| UNITED STATES |
| SECURITIES AND EXCHANGE COMMISSION |
| Washington, D.C. 20549 |
| FORM 10-K |
| [X] | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006 |
| OR |
| [ ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM________to________ |
| Commission File Number 0-26584 |
| BANNER CORPORATION (Exact name of registrant as specified in its charter) |
| Washington (State or other jurisdiction of incorporation or organization) |
91-1691604 (I.R.S. Employer Identification Number) |
| 10 South First Avenue, Walla Walla, Washington 99362 (Address of principal executive offices and zip code) |
| Registrant's telephone number, including area code: (509) 527-3636 |
Securities registered pursuant to Section 12(b) of the Act:None
Securities registered pursuant to section 12(g) of the Act:
Common Stock, $.01 par value per share
(Title of class)
| Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act | Yes | No | X |
| Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act | Yes | No | X |
| Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. | Yes | X | No |
| Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulations S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |
| Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act (Check One): |
| Large accelerated filer | Accelerated filer | X | Non-accelerated filer |
| Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) | Yes | No | X |
| The aggregate market value of the voting and nonvoting common equity held by nonaffiliates of the registrant based on the closing sales price of the registrant's common stock quoted on the Nasdaq Stock Market on June 30, 2006, was: |
| Common Stock - $472,869,536 |
| (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the Registrant that such person is an affiliate of the Registrant.) |
| The number of shares outstanding of the registrant's classes of common stock as of February 28, 2007: |
| Common Stock, $.01 par value - 12,706,385 shares |
| Documents Incorporated by Reference |
| Portions of Proxy Statement for Annual Meeting of Shareholders to be held April 24, 2007 are incorporated by reference into Part III. |
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BANNER CORPORATION AND SUBSIDIARIES |
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Table of Contents |
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PART I |
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Item 1. |
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PART II |
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Management's Discussion and Analysis of Financial Condition and Results of Operations |
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Comparison of Financial Condition at December 31, 2006 and 2005 |
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Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
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PART III |
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Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
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PART IV |
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Forward-Looking Statements
"Safe Harbor" statement under the Private Securities Litigation Reform Act of 1995: This Form 10-K contains forward-looking statements that are subject to risks and uncertainties, including, but not limited to, the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, deposit interest rates, our net interest margin and funding sources; fluctuations in the demand for loans and in real estate values in our market areas; fluctuations in agricultural commodity prices, crop yields and weather conditions; our ability to control operating costs and expenses; our ability to successfully implement our branch expansion strategy; our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames; our ability to manage loan delinquency rates; our ability to retain key members of our senior management team; costs and effects of litigation; increased competitive pressures among financial services companies; changes in consumer spending, borrowing and savings habits; legislative or regulatory changes that adversely affect our business; adverse changes in the securities markets; inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board; war or terrorist activities; other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and other risks detailed from time to time in our filings with the Securities and Exchange Commission. We caution readers not to place undue reliance on any forward-looking statements. We do not undertake and specifically disclaim any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause our actual results for 2007 and beyond to differ materially from those expressed in any forward-looking statements by, or on behalf of, us.
As used throughout this report, the terms "we", "our", "us", or the "Company" refer to Banner Corporation and its consolidated subsidiaries.
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Item 1 Business
Banner Corporation (BANR or the Company) is a bank holding company incorporated in the State of Washington. We are primarily engaged in the business of planning, directing and coordinating the business activities of our wholly owned subsidiary, Banner Bank (the Bank). Banner Bank is a Washington-chartered commercial bank that conducts business from its main office in Walla Walla, Washington and its 62 branch offices and 12 loan production offices located in 27 counties in Washington, Oregon and Idaho. Banner Corporation is subject to regulation by the Board of Governors of the Federal Reserve System, and Banner Bank is subject to regulation by the State of Washington Department of Financial Institutions, Division of Banks and the Federal Deposit Insurance Corporation. As of December 31, 2006 we had total consolidated assets of $3.5 billion, total deposits of $2.8 billion and total stockholders' equity of $250 million.
Our operating results depend primarily on our net interest income, which is the difference between interest income on interest-earning assets, consisting of loans and investment securities, and interest expense on interest-bearing liabilities, composed primarily of customer deposits, FHLB advances, repurchase agreements and junior subordinated debentures issued in connection with the sale of trust preferred securities. Our net income is also significantly affected by provisions for loan losses and the level of our other income, including deposit service charges, loan origination and servicing fees, and gains and losses on the sale of loans and securities, as well as our non-interest operating expenses and income tax provisions. Our net income for the year ended December 31, 2006 was $32.2 million, or $2.63 per share on a fully diluted basis, which included a $5.5 million insurance settlement. The net amount of the settlement, after costs, resulted in a $5.4 million credit to other operating expenses and contributed approximately $3.4 million, or $0.28 per share, to earnings for the year ended December 31, 2006. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" for more detailed information about our financial performance.
Banner Bank offers a wide variety of commercial banking services and financial products to individuals, businesses and public sector entities in its primary market areas. Banner Bank's primary business is that of a traditional banking institution, accepting deposits and originating loans in locations surrounding its offices in portions of Washington, Oregon and Idaho. Banner Bank is also an active participant in the secondary market, engaging in mortgage banking operations largely through the origination and sale of one- to four-family residential loans. Lending activities include commercial business and commercial real estate loans, agricultural business loans, construction and land development loans, one- to four-family residential loans and consumer loans. A portion of Banner Bank's construction and mortgage lending activities are conducted through its subsidiary, Community Financial Corporation or CFC, which is located in the Lake Oswego area of Portland, Oregon. In addition to loans, Banner Bank maintains a portion of its assets in marketable securities. The securities portfolio is heavily weighted toward mortgage-backed securities secured by one- to four-family residential properties. This portfolio also includes U.S. Government agency (including government-sponsored enterprises) securities, as well as investment grade corporate debt securities and tax-exempt municipal securities primarily issued by entities located in the State of Washington.
Over the past three years, we have invested significantly in expanding our branch and distribution systems with a primary emphasis on expanding our presence in the four largest areas of commerce in the Northwest: the Puget Sound region of Washington; and the greater Boise, Idaho; Portland, Oregon; and Spokane, Washington market areas. This branch expansion is a significant element in our strategy to grow loans, deposits and customer relationships. This emphasis on growth has resulted in an elevated level of operating expenses; however, management believes that over time these new branches should help improve profitability by providing lower cost core deposits which will allow us to proportionately reduce higher cost borrowings as a source of funds. We are committed to continuing this branch expansion strategy for the next two to three years and have plans and projects in process for six additional new offices expected to open in the next 12 months and are exploring other opportunities.
Consistent with our business strategy of continued growth in our core markets in the Northwest, we recently entered into two merger agreements. On December 11, 2006, we entered into a merger agreement with F&M Bank, a Washington state-chartered commercial bank located in Spokane, Washington. Under the terms of the merger agreement, Banner Bank will acquire F&M Bank through the merger of F&M Bank into Banner Bank, with Banner Bank being the surviving institution. F&M Bank operates 13 full-service banking offices in and around the Spokane area. At December 31, 2006, F&M Bank had total assets of $415 million, total loans of $367 million, deposits of $340 million and stockholders' equity of $39 million. Under the terms of the merger agreement and assuming all outstanding F&M Bank options are exercised (unexercised options will otherwise be cancelled), shareholders of F&M Bank will be entitled to receive, in exchange for each share of F&M Bank common stock held, 0.85 shares of our common stock and $9.30 in cash, plus a pro-ration of the F&M Bank annual cash dividend through the closing. We will issue 1,773,494 shares of our common stock and pay $19.4 million in cash in the transaction. The total value of the proposed transaction will be approximately $98.8 million. We expect to complete the merger in the second calendar quarter of 2007, pending the approval of the transaction by shareholders of F&M Bank, regulatory approval, and other customary closing conditions.
