial real estate loans”); as well as land and multi-family loans primarily located in its market area. At March 31, 2014, owner occupied properties accounted for 32.7% and non-owner occupied properties accounted for 67.3% of the Company’s commercial real estate portfolio.
Commercial real estate and multi-family loans typically have higher loan balances, are more difficult to evaluate and monitor, and involve a higher degree of risk than one-to-four family residential loans. As a result, commercial real estate and multi-family loans are generally priced at a higher rate of interest than residential one-to-four family loans. Often payments on loans secured by commercial properties are dependent on the successful operation and management of the property
securing the loan or business conducted on the property securing the loan; therefore, repayment of these loans may be affected by adverse conditions in the real estate market or the economy. Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral values and liquidation of the underlying real estate collateral being viewed as the primary source of repayment in the event of borrower default. The Company seeks to minimize these risks by generally limiting the maximum loan-to-value ratio to 80% and strictly scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan. Loans are secured by first mortgages and often require specified debt service coverage (“DSC”) ratios depending on the characteristics of the collateral. The Company generally imposes a minimum DSC ratio of 1.20 for loans secured by income producing properties. Rates and other terms on such loans generally depend on our assessment of credit risk after considering such factors as the borrower’s financial condition and credit history, loan-to-value ratio, DSC ratio and other factors.
The Company actively pursues commercial real estate loans. New loan originations within the Company’s market area were very competitive in fiscal year 2014 as stabilizing economic conditions resulted in an increase in loan demand from creditworthy borrowers and permitted existing borrowers with nonaccrual loans to return to a current payment status and refinance elsewhere. At March 31, 2014, the Company had eight commercial real estate loans totaling $8.1 million on non-accrual status compared to six commercial real estate loans totaling $10.3 million at March 31, 2013. For more information concerning risks related to commercial real estate loans, see Item 1A. “Risk Factors – Our emphasis on commercial real estate lending may expose us to increased lending risks.”
Land acquisition and development loans are included in the other real estate mortgage portfolio balance, and represent loans made to developers for the purpose of acquiring raw land and/or for the subsequent development and sale of residential lots. Such loans typically finance land purchases and infrastructure development of properties (i.e. roads, utilities, etc.) with the aim of making improved lots ready for subsequent sales to consumers or builders for ultimate construction of residential units. The primary source of repayment is generally the cash flow from developer sale of lots or improved parcels of land, secondary sources and personal guarantees, which may provide an additional measure of security for such loans. In recent months, statistics reflect an increase in demand and sales of building lots in the Company’s primary market area resulting in an increase in the number of closed sales for land and building lots as compared to previous years. The Company has been successful in reducing its exposure to land acquisition and development loans and plans to only originate these loans on a limited basis to developers that meet the Company’s underwriting standards. At March 31, 2014, land acquisition and development loans totaled $16.2 million, or 3.05% of total loans compared to $23.4 million, or 4.37% of total loans at March 31, 2013. The largest land acquisition and development loan had an outstanding balance at March 31, 2014 of $3.1 million and was performing according to its original payment terms. At March 31, 2014 all of the land acquisition and development loans were secured by properties located in Washington and Oregon. At March 31, 2014, the Company had one land acquisition and development loan totaling $800,000 on non-accrual status compared to five land acquisition and development loans totaling $3.3 million on non-accrual status at March 31, 2013.
Real Estate Construction.
The Company originates three types of residential construction loans: (i) speculative construction loans, (ii) custom/presold construction loans and (iii) construction/permanent loans. The Company also originates construction loans for the development of business properties and multi-family dwellings. All of the Company’s real estate construction loans were made on properties located in Washington and Oregon.
The composition of the Company’s construction loan portfolio including undisbursed funds was as follows:
|
At March 31,
|
|
|
|
2014
|
|
|
|
2013
|
|
|
|
Amount
(1)
|
|
|
Percent
|
|
|
|
Amount
(1)
|
|
|
Percent
|
|
|
|
(Dollars in thousands)
|
Speculative construction
|
$
|
4,771
|
|
|
9.54
|
%
|
|
$
|
5,718
|
|
|
35.77
|
%
|
Commercial/multi-family construction
|
|
44,281
|
|
|
88.57
|
|
|
|
6,495
|
|
|
40.63
|
|
Custom/presold construction
|
|
698
|
|
|
1.40
|
|
|
|
2,898
|
|
|
18.13
|
|
Construction/permanent
|
|
246
|
|
|
0.49
|
|
|
|
875
|
|
|
5.47
|
|
Total
|
$
|
49,996
|
|
|
100.00
|
%
|
|
$
|
15,986
|
|
|
100.00
|
%
|
(1)
Includes undisbursed funds of $30.5 million and $6.3 million at March 31, 2014 and 2013, respectively.
The Company has continued to focus on managing the residential construction and commercial construction loan portfolios. At March 31, 2014, the balance of the Company’s construction loan portfolio, including loan commitments, was $50.0 million compared to $16.0 million at March 31, 2013. The $34.0 million increase was primarily due to an increase in commercial and multi-family construction loans originated in fiscal year 2014 reflecting the improvement in economic conditions in our market areas. The Company plans to continue to proactively manage its construction loan portfolio in fiscal year 2015 and will continue to originate new construction loans to selected customers.
Speculative construction loans are made to home builders and are termed “speculative” because the home builder does not have, at the time of loan origination, a signed contract with a home buyer who has a commitment for permanent financing with either the Company or another lender for the finished home. The home buyer may be identified either during or after the construction period, with the risk that the builder will have to service the speculative construction loan and finance real estate taxes and other carrying costs of the completed home for a significant time after the completion of construction until a home buyer is identified. The largest speculative construction loan at March 31, 2014 was a loan to finance the construction of 37 townhouses totaling $2.5 million. This loan is to a single borrower that is secured by properties located in the Company’s market area. At March 31, 2014, the Company had no speculative construction loans on non-accrual.
The composition of speculative construction and land acquisition and development loans by geographical area is as follows:
|
|
|
Northwest
Oregon
|
|
|
|
Other
Oregon
|
|
|
|
Southwest Washington
|
|
|
|
Other
Washington
|
|
|
|
Other
|
|
|
|
Total
|
|
March 31, 2014
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land development
|
|
$
|
2,676
|
|
|
$
|
1,184
|
|
|
$
|
12,385
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
16,245
|
|
Speculative construction
|
|
|
-
|
|
|
|
-
|
|
|
|
3,617
|
|
|
|
-
|
|
|
|
30
|
|
|
|
3,647
|
|
Total land and speculative construction
|
|
$
|
2,676
|
|
|
$
|
1,184
|
|
|
$
|
16,002
|
|
|
$
|
-
|
|
|
$
|
30
|
|
|
$
|
19,892
|
|
March 31, 2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land development
|
|
$
|
4,674
|
|
|
$
|
1,339
|
|
|
$
|
17,391
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
23,404
|
|
Speculative construction
|
|
|
-
|
|
|
|
175
|
|
|
|
3,011
|
|
|
|
291
|
|
|
|
-
|
|
|
|
3,477
|
|
Total land and speculative construction
|
|
$
|
4,674
|
|
|
$
|
1,514
|
|
|
$
|
20,402
|
|
|
$
|
291
|
|
|
$
|
-
|
|
|
$
|
26,881
|
|
Unlike speculative construction loans, presold construction loans are made for homes that have buyers. Presold construction loans are made to homebuilders who, at the time of construction, have a signed contract with a home buyer who has a commitment for permanent financing for the finished home from the Company or another lender. Custom construction loans are made to the homeowner. Custom/presold construction loans are generally originated for a term of 12 months. At March 31, 2014, and March 31, 2013, the Company had no custom construction loans in its portfolio.
Construction/permanent loans are originated to the homeowner rather than the homebuilder along with a commitment by the Company to originate a permanent loan to the homeowner to repay the construction loan at the completion of construction. The construction phase of a construction/permanent loan generally lasts six to nine months. At the completion of construction, the Company may either originate a fixed rate mortgage loan or an adjustable rate mortgage (“ARM”) loan or use its mortgage brokerage capabilities to obtain permanent financing for the customer with another lender. At completion of construction, the interest rate of the Company-originated fixed rate permanent loan is set at a market rate. For adjustable rate loans, the interest rates adjust on their first adjustment date. See “—Mortgage Brokerage,” and “—Mortgage Loan Servicing.” At March 31, 2014, a single construction/permanent loan totaled $221,000 and was performing according to its original repayment terms. At March 31, 2013, construction/permanent loans totaled $479,000 of which the largest had an outstanding balance of $400,000 and was performing according to its original repayment terms.
The Company provides construction financing for non-residential business properties and multi-family dwellings. At March 31, 2014, such loans totaled $15.6
million, or 80.17% of total real estate construction loans and 2.93% of total loans. Borrowers may be the business owner/occupier of the building who intends to operate their business from the property upon construction, or non-owner developers. The expected source of repayment of these loans is typically the sale or refinancing of the project upon completion of the construction phase. In certain circumstances, the Company may provide or commit to take-out financing upon construction. Take-out financing is subject to the project meeting specific underwriting guidelines. No assurance can be given that such take-out financing will be available upon project completion. These loans are secured by office buildings, retail rental space, mini storage facilities, assisted living facilities and multi-family dwellings located in the Company’s market area. At March 31, 2014, the largest commercial construction loan had a balance of $3.4 million and was performing according to its original repayment terms. At March 31, 2014, the Company had no commercial construction loans on non-accrual status.
Construction lending affords the Company the opportunity to achieve higher interest rates and fees with shorter terms to maturity than the rates and fees generated by its single-family permanent mortgage lending. Construction lending, however, generally involves a higher degree of risk than single-family permanent mortgage lending because of the inherent difficulty in estimating both a property’s value at completion of the project and the estimated cost of the project, as well as the time needed to sell the property at completion. The nature of these loans is such that they are generally more difficult to evaluate and monitor. Because of the uncertainties inherent in estimating construction costs, as well as the market value of the
completed project and the effects of governmental regulation of real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the related loan-to-value ratio. This type of lending also typically involves higher loan principal amounts and is often concentrated with a small number of builders. As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness, rather than the ability of the borrower or guarantor to repay principal and interest. If the appraisal of the value of the completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project and may incur a loss. For additional information concerning the risks related to construction lending, see Item 1A. “Risk Factors – Our real estate construction and land acquisition and development loans are based upon estimates of costs and the value of the completed project.”
The Company has originated construction and land acquisition and development loans where a component of the cost of the project was the interest required to service the debt during the construction period of the loan, sometimes known as interest reserves. The Company allows disbursements of this interest component as long as the project is progressing as originally projected and if there has been no deterioration in the financial standing of the borrower or the underlying project. If the Company makes a determination that there is such deterioration, or if the loan becomes nonperforming, the Company halts any disbursement of those funds identified for use in paying interest. In some cases, additional interest reserves may be taken by use of deposited funds or through credit lines secured by separate and additional collateral.
Consumer Lending.
Consumer loans totaled $117.5 million at March 31, 2014, comprised of $69.8 million of one-to-four family mortgage loans, $20.3 million of home equity lines of credit, $2.9 million of land loans to consumers for the future construction of one-to-four family homes and $24.5 million of other secured and unsecured consumer loans, which primarily consisted of automobile loans.
One-to-four family residences located in the Company’s primary market area secure the majority of the residential loans. Underwriting standards require that one-to-four family portfolio loans generally be owner occupied and that loan amounts not exceed 80% (95% with private mortgage insurance) of the lesser of current appraised value or cost of the underlying collateral. Terms typically range from 15 to 30 years. The Company also offers balloon mortgage loans with terms of either five or seven years and originates both fixed rate mortgages and ARMs with repricing based on the one-year constant maturity U.S. Treasury index or other index. At March 31, 2014, the Company had nine residential real estate loans totaling $2.7 million on non-accrual status compared to 15 loans totaling $3.1 million at March 31, 2013. All of these loans were secured by properties located in Oregon and Washington.
The Company also made the decision during the third fiscal quarter of 2014 to purchase, from time to time, pools of automobile loans from another financial institution as a way to further diversify its loan portfolio and to earn a higher yield than on its cash or short-term investments. These indirect automobile loans are originated through a single dealership group located outside the Company’s primary market area. The collateral for these loans is comprised of a mix of used automobiles. These loans are purchased with servicing retained by the seller. The Company purchased a total of $22.1 million of automobile loans during fiscal year 2014. The Company plans to purchase additional automobile loans during fiscal year 2015, subject to these loans meeting our investment criteria, underwriting standards and internal loan concentration limits. At March 31, 2014, none of the purchased automobile loans were on non-accrual status.
The Company originates a variety of installment loans, including loans for debt consolidation and other purposes, automobile loans, boat loans and savings account loans. These consumer loans generally entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly, such as mobile homes, automobiles, boats and recreational vehicles. At March 31, 2014 and 2013, the Company had no installment loans on non-accrual status.
Loan Maturity.
The following table sets forth certain information at March 31, 2014 regarding the dollar amount of loans maturing in the Company’s portfolio based on their contractual terms to maturity, but does not include potential prepayments. Demand loans, loans having no stated schedule of repayments and no stated maturity and overdrafts are reported as due in one year or less. Loan balances are reported net of deferred fees.
|
|
Within 1
Year
|
|
|
1 – 3 Years
|
|
|
After 3 – 5
Years
|
|
|
After 5 – 10
Years
|
|
|
Beyond 10
Years
|
|
|
Total
|
Commercial and construction:
|
|
(In thousands)
|
Commercial business
|
$
|
26,933
|
|
$
|
12,256
|
|
$
|
14,758
|
|
$
|
17,554
|
|
$
|
131
|
|
$
|
71,632
|
Other real estate mortgage
|
|
45,270
|
|
|
54,392
|
|
|
125,385
|
|
|
96,190
|
|
|
3,644
|
|
|
324,881
|
Real estate construction
|
|
2,531
|
|
|
2,322
|
|
|
39
|
|
|
5,718
|
|
|
8,872
|
|
|
19,482
|
Total commercial & construction
|
|
74,734
|
|
|
68,970
|
|
|
140,182
|
|
|
119,462
|
|
|
12,647
|
|
|
415,995
|
Consumer:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate one-to-four family
|
|
1,292
|
|
|
5,617
|
|
|
1,151
|
|
|
8,057
|
|
|
76,890
|
|
|
93,007
|
Other installment
|
|
123
|
|
|
797
|
|
|
4,817
|
|
|
18,644
|
|
|
105
|
|
|
24,486
|
Total consumer
|
|
1,415
|
|
|
6,414
|
|
|
5,968
|
|
|
26,701
|
|
|
76,995
|
|
|
117,493
|
Total loans
|
$
|
76,149
|
|
$
|
75,384
|
|
$
|
146,150
|
|
$
|
146,163
|
|
$
|
89,642
|
|
$
|
533,488
|
The following table sets forth the dollar amount of all loans due after one year from March 31, 2014, which have fixed interest rates and have adjustable interest rates.
|
|
Fixed
Rate
|
|
|
Adjustable
Rate
|
|
|
Total
|
|
|
|
(In thousands)
|
|
Commercial and Construction:
|
|
|
|
|
|
|
|
|
|
Commercial business
|
$
|
28,330
|
|
$
|
16,369
|
|
$
|
44,699
|
|
Other real estate mortgage
|
|
87,181
|
|
|
192,430
|
|
|
279,611
|
|
Real estate construction
|
|
13,514
|
|
|
3,437
|
|
|
16,951
|
|
Total commercial and construction
|
|
129,025
|
|
|
212,236
|
|
|
341,261
|
|
Consumer:
|
|
|
|
|
|
|
|
|
|
Real estate one-to-four family
|
|
66,548
|
|
|
25,167
|
|
|
91,715
|
|
Other installment
|
|
23,872
|
|
|
491
|
|
|
24,363
|
|
Total consumer
|
|
90,420
|
|
|
25,658
|
|
|
116,078
|
|
Total loans
|
$
|
219,445
|
|
$
|
237,894
|
|
$
|
457,339
|
|
Loan Commitments
. The Company issues commitments to originate commercial loans, other real estate mortgage loans, construction loans, residential mortgage loans and other installment loans conditioned upon the occurrence of certain events. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments. Commitments to originate loans are conditional, and are honored for up to 45 days subject to the Company’s usual terms and conditions. Collateral is not required to support commitments. At March 31, 2014, the Company had outstanding commitments to originate loans of $8.1 million, compared to $29.7 million at March 31, 2013.
Mortgage Brokerage.