Subsequently, on December 18, 2006, we entered into a merger agreement with San Juan Financial Holding Company of Friday Harbor, Washington, the bank holding company of Islanders Bank, a Washington state-chartered commercial bank. Under the terms of the merger agreement, Banner Corporation will acquire San Juan Financial Holding Company and Islanders Bank through the merger of San Juan Financial Holding Company into Banner Corporation, with Banner Corporation being the surviving entity. After the merger of San Juan Financial Holding Company into Banner Corporation, Islanders Bank will become an independent financial institution subsidiary of Banner Corporation.
Islanders Bank operates three full-service banking offices in the North Puget Sound region of Washington State, which are located in Friday Harbor, on Orcas Island and on Lopez Island, Washington. We currently operate six branches and one loan office in the North Puget Sound region. At December 31, 2006, Islanders Bank had total assets of approximately $152 million, total loans of $113 million, deposits of $122 million and stockholders' equity of $17 million. Shareholders of Islanders Bank will be entitled to receive, in exchange for each share of Islanders Bank common stock held, 2.2503 shares of our common stock and $16.48 in cash, subject to certain conditions and assuming 364,078
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shares of San Juan Financial Holding Company common stock are outstanding at the closing of the transaction. Additional consideration will be paid by us to the San Juan Financial Holding Company shareholders in the event the transaction has not closed by March 31, 2007 and the failure to close is not a result of San Juan Financial Holding Company's failure to perform or observe its covenants and agreements contained in the merger agreement. The additional per share consideration will be equal to the amount of any dividends per share paid to our shareholders with a record date on or after March 31, 2007, but before the closing date of the transaction, that would have been payable on our common stock issued and outstanding if the closing of the transaction had occurred on March 31, 2007. Prior to closing, San Juan Financial Holding Company shareholders may also receive the net after tax proceeds from the sale of San Juan Title LLC. We will issue 819,277 shares of our common stock and pay $6.0 million in cash in the transaction. The total value of the proposed transaction will be approximately $40.8 million. We expect to complete the merger in the second calendar quarter of 2007, pending the approval of the transaction by shareholders of San Juan Financial Holding Company, regulatory approval, and other customary conditions of closing.
General: All of our lending activities are conducted through Banner Bank and its subsidiaries. We offer a wide range of loan products to meet the demands of our customers. We originate loans for our own loan portfolio and for sale in the secondary market. Management's strategy has been to maintain a significant percentage of assets in the loan portfolio with more frequent interest rate repricing terms or shorter maturities than traditional long-term fixed-rate mortgage loans. As part of this effort, we have developed a variety of floating or adjustable interest rate products that correlate more closely with our cost of funds. However, in response to customer demand, we continue to originate fixed-rate loans, including fixed interest rate mortgage loans with terms of up to 30 years. The relative amount of fixed-rate loans and adjustable-rate loans that can be originated at any time is largely determined by the demand for each in a competitive environment.
Historically, our lending activities have been primarily directed toward the origination of real estate and commercial loans. Real estate lending activities have been significantly focused on residential construction and first mortgages on owner-occupied, one- to four-family residential properties. In response to exceptionally strong housing markets, construction and land loan growth has been particularly significant over the past two years. To an increasing extent in recent years, our lending activities have also included the origination of multifamily and commercial real estate loans. Commercial lending has been directed toward meeting the credit and related deposit needs of various small- to medium-sized business and agri-business borrowers operating in our primary market areas. During the past four years, we have significantly added to our resources engaged in commercial lending, including senior credit administration personnel and experienced officers focused on middle market corporate lending opportunities. We also recently increased our emphasis on consumer lending. While continuing our commitment to construction and residential lending, management expects commercial lending, including commercial real estate, agricultural and consumer lending to become increasingly important activities for us.
At December 31, 2006, our net loan portfolio totaled $2.93 billion. For additional information concerning our loan portfolio, see Item 7, "Management's Discussion and Analysis of Financial Condition-Comparison of Financial Condition at December 31, 2006 and 2005-Loans/Lending." See also Table 5 contained therein, which sets forth the composition of our loan portfolio, and Tables 6 and 6(a), which contain information regarding the loans maturing in our portfolio.
One- to Four-Family Residential Real Estate Lending: At Banner Bank, we originate loans secured by first mortgages on one- to four-family residences and loans for the construction of one- to four-family residences in the Northwest communities where we have offices. Our mortgage lending subsidiary, CFC, provides residential and construction lending primarily in the Bend and greater Portland, Oregon market areas. At December 31, 2006, $362 million, or 12.0% of our loan portfolio, consisted of permanent loans on one- to four-family residences.
We offer fixed- and adjustable-rate mortgages (ARMs) at rates and terms competitive with market conditions, primarily with the intent of selling these loans into the secondary market. Fixed rate loans generally are offered on a fully amortizing basis for terms ranging from 15 to 30 years at interest rates and fees that reflect current secondary market pricing. Most ARM products offered adjust annually after an initial period ranging from one to five years, subject to a limitation on the annual change of 1.0% to 2.0% and a lifetime limitation of 5.0% to 6.0%. These ARM products most frequently adjust based upon the average yield on U.S. Treasury securities adjusted to a constant maturity of one year plus a margin or spread above the index. Generally, ARM loans held in our portfolio do not allow for interest-only payments nor negative amortization of principal and carry no prepayment restrictions. The retention of ARM loans in our loan portfolio can help reduce our exposure to changes in interest rates. However, borrower demand for ARM loans versus fixed-rate mortgage loans is a function of the level of interest rates, the expectations of changes in the level of interest rates and the difference between the initial interest rates and fees charged for each type of loan. In recent years, borrower demand for ARM loans has been limited and we have chosen not to aggressively pursue ARM loans by offering minimally profitable deeply discounted teaser rates or higher interest-only option ARM products. As a result, ARM loans have represented only a small portion of loans originated during this period.
Our residential loans are generally underwritten and documented in accordance with the guidelines established by the Federal Home Loan Mortgage Corporation (Freddie Mac or FHLMC) and the Federal National Mortgage Corporation (Fannie Mae or FNMA). Government insured loans are generally underwritten and documented in accordance with the guidelines established by the Department of Housing and Urban Development (HUD) and the Veterans Administration (VA). In the loan approval process, we assess the borrower's ability to repay the loan, the adequacy of the proposed security, the employment stability of the borrower and the creditworthiness of the borrower. Generally, we lend up to 95% of the lesser of the appraised value of the property or purchase price of the property on conventional loans, although higher loan-to-value ratios are available on certain government insured programs. We usually require private mortgage insurance on residential loans with a loan-to-value ratio at origination exceeding 80%.
We sell residential loans on either a servicing-retained or servicing-released basis. The decision to hold or sell loans is based on asset/liability management goals and policies and market conditions. During the past three years, we have sold a significant portion of our conventional residential mortgage originations and nearly all of our government insured loans into the secondary market.
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Construction and Land Lending: We invest a significant portion of our loan portfolio in residential construction loans to professional home builders. To a lesser extent, we also originate land loans and construction loans for commercial and multifamily real estate. Residential construction lending is a core competency of Banner Bank and the primary focus of its subsidiary, CFC. Our largest concentration of construction and development loans is in the Portland/Vancouver market area. We also have a significant amount of construction loans for properties in the Puget Sound region and in the greater Boise market. At December 31, 2006, construction and land loans totaled $1.111 billion (including $403 million of land or land development loans and $138 million of commercial and multifamily real estate construction loans), or 37% of total loans of the Company.
Construction and land lending affords us the opportunity to achieve higher interest rates and fees with shorter terms to maturity than are usually available on other types of lending. Construction and land lending, however, are generally considered to involve a higher degree of risk than other lending opportunities because of the inherent difficulty in estimating both a property's value at completion of the project and the estimated cost of the project. If the estimate of construction cost proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value upon completion proves to be inaccurate, we may be confronted at, or prior to, the maturity of the loan with a project the value of which is insufficient to assure full repayment. Disagreements between borrowers and builders and the failure of builders to pay subcontractors may also jeopardize projects. Loans to builders to construct homes for which no purchaser has been identified carry additional risk because the payoff for the loan is dependent on the builder's ability to sell the property before the construction loan is due. We address these risks by adhering to strict underwriting policies, disbursement procedures and monitoring practices.
Construction loans made by us include those with a sale contract or permanent loan in place for the finished homes and those for which purchasers for the finished homes may be identified either during or following the construction period. We actively monitor the number of unsold homes in our construction loan portfolio and local housing markets to ensure an appropriate balance between home sales and new loan originations. The maximum number of speculative loans approved for each builder is based on a combination of factors, including the financial capacity of the builder, the market demand for the finished product and the ratio of sold to unsold inventory the builder maintains. We have chosen to diversify the risk associated with speculative construction lending by doing business with a large number of small and mid-sized builders spread over a relatively large geographic area.
Loans for the construction of one- to four-family residences are generally made for a term of twelve months. Our loan policies include maximum loan-to-value ratios of up to 80% for speculative loans. Individual speculative loan requests are supported by an independent appraisal of the property, a set of plans, a cost breakdown and a completed specifications form. All speculative construction loans must be approved by senior loan officers.
We also make land loans to developers, builders and individuals to finance the acquisition and/or development of improved lots or unimproved land. In making land loans, we follow underwriting policies and disbursement and monitoring procedures similar to those for construction loans. The initial term on land loans is typically one to three years with interest only payments, payable monthly, and provisions for principal reduction as lots are sold and released from the lien of the mortgage.
We regularly monitor the construction and land loan portfolios and the economic conditions and housing inventory in each of our markets and will decrease this type of lending if we perceive unfavorable market conditions. We believe that the underwriting policies and internal monitoring systems we have in place mitigate many of the risks inherent in construction and land lending.
Commercial and Multifamily Real Estate Lending: We originate loans secured by multifamily and commercial real estate including, as noted above, loans for construction of multifamily and commercial real estate projects. At December 31, 2006, our loan portfolio included $147 million in multifamily and $596 million in commercial real estate loans which together comprised 25% of our total loans. Multifamily and commercial real estate lending affords us an opportunity to receive interest at rates higher than those generally available from one- to four-family residential lending. However, loans secured by multifamily and commercial properties are generally greater in amount, more difficult to evaluate and monitor and, therefore, riskier than one- to four-family residential mortgage loans. Because payments on loans secured by multifamily and commercial properties are often dependent on the successful operation and management of the properties, repayment of these loans may be affected by adverse conditions in the real estate market or the economy. In all multifamily and commercial real estate lending, we consider the location, marketability and overall attractiveness of the properties. Our current underwriting guidelines for multifamily and commercial real estate loans require an appraisal from a qualified independent appraiser and an economic analysis of each property with regard to the annual revenue and expenses, debt service coverage and fair value to determine the maximum loan amount. In the approval process we assess the borrowers' willingness and ability to repay the loan and the adequacy of the collateral in relation to the loan amount.
Multifamily and commercial real estate loans originated by us are both fixed- and adjustable-rate loans generally with intermediate terms of five to ten years. Most multifamily and commercial real estate loans originated in the past five years are linked to various U.S. Treasury indices or certain prime rates. Rates on these adjustable-rate loans generally adjust with a frequency of one to five years after an initial fixed-rate period ranging from one to ten years. Our commercial real estate portfolio consists of loans on a variety of property types with no large concentrations by property type or location.
Commercial Business Lending: We are active in small- to medium-sized business lending, including the origination of loans guaranteed by the Small Business Administration (SBA), and are engaged to a lesser extent in agricultural lending primarily by providing crop production loans. Our officers devote a great deal of effort to developing customer relationships and the ability to serve these types of borrowers. Management believes that many large banks have neglected these lending markets, which has contributed to our success. While strengthening our commitment to small business lending, in recent years we have added experienced officers and staff focused on middle market corporate lending opportunities for borrowers with credit needs generally in a $3 million to $15 million range. Management has leveraged the past success of these officers with local decision making ability to continue to expand this market niche. In addition to providing earning assets, this type of lending has helped us increase our deposit base. Expanding commercial lending and related commercial banking services is currently an area of significant focus by us and staffing has been increased in the areas of credit administration, business development, and loan and deposit operations.
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Commercial business loans may entail greater risk than other types of loans. Commercial business loans may be unsecured or secured by special purpose or rapidly depreciating assets, such as equipment, inventory and receivables, which may not provide an adequate source of repayment on defaulted loans. In addition, commercial business loans are dependent on the borrower's continuing financial strength and management ability, as well as market conditions for various products, services and commodities. For these reasons, commercial business loans generally provide higher yields than many other types of loans but also require more administrative and management attention. Loan terms, including the fixed or adjustable interest rate, the loan maturity and the collateral considerations, vary significantly and are negotiated on an individual loan basis.
We underwrite our commercial business loans on the basis of the borrower's cash flow and ability to service the debt from earnings rather than on the basis of the underlying collateral value. We seek to structure these loans so that they have more than one source of repayment. The borrower is required to provide us with sufficient information to allow us to make a lending determination. In most instances, this information consists of at least three years of financial statements, tax returns, a statement of projected cash flows, current financial information on any guarantor and information about the collateral. Loans to closely held businesses typically require personal guarantees by the principals. Our commercial loan portfolio is geographically dispersed across the market areas serviced by our branch network and there are no significant concentrations by industry or products.
Our commercial business loans may be structured as term loans or as lines of credit. Commercial business term loans are generally made to finance the purchase of fixed assets and have maturities of five years or less. Commercial business lines of credit are typically made for the purpose of providing working capital and are usually approved with a term of one year. Adjustable- or floating-rate loans are generally tied to various prime rate and London Inter-Bank Overnight Rate or LIBOR indices. At December 31, 2006, commercial loans totaled $468 million, or 16% of our total loans.
Agricultural Lending: Agriculture is a major industry in many parts of our service area. While agricultural loans are not a large part of our portfolio, we intend to continue to make agricultural loans to borrowers with a strong capital base, sufficient management depth, proven ability to operate through agricultural cycles, reliable cash flows and adequate financial reporting. Payments on agricultural loans depend, to a large degree, on the results of operations of the related farm entity. The repayment is also subject to other economic and weather conditions as well as market prices for agricultural products, which can be highly volatile. At December 31, 2006, agricultural business loans, including collateral secured loans to purchase farm land and equipment, totaled $164 million, or 6% of our loan portfolio.
Agricultural operating loans generally are made as a percentage of the borrower's anticipated income to support budgeted operating expenses. These loans generally are secured by a blanket lien on all crops, livestock, equipment, accounts and products and proceeds thereof. In the case of crops, consideration is given to projected yields and prices from each commodity. The interest rate is normally floating based on the prime rate as published in The Wall Street Journal, plus a negotiated margin. Because these loans are made to finance a farm or ranch's annual operations, they are written on a one-year review and renewable basis. The renewal is dependent upon the prior year's performance and the forthcoming year's projections as well as the overall financial strength of the borrower. We carefully monitor these loans and related variance reports on income and expenses compared to budget estimates. To meet the seasonal operating needs of a farm, borrowers may qualify for single payment notes, revolving lines of credit and/or non-revolving lines of credit.
In underwriting agricultural operating loans, we consider the cash flow of the borrower based upon the expected operating results as well as the value of collateral used to secure the loans. Collateral generally consists of cash crops produced by the farm, such as milk, grains, fruit, grass seed, peas, sugar beets, mint, onions, potatoes, corn and alfalfa or livestock. In addition to considering cash flow and obtaining a blanket security interest in the farm's cash crop, Banner Bank may also collateralize an operating loan with the farm's operating equipment, breeding stock, real estate and federal agricultural program payments to the borrower.