In addition to originating mortgage loans for retention in its portfolio, the Company employs four commissioned brokers who originate mortgage loans (including construction loans) for various mortgage companies, as well as for the Company. The loans brokered to mortgage companies are closed in the name of, and funded by the purchasing mortgage company and are not originated as an asset of the Company. In return, the Company receives a fee ranging from 1.5% to 2.0% of the loan amount that it shares with the commissioned broker. Loans brokered to the Company are closed on the Company's books and the commissioned broker receives a portion of the origination fee. During the year ended March 31, 2014, brokered loans totaled $45.4 million (including $37.3 million brokered to the Company), compared to $57.6 million of brokered loans in fiscal year 2013. Gross fees of $830,000, which includes brokered loan fees and loans sold to Federal Home Loan Mortgage Company (“FHLMC”), were earned for the year ended March 31, 2014. The interest rate environment has a strong influence on the loan volume and amount of fees generated from the mortgage broker activity. In general, during periods of rising interest rates, such as in fiscal 2014, the volume of loans and the amount of loan fees generally decrease as a result of slower mortgage loan demand. Conversely, during periods of falling interest rates, the volume of loans and the amount of loan fees generally increase as a result of the increased mortgage loan demand.
Mortgage Loan Servicing.
The Company is a qualified servicer for the FHLMC. The Company generally sells fixed-rate residential one-to-four mortgage loans that it originates with maturities of 15 years or more and balloon mortgages to the FHLMC as part of its asset liability strategy. Mortgage loans are sold to FHLMC on a non-recourse basis whereby foreclosure losses are the responsibility of FHLMC and not the Company. The Company's general policy is to close its residential loans on the FHLMC modified loan documents to facilitate future sales to FHLMC. Upon sale, the Company continues to collect payments on the loans, to supervise foreclosure proceedings, and to otherwise service the loans. At March 31, 2014, total loans serviced for others were $125.2 million, of which $119.2 million were serviced for the FHLMC.
Nonperforming Assets.
Loans are reviewed regularly and it is the Company’s general policy that when a loan is 90 days delinquent or when collection of principal or interest appears doubtful, it is placed on non-accrual status, at which time the accrual of interest ceases and a reserve for any unrecoverable accrued interest is established and charged against operations. Payments received on non-accrual loans are applied to reduce the outstanding principal balance on a cash-basis method.
Nonperforming assets were $21.8 million or 2.64% of total assets at March 31, 2014 compared with $36.8 million or 4.73% of total assets at March 31, 2013. The Company also had net recoveries totaling $608,000 during fiscal 2014 compared to net charge-offs totaling $5.2 million during fiscal 2013. Credit quality challenges have lessened in the past fiscal year and the real estate market in our primary market area has seen improvements. While the Company did not engage in any sub-prime lending programs, the effect on home values, housing markets and construction lending from problems associated with sub-prime and other non-traditional mortgage lending programs contributed substantially to the increased levels of builder and developer delinquencies during recent periods. Although it appears the economic conditions have stabilized, a prolonged weak economy in our market area could result in increases in nonperforming assets, increases in the provision for loan losses and charge-offs in the future.
The Company has continued to focus on managing the residential construction and land acquisition and development portfolios. At March 31, 2014, the Company’s residential construction and land acquisition and development loan portfolios were $3.9 million and $16.2 million, respectively as compared to $4.0 million and $23.4 million at March 31, 2013. The percentage of nonperforming loans in the residential construction and land acquisition and development portfolios was 0.00% and 4.92%, respectively as compared to 4.42% and 13.96%, respectively, a year ago. For the year ended March 31, 2014, the charge-off (recovery) ratio for the residential construction and land development portfolios was 0.18% and (3.84)%, respectively compared to (1.07)% and 2.37%, respectively, for the year ended March 31, 2013.
Nonperforming loans were $14.1 million or 2.64% of total loans at March 31, 2014 compared with $21.1 million or 3.94% of total loans at March 31, 2013. Nonperforming loans decreased as a result of the Company’s aggressive efforts to work out problem loans, seek full repayment or pursue foreclosure proceedings.
The following table sets forth information regarding the Company’s nonperforming loans (dollars in thousands).
|
|
March 31, 2014
|
|
|
March 31, 2013
|
|
|
|
Number
of Loans
|
|
|
Balance
|
|
|
Number
of Loans
|
|
|
Balance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
|
4
|
|
|
$
|
452
|
|
|
|
9
|
|
|
$
|
1,349
|
|
Commercial real estate
|
|
|
8
|
|
|
|
8,067
|
|
|
|
6
|
|
|
|
10,315
|
|
Land
|
|
|
1
|
|
|
|
800
|
|
|
|
5
|
|
|
|
3,267
|
|
Multi-family
|
|
|
1
|
|
|
|
2,014
|
|
|
|
1
|
|
|
|
2,968
|
|
Real estate construction
|
|
|
-
|
|
|
|
-
|
|
|
|
1
|
|
|
|
175
|
|
Consumer
|
|
|
9
|
|
|
|
2,729
|
|
|
|
15
|
|
|
|
3,059
|
|
Total
|
|
|
23
|
|
|
$
|
14,062
|
|
|
|
37
|
|
|
$
|
21,133
|
|
All of these loans are to borrowers with properties located in Oregon and Washington. At March 31, 2014, 96.19% of the Company’s nonperforming loans, totaling $13.5 million, were measured for impairment. These loans have been charged down to their estimated fair market value less selling costs or carry a specific reserve to reduce the net carrying value. The reserve associated with these impaired loans totaled $137,000 at March 31, 2014. At March 31, 2014, the largest single nonperforming loan was a commercial real estate loan totaling $4.2 million. Charge-offs for this property totaled $98,000 for fiscal year 2014. This loan was measured for impairment and determined that a specific reserve was not required since the loan has been charged down to its estimated market value less selling costs.
The balance of nonperforming assets included $7.7 million in real estate owned (“REO”) at March 31, 2014. The REO was comprised of single-family homes totaling $876,000, residential building lots totaling $1.5 million, commercial real estate property totaling $1.1 million and land development property totaling $4.2 million. All of the REO properties are located in Oregon and Washington. As a result of the Company’s decision to aggressively price its REO properties for quicker liquidation, the Company had $2.1 million in write-downs on existing REO properties during fiscal year 2014. Total REO sales were $12.4 million during fiscal year 2014. Maintenance and operating expenses for these properties totaled $709,000 during fiscal year 2014. The orderly resolution of nonperforming loans and REO properties remains a priority for management. Because of the uncertain real estate market, no assurance can be given as to the timing of ultimate disposition of such assets or that the selling price will be at or above the carrying value. Further declines in market values in our area could lead to additional valuation adjustments, which would have an adverse effect on our results of operations.
The following table sets forth information regarding the Company’s nonperforming assets.
|
At March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
|
(In thousands)
|
|
Loans accounted for on a non-accrual basis:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
$
|
452
|
|
$
|
1,349
|
|
$
|
3,930
|
|
$
|
2,871
|
|
$
|
6,430
|
|
Other real estate mortgage
|
|
10,881
|
|
|
16,550
|
|
|
28,562
|
|
|
4,289
|
|
|
15,079
|
|
Real estate construction
|
|
-
|
|
|
175
|
|
|
7,756
|
|
|
4,206
|
|
|
11,826
|
|
Consumer
|
|
2,729
|
|
|
3,059
|
|
|
3,915
|
|
|
957
|
|
|
2,676
|
|
Total
|
|
14,062
|
|
|
21,133
|
|
|
44,163
|
|
|
12,323
|
|
|
36,011
|
|
Accruing loans which are contractually
past due 90 days or more
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Total nonperforming loans
|
|
14,062
|
|
|
21,133
|
|
|
44,163
|
|
|
12,323
|
|
|
36,011
|
|
REO
|
|
7,703
|
|
|
15,638
|
|
|
18,731
|
|
|
27,590
|
|
|
13,325
|
|
Total nonperforming assets
|
$
|
21,765
|
|
$
|
36,771
|
|
$
|
62,894
|
|
$
|
39,913
|
|
$
|
49,336
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foregone interest on non-accrual loans
|
$
|
949
|
|
$
|
1,420
|
|
$
|
2,313
|
|
$
|
1,950
|
|
$
|
2,753
|
|
The following table sets forth information regarding the Company’s nonperforming assets by loan type and geographical area.
|
|
Northwest
Oregon
|
|
|
Other
Oregon
|
|
|
Southwest
Washington
|
|
|
Other
Washington
|
|
|
Total
|
March 31, 2014
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
452
|
|
|
$
|
-
|
|
|
$
|
452
|
|
Commercial real estate
|
|
|
2,194
|
|
|
|
-
|
|
|
|
5,873
|
|
|
|
-
|
|
|
|
8,067
|
|
Multi-family
|
|
|
2,014
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,014
|
|
Land
|
|
|
-
|
|
|
|
800
|
|
|
|
-
|
|
|
|
-
|
|
|
|
800
|
|
Consumer
|
|
|
395
|
|
|
|
-
|
|
|
|
2,065
|
|
|
|
269
|
|
|
|
2,729
|
|
Total nonperforming loans
|
|
|
4,603
|
|
|
|
800
|
|
|
|
8,390
|
|
|
|
269
|
|
|
|
14,062
|
|
REO
|
|
|
374
|
|
|
|
542
|
|
|
|
5,966
|
|
|
|
821
|
|
|
|
7,703
|
|
Total nonperforming assets
|
|
$
|
4,977
|
|
|
$
|
1,342
|
|
|
$
|
14,356
|
|
|
$
|
1,090
|
|
|
$
|
21,765
|
|
March 31, 2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
$
|
94
|
|
|
$
|
169
|
|
|
$
|
1,086
|
|
|
$
|
-
|
|
|
$
|
1,349
|
|
Commercial real estate
|
|
|
2,638
|
|
|
|
-
|
|
|
|
7,379
|
|
|
|
298
|
|
|
|
10,315
|
|
Multi-family
|
|
|
-
|
|
|
|
2,968
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,968
|
|
Land
|
|
|
-
|
|
|
|
800
|
|
|
|
2,467
|
|
|
|
-
|
|
|
|
3,267
|
|
One-to-four family construction
|
|
|
-
|
|
|
|
175
|
|
|
|
-
|
|
|
|
-
|
|
|
|
175
|
|
Consumer
|
|
|
349
|
|
|
|
401
|
|
|
|
1,703
|
|
|
|
606
|
|
|
|
3,059
|
|
Total nonperforming loans
|
|
|
3,081
|
|
|
|
4,513
|
|
|
|
12,635
|
|
|
|
904
|
|
|
|
21,133
|
|
REO
|
|
|
1,637
|
|
|
|
5,272
|
|
|
|
6,548
|
|
|
|
2,181
|
|
|
|
15,638
|
|
Total nonperforming assets
|
|
$
|
4,718
|
|
|
$
|
9,785
|
|
|
$
|
19,183
|
|
|
$
|
3,085
|
|
|
$
|
36,771
|
|
Other loans of concern consist of loans where the borrowers have cash flow problems, or the collateral securing the respective loans may be inadequate. In either or both of these situations, the borrowers may be unable to comply with the present loan repayment terms, and the loans may subsequently be included in the non-accrual category. Management considers the allowance for loan losses to be adequate to cover the probable losses inherent in these and other loans.
The following table sets forth information regarding the Company’s other loans of concern (dollars in thousands).
|
|
March 31, 2014
|
|
|
March 31, 2013
|
|
|
|
Number
of Loans
|
|
|
Balance
|
|
|
Number
of Loans
|
|
|
Balance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
|
15
|
|
|
$
|
7,967
|
|
|
|
12
|
|
|
$
|
2,467
|
|
Commercial real estate
|
|
|
11
|
|
|
|
11,771
|
|
|
|
22
|
|
|
|
27,328
|
|
Land
|
|
|
-
|
|
|
|
-
|
|
|
|
3
|
|
|
|
1,038
|
|
Multi-family
|
|
|
1
|
|
|
|
14
|
|
|
|
2
|
|
|
|
879
|
|
Total
|
|
|
27
|
|
|
$
|
19,752
|
|
|
|
39
|
|
|
$
|
31,712
|
|
At March 31, 2014, loans delinquent 30 to 89 days were 0.42% of total loans compared to 1.74% at March 31, 2013. At March 31, 2014, the 30 to 89 day delinquency rate in our commercial business loan portfolio was 0.17%. The 30 to 89 day delinquency rate in our commercial real estate (“CRE”) portfolio was 0.07%. CRE loans represent the largest portion of our loan portfolio at 53.89% of total loans and the commercial business loans represent 13.43% of total loans.
Troubled debt restructurings (“TDRs”) are loans where the Company, for economic or legal reasons related to the borrower's financial condition, has granted a concession to the borrower that it would otherwise not consider. A TDR typically involves a modification of terms such as a reduction of the stated interest rate or face amount of the loan, a reduction of accrued interest, or an extension of the maturity date(s) at a stated interest rate lower than the current market rate for a new loan with similar risk.
TDRs are considered impaired loans and as such, when a loan is deemed to be impaired, the amount of the impairment is measured using discounted cash flows using the original note rate, except when the loan is collateral dependent. In these cases, the estimated fair value of the collateral and when applicable, less selling costs, are used. Impairment is recognized as a specific component within the allowance for loan losses if the value of the impaired loan is less than the recorded investment in the loan. When the amount of the impairment represents a confirmed loss, it is charged off against the allowance for loan losses. At March 31, 2014, the Company had TDRs totaling $22.8 million of which $12.4 million were on accrual status. However, all of the Company’s TDRs are paying as agreed except for one of the Company’s TDRs that totaled $270,000 at March 31, 2014, that was restructured during fiscal year 2012 and defaulted subsequent to modification. The related amount of interest income recognized on these TDRs was $553,000 for the year ended March 31, 2014.
The Company has determined that, in certain circumstances, it is appropriate to split a loan into multiple notes. This typically includes a nonperforming charged-off loan that is not supported by the cash flow of the relationship and a performing loan that is supported by the cash flow. These may also be split into multiple notes to align portions of the loan balance with the various sources of repayment when more than one exists. Generally the new loans are restructured based on customary underwriting standards. In situations where they were not, the policy exception qualifies as a concession, and the borrower is experiencing financial difficulties, the loans are accounted for as TDRs.
The accrual status of a loan may change after it has been classified as a TDR. The Company’s general policy related to TDRs is to perform a credit evaluation of the borrower’s financial condition and prospects for repayment under the revised terms. This evaluation includes consideration of the borrower’s sustained historical repayment performance for a reasonable period of time in order for the restructured loan to be returned to an accrual status. A sustained period of repayment performance generally would be a minimum of six months, and may include repayments made prior to the restructuring date. If repayment of principal and interest appears doubtful, it is placed on non-accrual status.
In accordance with the Company’s policy guidelines, unsecured loans are generally charged-off when no payments have been received for three consecutive months unless an alternative action plan is in effect. Consumer installment loans delinquent six months or more that have not received at least 75% of their required monthly payment in the last 90 days are charged-off. In addition, loans discharged in bankruptcy proceedings are charged-off. Loans under bankruptcy protection with no payments received for four consecutive months will be charged-off. The outstanding balance of a secured loan that is in excess of the net realizable value is generally charged-off if no payments are received for four to five consecutive months. However, charge-offs are postponed if alternative proposals to restructure, obtain additional guarantors, obtain additional assets as collateral or a potential sale would result in full repayment of the outstanding loan balance. Once any of these or other potential sources of repayment are exhausted the impaired portion of the loan is charged-off, unless an updated valuation of the collateral reveals no impairment. Regardless of whether a loan is unsecured or collateralized, once an amount is determined to be a confirmed loan loss it is promptly charged off.
Asset Classification.
The OCC has adopted various regulations regarding problem assets of savings institutions. The regulations require that each insured institution review and classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, OCC examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss (collectively “classified loans”). Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified as loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted.
When the Company classifies problem assets as either substandard or doubtful, we may establish a specific allowance in an amount we deem prudent to address the risk specifically or we may allow the loss to be addressed in the general allowance. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been specifically allocated to particular problem assets. When a problem asset is classified by us as a loss, we are required to charge off the asset in the period in which it is deemed uncollectible.
The aggregate amount of the Company's classified loans, general loss allowances, specific loss allowances and charge-offs were as follows at the dates indicated:
|
|
At or For the Year
|
|
|
|
Ended March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
(In thousands)
|
|
Classified loans
|
|
$
|
33,814
|
|
|
$
|
52,845
|
|
|
|
|
|
|
|
|
|
|
General loss allowances
|
|
|
12,272
|
|
|
|
14,924
|
|
Specific loss allowances
|
|
|
279
|
|
|
|
719
|
|
Net charge-offs (recoveries)
|
|
|
(608
|
)
|
|
|
5,178
|
|
All of the loans on non-accrual status as of March 31, 2014 were categorized as classified loans. Classified loans at March 31, 2014 were comprised of 19 commercial business loans totaling $8.4 million (the largest of these loans totaling $3.5 million), 19 commercial real estate loans totaling $19.8 million (the largest of which was $4.9 million), two multi-family loans totaling $2.0 million, one land development loan totaling $800,000 and nine one-to-four family real estate loans totaling $2.7 million (the largest of which was $1.1 million).
Allowance for Loan Losses.
The Company maintains an allowance for loan losses to provide for probable losses inherent in the loan portfolio. The adequacy of the allowance is evaluated monthly to maintain the allowance at levels sufficient to provide for inherent losses existing at the balance sheet date. The key components to the evaluation are the Company’s internal loan review function by its credit administration, which reviews and monitors the risk and quality of the loan portfolio; as well as the Company’s external loan reviews and its loan classification systems. Credit officers are expected to monitor their portfolios and make recommendations to change loan grades whenever changes are warranted. Credit administration approves any changes to loan grades and monitors loan grades.
For additional discussion of the Company’s methodology for assessing the appropriate level of the allowance for loan losses see
Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies."
At March 31, 2014, the Company had an allowance for loan losses of $12.6 million, or 2.35% of total loans, compared to $15.6 million, or 2.92% at March 31, 2013. The decrease in the balance of the allowance for loan losses at March 31, 2014 reflects the continuing trend of lower levels of delinquent and classified loans, decreased charge-offs and increased recoveries, as well as stabilizing real estate values compared to the prior fiscal year, which resulted in the Company recording a recapture of loan losses of $3.7 million for the year ended March 31, 2014. Nonperforming loans decreased $7.1 million and 30-89 day delinquent loans also decreased $7.1 million during the year ended March 31, 2014. Classified loans were $33.8 million at March 31, 2014 compared to $52.8 million at March 31, 2013. The decrease in nonperforming and classified assets can be attributed to the Company’s efforts to reduce its level of nonperforming and classified assets through write-downs, collections and modifications.
The coverage ratio of allowance for loan losses to nonperforming loans was 89.25% at March 31, 2014 compared to 74.02% at March 31, 2013. This coverage ratio increased from March 31, 2013 primarily as a result of the decrease in nonperforming loans. At March 31, 2014, 18 of the Company’s nonperforming loans, totaling $13.5 million or 96.19% of total nonperforming loans, were measured for impairment, with all of these loans being considered collateral dependent. The additional reserves associated with these impaired loans totaled $137,000 at March 31, 2014. The Company’s general valuation allowance to non-impaired loans was 2.42% and 2.96% at March 31, 2014 and 2013, respectively.
Management considers the allowance for loan losses to be adequate to
cover probable losses inherent in the loan portfolio based on the assessment of various factors affecting the loan portfolio
and the Company believes it has established its existing allowance for loan losses in accordance with accounting principles generally accepted in the United States of America (“generally accepted accounting principles” or "GAAP"). However, a further decline in local economic conditions, results of examinations by the Company’s regulators, or other factors could result in a material increase in the allowance for loan losses and may adversely affect the Company’s financial condition and results of operations.
In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing
allowance for loan losses will be adequate or that substantial increases will not be necessary should the quality of any loans deteriorate or should collateral values further decline as a result of the factors discussed elsewhere in this document.
The following table sets forth an analysis of the Company's allowance for loan losses for the periods indicated.
|
|
Year Ended March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
|
(Dollars in thousands)
|
|
Balance at beginning of year
|
|
$
|
15,643
|
|
|
$
|
19,921
|
|
|
$
|
14,968
|
|
|
$
|
21,642
|
|
|
$
|
16,974
|
|
Provision for (recapture of) loan losses
|
|
|
(3,700
|
)
|
|
|
900
|
|
|
|
29,350
|
|
|
|
5,075
|
|
|
|
15,900
|
|
Recoveries:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial and construction
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
|
526
|
|
|
|
118
|
|
|
|
29
|
|
|
|
7
|
|
|
|
5
|
|
Other real estate mortgage
|
|
|
873
|
|
|
|
1,263
|
|
|
|
103
|
|
|
|
31
|
|
|
|
1
|
|
Real estate construction
|
|
|
4
|
|
|
|
228
|
|
|
|
3
|
|
|
|
7
|
|
|
|
76
|
|
Total commercial and construction
|
|
|
1,403
|
|
|
|
1,609
|
|
|
|
135
|
|
|
|
45
|
|
|
|
82
|
|
Consumer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate one-to-four family
|
|
|
304
|
|
|
|
138
|
|
|
|
12
|
|
|
|
11
|
|
|
|
7
|
|
Other installment
|
|
|
7
|
|
|
|
1
|
|
|
|
3
|
|
|
|
2
|
|
|
|
-
|
|
Total consumer
|
|
|
311
|
|
|
|
139
|
|
|
|
15
|
|
|
|
13
|
|
|
|
7
|
|
Total recoveries
|
|
|
1,714
|
|
|
|
1,748
|
|
|
|
150
|
|
|
|
58
|
|
|
|
89
|
|
Charge-offs:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial and construction
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
|
340
|
|
|
|
1,606
|
|
|
|
2,801
|
|
|
|
2,371
|
|
|
|
2,466
|
|
Other real estate mortgage
|
|
|
406
|
|
|
|
3,869
|
|
|
|
16,895
|
|
|
|
4,404
|
|
|
|
3,836
|
|
Real estate construction
|
|
|
11
|
|
|
|
141
|
|
|
|
2,101
|
|
|
|
4,329
|
|
|
|
3,737
|
|
Total commercial and construction
|
|
|
757
|
|
|
|
5,616
|
|
|
|
21,797
|
|
|
|
11,104
|
|
|
|
10,039
|
|
Consumer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate one-to-four family
|
|
|
346
|
|
|
|
1,238
|
|
|
|
2,694
|
|
|
|
682
|
|
|
|
1,232
|
|
Other installment
|
|
|
3
|
|
|
|
72
|
|
|
|
56
|
|
|
|
21
|
|
|
|
50
|
|
Total consumer
|
|
|
349
|
|
|
|
1,310
|
|
|
|
2,750
|
|
|
|
703
|
|
|
|
1,282
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total charge-offs
|
|
|
1,106
|
|
|
|
6,926
|
|
|
|
24,547
|
|
|
|
11,807
|
|
|
|
11,321
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net charge-offs (recoveries)
|
|
|
(608
|
)
|
|
|
5,178
|
|
|
|
24,397
|
|
|
|
11,749
|
|
|
|
11,232
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of year
|
|
$
|
12,551
|
|
|
$
|
15,643
|
|
|
$
|
19,921
|
|
|
$
|
14,968
|
|
|
$
|
21,642
|
|
Ratio of allowance to total loans
outstanding at end of year
|
|
|
2.35
|
%
|
|
|
2.92
|
%
|
|
|
2.91
|
%
|
|
|
2.18
|
%
|
|
|
2.95
|
%
|
Ratio of net charge-offs (recoveries) to average net
loans outstanding during year
|
|
|
(0.12
|
)
|
|
|
0.86
|
|
|
|
3.51
|
|
|
|
1.67
|
|
|
|
1.48
|
|
Ratio of allowance to total nonperforming loans
|
|
|
89.25
|
|
|
|
74.02
|
|
|
|
45.11
|
|
|
|
121.46
|
|
|
|
60.10
|
|
The Company’s allowance consists of specific, general and unallocated components. The Company’s specific allowance decreased from prior year due to a decrease in the balance of impaired loans during the year. The general component also decreased from prior year due to a decrease in the balance of classified and nonperforming loans and a decrease in charge-offs during the year. The unallocated component has remained elevated compared to historical levels as a result of the
continued economic uncertainty.
The following table sets forth the breakdown of the allowance for loan losses by loan category and is based on applying a specific loan loss factor to the outstanding balances of related loan category as of the date of the allocation for the periods indicated.
|
|
At March 31,
|
|
|
|
2014
|
|
|
|
2013
|
|
|
|
2012
|
|
|
|
2011
|
|
|
|
2010
|
|
|
|
Amount
|
|
Loan Category
as a
Percent
of Total
Loans
|
|
|
|
Amount
|
|
Loan Category
as a
Percent
of Total
Loans
|
|
|
|
Amount
|
|
Loan Category
as a
Percent of Total
Loans
|
|
|
|
Amount
|
|
Loan Category as a Percent of Total Loans
|
|
|
|
Amount
|
|
Loan Category as a Percent
of Total Loans
|
|
|
|
(Dollars in thousands)
|
Commercial and construction:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
$
|
2,409
|
|
13.43
|
%
|
|
$
|
2,128
|
|
13.42
|
%
|
|
$
|
2,688
|
|
12.74
|
%
|
|
$
|
1,822
|
|
12.44
|
%
|
|
$
|
3,181
|
|
14.76
|
%
|
Other real estate mortgage
|
|
5,812
|
|
60.90
|
|
|
|
8,539
|
|
66.30
|
|
|
|
11,626
|
|
63.49
|
|
|
|
8,919
|
|
67.19
|
|
|
|
10,028
|
|
62.52
|
|
Real estate construction
|
|
387
|
|
3.65
|
|
|
|
221
|
|
1.81
|
|
|
|
412
|
|
3.76
|
|
|
|
820
|
|
3.98
|
|
|
|
5,137
|
|
10.27
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate one-to-four family
|
|
2,190
|
|
17.43
|
|
|
|
2,868
|
|
18.12
|
|
|
|
3,220
|
|
19.71
|
|
|
|
1,294
|
|
16.06
|
|
|
|
1,522
|
|
12.10
|
|
Other installment
|
|
463
|
|
4.59
|
|
|
|
81
|
|
0.35
|
|
|
|
54
|
|
0.30
|
|
|
|
45
|
|
0.33
|
|
|
|
52
|
|
0.35
|
|
Unallocated
|
|
1,290
|
|
-
|
|
|
|
1,806
|
|
-
|
|
|
|
1,921
|
|
-
|
|
|
|
2,068
|
|
-
|
|
|
|
1,722
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total allowance for loan loss
|
$
|
12,551
|
|
100.00
|
%
|
|
$
|
15,643
|
|
100.00
|
%
|
|
$
|
19,921
|
|
100.00
|
%
|
|
$
|
14,968
|
|
100.00
|
%
|
|
$
|
21,642
|
|
100.00
|
%
|
Investment Activities
The Board sets the investment policy of the Company. The Company's investment objectives are: to provide and maintain liquidity within regulatory guidelines; to maintain a balance of high quality, diversified investments to minimize risk; to provide collateral for pledging requirements; to serve as a balance to earnings; and to optimize returns. The policy permits investment in various types of liquid assets permissible under OCC regulation, which includes U.S. Treasury obligations, securities of various federal agencies, "bank qualified" municipal bonds, certain certificates of deposit of insured banks, repurchase agreements, federal funds and mortgage-backed securities (“MBS”), but does not permit investment in non-investment grade bonds. The policy also dictates the criteria for classifying securities into one of three categories: held to maturity, available for sale or trading. At March 31, 2014, no investment securities were held for trading.
See
Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies."
At March 31, 2014, the Company’s investment portfolio totaled $102.1 million, primarily consisting of $21.5 million in U.S. agency securities available-for-sale, $78.6 million in mortgage-backed securities available-for-sale, and $1.9 million in trust preferred securities available-for-sale. This compares with a total investment portfolio of $6.8 million at March 31, 2013, primarily consisting of $5.0 million in U.S. agency securities available-for-sale, $431,000 in mortgage-backed securities available-for-sale, and $1.2 million in trust preferred securities available-for-sale. The increase was due to a decision by the Company to invest additional excess cash into higher yielding investment securities and mortgage-backed securities. The Company primarily purchases agency securities with maturities of five years or less and purchases a combination of mortgage-backed securities backed by government agencies (FHLMC, Fannie Mae (“FNMA”), U.S. Small Business Administration (“SBA”) or Ginnie Mae (“GNMA”)). At March 31, 2014, the Company owned no privately issued mortgage-backed securities. Our real estate mortgage investment conduits (“REMICS”) consist of FHLMC and FNMA securities and our CRE mortgage-backed securities consist of FNMA securities. The Company does not believe that it has any exposure to sub-prime lending in its mortgage-backed securities portfolio. See Note 4 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K for additional information.
The following table sets forth the investment securities portfolio and carrying values at the dates indicated.
|
At March 31,
|
|
|
|
2014
|
|
|
|
2013
|
|
|
|
2012
|
|
|
|
Carrying
Value
|
|
Percent of
Portfolio
|
|
|
|
Carrying
Value
|
|
Percent of
Portfolio
|
|
|
|
Carrying
Value
|
|
Percent of
Portfolio
|
|
|
|
(Dollars in thousands)
|
|
Held to maturity (at amortized cost):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FHLMC mortgage-backed securities
|
$
|
26
|
|
0.03
|
%
|
|
$
|
31
|
|
0.46
|
%
|
|
$
|
69
|
|
0.87
|
%
|
FNMA mortgage-backed securities
|
|
75
|
|
0.07
|
|
|
|
94
|
|
1.39
|
|
|
|
102
|
|
1.28
|
|
Municipal securities
|
|
-
|
|
-
|
|
|
|
-
|
|
-
|
|
|
|
493
|
|
6.20
|
|
|
|
101
|
|
0.10
|
|
|
|
125
|
|
1.85
|
|
|
|
664
|
|
8.35
|
|
Available for sale (at fair value):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency securities
|
|
21,491
|
|
21.06
|
|
|
|
4,978
|
|
73.51
|
|
|
|
4,999
|
|
62.87
|
|
REMICs
|
|
7,150
|
|
7.00
|
|
|
|
237
|
|
3.50
|
|
|
|
329
|
|
4.14
|
|
FHLMC mortgage-backed securities
|
|
25,386
|
|
24.87
|
|
|
|
191
|
|
2.82
|
|
|
|
636
|
|
8.00
|
|
FNMA mortgage-backed securities
|
|
38,950
|
|
38.16
|
|
|
|
3
|
|
0.04
|
|
|
|
9
|
|
0.11
|
|
SBA mortgage-backed securities
|
|
3,932
|
|
3.85
|
|
|
|
-
|
|
-
|
|
|
|
-
|
|
-
|
|
GNMA mortgage-backed securities
|
|
1,077
|
|
1.06
|
|
|
|
-
|
|
-
|
|
|
|
-
|
|
-
|
|
CRE mortgage-backed securities
|
|
2,080
|
|
2.04
|
|
|
|
-
|
|
-
|
|
|
|
-
|
|
-
|
|
Municipal securities
|
|
-
|
|
-
|
|
|
|
-
|
|
-
|
|
|
|
149
|
|
1.87
|
|
Trust preferred securities
|
|
1,903
|
|
1.86
|
|
|
|
1,238
|
|
18.28
|
|
|
|
1,166
|
|
14.66
|
|
|
|
101,969
|
|
99.90
|
|
|
|
6,647
|
|
98.15
|
|
|
|
7,288
|
|
91.65
|
|
Total investment securities
|
$
|
102,070
|
|
100.00
|
%
|
|
$
|
6,772
|
|
100.00
|
%
|
|
$
|
7,952
|
|
100.00
|
%
|
The following table sets forth the maturities and weighted average yields in the securities portfolio at March 31, 2014.
|
Less Than One Year
|
|
|
One to Five Years
|
|
|
More Than Five to Ten Years
|
|
|
More Than
Ten Years
|
|
|
Amount
|
|
Weighted Average
Yield
(1)
|
|
|
Amount
|
|
Weighted Average
Yield
(1)
|
|
|
Amount
|
|
Weighted Average
Yield
(1)
|
|
|
Amount
|
|
Weighted Average
Yield
(1)
|
|
|
|
(Dollars in thousands)
|
|
Agency securities
|
$
|
-
|
|
-
|
%
|
|
$
|
14,099
|
|
1.15
|
%
|
|
$
|
7,392
|
|
1.52
|
%
|
|
$
|
-
|
|
-
|
%
|
REMICs
|
|
-
|
|
-
|
|
|
|
27
|
|
5.26
|
|
|
|
137
|
|
4.39
|
|
|
|
6,986
|
|
2.30
|
|
FHLMC mortgage-backed securities
|
|
4
|
|
4.03
|
|
|
|
-
|
|
-
|
|
|
|
1,567
|
|
1.33
|
|
|
|
23,841
|
|
1.99
|
|
FNMA mortgage-backed securities
|
|
1
|
|
7.06
|
|
|
|
-
|
|
-
|
|
|
|
9,522
|
|
1.86
|
|
|
|
29,502
|
|
2.04
|
|
SBA mortgage-backed securities
|
|
-
|
|
-
|
|
|
|
-
|
|
-
|
|
|
|
-
|
|
-
|
|
|
|
3,932
|
|
1.18
|
|
GNMA mortgage-backed securities
|
|
-
|
|
-
|
|
|
|
-
|
|
-
|
|
|
|
-
|
|
-
|
|
|
|
1,077
|
|
1.97
|
|
CRE mortgage-backed securities
|
|
-
|
|
-
|
|
|
|
-
|
|
-
|
|
|
|
-
|
|
-
|
|
|
|
2,080
|
|
3.40
|
|
Trust preferred securities
|
|
-
|
|
-
|
|
|
|
-
|
|
-
|
|
|
|
-
|
|
-
|
|
|
|
1,903
|
|
3.73
|
|
Total
|
$
|
5
|
|
4.64
|
%
|
|
$
|
14,126
|
|
1.16
|
%
|
|
$
|
18,618
|
|
1.70
|
%
|
|
$
|
69,321
|
|
1.89
|
%
|
(1)
For available for sale securities carried at fair value, the weighted average yield is computed using amortized cost without a tax equivalent
adjustment for tax-exempt obligations.