We also originate loans to finance the purchase of farm equipment. Loans to purchase farm equipment are made for terms of up to seven years. On occasion, we also originate agricultural real estate loans secured primarily by first liens on farmland and improvements thereon located in our market area, although generally only to service the needs of our existing customers. Loans are written in amounts up to 50% to 75% of the tax assessed or appraised value of the property at terms ranging from five to 20 years. These loans have interest rates that generally adjust at least every five years based typically upon a U.S. Treasury index plus a negotiated margin. Fixed-rate loans are granted on terms generally not to exceed five years with rates established at inception based on margins set above the current five-year U.S. Treasury Note or another generally accepted index. In originating agricultural real estate loans, we consider the debt service coverage of the borrower's cash flow, the appraised value of the underlying property, the experience and knowledge of the borrower, and the borrower's past performance with us and/or the market area. These loans normally are not made to start-up businesses but are generally reserved for existing customers with substantial equity and a proven history.
Among the more common risks to agricultural lending can be weather conditions and disease. These risks can be mitigated through multi-peril crop insurance. Commodity prices also present a risk, which may be reduced by the use of set price contracts. Normally, required beginning and projected operating margins provide for reasonable reserves to offset unexpected yield and price deficiencies. In addition to these risks, we also consider management succession, life insurance and business continuation plans when evaluating agricultural loans.
Consumer and Other Lending: We originate a variety of consumer loans, including home equity lines of credit, automobile loans and loans secured by deposit accounts. While consumer lending has traditionally been a small part of our business, with loans made primarily to accommodate our existing customer base, it has received renewed emphasis in recent years and management anticipates increased activity in future periods. Part of this emphasis has been the reintroduction of a Banner Bank-funded credit card program which we began marketing in the fourth quarter of 2005. Similar to other consumer loan programs, we primarily focus this credit card program on its existing customer base to add to the depth of its customer relationships. As a result of increased marketing efforts, an improved retail delivery network and strong borrower demand, our consumer loans increased significantly in the past year. At December 31, 2006, we had $118 million, or 4% of our loans receivable, in consumer related loans, an increase of $26 million or 28% from December 31, 2005.
Similar to commercial loans, consumer loans often entail greater risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral for a defaulted
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consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. These loans may also give rise to claims and defenses by a consumer loan borrower against an assignee of such loans such as us, and a borrower may be able to assert against the assignee claims and defenses that it has against the seller of the underlying collateral.
Loan Solicitation and Processing: We originate real estate loans by direct solicitation of real estate brokers, builders, depositors and walk-in customers. Loan applications are taken by our loan officers and are processed in branch or regional locations. Most underwriting and loan administration functions are performed by loan personnel at central locations.
Our commercial loan officers solicit commercial and agricultural business loans through call programs focused on local businesses and farmers. While commercial loan officers are delegated reasonable commitment authority based upon their qualifications, credit decisions on significant commercial and agricultural loans are made by senior loan officers or in certain instances by the Board of Directors of Banner Bank or Banner Corporation.
We originate consumer loans through various marketing efforts directed primarily toward our existing deposit and loan customers. Consumer loan applications may be processed at branch locations or by administrative personnel at our main office.
Loan Originations, Sales and Purchases
While we originate a variety of loans, our ability to originate each type of loan is dependent upon the relative customer demand and competition in each market we serve. For the years ended December 31, 2006, 2005 and 2004, we originated loans, net of repayments, of $921 million, $720 million and $696 million, respectively.
In recent years, we generally have sold most of our newly originated one- to four-family residential mortgage loans and a portion of our SBA guaranteed loans to secondary market purchasers as part of our interest rate risk management strategy. Proceeds from sales of loans for the years ended December 31, 2006, 2005 and 2004, totaled $442 million, $397 million and $338 million, respectively. Sales of loans generally are beneficial to us because these sales may generate income at the time of sale, provide funds for additional lending and other investments and increase liquidity. We sell loans on both a servicing-retained and a servicing-released basis. All loans are sold without recourse. See "Loan Servicing." At December 31, 2006, we had $5.1 million in loans held for sale.
We periodically purchase whole loans and loan participation interests primarily during periods of reduced loan demand in our primary market area and at times to support our Community Reinvestment Act lending activities. Any such purchases are made consistent with our underwriting standards; however, the loans may be located outside of our normal lending area. During the years ended December 31, 2006, 2005 and 2004, we purchased $45 million, $23 million and $18 million, respectively, of loans and loan participation interests.
Loan Servicing
We receive fees from a variety of institutional owners in return for performing the traditional services of collecting individual payments and managing portfolios of sold loans. At December 31, 2006, we were servicing $361 million of loans for others. Loan servicing includes processing payments, accounting for loan funds and collecting and paying real estate taxes, hazard insurance and other loan-related items such as private mortgage insurance. In addition to earning fee income, we retain certain amounts in escrow for the benefit of the lender for which we incur no interest expense but are able to invest the funds into earning assets. At December 31, 2006, we held $3.4 million in escrow for our portfolio of loans serviced for others. The loan servicing portfolio at December 31, 2006 was composed of $197 million of Freddie Mac mortgage loans, $22 million of Fannie Mae mortgage loans and $142 million of loans serviced for a variety of private investors. The portfolio included loans secured by property located primarily in the states of Washington and Oregon. For the year ended December 31, 2006, $1.3 million of loan servicing fees, net of $518,000 of servicing rights amortization, was recognized in operations.
Mortgage Servicing Rights: We record mortgage servicing rights (MSRs) with respect to loans we originate and sell in the secondary market on a servicing-retained basis. The cost of MSRs is capitalized and amortized in proportion to, and over the period of, the estimated future net servicing income. For the years ended December 31, 2006, 2005 and 2004, we capitalized $1.6 million, $502,000, and $78,000, respectively, of MSRs relating to loans sold with servicing retained. No MSRs were purchased in those periods. Amortization of MSRs for the years ended December 31, 2006, 2005 and 2004, was $518,000, $507,000, and $489,000, respectively. Management periodically evaluates the estimates and assumptions used to determine the carrying values of MSRs and the amortization of MSRs. These carrying values are adjusted when the valuation indicates the carrying value is impaired. MSRs generally are adversely affected by higher levels of current or anticipated prepayments resulting from decreasing interest rates. At December 31, 2006, MSRs were carried at a value of $2.7 million, net of amortization.
Classified Assets:State and federal regulations require that Banner Bank review and classify its problem assets on a regular basis. In addition, in connection with examinations of insured institutions, state and federal examiners have authority to identify problem assets and, if appropriate, require them to be classified. Banner Bank's Credit Policy Division reviews detailed information with respect to the composition and performance of the loan portfolio, including information on risk concentrations, delinquencies and classified assets. The Credit Policy Division approves all recommendations for new classified assets or changes in classifications, and develops and monitors action plans to resolve the problems associated with the assets. The Credit Policy Division also approves recommendations for establishing the appropriate level of the allowance for loan losses. Significant problem loans are transferred to Banner Bank's Special Assets Department for resolution or collection activities. Banner Bank's Board of Directors is given a detailed report on classified assets and asset quality at least quarterly.
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For additional information with respect to asset quality and non-performing loans, see Item 7, "Management's Discussion and Analysis of Financial Condition-Comparison of Financial Condition at December 31, 2006 and 2005-Asset Quality," and Table 10 contained therein.