Investment securities available-for-sale, comprised of agency securities and trust preferred securities, were $23.4 million at March 31, 2014 compared to $6.2 million at March 31, 2013. Management reviews investment securities quarterly for the presence of other than temporary impairment (“OTTI”), taking into consideration current market conditions, the extent and nature of changes in fair value, issuer rating changes and trends, financial condition of the underlying issuers, current analysts’ evaluations, the Company’s ability and intent to hold investments until a recovery of fair value, which may be maturity, as well as other factors. A $1.9 million investment security that the Company currently holds is a single collateralized debt obligation (“CDO”) secured by trust preferred securities issued by other bank holding companies. There was no impairment charge of this security for the years ended March 31, 2014, 2013 or 2012. Management believes that it is probable that principal payments will exceed the Company’s recorded investment in this security, that the Company does not intend to sell this security and it is not more likely than not that the Company will be required to sell this security before the anticipated recovery of the remaining amortized cost basis.
At March 31, 2014, the market for the Company’s CDO was determined to be inactive in management’s judgment. This determination was made by the Company after considering the last known trade date for this specific security, the low number of transactions for similar types of securities, the low number of new issuances for similar securities, the increased implied liquidity risk premium for similar securities, the lack of information that is released publicly and discussions with third-party industry analysts. Due to the inactivity in the market, observable market data was not readily available for all significant inputs for this security. Accordingly, the trust preferred pooled security was classified as Level 3 in the fair value hierarchy. The Company utilized observable inputs where available, unobservable data and modeled the cash flows adjusted by an appropriate liquidity and credit risk adjusted discount rate using an income approach valuation technique in order to measure the fair value of the security. Significant unobservable inputs were used that reflect the Company’s assumptions of what a market participant would use to price the security. Significant unobservable inputs included selecting an appropriate discount rate, default rate and repayment assumptions. The Company estimated the discount rate by comparing rates for similarly rated corporate bonds, with additional consideration given to market liquidity. The default rates and repayment assumptions were estimated based on the individual issuer’s financial condition, historical repayment information, as well as the Company’s future expectations of the capital markets. Using this information, the Company estimated the fair value of the security at March 31, 2014 to be $1.9 million.
Additionally, the Company received two independent Level 3 valuation estimates for this security. Those valuation estimates were based on proprietary pricing models utilizing significant unobservable inputs. The Company’s estimate of fair value fell within the range of valuations provided, however, the magnitude in the range of fair value estimates further supported the difficulty in estimating the fair value for these types of securities in the current environment. Additionally, the Company believes that some of the assumptions used by the independent parties were overly aggressive and unrealistic. Therefore, the Company believes the use of its internally developed valuation model at March 31, 2014 is reasonable.
For additional information on our Level 3 fair value measurements see
Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Comparison of Financial Condition at March 31, 2014 and 2013,” “Fair Value of Level 3 Assets,” and Note 17 of the Notes to the Consolidated Financial Statements contained in Item 8 of the Form 10-K.
Deposit Activities and Other Sources of Funds
General.
Deposits, loan repayments and loan sales are the major sources of the Company's funds for lending and other investment purposes. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds from other sources. They may also be used on a longer-term basis for general business purposes.
Deposit Accounts.
The Company attracts deposits from within its primary market area by offering a broad selection of deposit instruments, including demand deposits, negotiable order of withdrawal ("NOW") accounts, money market accounts, regular savings accounts, certificates of deposit and retirement savings plans. The Company has focused on building customer relationships deposits which includes both business and consumer depositors. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of its deposit accounts, the Company considers the rates offered by its competition, profitability to the Company, matching deposit and loan products and customer preferences and concerns.
The following table sets forth the average balances of deposit accounts offered by the Company at the dates indicated.
|
Year Ended March 31,
|
|
|
|
2014
|
|
|
|
2013
|
|
|
|
2012
|
|
|
|
Average
Balance
|
|
Average
Rate
|
|
|
|
Average
Balance
|
|
Average
Rate
|
|
|
|
Average
Balance
|
|
Average
Rate
|
|
|
|
(Dollars in thousands)
|
|
Non-interest-bearing demand
|
$
|
120,290
|
|
0.00
|
%
|
|
$
|
127,048
|
|
0.00
|
%
|
|
$
|
110,959
|
|
0.00
|
%
|
Interest checking
|
|
93,395
|
|
0.11
|
|
|
|
86,091
|
|
0.16
|
|
|
|
96,764
|
|
0.29
|
|
Regular savings accounts
|
|
59,844
|
|
0.15
|
|
|
|
49,394
|
|
0.19
|
|
|
|
40,345
|
|
0.31
|
|
Money market accounts
|
|
224,689
|
|
0.21
|
|
|
|
228,269
|
|
0.26
|
|
|
|
234,325
|
|
0.45
|
|
Certificates of deposit
|
|
174,522
|
|
0.75
|
|
|
|
206,565
|
|
0.89
|
|
|
|
248,696
|
|
1.17
|
|
Total
|
$
|
672,740
|
|
0.29
|
%
|
|
$
|
697,367
|
|
0.38
|
%
|
|
$
|
731,089
|
|
0.60
|
%
|
Deposit accounts totaled $690.1 million at March 31, 2014 compared to $663.8 million at March 31, 2013. The Company did not have any wholesale-brokered deposits at March 31, 2014 and 2013. The Company continues to focus on core deposits and growth around customer relationships as opposed to obtaining deposits through the wholesale markets. The Company has continued to experience increased competition for customer deposits within its market area. Customer branch deposit balances increased $33.4 million since March 31, 2013. The Company had $38.3 million, or 5.6% of total deposits, in Certificate of Deposit Account Registry Service (“CDARS”) and Insured Cash Sweep (“ICS”) deposits, which were gathered from customers within the Company’s primary market-area. CDARS and ICS deposits allow customers access to FDIC insurance on deposits exceeding the $250,000 FDIC insurance limit.
At March 31, 2014 and 2013, deposits from RAMCorp totaled $4.2 million and $4.9 million, respectively. These deposits were included in interest bearing and non-interest bearing accounts and represent assets under management by RAMCorp. At March 31, 2014, and 2013, the Company also had $11.7 million and $9.9 million, respectively in deposits from public entities located in the States of Washington and Oregon, all of which were fully covered by FDIC insurance or secured by pledged collateral.
The Company is enrolled in an internet deposit listing service. Under this listing service, the Company may post certificates of deposit rates on an internet site where institutional investors have the ability to deposit funds with the Company. At March 31, 2014 and 2013, the Company had $249,000 and $5.9 million, respectively, in deposits through this listing service. The decrease was due to maturities that occurred in fiscal year 2014 that the Company elected not to renew which were redeemed by the depositing institution. The Company plans to discontinue the utilization of internet based deposits during fiscal year 2015; however, the Company will continue to have accessibility to these funds in the future. Furthermore, the Company may utilize the internet deposit listing service to purchase certificates of deposit at other financial institutions.
Deposit growth remains a key strategic focus for the Company and our ability to achieve deposit growth, particularly growth in core deposits, is subject to many risk factors including the effects of competitive pricing pressures, changing customer deposit behavior, and increasing or decreasing interest rate environments. Adverse developments with respect to any of these risk factors could limit the Company’s ability to attract and retain deposits and could have a material negative impact on the Company’s financial condition, results of operations and cash flows.
The following table presents the amount and weighted average rate of certificates of deposit equal to or greater than $100,000 at March 31, 2014.
Maturity Period
|
|
Amount
|
|
|
Weighted
Average Rate
|
|
|
|
(Dollars in thousands)
|
|
Three months or less
|
|
$
|
20,669
|
|
|
|
0.40
|
%
|
Over three through six months
|
|
|
17,270
|
|
|
|
0.51
|
|
Over six through 12 months
|
|
|
25,981
|
|
|
|
0.36
|
|
Over 12 Months
|
|
|
26,252
|
|
|
|
1.38
|
|
Total
|
|
$
|
90,172
|
|
|
|
0.70
|
%
|
Borrowings.
Deposits are the primary source of funds for the Company's lending and investment activities and for its general business purposes. The Company relies upon advances from the FHLB and borrowings from the Federal Reserve Bank of San Francisco (“FRB”) to supplement its supply of lendable funds and to meet deposit withdrawal requirements. Advances from the FHLB and borrowings from the FRB are typically secured by the Bank's commercial loans, commercial real estate loans, first mortgage loans and investment securities. At March 31, 2014, 2013 and 2012, the Bank had no FHLB advances or FRB borrowings.
The FHLB functions as a central reserve bank providing credit for member financial institutions. As a member, the Bank is required to own capital stock in the FHLB and is authorized to apply for advances on the security of such stock and certain of its mortgage loans and other assets (primarily securities which are obligations of, or guaranteed by, the United States) provided certain standards related to creditworthiness have been met. The FHLB determines specific lines of credit for each member institution and the Bank has a line of credit with the FHLB equal to 30% of its total assets to the extent the Bank provides qualifying collateral and holds sufficient FHLB stock. At March 31, 2014, the Bank had an available credit facility of $240.9 million, which is limited to available pledged collateral.
The Bank also has a borrowing arrangement with the FRB with an available credit facility of $58.1 million, subject to pledged collateral, as of March 31, 2014.
|
Year Ended March 31,
|
|
|
2014
|
|
|
2013
|
|
|
2012
|
|
|
|
(Dollars in thousands)
|
|
Maximum amounts of FHLB advances
outstanding at any month end
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Average FHLB advances outstanding
|
|
5
|
|
|
|
3
|
|
|
|
3
|
|
Weighted average rate on FHLB advances
|
|
0.52
|
%
|
|
|
0.55
|
%
|
|
|
0.25
|
%
|
Maximum amounts of FRB borrowings
outstanding at any month end
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Average FRB borrowings outstanding
|
|
-
|
|
|
|
3
|
|
|
|
11
|
|
Weighted average rate on FRB borrowings
|
|
-
|
%
|
|
|
0.75
|
%
|
|
|
0.75
|
%
|
At March 31, 2014, the Company had two wholly-owned subsidiary grantor trusts totaling $22.7 million for the purpose of issuing trust preferred securities and common securities. The trust preferred securities accrue and pay distributions periodically at specified annual rates as provided in each trust agreement. The trusts used the net proceeds from each of the offerings to purchase a like amount of junior subordinated debentures (the “Debentures”) of the Company. The Debentures are the sole assets of the trusts. The Company’s obligations under the Debentures and related documents, taken together, constitute a full and unconditional guarantee by the Company of the obligations of the trusts. The trust preferred securities are mandatorily redeemable upon maturity of the Debentures, or upon earlier redemption as provided in the indentures. The Company has the right to redeem the Debentures in whole or in part on or after specific dates, at a redemption price specified in the indentures governing the Debentures plus any accrued but unpaid interest to the redemption date. The Company also has the right to defer the payment of interest on each of the Debentures for a period not to exceed 20 consecutive quarters, provided that the deferral period does not extend beyond the stated maturity. During such deferral period, distributions on the corresponding trust preferred securities will also be deferred and the Company may not pay cash dividends to the holders of shares of our common stock. Beginning in the first quarter of fiscal 2011, the Company elected to defer regularly scheduled interest payments on its outstanding $22.7 million aggregate principal amount of Debentures and distributions on the corresponding trust preferred securities are also being deferred. The Company continued with the interest deferral through March 31, 2014. As of March 31, 2014, the Company had deferred a total of $3.7 million of interest
payments. The common securities issued by the grantor trusts were purchased by the Company, and the Company’s investment in the common securities of $681,000 at March 31, 2014 and 2013 is included in prepaid expenses and other assets in the Consolidated Balance Sheets included in the Consolidated Financial Statements contained in Item 8 of the Form 10-K. See also Note 11 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K.
Taxation
For details regarding the Company’s taxes, see Item 8 – “Financial Statements and Supplementary Data - Note 12 of the Notes to the Consolidated Financial Statements.”
Personnel
As of March 31, 2014, the Company had 219 full-time equivalent employees, none of whom are represented by a collective bargaining unit. The Company believes its relationship with its employees is good.
Corporate Information
The Company’s principal executive offices are located at 900 Washington Street, Vancouver, Washington 98660. Its telephone number is (360) 693-6650. The Company maintains a website with the address
www.riverviewbank.com
. The information contained on the Company’s website is not included as a part of, or incorporated by reference into, this Annual Report on Form 10-K. Other than an investor’s own internet access charges, the Company makes available free of charge through its website the Annual Report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after it has electronically filed such material with, or furnished such material to, the Securities and Exchange Commission (“SEC”).
Subsidiary Activities
Under OCC regulations, the Bank is authorized to invest up to 3% of its assets in subsidiary corporations, with amounts in excess of 2% only if primarily for community purposes. At March 31, 2014, the Bank’s investments of $1.1 million in Riverview Services, Inc. (“Riverview Services”), its wholly owned subsidiary, and $4.0 million in RAMCorp, a 90% owned subsidiary, were within these limitations.
Riverview Services acts as a trustee for deeds of trust on mortgage loans granted by the Bank, and receives a reconveyance fee for each deed of trust. Riverview Services had net income of $21,000 for the fiscal year ended March 31, 2014 and total assets of $1.1 million at that date. Riverview Services’ operations are included in the Consolidated Financial Statements of the Company contained in Item 8 of the Form 10-K.
RAMCorp is an asset management company providing trust, estate planning and investment management services. RAMCorp commenced business in December 1998 and had net income of $609,000 for the fiscal year ended March 31, 2014 and total assets of $4.6 million at that date. RAMCorp earns fees on the management of assets held in fiduciary or agency capacity. At March 31, 2014, total assets under management totaled $359.7 million. RAMCorp’s operations are included in the Consolidated Financial Statements of the Company contained in Item 8 of this Form 10-K.
Executive Officers
. The following table sets forth certain information regarding the executive officers of the Company.
Name
|
Age
(1
)
|
Position
|
Patrick Sheaffer
|
74
|
Chairman of the Board and Chief Executive Officer
|
Ronald A. Wysaske
|
61
|
President and Chief Operating Officer
|
Kevin J. Lycklama
|
36
|
Executive Vice President and Chief Financial Officer
|
Daniel D. Cox
|
36
|
Executive Vice President and Chief Credit Officer
|
Richard S. Michalek
|
69
|
Executive Vice President and Chief Lending Officer
|
John A. Karas
|
65
|
Executive Vice President
|
James D. Baldovin
|
55
|
Executive Vice President Retail Banking
|
Kim J. Capeloto
|
52
|
Executive Vice President Marketing and Operations
|
(1)
At March 31, 2014
Patrick Sheaffer
is
Chairman of the Board and Chief Executive Officer
of the Company and Chief Executive Officer of the Bank, positions he has held since February 2004. Prior to February 2004, Mr. Sheaffer served as Chairman of the Board, President and Chief Executive Officer of the Company since its inception in 1997. He became Chairman of the Board of the Bank in 1993. Mr. Sheaffer joined the Bank in 1963. He is responsible for leadership and management of the Company. Mr. Sheaffer is active in numerous professional and civic organizations.
Ronald A. Wysaske
is President and Chief Operating Officer of the Bank, positions he has held since February 2004. Prior to February 2004, Mr. Wysaske served as Executive Vice President, Treasurer and Chief Financial Officer of the Bank from 1981 to 2004 and of the Company since its inception in 1997. He joined the Bank in 1976. Mr. Wysaske is responsible for daily operations and management of the Bank. He holds an M.B.A. from Washington State University and is active in numerous professional, educational and civic organizations.
Kevin J. Lycklama
is Executive Vice President and Chief Financial Officer of the Company, positions he has held since February 2008. Prior to February 2008, Mr. Lycklama served as Vice President and Controller of the Bank since 2006. Prior to joining Riverview, Mr. Lycklama spent five years with a local public accounting firm advancing to the level of audit manager. He is responsible for accounting, SEC reporting as well as treasury functions for the Bank and the Company. He holds a Bachelor of Arts degree from Washington State University, is a graduate of the Pacific Coast Banking School and is a certified public accountant.
Daniel D. Cox
is Executive Vice President and Chief Credit Officer and is responsible for credit administration related to its commercial, mortgage and consumer loan activities. Mr. Cox joined Riverview in August 2002 and spent five years as a commercial lender and progressed through the credit administration function, most recently serving as Senior Vice President of Credit Administration. He holds a Bachelor of Arts degree from Washington State University and was an Honor Roll graduate of the Pacific Coast Banking School. Mr. Cox is an active mentor in our local schools and was the Past Treasurer and Endowment Chair for the Washougal Schools Foundation and Past Board Member of Camas-Washougal Chamber of Commerce.