Allowance for Loan Losses:In originating loans, we recognize that losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the security for the loan. As a result, we maintain an allowance for loan losses consistent with the generally acceptable accounting principles (GAAP) guidelines. We increase our allowance for loan losses by charging provisions for possible loan losses against our income. The allowance for losses on loans is maintained at a level which, in management's judgment, is sufficient to provide for estimated losses based on evaluating known and inherent risks in the loan portfolio and upon continuing analysis of the factors underlying the quality of the loan portfolio. At December 31, 2006, we had an allowance for loan losses of $36 million, which represented 1.20% of net loans and 253% of non-performing loans compared to 1.27% and 296%, respectively, at December 31, 2005. For additional information concerning our allowance for loan losses, see Item 7, "Management's Discussion and Analysis of Financial Condition-Comparison of Results of Operations for the Years Ended December 31, 2006 and 2005-Provision and Allowance for Loan Losses," and Tables 11 and 12 contained therein.
Under Washington state law, banks are permitted to invest in various types of marketable securities. Authorized securities include but are not limited to U.S. Treasury obligations, securities of various federal agencies (including government-sponsored enterprises), mortgage-backed securities, certain certificates of deposit of insured banks and savings institutions, bankers' acceptances, repurchase agreements, federal funds, commercial paper, corporate debt and equity securities and obligations of states and their political subdivisions. Our investment policies are designed to provide and maintain adequate liquidity and to generate favorable rates of return without incurring undue interest rate or credit risk. Our policies generally limit investments to U.S. Government and government agency (including government-sponsored entities) securities, municipal bonds, certificates of deposit, marketable corporate debt obligations and mortgage-backed securities. Investment in mortgage-backed securities includes those issued or guaranteed by Freddie Mac, Fannie Mae, Government National Mortgage Association (Ginnie Mae or GNMA) and privately-issued mortgage-backed securities that have an AA credit rating or higher, as well as collateralized mortgage obligations (CMOs). A high credit rating indicates only that the rating agency believes there is a low risk of loss or default. However, all of our investment securities, including those that have high credit ratings, are subject to market risk in so far as a change in market rates of interest or other conditions may cause a change in an investment's earning performance and/or market value.
At December 31, 2006, our consolidated investment portfolio totaled $274 million and consisted principally of U.S. Government agency obligations, mortgage-backed securities, municipal bonds, corporate debt obligations, and stock of Fannie Mae and Freddie Mac. From time to time, investment levels may be increased or decreased depending upon yields available on investment alternatives, and management's projections as to the demand for funds to be used in loan originations, deposits and other activities. During the year ended December 31, 2006, investments and securities decreased by $37 million. (See Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operation; Recent Developments and Significant Events.") During the year ended December 31, 2006, holdings of mortgage-backed securities decreased $29 million to $150 million, U.S. Treasury and agency obligations increased $2 million to $27 million, corporate and other securities decreased $7 million to $49 million, and municipal bonds decreased $4 million to $47 million.
For detailed information on our investment securities, see Item 7, "Management's Discussion and Analysis of Financial Condition-Comparison of Financial Condition at December 31, 2006 and 2005-Investments," and Tables 1, 2, 3 and 4 contained therein.
Off-Balance-Sheet Derivatives: Derivatives include "off-balance-sheet" financial products whose value is dependent on the value of an underlying financial asset, such as a stock, bond, foreign currency, or a reference rate or index. Such derivatives include "forwards," "futures," "options" or "swaps." We generally have not invested in "off-balance-sheet" derivative instruments, although investment policies authorize such investments. However, as a part of mortgage banking activities, we issue "rate lock" commitments to borrowers and obtain offsetting "best efforts" delivery commitments from purchasers of loans. While not providing any trading or net settlement mechanisms, these off-balance-sheet commitments do have many of the prescribed characteristics of derivatives and as a result are accounted for as such in accordance with Statement of Financial Accounting Standards (SFAS) No. 133, as amended. Accordingly, on December 31, 2006, we recorded an asset of $35,000 and a liability of $35,000, representing the estimated market value of those commitments. On December 31, 2006, we had no other investment related off-balance-sheet derivatives.
Deposit Activities and Other Sources of Funds
General: Deposits, FHLB advances (or other borrowings) and loan repayments are the major sources of our funds for lending and other investment purposes. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are influenced by general economic, interest rate and money market conditions and may vary significantly. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds from other sources. Borrowings may also be used on a longer-term basis for general business purposes, including funding loans and investments.
We compete with other financial institutions and financial intermediaries in attracting deposits. There is strong competition for transaction balances and savings deposits from commercial banks, credit unions and nonbank corporations, such as securities brokerage companies, mutual funds and other diversified companies, some of which have nationwide networks of offices. Much of the focus of our recent branch expansion, relocations and renovation has been directed toward attracting additional deposit customer relationships and balances, and we have enjoyed strong deposit growth in recent years. In addition, our electronic banking activities including debit card and automated teller machine (ATM) programs, online Internet banking services and, most recently, customer remote deposit capabilities, are all directed at providing products and services that enhance customer relationships and result in growing deposit balances. Growing deposits is a fundamental element of our core business strategies.
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Deposit Accounts: We generally attract deposits from within our primary market areas by offering a broad selection of deposit instruments, including demand checking accounts, negotiable order of withdrawal (NOW) accounts, money market deposit accounts, regular savings accounts, certificates of deposit, cash management services and retirement savings plans. 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 deposit accounts, we consider current market interest rates, profitability to us, matching deposit and loan products and customer preferences and concerns. At December 31, 2006, we had $2.8 billion of deposits, including $1.2 billion of transaction and savings accounts and $1.6 billion in time deposits. For additional information concerning our deposit accounts, see Item 7, "Management's Discussion and Analysis of Financial Condition-Comparison of Financial Condition at December 31, 2006 and 2005-Deposit Accounts." See also Table 7 contained therein, which sets forth the balances of deposits in the various types of accounts offered by us, and Table 8, which sets forth the amount of our certificates of deposit greater than $100,000 by time remaining until maturity as of December 31, 2006.
Borrowings: While deposits are the primary source of funds for our lending and investment activities and for its general business purposes, we also use borrowings to supplement our supply of lendable funds, to meet deposit withdrawal requirements and to more efficiently leverage our capital position. The FHLB-Seattle serves as our primary borrowing source. The FHLB-Seattle provides credit for member financial institutions such as Banner Bank. As a member, Banner Bank is required to own capital stock in the FHLB-Seattle and is authorized to apply for advances on the security of that stock and certain of its mortgage loans and securities provided certain credit worthiness standards have been met. Limitations on the amount of advances are based on the financial condition of the member institution and the adequacy of collateral pledged to secure the credit. At December 31, 2006, we had $177 million of combined borrowings from the FHLB-Seattle at a weighted average rate of 5.01%. At that date, Banner Bank had been authorized by the FHLB-Seattle to borrow up to $587 million under a blanket floating lien security agreement. Banner Bank also has access to additional short-term funds through a $35 million commercial bank credit line. At December 31, 2006, there was no outstanding balance on this commercial banking credit line. For additional information concerning our borrowings from the FHLB-Seattle, see Item 7, "Management's Discussion and Analysis of Financial Condition-Comparison of Financial Condition at December 31, 2006 and 2005-Borrowings," Table 9 contained therein, and Note 12 of the Notes to the Consolidated Financial Statements.
We issue retail repurchase agreements, generally due within 90 days, as an additional source of funds, primarily in connection with cash management services provided to our larger deposit customers. At December 31, 2006, we had issued retail repurchase agreements totaling $77 million, with a weighted average interest rate of 3.67%, which were secured by a pledge of certain mortgage-backed securities with a market value of $90 million.
We also borrow funds through the use of secured wholesale repurchase agreements with securities brokers. The broker holds our investment securities while we continue to receive the principal and interest payments from the securities. Our outstanding borrowings at December 31, 2006 under wholesale repurchase agreements totaled $26 million, with a weighted average rate of 5.38%, and were collateralized by mortgage-backed securities with a fair value of $27 million.
In addition to our borrowings, we have also issued $120 million of trust preferred securities (TPS). The TPS were issued in 2002, 2003, 2004, 2005 and 2006 by special purpose business trusts formed by Banner Corporation and were sold in private offerings to pooled investment vehicles. The junior subordinated debentures associated with the TPS have been recorded as liabilities on our Consolidated Statements of Financial Condition; however, approximately $84 million of the TPS qualify as Tier 1 capital for regulatory capital purposes and the balance of the TPS qualify as Tier II capital. We have invested a significant portion of the proceeds from the issuance of the TPS as additional paid in capital at Banner Bank. For additional information about deposits and other sources of funds, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources," and Notes 11, 12 and 13 of the Notes to the Consolidated Financial Statements contained in Item 8.
As of December 31, 2006, we had 855 full-time and 69 part-time employees. Banner Corporation has no employees except for those who are also employees of Banner Bank and its subsidiaries. The employees are not represented by a collective bargaining unit. We believe our relationship with our employees is good.
Federal Taxation
General: For tax reporting purposes, we report our income on a calendar year basis using the accrual method of accounting on a consolidated basis. We are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to us. Reference is made to Note 14 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K for additional information concerning the income taxes payable by us.
Provisions of the Small Business Job Protection Act of 1996 (the Job Protection Act) significantly altered our tax bad debt deduction method and the circumstances that would require a tax bad debt reserve recapture. Prior to enactment of the Job Protection Act, savings institutions (Banner Bank was previously chartered as a savings institution) were permitted to compute their tax bad debt deduction through use of either the reserve method or the percentage of taxable income method. The Job Protection Act repealed both of these methods for large savings institutions and allows bad debt deductions based only on actual current losses. While repealing the reserve method for computing tax bad debt deductions, the Job Protection Act allowed savings institutions to retain their existing base year bad debt reserves but required that reserves in excess of the balance at December 31, 1987, be recaptured into taxable income over six years. The reserves in excess of the base year (December 31, 1987) had been fully recaptured into taxable income as of December 31, 2003.
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The base year reserve is recaptured into taxable income only in limited situations, such as in the event of certain excess distributions, complete liquidation or disqualification as a bank. None of the limited circumstances requiring recapture are contemplated by us. The amount of our tax bad debt reserves subject to recapture in these circumstances was approximately $5.3 million at December 31, 2006. As a result of the remote nature of events that may trigger the recapture provisions, no tax liability has been established in the accompanying Consolidated Financial Statements.
State Taxation
Washington Taxation: We are subject to a Business and Occupation (B&O) tax which is imposed under Washington law at the rate of 1.50% of gross receipts; however, interest received on loans secured by mortgages or deeds of trust on residential properties, residential mortgage-backed securities, and certain U.S. Government and agency securities is not subject to such tax. Our B&O tax expense was $1.5 million, $1.3 million and $1.1 million for the years ended December 31, 2006, 2005 and 2004, respectively.
Oregon and Idaho Taxation: Corporations with nexus in the states of Oregon and Idaho are subject to a corporate level income tax. Our operations in those states resulted in corporate income taxes of approximately $587,000, $98,000 and $254,000 (net of federal tax benefit) for the years ended December 31, 2006, 2005 and 2004, respectively. For 2005, corporate income taxes for Oregon were reduced approximately $51,000 due to a one-time biannual state credit that is not guaranteed to be repeated. In addition, for 2005 our Oregon and Idaho taxes also decreased as a result of the overall decrease in pre-tax book income due to balance-sheet restructuring transactions. As our operations in these states increase, the state income tax provision will have an increasing effect on our effective tax rate and results of operations.
Our business is affected from time to time by federal and state laws and regulations relating to hazardous substances. Under the federal Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), owners and operators of properties containing hazardous substances may be liable for the costs of cleaning up the substances. CERCLA and similar state laws can affect us both as an owner of branches and other properties used in our business and as a lender holding a security interest in property which is found to contain hazardous substances. While CERCLA contains an exemption for holders of security interests, the exemption is not available if the holder participates in the management of a property, and some courts have broadly defined what constitutes participation in management of property. Moreover, CERCLA and similar state statutes can affect our decision whether or not to foreclose on a property. Before foreclosing on commercial real estate, our general policy is to obtain an environmental report, thereby increasing the costs of foreclosure. In addition, the existence of hazardous substances on a property securing a troubled loan may cause us to elect not to foreclose on the property, thereby reducing our flexibility in handling the loan.
We encounter significant competition both in attracting deposits and in originating loans. Our most direct competition for deposits comes from other commercial and savings banks, savings associations and credit unions in its market areas. We also experience competition from securities firms, insurance companies, money market and mutual funds, and other investment vehicles. We expect continued strong competition from such financial institutions and investment vehicles in the foreseeable future. Our ability to attract and retain deposits depends on our ability to provide transaction services and investment opportunities that satisfy the requirements of depositors. We compete for deposits by offering a variety of accounts and financial services with competitive rates and terms, at convenient locations and business hours, and delivered with a high level of personal service and expertise.
Competition for loans comes principally from other commercial banks, loan brokers, mortgage banking companies, savings banks and credit unions. The competition for loans is intense as a result of the large number of institutions competing in our market areas. We compete for loans primarily by offering competitive rates and fees and providing timely decisions and excellent service to borrowers.
Banner Bank
General: As a state-chartered, federally insured commercial bank, Banner Bank is subject to extensive regulation and must comply with various statutory and regulatory requirements, including prescribed minimum capital standards. Banner Bank is regularly examined by the FDIC and state banking regulators and files periodic reports concerning its activities and financial condition with its regulators. Banner Bank's relationship with depositors and borrowers also is regulated to a great extent by both federal and state law, especially in such matters as the ownership of deposit accounts and the form and content of mortgage and other loan documents.
Federal and state banking laws and regulations govern all areas of the operation of Banner Bank, including reserves, loans, investments, deposits, capital, issuance of securities, payment of dividends and establishment of branches. Federal and state bank regulatory agencies also have the general authority to limit the dividends paid by insured banks and bank holding companies if such payments should be deemed to constitute an unsafe and unsound practice. The respective primary federal regulators of Banner Corporation and Banner Bank have authority to impose penalties, initiate civil and administrative actions and take other steps intended to prevent banks from engaging in unsafe or unsound practices.
State Regulation and Supervision: As a Washington state-chartered commercial bank with branches in the States of Washington, Oregon and Idaho, Banner Bank is subject to the applicable provisions of Washington, Oregon and Idaho law and regulations. State law and regulations govern Banner Bank's ability to take deposits and pay interest thereon, to make loans on or invest in residential and other real estate, to make consumer loans, to invest in securities, to offer various banking services to its customers and to establish branch offices.
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Deposit Insurance: The FDIC is an independent federal agency that insures the deposits, up to applicable limits, of depository institutions. As insurer of Banner Bank's deposits, the FDIC has examination, supervisory and enforcement authority over Banner Bank.
Banner Bank pays deposit insurance premiums based on a risk-based system established by the FDIC. Under this system, an institution's insurance assessment varies according to the level of capital the institution holds, the balance of insured deposits during the preceding two quarters, and the degree to which it is the subject of supervisory concern. In addition, regardless of the potential risk to the insurance fund, federal law requires the ratio of reserves to insured deposits to range from $1.15 to $1.50 per $100 as determined by the FDIC.
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 termination, less subsequent withdrawals, will 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 that could result in termination of the deposit insurance of Banner Bank.