Richard S. Michalek
is Executive Vice President and Chief Lending Officer of the Company, a position he has held since June 2012. Mr. Michalek is responsible for all of the Bank’s lending division related to commercial, real estate and consumer loan activities. Prior to joining Riverview in 2001, Mr. Michalek spent seven years at Northwest National Bank where he was a commercial loan officer and later managed the retail banking loan center. Mr. Michalek also spent 19 years at Seattle First National Bank/Bank of America in various capacities. Mr. Michalek holds a Bachelor of Arts and M.B.A. from Seattle University and is a graduate of the Pacific Coast Banking School.
John A. Karas
is Executive Vice President of the Bank and also serves as Chairman of the Board, President and CEO of its subsidiary, RAMCorp. Mr. Karas has been employed by the Company since 1999 and has over 30 years of trust experience. He is familiar with all phases of the trust business and his experience includes trust administration, trust legal counsel, investments and real estate. Mr. Karas received his B.A. from Willamette University and his Juris Doctor degree from Lewis & Clark Law School’s Northwestern School of Law. He is a member of the Oregon, Multnomah County and American Bar Associations and is a Certified Trust and Financial Advisor. Mr. Karas is also active in numerous civic organizations.
James D.
Baldovin
is Executive Vice President of Retail Banking and is responsible for the Bank’s branch banking network, customer service, sales and community development. Mr. Baldovin has been employed by the Bank since January 2003 and has over 30 years of banking expertise in developing and leading sales and service cultures. He holds a Bachelor of Arts degree in economics from Linfield College and is a graduate of the Pacific Coast Banking School.
Kim J. Capeloto
is Executive Vice President of Marketing, Operations and Information Technology. Mr. Capeloto has been employed by the Bank since September 2010. Mr. Capeloto has over 30 years of banking experience serving as regional manager for Union Bank of California and Wells Fargo Bank directing small business and personal banking activities. Prior to joining the Bank, Mr. Capeloto held the position of President and Chief Executive Officer of the Greater Vancouver Chamber of Commerce. Mr. Capeloto is active in numerous professional and civic organizations.
REGULATION
The following is a brief description of certain laws and regulations, which are applicable to the Company and the Bank. The description of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.
Legislation is introduced from time to time in the United States Congress (“Congress”) that may affect the Company’s and Bank’s operations. In addition, the regulations governing the Company and the Bank may be amended from time to time by the OCC, the FDIC, the Federal Reserve Board or the SEC, as appropriate. Any such legislation or regulatory changes in the future could have an adverse effect
on our operations and financial condition. We cannot predict whether any such changes may occur.
General
As a federally chartered savings bank, the Bank is subject to extensive regulation, examination and supervision by the OCC, as its primary federal regulator, and the FDIC, as the insurer of its deposits. Additionally, the Company is subject to extensive regulation, examination and supervision by the Federal Reserve Board as its primary federal regulator. The Bank is a member of the FHLB System and its deposit accounts are insured up to applicable limits by the Deposit Insurance Fund, which is administered by the FDIC. The Bank must file reports with the OCC and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. There are periodic examinations by the OCC, the Federal Reserve and under certain circumstances, the FDIC, to evaluate the Bank’s safety and soundness and compliance with various regulatory requirements. This regulatory structure establishes a comprehensive framework of activities in which the Bank may engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such policies, whether by the OCC, the Federal Reserve, the FDIC or Congress, could have a material adverse impact on the Company and the Bank and their operations.
Federal Regulation of Savings Institutions
Office of the Comptroller of the Currency.
The OCC has extensive authority over the operations of savings institutions. As part of this authority, the Bank is required to file periodic reports with the OCC and is subject to periodic examinations by the OCC. The OCC also has extensive enforcement authority over all savings institutions, including the Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease-and-desist or removal orders and initiate prompt corrective action orders. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OCC. Except under certain circumstances, public disclosure of final enforcement actions by the OCC is required by law.
In January 2009, the Bank entered into a Memorandum of Understanding (“MOU”) with the Office of Thrift Supervision (“OTS”), at the time the Bank’s primary regulator. Following the transfer of the responsibilities and authority of the OTS to the OCC on July 21, 2011, the MOU was enforced by the OCC. On January 25, 2012, the Bank entered into a formal written agreement (“Agreement”) with the OCC. Upon effectiveness of the Agreement, the MOU was terminated by the OCC. The Agreement remained in effect and enforceable until modified, waived or terminated in writing by the OCC. On April 2, 2014, the Bank was notified that the Agreement was rescinded.
The Bank has also separately agreed to the OCC establishing higher minimum capital ratios for the Bank, specifically that the Bank maintain a Tier 1 capital (leverage) ratio of not less than 9.00% and a total risk-based capital ratio of not less than 12.00%. As of March 31, 2014, the Bank’s Tier 1 capital (leverage) ratio was 10.71% and its total risk-based capital ratio was 16.66%.
All savings institutions are required to pay assessments to the OCC to fund the agency's operations. The general assessments, paid on a semi-annual basis, are determined based on the savings institution's total assets, including consolidated subsidiaries. The Bank's OCC assessment for the fiscal year ended March 31, 2014 was $365,000.
The Bank's general permissible lending limit for loans-to-one-borrower is equal to the greater of $500,000 or 15% of unimpaired capital and surplus (except for loans fully secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus). At March 31, 2014, the Bank's lending limit under this restriction was $14.5 million and, at that date, the Bank’s largest lending relationship with one borrower was $11.0 million, which consisted of one commercial construction loan which was performing according to its original payment terms at March 31, 2014.
The OCC’s oversight of the Bank includes reviewing its compliance with the customer privacy requirements imposed by the Gramm-Leach-Bliley Act of 1999 (“GLBA”) and the anti-money laundering provisions of the USA Patriot Act. The GLBA privacy requirements place limitations on the sharing of consumer financial information with unaffiliated third parties. They also require each financial institution offering financial products or services to retail customers to provide such customers with its privacy policy and with the opportunity to “opt out” of the sharing of their personal information with unaffiliated third parties. The USA Patriot Act significantly expands the responsibilities of financial institutions in preventing the use of the United States financial system to fund terrorist activities. Its anti-money laundering provisions require financial institutions operating in the United States to develop anti-money laundering compliance programs and due diligence policies and controls to ensure the detection and reporting of money laundering. These compliance programs are intended to supplement existing compliance requirements under the Bank Secrecy Act and the Office of Foreign Assets Control Regulations.
The OCC, as well as the other federal banking agencies, has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits. Any institution that fails to comply with these standards must submit a compliance plan.
Current Capital Requirements.
Federally insured savings institutions, such as the Bank, are required by the OCC to maintain minimum levels of regulatory capital. These minimum capital standards include: a 1.5% tangible capital to total assets ratio, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS examination rating system) and an 8% risk-based capital ratio. In addition, the prompt corrective action standards, discussed below, also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS system) and, together with the risk-based capital standard itself, a 4% tier 1 risk-based capital standard. The OCC regulations also require that, in meeting the tangible, leverage and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank.
The risk-based capital standard requires federal savings institutions to maintain tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, recourse obligations, residual interests and direct credit substitutes, are multiplied by a risk-weight factor of 0% to 100%, assigned by the OCC capital regulation based on the risks believed inherent in the type of asset. Tier 1 (core) capital is defined as common stockholders’ equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.
The OCC also has authority to establish individual minimum capital requirements for financial institutions. In January 2012, the Bank agreed to the OCC establishing minimum capital ratios for the Bank in excess of the minimum capital standards required under OCC’s Prompt Corrective Actions. Specifically, the Bank must achieve and maintain tier 1 (core) leverage ratio of 9% and total risk-based capital ratio of 12%. As of March 31, 2014, the Bank’s Tier 1 capital (leverage) ratio was 10.71% and its total risk-based capital ratio was 16.66%. For additional information, see Note 15 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
New Capital Rules.
On July 9, 2013, the OCC and the other federal bank regulatory agencies issued a final rule that will revise their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The final rule applies to all depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more and top-tier savings and loan holding companies.
Effective in 2015 (with some changes generally transitioned into full effectiveness over two to four years), the Bank will be subject to new capital requirements adopted by the FDIC. These new requirements create a new required ratio for common equity Tier 1 (“CET1”) capital, increase the leverage and Tier 1 capital ratios, change the risk-weights of certain assets for purposes of the risk-based capital ratios, create an additional capital conservation buffer over the required capital ratios and change what qualifies as capital for purposes of meeting these various capital requirements. Beginning in 2016, failure to maintain the required capital conservation buffer will limit the ability of the Bank to pay dividends, repurchase shares or pay discretionary bonuses.
When these new requirements become effective in 2015, the Bank’s leverage ratio of 4% of adjusted total assets and total capital ratio of 8% of risk-weighted assets will remain the same; however, the Tier 1 capital ratio requirement will increase from 4.0% to 6.5% of risk-weighted assets. In addition, the Bank will have to meet the new CET1 capital ratio of 4.5% of risk-weighted assets, with CET1 consisting of qualifying Tier 1 capital less all capital components that are not considered common equity.
For all of these capital requirements, there are a number of changes in what constitutes regulatory capital, some of which are subject to a two-year transition period. These changes include the phasing-out of certain instruments as qualifying capital. The Bank does not have any of these instruments. Under the new requirements for total capital, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital.
Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock will be deducted from capital, subject to a two-year transition period. In addition, Tier 1 capital will include accumulated other comprehensive income, which includes all unrealized gains and losses on available-for-sale debt and equity securities, subject to a two-year transition period. Because of their asset size, the Bank has the one-time option of deciding in the first quarter of 2015 whether to permanently opt out of the inclusion of accumulated other comprehensive income in their capital calculations. The Bank is considering whether to take advantage of this opt-out to reduce the impact of market volatility on its regulatory capital levels.
The new requirements also include changes in the risk-weights of assets to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisitions, development and construction loans and for non-residential mortgage loans that are 90 days past due or otherwise in nonaccrual status; a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable; a 250% risk weight (up from 100%) for mortgage servicing and deferred tax assets that are not deducted from capital; and increased risk-weights (0% to 600%) for equity exposures.
In addition to the minimum CET1, Tier 1 and total capital ratios, the Bank will have to maintain a capital conservation buffer consisting of additional CET1 capital equal to 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses based on percentages of eligible retained income that could be utilized for such actions. This new capital conservation buffer requirement is be phased in beginning in January 2016 at 0.625% of risk-weighted assets and increasing each year until fully implemented at 2.5% in January 2019.
The OCC’s prompt corrective action standards will change when these new capital ratios become effective. Under the new standards, in order to be considered well-capitalized, the Bank would have to have a CET1 ratio of 6.5% (new), a Tier 1 ratio of 8% (increased from 6%), a total capital ratio of 10% (unchanged) and a leverage ratio of 5% (unchanged).
Prompt Corrective Action.
The OCC is required to take certain supervisory actions against undercapitalized savings institutions, the severity of which depends upon the institution's degree of undercapitalization. Generally, an institution that has a ratio of total capital to risk-weighted assets of less than 8%, a ratio of tier 1 (core) capital to risk-weighted assets of less than 4%, or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be "undercapitalized." An institution that has a total risk-based capital ratio less than 6%, a tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be "significantly undercapitalized" and an institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized." Subject to a narrow exception, the OCC is required to appoint a receiver or conservator for a savings institution that is "critically undercapitalized." OCC regulations also require that a capital restoration plan be filed with the OCC within 45 days of the date a savings institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. “Significantly undercapitalized” and “critically undercapitalized” institutions are subject
to more extensive mandatory regulatory actions. The OCC also could take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. At March 31, 2014, the Bank’s capital ratios met the "well capitalized" standards. For additional information see “-Capital Requirements.”
In addition, the final capital rule adopted in July 2013 revises the prompt corrective action categories to incorporate the revised minimum capital requirements of that rule when it becomes effective. The OCC’s prompt corrective action standards will change when these new capital ratios become effective. Under the new standards, in order to be considered well-capitalized, the Bank would have to have a common equity Tier 1 ratio of 6.5% (new), a Tier 1 risk-based capital ratio of 8.0% (increased from 6.0%), a total risk-based capital ratio of 10.0% (unchanged), and a Tier 1 leverage ratio of 5.0% (unchanged).
Federal Home Loan Bank System.
The Bank is a member of the FHLB of Seattle, which is one of 12 regional FHLBs that administer the home financing credit function of savings institutions. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans or advances to members in accordance with policies and procedures, established by the Board of Directors of the FHLB, which are subject to the oversight of the Federal Housing Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term advances are required to provide funds for residential home financing. See Business – “Deposit Activities and Other Sources of Funds – Borrowings.”
As a member, the Bank is required to purchase and maintain stock in the FHLB. At March 31, 2014, the Bank had $6.7 million in FHLB stock, which was in compliance with this requirement. In 2009, the FHLB reported a risk-based capital deficiency under the regulations of the Federal Housing Finance Agency (“FHFA”), its primary regulator as of December 31, 2008, and stated that it would suspend future dividends and the repurchase and redemption of outstanding common stock. In September 2012, the FHLB announced that the FHFA now considers it to be adequately capitalized. Dividends on, or repurchases of, the FHLB stock continue to require consent of the FHFA. The FHFA subsequently approved the repurchase of portions of FHLB stock and during fiscal year 2014, the FHLB had repurchased $410,000 of its stock, at par, from the Bank. The FHLB announced in July 2013 that, based on its second quarter 2013 fanatical results, their Board of Directors had declared a $0.025 per share cash dividend. For the year ended March 31, 2014, the Bank received $5,000 of dividends on FHLB stock.
The FHLBs have continued and continue to contribute to low- and moderately-priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have in the past affected adversely the level of FHLB dividends paid and could continue to do so in the future if dividend payments resume. These contributions could also have an adverse effect on the value of FHLB stock in the future. A reduction in value of the Bank's FHLB stock may result in a corresponding reduction in the Bank's capital.
Federal Deposit Insurance Corporation
. The DIF of the FDIC insures deposit accounts in the Bank up to $250,000 per separately insured depositor. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. The Bank’s deposit insurance premiums for the year ended March 31, 2014 were $1.5 million.
The Dodd-Frank Act requires the FDIC's deposit insurance assessments to be based on assets instead of deposits. In 2011, the FDIC published a final rule under the Dodd-Frank Act, which specify that the assessment base for a bank is equal to its total average consolidated assets less average tangible capital. The FDIC assessment rates range from approximately 2.5 basis points to 45 basis points, depending on applicable adjustments for unsecured debt issued by an institution and brokered deposits (and to further adjustment for institutions that hold unsecured debt of other FDIC-insured institutions), until such time as the FDIC's reserve ratio equals 1.15%. Once the FDIC's reserve ratio reaches 1.15% and the reserve ratio for the immediately prior assessment period is less than 2.0%, the applicable assessment rates may range from 1.5 basis points to 40 basis points (subject to adjustments as described above). If the reserve ratio for the prior assessment period is equal to, or greater than 2.0% and less than 2.5%, the assessment rates may range from one basis point to 38 basis points and if the prior assessment period is greater than 2.5%, the assessment rates may range from a half basis point to 35 basis points (in each case subject to adjustments as described above. No institution may pay a dividend if it is in default on its federal deposit insurance assessment.
As insurer, the FDIC is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the DIF. The FDIC also has the authority to take enforcement actions against banks and savings associations. The FDIC may terminate the deposit insurance of any insured depository institution if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is not aware of any existing circumstances which would result in termination of the deposit insurance of the Bank.
Qualified Thrift Lender Test.
All savings institutions, including the Bank, are required to meet a qualified thrift lender ("QTL") test to avoid certain restrictions on their operations. This test requires a savings institution to have at least 65% of its total assets, as defined by regulation, in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. As an alternative, the savings institution may maintain 60% of its assets in those assets specified in Section 7701(a) (19) of the Internal Revenue Code ("Code"). Under either test, such assets primarily consist of residential housing related loans and investments.
Any institution that fails to meet the QTL test must either become a national bank or be prohibited from making new investments or engaging in activities not allowed for both a national bank and a savings association, from establishing a new branch unless such branch is allowable for a national bank, and from paying dividends unless allowable for a national bank; unless within one year it meets the test, and thereafter remains a qualified thrift lender. Any holding company of an institution that fails the test and does not re-qualify within a year must become a bank holding company. If such an institution has not converted to a bank within three years after it failed the test, it must divest of any investments and cease any activities not permissible for both a national bank and a savings association. The Company does not believe that any of its investments or operating activities would be prohibited under such circumstances. As of March 31, 2014, the Bank maintained 90.95% of its portfolio assets in qualified thrift investments and therefore met the QTL test.
Limitations on Capital Distributions.