Prompt Corrective Action: Federal statutes establish a supervisory framework based on five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. An institution's category depends upon where its capital levels are in relation to relevant capital measures, which include a risk-based capital measure, a leverage ratio capital measure and certain other factors. The federal banking agencies have adopted regulations that implement this statutory framework. Under these regulations, an institution is treated as well capitalized if its ratio of total capital to risk-weighted assets is 10% or more, its ratio of core capital to risk-weighted assets is 6% or more, its ratio of core capital to adjusted total assets (leverage ratio) is 5% or more, and it is not subject to any federal supervisory order or directive to meet a specific capital level. In order to be adequately capitalized, an institution must have a total risk-based capital ratio of not less than 8%, a Tier 1 risk-based capital ratio of not less than 4%, and a leverage ratio of not less than 4%. Any institution which is neither well capitalized nor adequately capitalized is considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls and restrictions which become more extensive as an institution becomes more severely undercapitalized. Failure by Banner Bank to comply with applicable capital requirements would, if unremedied, result in restrictions on its activities and lead to enforcement actions, including, but not limited to, the issuance of a capital directive to ensure the maintenance of required capital levels. Banking regulators will take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. Additionally, approval of any regulatory application filed for their review may be dependent on compliance with capital requirements.
At December 31, 2006, Banner Bank was categorized as "well capitalized" under the prompt corrective action regulations of the FDIC.
Capital Requirements: Federally insured financial institutions, such as Banner Bank, are required to maintain a minimum level of regulatory capital. FDIC regulations recognize two types, or tiers, of capital: core (Tier 1) capital and supplementary (Tier 2) capital. Tier 1 capital generally includes common stockholders' equity and noncumulative perpetual preferred stock, less most intangible assets. Tier 2 capital, which is limited to 100% of Tier 1 capital, includes such items as qualifying general loan loss reserves, cumulative perpetual preferred stock, mandatory convertible debt, term subordinated debt and limited life preferred stock; however, the amount of term subordinated debt and intermediate term preferred stock (original maturity of at least five years but less than 20 years) that may in included in Tier 2 capital is limited to 50% of Tier 1 capital.
The FDIC currently measures an institution's capital using a leverage limit together with certain risk-based ratios. The FDIC's minimum leverage capital requirement specifies a minimum ratio of Tier 1 capital to average total assets. Most banks are required to maintain a minimum leverage ratio of at least 4% to 5% of total assets. At December 31, 2006, Banner Bank had a Tier 1 leverage capital ratio of 8.80%. The FDIC retains the right to require a particular institution to maintain a higher capital level based on an institution's particular risk profile.
FDIC regulations also establish a measure of capital adequacy based on ratios of qualifying capital to risk-weighted assets. Assets are placed in one of four categories and given a percentage weight based on the relative risk of the category. In addition, certain off-balance-sheet items are converted to balance-sheet credit equivalent amounts, and each amount is then assigned to one of the four categories. Under the guidelines, the ratio of total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets must be at least 8%, and the ratio of Tier 1 capital to risk-weighted assets must be at least 4%. In evaluating the adequacy of a bank's capital, the FDIC may also consider other factors that may affect the bank's financial condition. Such factors may include interest rate risk exposure, liquidity, funding and market risks, the quality and level of earnings, concentration of credit risk, risks arising from nontraditional activities, loan and investment quality, the effectiveness of loan and investment policies, and management's ability to monitor and control financial operating risks. At December 31, 2006, Banner Bank had a Tier 1 risk-based capital ratio of 9.58% and a total risk-based capital ratio of 10.73%.
The Washington Department of Financial Institutions requires that net worth equal at least 5% of total assets. Intangible assets must be deducted from net worth and assets when computing compliance with this requirement. At December 31, 2006, Banner Bank had a net worth of 8.60% of total assets under this standard.
FDIC capital requirements are designated as the minimum acceptable standards for banks whose overall financial condition is fundamentally sound, which are well-managed and have no material or significant financial weaknesses. The FDIC capital regulations state that, where the FDIC determines that the financial history or condition, including off-balance-sheet risk, managerial resources and/or the future earnings prospects of a bank are not adequate and/or a bank has a significant volume of assets classified substandard, doubtful or loss or otherwise criticized, the FDIC may determine that the minimum adequate amount of capital for the bank is greater than the minimum standards established in the regulation.
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We believe that, under the current regulations, Banner Bank exceeds its minimum capital requirements. However, events beyond the control of Banner Bank, such as weak or depressed economic conditions in areas where Banner Bank has most of its loans, could adversely affect future earnings and, consequently, the ability of Banner Bank to meet is capital requirements. For additional information concerning Banner Bank's capital, see Note 18 of the Notes to the Consolidated Financial Statements.
Standards for Safety and Soundness: The federal banking regulatory agencies have prescribed, by regulation, guidelines for all insured depository institutions relating to internal controls, information systems and internal audit systems; loan documentation; credit underwriting; interest rate risk exposure; asset growth; asset quality; earnings; and compensation, fees and benefits. 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 FDIC determines that Banner Bank fails to meet any of these guidelines, it may require Banner Bank to submit to the FDIC an acceptable plan to achieve compliance with the guideline. We believe that at December 31, 2006, Banner Bank met all of the FDIC guidelines.
Activities and Investments of Insured State-Chartered Financial Institutions: Federal law generally limits the activities and equity investments of FDIC insured, state-chartered banks to those that are permissible for national banks. An insured state bank is not prohibited from, among other things, (1) acquiring or retaining a majority interest in a subsidiary, (2) investing as a limited partner in a partnership the sole purpose of which is direct or indirect investment in the acquisition, rehabilitation or new construction of a qualified housing project, provided that such limited partnership investments may not exceed 2% of the bank's total assets, (3) acquiring up to 10% of the voting stock of a company that solely provides or reinsures directors', trustees' and officers' liability insurance coverage or bankers' blanket bond group insurance coverage for insured depository institutions, and (4) acquiring or retaining the voting shares of a depository institution if certain requirements are met.
Washington State has enacted a law regarding financial institution parity. Primarily, the law affords Washington-chartered commercial banks the same powers as Washington-chartered savings banks. In order for a bank to exercise these powers, it must provide 30 days notice to the Director of the Washington Department of Financial Institutions and the Director must authorize the requested activity. In addition, the law provides that Washington-chartered commercial banks may exercise any of the powers that the Federal Reserve has determined to be closely related to the business of banking and the powers of national banks, subject to the approval of the Director in certain situations. The law also provides that Washington-chartered savings banks may exercise any of the powers of Washington-chartered commercial banks, national banks and federally-chartered savings banks, subject to the approval of the Director in certain situations. Finally, the law provides additional flexibility for Washington-chartered commercial and savings banks with respect to interest rates on loans and other extensions of credit. Specifically, they may charge the maximum interest rate allowable for loans and other extensions of credit by federally-chartered financial institutions to Washington residents.
Federal Reserve System: The Federal Reserve Board requires, under Regulation D, reserves on all depository institutions that maintain transaction accounts or nonpersonal time deposits. These reserves may be in the form of cash or non-interest-bearing deposits with the regional Federal Reserve Bank. NOW accounts and other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to Regulation D reserve requirements, as are any nonpersonal time deposits at a bank. Under Regulation D, for 2006, a bank was required to establish reserves equal to 3% of the first $48.3 million of transaction accounts, of which the first $8.5 million was exempt, and 10% of the remainder. Currently there is no reserve requirement on nonpersonal time deposits. As of December 31, 2006, Banner Bank met its reserve requirements.
Affiliate Transactions: Banner Corporation and Banner Bank are separate and distinct legal entities. Various legal limitations restrict Banner Bank from lending or otherwise supplying funds to us (an "affiliate"), generally limiting such transactions with the affiliate to 10% of Banner Bank's capital and surplus and limiting all such transactions to 20% of Banner Bank's capital and surplus. Such transactions, including extensions of credit, sales of securities or assets and provision of services, also must be on terms and conditions consistent with safe and sound banking practices, including credit standards that are substantially the same or at least as favorable to Banner Bank as those prevailing at the time for transactions with unaffiliated companies.