OCC regulations impose various restrictions on savings institutions with respect to their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. Generally, savings institutions, such as the Bank, that before and after the proposed distribution are well-capitalized, may make capital distributions during any calendar year equal to up to 100% of net income for the year-to-date plus retained net income for the two preceding years. However, an institution deemed to be in need of more than normal supervision by the OCC, such as the Bank, may have its dividend authority restricted by the OCC.
Generally, savings institutions proposing to make any capital distribution need not submit written notice to the OCC prior to such distribution unless they are a subsidiary of a holding company or would not remain well capitalized following the distribution. Savings institutions that do not, or would not meet their current minimum capital requirements following a proposed capital distribution or propose to exceed these net income limitations, must obtain OCC approval prior to making such distribution. The OCC may object to the distribution during that 30-day period based on safety and soundness concerns. See "- Current Capital Requirements."
Activities of Associations and their Subsidiaries.
When a savings institution establishes or acquires a subsidiary or elects to conduct any new activity through a subsidiary that the association controls, the savings institution must file a notice or application with the FDIC and the OCC at least 30 days in advance and receive regulatory approval or non-objection. Savings institutions also must conduct the activities of subsidiaries in accordance with existing regulations and orders.
The OCC may determine that the continuation by a savings institution of its ownership control of, or its relationship to, the subsidiary constitutes a serious risk to the safety, soundness or stability of the association or is inconsistent with sound banking practices or with the purposes of the FDIC. Based upon that determination, the FDIC or the OCC has the authority to order the savings institution to divest itself of control of the subsidiary. The FDIC also may determine by regulation or order that any specific activity poses a serious threat to the Deposit Insurance Fund. If so, it may require that no FDIC insured institution engage in that activity directly.
Transactions with Affiliates.
The Bank’s authority to engage in transactions with “affiliates” is limited by OCC regulations and by Sections 23A and 23B of the Federal Reserve Act as implemented by the Federal Reserve Board’s Regulation W. The term “affiliates” for these purposes generally means any company that controls or is under common control with an institution. The Company and its non-savings institution subsidiaries are affiliates of the Bank. In general, transactions with affiliates must be on terms that are as favorable to the institution as comparable transactions with non-affiliates. In addition, certain types of transactions are restricted to an aggregate percentage of the institution’s capital. Collateral in specified amounts must be provided by affiliates in order to receive loans from an institution. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary.
The Sarbanes-Oxley Act of 2002
("Sarbanes-Oxley Act")
generally prohibits a company from making loans to its executive officers and directors. However, that act contains a specific exception for loans by a depository institution to its executive officers and directors in compliance with federal banking laws. Under such laws, the Bank’s authority to extend credit to executive officers, directors and 10% stockholders of the Bank and its affiliates (“insiders”), as well as entities such persons control is limited. The law restricts both the individual and aggregate amount of loans the Bank may make to insiders based, in part, on the Bank’s capital position and requires certain Board approval procedures to be followed. Such loans must be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. There are additional restrictions applicable to loans to executive officers.
Community Reinvestment Act and Consumer Protection Laws.
Under the Community Reinvestment Act (“CRA”), every FDIC-insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the OCC, in connection with the examination of the Bank, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by the Bank. An unsatisfactory rating may be used as the basis for the denial of an application by the OCC. Due to the heightened attention being given to the CRA in the past few years, the Bank may be required to devote additional funds for investment and lending in its local community. The Bank received a satisfactory rating during its most recent examination.
In connection with its deposit-taking, lending and other activities, the Bank is subject to a number of federal laws designed to protect consumers and promote lending to various sectors of the economy and population. The Dodd-Frank Act created a new Consumer Financial Protection Bureau (“CFPB”) as an independent bureau of the Federal Reserve. The CFPB assumed responsibility for the implementation of the federal financial consumer protection and fair lending laws and regulations and has authority to impose new requirements. However, institutions of less than $10 billion in assets, such as the Bank, will continue to be examined for compliance with consumer protection and fair lending laws and regulations by, and be subject to the enforcement authority of, their primary regulators.
The CFPB issues regulations and standards under these federal consumer protection laws, which include the Equal Credit Opportunity Act, the Truth-in-Lending Act, the Home Mortgage Disclosure Act and the Real Estate Settlement Procedures Act. Through its rulemaking authority, the CFPB has promulgated several proposed and final regulations under these laws that will affect the Bank’s consumer businesses. Among these regulatory initiatives, are final regulations setting “ability to repay” and “qualified mortgage” standards for residential mortgage loans and establishing new mortgage loan servicing and loan originator compensation standards. The Bank is evaluating these recent CFPB regulations and proposals and devotes substantial compliance, legal and operational business resources to ensure compliance with these consumer protection standards. In addition, the OCC has enacted customer privacy regulations that limit the ability of the Bank to disclose nonpublic consumer information to non-affiliated third parties. The regulations require disclosure of privacy policies and allow consumers to prevent certain personal information from being shared with non-affiliated parties.
Enforcement.
The OCC has primary enforcement responsibility over savings institutions and has the authority to bring action against all "institution-affiliated parties," including shareholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers or directors, receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can range from $25,000 to $1.1 million per day. The FDIC has the authority to recommend to the OCC that enforcement action be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.
Standards for Safety and Soundness.
As required by statute, the federal banking agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the OCC determines that a savings institution fails to meet any standard prescribed by the guidelines, the OCC may require the institution to submit an acceptable plan to achieve compliance with the standard.
Federal Reserve System.
The Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts, primarily checking, NOW and Super NOW checking accounts. At March 31, 2014, the Bank was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy any liquidity requirements that may be imposed by the OCC.
Commercial Real Estate Lending Concentrations
. The federal banking agencies have issued guidance on sound risk management practices for concentrations in commercial real estate lending. The particular focus is on exposure to commercial real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be sensitive to conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary source of repayment or as an abundance of caution). The purpose of the guidance is not to limit a bank’s commercial real estate lending but to guide banks in developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations. The guidance directs the FDIC and other bank regulatory agencies to focus their supervisory resources on institutions that may have significant commercial real estate loan concentration risk. A bank that has experienced rapid growth in commercial real estate lending, has notable exposure to a specific type of commercial real estate loan, or is approaching or exceeding the following supervisory criteria may be identified for further supervisory analysis with respect to real estate concentration risk:
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Total reported loans for construction, land development and other land represent 100% or more of the bank’s capital; or
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Total commercial real estate loans (as defined in the guidance) represent 300% or more of the bank’s total capital or the outstanding balance of the bank’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months.
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The guidance provides that the strength of an institution’s lending and risk management practices with respect to such concentrations will be taken into account in supervisory guidance on evaluation of capital adequacy.
Environmental Issues Associated with Real Estate Lending.
The Comprehensive Environmental Response Compensation and Liability Act ("CERCLA"), a federal statute, generally imposes strict liability on all prior and present "owners and operators" of sites containing hazardous waste. However, Congress asked to protect secured creditors by providing that the term "owner and operator" excludes a person whose ownership is limited to protecting its security interest in the site. Since the enactment of the CERCLA, this "secured creditor exemption" has been the subject of judicial interpretations which have left open the possibility that lenders could be liable for cleanup costs on contaminated property that they hold as collateral for a loan. In addition, we may be subject to environmental liabilities with respect to real estate properties that are placed in foreclosure that we subsequently take title to.
To the extent that legal uncertainty exists in this area, all creditors, including the Bank, that have made loans secured by properties with potential hazardous waste contamination (such as petroleum contamination) could be subject to liability for cleanup costs, which could substantially exceed the value of the collateral property.
Other Consumer Protection Laws and Regulations.
The Bank is subject to a broad array of federal and state consumer protection laws and regulations that govern almost every aspect of its business relationships with consumers. While the list set forth below is not exhaustive, these include the Gramm-Leach-Bliley Financial Services Modernization Act of 1999, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“Patriot Act”), the Truth-in-Lending Act, the Truth in Savings Act, the Electronic Fund Transfers Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Home Mortgage Disclosure Act, the Fair Credit Reporting Act, the Right to Financial Privacy Act, the Home Ownership and Equity Protection Act, the Fair Credit Billing Act, the Homeowners Protection Act, the Check Clearing for the 21st Century Act, laws governing flood insurance, laws governing consumer protections in connection with the sale of insurance, federal and state laws prohibiting unfair and deceptive business practices, and various regulations that implement some or all of the foregoing. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans, collecting loans, and providing other services. Failure to comply with these laws and regulations can subject the Bank to various penalties, including but not limited to, enforcement actions, injunctions, fines, civil liability, criminal penalties, punitive damages, and the loss of certain contractual rights.
Savings and Loan Holding Company Regulations
General.
The Company is a unitary savings and loan holding company subject to regulatory oversight of the Federal Reserve. Accordingly, the Company is required to register and file reports with the Federal Reserve and is subject to regulation and examination by the Federal Reserve. In addition, the Federal Reserve has enforcement authority over the Company and its non-savings institution subsidiaries, which also permits the Federal Reserve to restrict or prohibit activities that are determined to present a serious risk to the subsidiary savings institution.
In October 2009, the Company also entered into a separate MOU agreement with the OTS, at the time the Company’s primary regulator. In May 2013, the Company entered into a written agreement with the Federal Reserve to replce its MOU agreement. For additional information regarding the specifics of the written agreement, see Item 1A, “Risk Factors – We are required to comply with the terms of a written agreement with the Federal Reserve and lack of compliance could result in monetary penalties and /or additional regulatory actions.”
The Company believes it is currently in compliance with all of the requirements of the written agreement with the Federal Reserve through its normal business operations. The written agreement will remain in effect until modified or terminated by the Federal Reserve.
Under the Dodd-Frank Act, the federal banking regulators must require any company that controls an FDIC-insured depository institution to serve as a source of strength for the institution, with the ability to provide financial assistance if the institution suffers financial distress. In addition to the written agreement, these and other Federal Reserve Board policies may restrict the Company’s ability to pay dividends.
Capital Requirements.
The Company is not subject to any minimum regulatory capital requirements. However, beginning in 2015, it will be subject to regulatory capital requirements adopted by the Federal Reserve, which generally are the same as the new capital requirements for the Bank. These new capital requirements include provisions that might limit the ability of the Company to pay dividends to its stockholders or repurchase its shares. For a description of the new capital regulations, see “-Federal Regulation of Savings Institutions--New Capital Rules”.
Activities Restrictions.
The GLBA provides that no company may acquire control of a savings association after May 4, 1999 unless it engages only in the financial activities permitted for financial holding companies under the law or for multiple savings and loan holding companies as described below. Further, the GLBA specifies that, subject to a grandfather provision, existing savings and loan holding companies may only engage in such activities. The Company qualifies for the grandfathering and is therefore not restricted in terms of its activities. Upon any non-supervisory acquisition by the Company of another savings association as a separate subsidiary, the Company would become a multiple savings and loan holding company and would be limited to activities permitted multiple holding companies by Federal Reserve regulation. Federal Reserve has issued an interpretation concluding that multiple savings holding companies may also engage in activities permitted for financial holding companies, including lending, trust services, insurance activities and underwriting, investment banking and real estate investments.
Mergers and Acquisitions.
The Company must obtain approval from the Federal Reserve before acquiring more than 5% of the voting stock of another savings institution or savings and loan holding company or acquiring such an institution or holding company by merger, consolidation or purchase of its assets. In evaluating an application for the Company to acquire control of a savings institution, the Federal Reserve would consider the financial and managerial resources and future prospects of the Company and the target institution, the effect of the acquisition on the risk to the Deposit Insurance Fund, the convenience and the needs of the community and competitive factors.
The Federal Reserve may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions; (i) the approval of interstate supervisory acquisitions by savings and loan holding companies and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Acquisition of the Company.
Any company, except a bank holding company, that acquires control of a savings association or savings and loan holding company becomes a “savings and loan holding company” subject to registration, examination and regulation by the Federal Reserve and must obtain the prior approval of the Federal Reserve under the Savings and Loan Holding Company Act before obtaining control of a savings association or savings and loan holding company. A bank holding company must obtain the prior approval of the Federal Reserve under the Bank Holding Company Act before obtaining control of a savings association or savings and loan holding company and remains subject to regulation under the Bank Holding Company Act. The term “company” includes corporations, partnerships, associations, and certain trusts and other entities. “Control” of a savings association or savings and loan holding company is deemed to exist if a company has voting control, directly or indirectly of more than 25% of any class of the savings association’s voting stock or controls in any manner the election of a majority of the directors of the savings association or savings and loan holding company, and may be presumed under other circumstances, including, but not limited to, holding 10% or more of a class of voting securities if the institution has a class of registered securities, as Riverview Bancorp, Inc. has. Control may be direct or indirect and may occur through acting in concert with one or more other persons. In addition, a savings and loan holding company must obtain Federal Reserve approval prior to acquiring voting control of more than 5% of any class of voting stock of another savings association or another savings association holding company. A similar provision limiting the acquisition by a bank holding company of 5% or more of a class of voting stock of any company is included in the Bank Holding Company Act.
Accordingly, the prior approval of the Federal Reserve Board would be required:
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before any savings and loan holding company or bank holding company could acquire 5% or more of the common stock of Riverview Bancorp, Inc.; and
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before any other company could acquire 25% or more of the common stock of Riverview Bancorp, Inc., and may be required for an acquisition of as little as 10% of such stock.
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In addition, persons that are not companies are subject to the same or similar definitions of control with respect to savings and loan holding companies and savings associations and requirements for prior regulatory approval by the Federal Reserve in the case of control of a savings and loan holding company or by the OCC in the case of control of a savings association not obtained through control of a holding company of such savings association.
Sarbanes-Oxley Act of 2002.
The Sarbanes-Oxley Act was signed into law on July 30, 2002 in response to public concerns regarding corporate accountability in connection with recent accounting scandals. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the SEC under the Securities Exchange Act of 1934, including the Company.
The SOX Act includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and related rules. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.
Dividends and Stock Repurchases.
The Federal Reserve has issued a policy statement on the payment of cash dividends applicable to savings and loan holding companies, which expresses its view that although there are no specific regulations restricting dividend payments other than state corporate laws, a savings and loan holding company must maintain an adequate capital position and generally should not pay cash dividends unless the company’s net income for the past year is sufficient to fully fund the cash dividends and that the prospective rate of earnings appears consistent with the company’s capital needs, asset quality, and overall financial condition. The Federal Reserve policy statement also indicates that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. In addition, a savings and loan holding company is required to give the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding twelve months, is equal to 10% or more of its consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve order or any condition imposed by, or written agreement with, the Federal Reserve. Pursuant to the written agreement with the Federal Reserve, we are required to provide notice to and obtain written approval from the Federal Reserve prior to declaring or paying any dividend or redeeming any capital stock. See Item 1A, “Risk Factors – We are required to comply with the terms of a written agreement with the Federal Reserve and lack of compliance could result in monetary penalties and /or additional regulatory actions.” We did not repurchase, pay dividends or redeem any shares of common stock during the 2014 fiscal year.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010:
On July 21, 2010, the Dodd-Frank Act was signed into law. The Dodd-Frank-Act imposes new restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions and implements new capital regulations that the Company will become subject to and that are discussed above under “- Regulation and Supervision of the Bank - New Capital Rules.” In addition, among other changes, the Dodd-Frank Act requires public companies, such as the Company, to (i) provide their shareholders with a non-binding vote (a) at least once every three years on the compensation paid to executive officers and (b) at least once every six years on whether they should have a “say on pay” vote every one, two or three years; (ii) have a separate, non-binding shareholder vote regarding golden parachutes for named executive officers when a shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would trigger the parachute payments; (iii) provide disclosure in annual proxy materials concerning the relationship between the executive compensation paid and the financial performance of the issuer; and (iv) amend Item 402 of Regulation S-K to require companies to disclose the ratio of the Chief Executive Officer's annual total compensation to the median annual total compensation of all other employees. For certain of these changes, the implementing regulations have not been promulgated, so the full impact of the Dodd-Frank Act on public companies cannot be determined at this time.
Item1A. Risk Factors
An investment in our common stock is subject to risks inherent in our business. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included in this report. In addition to the risks and uncertainties described below,
other
risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition and results of operations.
The value or market price of our common stock could decline due to any of these identified or other risks, and you could lose all or part of your investment. The risks below also include forward-looking statements. This report is qualified in its entirety by these risk factors.
We are required to comply with the terms of a written agreement with the Federal Reserve and lack of compliance could result in monetary penalties and /or additional regulatory actions.
In 2009, Riverview Bancorp, Inc. and the Bank each entered into separate MOU agreements with the OTS, at the time their primary regulator. The Bank’s agreement was subsequently assumed by the OCC and replaced by another formal agreement with the OCC in 2012. In April 2014 the OCC terminated this agreement in light of the improvement in the Bank’s financial condition and risk profile.
In May 2013, the Company entered into a written agreement with the Federal Reserve to replace its MOU agreement. This written agreement requires the Company to: (a) provide notice to and obtain written approval from the Federal Reserve prior to the Company declaring a dividend or redeeming any capital stock or receiving dividends or other payments from the Bank; (b) provide notice to and obtain written approval from the Federal Reserve prior to the Company incurring, issuing, renewing or repurchasing any new debt; (c) provide notice to and obtain written approval from the Federal Reserve prior to the Company making payments on its Debentures; (d) submit written statement of its planned sources and uses of cash for debt service, operating expenses, and other purposes (“Cash Flow Projection”) beginning for calendar year 2013 and submit progress reports related to its Cash Flow Projections and financial results.
Under the written agreement with the Federal Reserve, the Company also agreed to take any required action to ensure compliance by the Bank with Sections 23A and 23B of the Federal Reserve Act as implemented by the Federal Reserve Board’s Regulation W and to not appoint any new Riverview director or senior executive officer or change the responsibilities of any current senior executive officers, without the prior written non-objection of the Federal Reserve. We are also limited and/or prohibited, in certain circumstances, in our ability to enter into contracts to pay and to make golden parachute severance and indemnification payments. The written agreement will remain in effect until stayed, modified, terminated or suspended by the Federal Reserve. If either the Company or Bank is found not in compliance with the written agreement, it could be subject to various remedies, including among others, the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to direct an increase in capital, to restrict the growth of the Company or the Bank, to remove officers and/or directors, and to assess civil monetary penalties. Management of the Company and the Bank have taken action and implemented programs to comply with the requirements of the written agreement and compliance will be determined by the Federal Reserve. Management believes that the Company and the Bank have complied in all material respects with the provisions of the written agreement. The Federal Reserve may determine, however, in its sole discretion that the issues raised by the written agreement have not been addressed satisfactorily, or that any current or past actions, violations or deficiencies could be the subject of further regulatory enforcement actions. Such enforcement actions could involve penalties or limitations on the business of the Bank or the Company and negatively affect our ability to implement our business plan, pay dividends on our common stock and the value of our common stock as well as our financial condition and results of operations.
The Bank has also separately agreed to the OCC establishing higher minimum capital ratios for the Bank, specifically that the Bank maintain a Tier 1 capital (leverage) ratio of not less than 9.00% and a total risk-based capital ratio of not less than 12.00%. As of March 31, 2014, the Bank’s Tier 1 capital (leverage) ratio was 10.71% and its total risk-based capital ratio was 16.66%.
Our business may continue to be adversely affected by downturns in the national and the regional economies on which we depend.
Substantially all of our loans are to businesses and individuals in the states of Washington and Oregon. A continuing decline in the economies of the seven counties, in which we operate, including the Portland, Oregon metropolitan area, which we consider to be our primary market area, could have a material adverse effect on our business, financial condition, results of operations and prospects. In particular, Washington and Oregon have experienced substantial home price declines and increased foreclosures and have experienced above average unemployment rates.
A further deterioration in economic conditions in the market areas we serve could result in the following consequences, any of which could have a materially adverse impact on our business, financial condition and results of operations:
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loan delinquencies, problem assets and foreclosures may increase;
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the slowing of sales of foreclosed assets;
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demand for our products and services may decline;
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collateral for loans made may decline further in value, in turn reducing customers’ borrowing power, reducing the value of assets and collateral associated with existing loans; and
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the amount of our low-cost or non-interest bearing deposits may decrease.
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A return of recessionary conditions could result in increases in our level of nonperforming loans and/or reduce demand for our products and services, which could have adverse effect on our results of operations.
The ongoing debate in Congress regarding the national debt ceiling and federal budget deficit and concerns over the United States' credit rating (which was downgraded by Standard & Poor's), the European sovereign debt crisis, the overall weakness in the economy and continued high unemployment in the United States, among other economic indicators, have contributed to increased volatility in the capital markets and diminished expectations for the economy.
A return of recessionary conditions and/or continued negative developments in the domestic and international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Further declines in real estate values and sales volumes and continued high unemployment levels may result in higher than expected loan delinquencies and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity, and financial condition.
Furthermore, the Board of Governors of the Federal Reserve System, in an attempt to help the overall economy, has, among other things, kept interest rates low through its targeted federal funds rate and the purchase of mortgage-backed securities. If the Federal Reserve increases the federal funds rate, or more rapidly curtails purchases of mortgage-backed securities, overall interest rates will likely rise, which may negatively impact the housing markets and the U.S. economic recovery. In addition, deflationary pressures, while possibly lowering our operating costs, could have a significant negative effect on our borrowers, especially our business borrowers, and the values of underlying collateral securing loans, which could negatively affect our financial performance. In addition, deflationary pressures, while possibly lowering our operating costs, could have a significant negative effect on our borrowers, especially our business borrowers, and the values of underlying collateral securing loans, which could negatively affect our financial performance.
Our real estate construction and land acquisition or development loans expose us to risk.
We make real estate construction loans to individuals and builders, primarily for the construction of residential properties. We originate these loans whether or not the collateral property underlying the loan is under contract for sale. At March 31, 2014, construction loans totaled $19.5 million, or 3.7% of our total loan portfolio, of which $3.9 million were for residential real estate projects. Land loans, which are loans made with land as security, totaled $16.2 million, or 3.0%, of our total loan portfolio at March 31, 2014. Land loans include raw land and land acquisition and development loans. In our primary market area, the housing market has slowed, with weaker demand for housing, higher inventory levels and longer marketing times. A further downturn in housing, or the real estate market, could increase loan delinquencies, defaults and foreclosures, and significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure.
In general, construction, and land lending involves additional risks because of the inherent difficulty in estimating a property's value both before and at completion of the project as well as the estimated cost of the project. Construction costs may exceed original estimates as a result of increased materials, labor or other costs. In addition, because of current
uncertainties in the residential real estate market, property values have become more difficult to determine than they have historically been. Construction loans and land acquisition and development loans often involve the disbursement of funds with repayment dependent, in part, on the success of the project and the ability of the borrower to sell or lease the property or refinance the indebtedness, rather than the ability of the borrower or guarantor to repay principal and interest. These loans are also generally more difficult to monitor. Loans on land under development or held for future construction as well as lot loans made to individuals for the future construction of a residence also pose additional risk because of the lack of income being produced by the property and the potential illiquid nature of the collateral. These risks can be significantly impacted by supply and demand conditions. In addition, speculative construction loans to a builder are often associated with homes that are not pre-sold, and thus pose a greater potential risk than construction loans to individuals on their personal residences. At March 31, 2014, speculative construction and land development loans totaled $19.9 million, of which, $800,000, or 4.0%, were nonperforming.
Our emphasis on commercial real estate lending may expose us to increased lending risks.
Our current business strategy is focused on the expansion of commercial real estate lending. This type of lending activity, while potentially more profitable than single-family residential lending, is generally more sensitive to regional and local economic conditions, making loss levels more difficult to predict. Collateral evaluation and financial statement analysis in these types of loans requires a more detailed analysis at the time of loan underwriting and on an ongoing basis. Many of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss.
At March 31, 2014, we had $308.6 million of commercial and multi-family real estate mortgage loans, representing 57.9% of our total loan portfolio. These loans typically involve higher principal amounts than other types of loans, and repayment is dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service, which may be adversely affected by changes in the economy or local market conditions. For example, if the cash flow from the borrower’s project is reduced as a result of leases not being obtained or renewed, the borrower’s ability to repay the loan may be impaired. Commercial and multi-family mortgage loans also expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans typically cannot be sold as easily as residential real estate. In addition, many of our commercial and multi-family real estate loans are not fully amortizing and contain large balloon payments upon maturity. Balloon payments may require the borrower to either sell or refinance the underlying property in order to make the payment, which may increase the risk of default or non-payment. At March 31, 2014, $10.1 million or 3.3% of our commercial real estate and multi-family loans were nonperforming.
A secondary market for most types of commercial real estate and multi-family loans is not readily liquid, so we have less opportunity to mitigate credit risk by selling part or all of our interest in these loans. As a result of these characteristics, if we foreclose on a commercial or multi-family real estate loan, our holding period for the collateral typically is longer than for one-to-four family residential mortgage loans because there are fewer potential purchasers of the collateral. Accordingly, charge-offs on commercial and multi-family real estate loans may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios.
Our business may be adversely affected by credit risk associated with residential property.
At March 31, 2014, $93.0 million, or 17.4% of our total loan portfolio, was secured by one- to four-family mortgage loans and home equity loans. This type of lending is generally sensitive to regional and local economic conditions that significantly impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. The decline in residential real estate values as a result of the downturn in our market area has reduced the value of the real estate collateral securing these types of loans and increased the risk that we would incur losses if borrowers default on their loans.
Many of our one- to four-family loans and home equity lines of credit are secured by liens on mortgage properties in which the borrowers have little or no equity because of these declines in home values in our primary market area. Residential loans with high combined loan-to-value ratios will be more sensitive to declining property values than those with lower combined loan-to-value ratios and therefore may experience a higher incidence of default and severity of losses. In addition, if the borrowers sell their homes, they may be unable to repay their loans in full from the sale. Further, the majority of our home equity lines of credit consist of second mortgage loans. For those home equity lines secured by a second mortgage, it is unlikely that we will be successful in recovering all or a portion of our loan proceeds in the event of default unless we are prepared to repay the first mortgage loan and such repayment and the costs associated with a foreclosure are justified by the
value of the property. For these reasons, we could experience higher rates of delinquencies, defaults and losses. At March 31, 2014, $2.7 million or 2.9% of our residential real estate loans were nonperforming.
Repayment of our commercial business loans is often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value.
At March 31, 2014, we had $71.6 million or 13.4% of total loans in commercial business loans. Commercial lending involves risks that are different from those associated with residential and commercial real estate lending. Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral values and liquidation of the underlying real estate collateral being viewed as the primary source of repayment in the event of borrower default. Our commercial loans are primarily made based on the cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The borrowers' cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Although commercial loans are often collateralized by equipment, inventory, accounts receivable, or other business assets, the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use, among other things. Accordingly, the repayment of commercial loans depends primarily on the cash flow and credit worthiness of the borrower and secondarily on the underlying collateral provided by the borrower. At March 31, 2014, $452,000 or 0.6% of our commercial business loans were nonperforming.
Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.
Lending money is a substantial part of our business and each loan carries a certain risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:
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the cash flow of the borrower and/or the project being financed;
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changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;
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the duration of the loan;
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the credit history of a particular borrower; and
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changes in economic and industry conditions.
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We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, which we believe is appropriate to provide for probable losses in our loan portfolio. The amount of this allowance is determined by management through periodic reviews and consideration of several factors, including, but not limited to:
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our general reserve, based on our historical default and loss experience and certain macroeconomic factors based on management’s expectations of future events;
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our specific reserve, based on our evaluation of nonperforming loans and their underlying collateral; and
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an unallocated reserve to provide for other credit losses inherent in our portfolio that may not have been contemplated in the other loss factors.
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The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, we review our loans and the loss and delinquency experience, and evaluate economic conditions and make significant estimates of current credit risks and future trends, all of which may undergo material changes. If our estimates are incorrect, the allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in the need for additions to our allowance through an increase in the provision for loan losses. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. Our allowance for loan losses was 2.35% of gross loans held for investment and 89.25% of nonperforming loans at March 31, 2014. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. If charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the provision for loan losses will result in a decrease in net income and may have a material adverse effect on our financial condition, results of operations and our capital.
If our investments in real estate are not properly valued or sufficiently reserved to cover actual losses, or if we are required to increase our valuation reserves, our earnings could be reduced.
We obtain updated valuations in the form of appraisals and broker price opinions when a loan has been foreclosed upon and the property taken in as REO, and at certain other times during the assets holding period. Our net book value (“NBV”) in the loan at the time of foreclosure and thereafter is compared to the updated market value of the foreclosed property less estimated selling costs (fair value). A charge-off is recorded for any excess in the asset’s NBV over its fair value. If our valuation process is incorrect, the fair value of our investments in real estate may not be sufficient to recover our NBV in such assets, resulting in the need for additional charge-offs. Additional material charge-offs to our investments in real estate could have a material adverse effect on our financial condition and results of operations. In addition, bank regulators periodically review our REO and may require us to recognize further charge-offs. Any increase in our charge-offs may have a material adverse effect on our financial condition and results of operations.
Our securities portfolio may be negatively impacted by fluctuations in market value and interest rates.
Our securities portfolio may be impacted by fluctuations in market value, potentially reducing accumulated other comprehensive income and/or earnings. Fluctuations in market value may be caused by changes in market interest rates, lower market prices for securities and limited investor demand. Our securities portfolio is evaluated for other-than-temporary impairment. If this evaluation shows impairment to the actual or projected cash flows associated with one or more securities, a potential loss to earnings may occur. Changes in interest rates can also have an adverse effect on our financial condition, as our available-for-sale securities are reported at their estimated fair value, and therefore are impacted by fluctuations in interest rates. We increase or decrease our shareholders' equity by the amount of change in the estimated fair value of the available-for-sale securities, net of taxes. There can be no assurance that the declines in market value will not result in other-than-temporary impairments of these assets, which would lead to accounting charges that could have a material adverse effect on our net income and capital levels.
Changes in interest rates may reduce our net interest income, and may result in higher defaults in a rising rate environment.
Our profitability is dependent to a large extent upon net interest income, which is the difference, or spread, between the interest earned on loans, securities and other interest-earning assets and the interest paid on deposits, borrowings, and other interest-bearing liabilities. Because of the differences in maturities and repricing characteristics of our interest-earning assets and interest-bearing liabilities, changes in interest rates do not produce equivalent changes in interest income earned on interest-earning assets and interest paid on interest-bearing liabilities. We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities. In a changing interest rate environment, we may not be able to manage this risk effectively. Changes in interest rates also can affect: (1) our ability to originate and/or sell loans; (2) the fair value of our financial assets and liabilities, which could negatively impact shareholders’ equity, and our ability to realize gains from the sale of such assets; (3) our ability to obtain and retain deposits in competition with other available investment alternatives; (4) the ability of our borrowers to repay adjustable or variable rate loans; and (5) the average duration of our mortgage backed securities portfolio and other interest-earning assets.
If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. As a result of the relatively low interest rate environment, an increasing percentage of our deposits have been comprised of short-term certificates of deposit and other deposits yielding no or a relatively low rate of interest. At March 31, 2014, we had $112.9 million in certificates of deposit that mature within one year and $128.6 million in non-interest bearing demand deposits. We would incur a higher cost of funds to retain these deposits in a rising interest rate environment. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. In addition, a substantial amount of our mortgage loans and home equity lines of credit have adjustable interest rates. As a result, these loans may experience a higher rate of default in a rising interest rate environment.
Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations. Further, a prolonged period of exceptionally low market interest rates, such as we are currently experiencing, and the Board of Governors of the Federal Reserve System has indicated it intends to maintain, limits our ability to lower our interest expense, while the average yield on our interest-earning assets may continue to decrease as our loans reprice or are originated at these low market rates. Accordingly, our net interest income may continue to decrease, which may have an adverse effect on our profitability. Also, our interest rate risk modeling techniques and
assumptions likely may not fully predict or capture the impact of actual interest rate changes on our balance sheet or projected operating results.
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition, growth and prospects.
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. We rely on customer deposits and, as needed, advances from the FHLB of Seattle (“FHLB”), borrowings from the Federal Reserve Bank of San Francisco ("FRB") and other borrowings to fund our operations. Although we have historically been able to replace maturing deposits and advances if desired, we may not be able to replace such funds in the future if, among other things, our financial condition, the financial condition of the FHLB or FRB, or market conditions change. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the Washington or Oregon markets where our loans are concentrated or adverse regulatory action against us
Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. Although we consider our sources of funds adequate for our liquidity needs, we may seek additional debt in the future to achieve our long-term business objectives. Additional borrowings, if sought, may not be available to us or, if available, may not be available on reasonable terms. If additional financing sources are unavailable, or are not available on reasonable terms, our financial condition, results of operations, growth and future prospects could be materially adversely affected. In addition, the Company may not incur additional debt without the prior written non-objective of the Federal Reserve. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. See also “-We have deferred payments of interest on our outstanding junior subordinated debentures and as a result we are prohibited from declaring or paying dividends or distributions on, and from making liquidation payments with respect to, our common stock.”
An increase in interest rates, change in the programs offered by governmental sponsored entities (“GSE”) or our ability to qualify for such programs may reduce our mortgage revenues, which would negatively impact our non-interest income.
Our mortgage banking operations provide a significant portion of our non-interest income. We generate mortgage revenues primarily from gains on the sale of single-family mortgage loans pursuant to programs currently offered by Fannie Mae, Freddie Mac, Ginnie Mae and non-GSE investors. These entities account for a substantial portion of the secondary market in residential mortgage loans. Any future changes in these programs, our eligibility to participate in such programs, the criteria for loans to be accepted or laws that significantly affect the activity of such entities could, in turn, materially adversely affect our results of operations. Mortgage banking is generally considered a volatile source of income because it depends largely on the level of loan volume which, in turn, depends largely on prevailing market interest rates. In a rising or higher interest rate environment, our originations of mortgage loans may decrease, resulting in fewer loans that are available to be sold to investors. This would result in a decrease in mortgage banking revenues and a corresponding decrease in non-interest income. In addition, our results of operations are affected by the amount of non-interest expense associated with mortgage banking activities, such as salaries and employee benefits, occupancy, equipment and data processing expense and other operating costs. During periods of reduced loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in loan originations. In addition, although we sell loans into the secondary market without recourse, we are required to give customary representations and warranties about the loans to the buyers. If we breach those representations and warranties, the buyers may require us to repurchase the loans and we may incur a loss on the repurchase.
A general decline in economic conditions may adversely affect the fees generated by our asset management company.
To the extent our asset management clients and their assets become adversely affected by weak economic and stock market conditions, they may choose to withdraw the amount of assets managed by us and the value of their assets may decline. Our asset management revenues are based on the value of the assets we manage. If our clients withdraw assets or the value of their assets decline, the revenues generated by Riverview Asset Management Corp. will be adversely affected.
Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed or the cost of that capital may be very high.
We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate that our capital resources will satisfy our capital requirements for the foreseeable future, including the heightened capital requirements with the OCC. Nonetheless, we may elect to raise additional capital to support our business or to finance acquisitions, if any, or we may otherwise elect or be required to raise additional capital. Should we elect to raise additional capital, we may seek to do so through the issuance of, among other things, our common stock or preferred stock. The issuance of additional shares of common stock or convertible securities to new stockholders would be dilutive to our current stockholders.
Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance. Accordingly, we cannot make assurances that we will be able to raise additional capital if needed on terms that are acceptable to us, or at all. If we cannot raise additional capital when needed, our operations could be materially impaired and our financial condition and liquidity could be materially and adversely affected. In addition, if we are unable to raise additional capital when required by the Federal Reserve or the OCC, we may be subject to additional adverse regulatory action. See “--We are required to comply with the terms of a written agreement with the Federal Reserve and lack of compliance could result in monetary penalties and /or additional regulatory actions.”
We may experience future goodwill impairment, which could reduce our earnings.
We performed our annual goodwill impairment test during the quarter-ended December 31, 2013, but no impairment was identified. Our assessment of the fair value of goodwill is based on an evaluation of current purchase transactions, discounted cash flows from forecasted earnings, our current market capitalization, and a valuation of our assets. Our evaluation of the fair value of goodwill involves a substantial amount of judgment. If our judgment was incorrect and an impairment of goodwill was deemed to exist, we would be required to write down our assets resulting in a charge to earnings, which could materially adversely affect our results of operations, perhaps materially; however, it would have no impact on our liquidity, operations or regulatory capital.
Changes in laws and regulations and the cost of regulatory compliance with new laws and regulations may adversely affect our operations, increase our costs of operations and decrease our efficiency.
The Bank is subject to extensive examination, supervision and comprehensive regulation by the OCC and the FDIC, and Riverview is subject to examination and supervision by the Federal Reserve. The OCC, FDIC and the Federal Reserve govern the activities in which we may engage, primarily for the protection of depositors and the Deposit Insurance Fund. These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the ability to impose restrictions on an institution's operations, reclassify assets, determine the adequacy of an institution's allowance for loan losses and determine the level of deposit insurance premiums assessed. The significant federal and state banking regulations that affect us are described in this report under the heading “Item 1. Business-Regulation.” These regulations, along with the currently existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time. Such changes could subject us to additional costs, limit the types of financial services and products we may offer, restrict mergers and acquisitions, investments, access to capital, the location of banking offices, and/or increase the ability of non-banks to offer competing financial services and products, among other things. Further, changes in accounting standards can be both difficult to predict and involve judgment and discretion in their interpretation by us and our independent accounting firms. These changes could materially impact, potentially even retroactively, how we report our financial condition and results of our operations as could our interpretation of those changes.
Additionally, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) has significantly changed the bank regulatory structure and has affected the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting and implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.
Certain provisions of the Dodd-Frank Act are expected to have a near term impact on us. For example, a provision of the Dodd-Frank Act eliminates the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts. Depending on competitive responses, this significant change to existing law could have an adverse impact on our interest expense.
The Dodd-Frank Act also broadens the base for FDIC insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor.
The Dodd-Frank Act requires publicly traded companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments. The legislation also directs the Federal Reserve to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded.
The Dodd-Frank Act created a new Consumer Financial Protection Bureau (“CFPB”) with broad powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Financial institutions such as the Bank with $10 billion or less in assets will continue to be examined for compliance with the consumer laws by their primary bank regulator.
In 2013, the CFPB issued several final regulations and changes to certain consumer protections under existing laws. These final rules, most of the provisions of which (including the qualified mortgage rule) became effective January 10, 2014, generally prohibit creditors from extending mortgage loans without regard for the consumer’s ability to repay and add restrictions and requirements to mortgage origination and servicing practices. In addition, these rules limit prepayment penalties and require the creditor to retain evidence of compliance with the ability-to-repay requirement for three years. Compliance with these rules will likely increase our overall regulatory compliance costs and may require changes to our underwriting practices with respect to mortgage loans. Moreover, these rules may adversely affect the volume of mortgage loans that we underwrite and may subject us to increased potential liabilities related to such residential loan origination activities.
Effective December 10, 2013, pursuant to the Dodd-Frank Act, federal banking and securities regulators issued final rules to implement Section 619 of the Dodd-Frank Act (the Volcker Rule). Generally, subject to a transition period and certain exceptions, the Volcker Rule restricts insured depository institutions and their affiliated companies from engaging in short-term proprietary trading of certain securities, investing in funds with collateral comprised of less than 100% loans that are not registered with the Securities and Exchange Commission (“SEC”) and from engaging in hedging activities that do not hedge a specific identified risk. After the transition period, the Volcker Rule prohibitions and restrictions will apply to banking entities unless an exception applies. We are analyzing the impact of the Volcker Rule on our investment portfolio and possible changes to our investment strategies, which could negatively affect our earnings.
It is difficult to predict at this time what specific impact the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on community banks. However, it is expected that at a minimum they will increase our operating and compliance costs and could increase our interest expense. Any additional changes in our regulation and oversight, whether in the form of new laws, rules or regulations, could make compliance more difficult or expensive or otherwise materially adversely affect our business, financial condition or prospects.
Any other additional changes in our regulation and oversight, whether in the form of new laws, rules or regulations, could likewise make compliance more difficult or expensive or otherwise materially adversely affect our business, financial condition or prospects.
The short-term and long-term impact of the changing regulatory capital requirements and anticipated new capital rules is uncertain.
On July 9, 2013, the FDIC and the other federal bank regulatory agencies issued a final rule that will revise their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The final rule applies to all depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more and top-tier savings and loan holding companies. Among other things, the rule establishes a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets requirement (from 4.0% to 6.0% of risk-weighted assets) and assigns a higher risk weight (150%) to exposures that are more
than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The final rule also requires unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt-in or opt-out is exercised. The rule limits a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements. The final rule becomes effective for the Company on January 1, 2015. The capital conservation buffer requirement will be phased in beginning January 1, 2016 and ending January 1, 2019, when the full capital conservation buffer requirement will be effective.
The application of these more stringent capital requirements could, among other things, result in lower returns on invested capital, require the raising of additional capital, and result in regulatory actions if we were to be unable to comply with such requirements. Furthermore, the imposition of liquidity requirements in connection with the implementation of Basel III could result in our having to lengthen the term of our funding, restructure our business models, and/or increase our holdings of liquid assets. Implementation of changes to asset risk weightings for risk-based capital calculations, items included or deducted in calculating regulatory capital and/or additional capital conservation buffers could result in management modifying its business strategy, and could limit our ability to make distributions, including paying out dividends or buying back shares. Specifically, beginning in 2016, the Company’s ability to pay dividends will be limited if does not have the capital conservation buffer required by the new capital rules, which may limit our ability to pay dividends to stockholders. See “Federal Regulation of Savings Institutions—New Capital Rules.”
Our litigation related costs might continue to increase.
Riverview Community Bank is subject to a variety of legal proceedings that have arisen in the ordinary course of Riverview Community Bank’s business. In the current economic environment Riverview Community Bank’s involvement in litigation has increased significantly, primarily as a result of defaulted borrowers asserting claims in order to defeat or delay foreclosure proceedings. Riverview Community Bank believes that it has meritorious defenses in legal actions where it has been named as a defendant and is vigorously defending these suits. Although management, based on discussion with litigation counsel, believes that such proceedings will not have a material adverse effect on the financial condition or operations of Riverview Community Bank, there can be no assurance that a resolution of any such legal matters will not result in significant liability to Riverview Community Bank nor have a material adverse impact on its financial condition and results of operations or Riverview Community Bank’s ability to meet applicable regulatory requirements. Moreover, the expenses of pending legal proceedings will adversely affect Riverview Community Bank’s results of operations until they are resolved. There can be no assurance that Riverview Community Bank’s loan workout and other activities will not expose Riverview Community Bank to additional legal actions, including lender liability or environmental claims.
Our investment in Federal Home Loan Bank stock may become impaired.
As a member, the Bank is required to purchase and maintain stock in the FHLB. At March 31, 2014, the Bank had $6.7 million in FHLB stock, which was in compliance with this requirement. In 2009, the FHLB reported a risk-based capital deficiency under the regulations of the Federal Housing Finance Agency (“FHFA”), its primary regulator as of December 31, 2008, and stated that it would suspend future dividends and the repurchase and redemption of outstanding common stock. In September 2012, the FHLB announced that the FHFA now considers it to be adequately capitalized. Dividends on, or repurchases of, the FHLB stock continue to require consent of the FHFA. The FHFA subsequently approved the repurchase of portions of FHLB stock and during fiscal year 2014, the FHLB had repurchased $410,000 of its stock, at par, from the Bank. The FHLB announced in July 2013 that, based on its second quarter 2013 fanatical results, their Board of Directors had declared a $0.025 per share cash dividend. For the year ended March 31, 2014, the Bank received $5,000 of dividends on FHLB stock. Based on the above, we have not recorded an impairment on our investment in FHLB stock. Deterioration in the FHLB’s financial position may, however, result in future impairment in the value of those securities. We will continue to monitor the financial condition of the FHLB as it relates to, among other things, the recoverability of our investment.
Competition with other financial institutions could adversely affect our profitability.
The banking and financial services industry is very competitive. Legal and regulatory developments have made it easier for new and sometimes unregulated competitors to compete with us. Consolidation among financial service providers has resulted in fewer very large national and regional banking and financial institutions holding a large accumulation of assets. These institutions generally have significantly greater resources, a wider geographic presence or greater accessibility. Our competitors sometimes are also able to offer more services, more favorable pricing or greater customer convenience than we
do. In addition, our competition has grown from new banks and other financial services providers that target our existing or potential customers. As consolidation continues, we expect additional institutions to try to exploit our market.
Technological developments have allowed competitors including some non-depository institutions, to compete more effectively in local markets and have expanded the range of financial products, services and capital available to our target customers. If we are unable to implement, maintain and use such technologies effectively, we may not be able to offer products or achieve cost-efficiencies necessary to compete in our industry. In addition, some of these competitors have fewer regulatory constraints and lower cost structures.
We rely heavily on the proper functioning of our technology.
We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations. We have experienced attempted attacks on our information systems; however our monitoring systems detected these attacks and the attempted attack was ultimately not successful.
We rely heavily on third-party service providers for much of our communications, information, operating and financial control systems technology including our internet banking services and data processing systems. Any failure or interruption of these services or systems or breaches in security of these systems could result in failures or interruptions in our customer relationship management, general ledger, deposit, servicing and/or loan origination systems. If any of our third-party service providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to locate alternative sources of such services, and we cannot assure that we could negotiate terms that are as favorable to us, or could obtain services with similar functionality, as found in our existing systems, without the need to expend substantial resources, if at all. Any of these circumstances could have an adverse effect on our business.
We are dependent on key personnel and the loss of one or more of those key personnel may materially and adversely affect our prospects.
Competition for qualified employees and personnel in the banking industry is intense and there are a limited number of qualified persons with knowledge of, and experience in, the community banking industry where the Bank conducts its business. The process of recruiting personnel with the combination of skills and attributes required to carry out our strategies is often lengthy. Our success depends to a significant degree upon our ability to attract and retain qualified management, loan origination, finance, administrative, marketing and technical personnel and upon the continued contributions of our management and personnel. In particular, our success has been and continues to be highly dependent upon the abilities of key executives, including our President, and certain other employees. In addition, our success has been and continues to be highly dependent upon the services of our directors, many of whom are at or nearing retirement age, and we may not be able to identify and attract suitable candidates to replace such directors.
Our exposure to operational risks may adversely affect us.
Similar to other financial institutions, we are exposed to many types of operational risk, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, the risk that sensitive customer or Company data is compromised, unauthorized transactions by employees or operational errors, including clerical or record-keeping errors. Nationally, reported incidents of fraud and other financial crimes have increased. While we have policies and procedures designed to prevent such losses, there can be no assurance that such losses will not occur. If any of these risks occur, it could result in material adverse consequences for us.
Regulatory and contractual restrictions may limit or prevent us from paying dividends on our common stock.
Holders of our common stock are only entitled to receive such dividends as our Board may declare out of funds legally available for such payments. Further, holders of our common stock are subject to the prior dividend rights of any holders of our preferred stock at any time outstanding or depositary shares representing such preferred stock then outstanding. Although we have historically declared cash dividends on our common stock, we are not required to do so. We suspended our cash dividend during the quarter ended December 31, 2008 and we do not know if we will resume the payment of
dividends in the future. Furthermore, the Company elected to defer regularly scheduled interest payments on its junior subordinated debentures during the first quarter of fiscal 2011, which in turn, restricts the Company’s ability to pay dividends on its common stock. See “-We have deferred payments of interest on our outstanding junior subordinated debentures and as a result we are prohibited from declaring or paying dividends or distributions on, and from making liquidation payments with respect to, our common stock.”
In addition, under the terms of the Company’s written agreement with the Federal Reserve, the payment of dividends by the Company to the shareholders is subject to the prior written agreement of the Federal Reserve. As an entity separate and distinct from the Bank, the Company derives substantially all of its revenue in the form of dividends from the Bank. Accordingly, the Company is and will be dependent upon dividends from the Bank to satisfy its cash needs and to pay dividends on its common stock and service the interest payments on its trust preferred security. The inability to receive dividends from the Bank could have a material adverse effect on the Company’s business, financial condition and results of operations. The Bank’s ability to pay dividends is subject to its ability to earn net income and, to meet certain regulatory requirements. The Bank does not currently meet these regulatory requirements. As discussed above, under the written agreement with the Federal Reserve, Riverview may not receive any such dividends without the approval of the Federal Reserve, which also limits the Company’s ability to pay dividends on its common stock. The lack of a cash dividend could adversely affect the market price of our common stock.
We have deferred payments of interest on our outstanding junior subordinated debentures and as a result we are prohibited from declaring or paying dividends or distributions on, and from making liquidation payments with respect to, our common stock.
In the first quarter of fiscal 2011, we elected to defer regularly scheduled interest payments on our outstanding $22.7 million aggregate principal amount of junior subordinated debentures issued in connection with the sale of trust preferred securities through statutory business trusts. There are currently two separate series of these junior subordinated debentures outstanding, each series having been issued under a separate indenture and with a separate guarantee from Riverview. During the deferral period, interest will continue to accrue on the junior subordinated debentures at the stated coupon rate, including the deferred interest, and Riverview may not, among other things, pay cash dividends on or, with limited exceptions, repurchase its common stock nor make any payment on outstanding debt obligations that rank equally with or are junior to the junior subordinated debentures.
We may, without notice to or consent from the holders of our common stock, issue additional series of junior subordinated debentures in the future with terms similar to those of our existing junior subordinated debentures or enter into other financing agreements that limit our ability to purchase or to pay dividends or distributions on our capital stock, including our common stock. As a result of our deferral of interest on the junior subordinated debentures, it is likely that we will not be able to raise funds through the offering of debt securities until we become current on these obligations or these obligations are restructured.
This deferral may also adversely affect our ability to obtain debt financing on commercially reasonable terms, or at all. In addition, if Riverview defers interest payments on the junior subordinated debentures for more than 20 consecutive quarters, it would be in default under the indentures governing these debentures and the amount due under such agreements would be immediately due and payable.
Events of default under the indenture generally consist of our failure to pay interest on the junior subordinated debt securities under certain circumstances, our failure to pay any principal of or premium on such junior subordinated debt securities when due, our failure to comply with certain covenants under the indenture, and certain events of bankruptcy, insolvency or liquidation relating to us or the Bank.
As long as we defer interest payments, we will likely have greater difficulty in obtaining financing and have fewer financing sources. In addition, the market value of our common stock may be adversely affected.