Federally insured banks are subject, with certain exceptions, to certain restrictions on extensions of credit to their parent holding companies or other affiliates, on investments in the stock or other securities of affiliates and on the taking of such stock or securities as collateral from any borrower. In addition, such banks are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or the providing of any property or service.
Community Reinvestment Act: Banner Bank is also subject to the provisions of the Community Reinvestment Act of 1977, which requires the appropriate federal bank regulatory agency to assess the bank's record in meeting the credit needs of the community serviced by the bank, including low and moderate income neighborhoods. The regulatory agency's assessment of the bank's record is made available to the public. Further, such assessment is required of any bank which has applied, among other things, to establish a new branch office that will accept deposits, relocate an existing office or merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution. Banner Bank received a "satisfactory" rating during its most recent examination.
Dividends: Dividends from Banner Bank constitute the major source of funds for dividends paid by us to our shareholders The amount of dividends payable by Banner Bank to us will depend upon Banner Bank's earnings and capital position, and is limited by federal and state laws, regulations and policies. Federal law further provides that no insured depository institution may make any capital distribution (which includes a cash dividend) if, after making the distribution, the institution would be "undercapitalized," as defined in the prompt corrective action regulations. Moreover, the federal bank regulatory agencies also have the general authority to limit the dividends paid by insured banks if such payments should be deemed to constitute an unsafe and unsound practice.
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Privacy Standards: On November 12, 1999, the Gramm-Leach-Bliley Financial Services Modernization Act of 1999 ("GLBA") was signed into law. The purpose of this legislation is to modernize the financial services industry by establishing a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers.
Banner Bank is subject to FDIC regulations implementing the privacy protection provisions of the GLBA. These regulations require Banner Bank to disclose its privacy policy, including identifying with whom it shares "non-public personal information," to customers at the time of establishing the customer relationship and annually thereafter.
The regulations also require Banner Bank to provide its customers with initial and annual notices that accurately reflect its privacy policies and practices. In addition, Banner Bank is required to provide its customers with the ability to "opt-out" of having Banner Bank share their non-public personal information with unaffiliated third parties before they can disclose such information, subject to certain exceptions.
Banner Bank is subject to regulatory guidelines establishing standards for safeguarding customer information. These regulations implement certain provisions of the GLBA. The guidelines describe the agencies' expectations for the creation, implementation and maintenance of an information security program, which would include administrative, technical and physical safeguards appropriate to the size and complexity of the institution and the nature and scope of its activities. The standards set forth in the guidelines are intended to insure the security and confidentiality of customer records and information, protect against any anticipated threats or hazards to the security or integrity of such records and protect against unauthorized access to or use of such records or information that could result in substantial harm or inconvenience to any customer.
Anti-Money Laundering and Customer Identification: In response to the terrorist events of September 11, 2001, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "USA Patriot Act") was signed into law on October 26, 2001. The USA Patriot Act gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing, and broadened anti-money laundering requirements. The Bank Secrecy Act, Title III of the USA Patriot Act, takes measures intended to encourage information sharing among bank regulatory agencies and law enforcement bodies. Further, certain provisions of Title III impose affirmative obligations on a broad range of financial institutions. Title III of the USA Patriot Act and the related FDIC regulations impose the following requirements with respect to financial institutions:
| * | establishment of anti-money laundering programs; |
| * | establishment of a program specifying procedures for obtaining identifying information from customers seeking to open new accounts, including verifying the identity of customers within a reasonable period of time; establishment of enhanced due diligence policies, procedures and controls designed to detect and report money laundering; and |
| * | prohibitions on correspondent accounts for foreign shell banks and compliance with record keeping obligations with respect to correspondent accounts of foreign banks. |
Bank regulators are directed to consider a holding company's effectiveness in combating money laundering when ruling on Federal Reserve Act and Bank Merger Act applications. Banner Bank's policies and procedures have been updated to reflect the requirements of the USA Patriot Act.
Banner Corporation
General: Banner Corporation, as sole shareholder of Banner Bank, is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to comprehensive regulation by the Federal Reserve under the Bank Holding Company Act of 1956, as amended (BHCA), and the regulations of the Federal Reserve. We are required to file quarterly reports with the Federal Reserve and such additional information as the Federal Reserve may require and is subject to regular examinations by the Federal Reserve. The Federal Reserve also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices.
The Bank Holding Company Act: Under the BHCA, we are supervised by the Federal Reserve. The Federal Reserve has a policy that a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, the Federal Reserve provides that bank holding companies should serve as a source of strength to its subsidiary banks by being prepared to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity, and should maintain the financial flexibility and capital raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligation to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve to be an unsafe and unsound banking practice or a violation of the Federal Reserve's regulations or both. We are required to file quarterly and periodic reports with the Federal Reserve and provide additional information as the Federal Reserve may require. The Federal Reserve may examine us, and any of our subsidiaries, and charge us for the cost of the examination. Banner Corporation and any subsidiaries that it may control are considered "affiliates" within the meaning of the Federal Reserve Act, and transactions between Banner Bank and affiliates are subject to numerous restrictions. With some exceptions, Banner Corporation, and its subsidiaries, are prohibited from tying the provision of various services, such as extensions of credit, to other services offered by Banner Corporation, or by its affiliates.
Acquisitions: The BHCA prohibits a bank holding company, with certain exceptions, from acquiring ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company and from engaging in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. Under the BHCA, the Federal Reserve may approve the ownership of shares by a bank holding company in any company, the activities of which the Federal Reserve has determined to be so closely related to the business of banking or managing or controlling banks as to be a proper incident thereto. These activities include: operating a savings institution, mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing certain investment and financial advice; underwriting and acting as an insurance agent for certain types of credit-related insurance;
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leasing property on a full-payout, non-operating basis; selling money orders, travelers' checks and U.S. Savings Bonds; real estate and personal property appraising; providing tax planning and preparation services; and, subject to certain limitations, providing securities brokerage services for customers.
Sarbanes-Oxley Act of 2002: The Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley Act) was signed into law on July 30, 2002 in response to public concerns regarding corporate accountability in connection with various 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 that file or are required to file periodic reports with the Securities and Exchange Commission (SEC), under the Securities Exchange Act of 1934 (Exchange Act).
The Sarbanes-Oxley 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 other 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. Our policies and procedures have been updated to comply with the requirements of the Sarbanes-Oxley Act.
Interstate Banking and Branching: The Federal Reserve must approve an application of a bank holding company to acquire control of, or acquire all or substantially all of the assets of, a bank located in a state other than the holding company's home state, without regard to whether the transaction is prohibited by the laws of any state. The Federal Reserve may not approve the acquisition of a bank that has not been in existence for the minimum time period (not exceeding five years) specified by the statutory law of the host state. Nor may the Federal Reserve approve an application if the applicant (and its depository institution affiliates) controls or would control more than 10% of the insured deposits in the United States or 30% or more of the deposits in the target bank's home state or in any state in which the target bank maintains a branch. Federal law does not affect the authority of states to limit the percentage of total insured deposits in the state which may be held or controlled by a bank holding company to the extent such limitation does not discriminate against out-of-state banks or bank holding companies. Individual states may also waive the 30% state-wide concentration limit contained in the federal law.
The federal banking agencies are authorized to approve interstate merger transactions without regard to whether the transaction is prohibited by the law of any state, unless the home state of one of the banks adopted a law prior to June 1, 1997 which applies equally to all out-of-state banks and expressly prohibits merger transactions involving out-of-state banks. Interstate acquisitions of branches will be permitted only if the law of the state in which the branch is located permits such acquisitions. Interstate mergers and branch acquisitions will also be subject to the nationwide and statewide insured deposit concentration amounts described above.
Dividends: The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses its view that although there are no specific regulations restricting dividend payments by bank holding companies other than state corporate laws, a bank 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.
Capital Requirements: The Federal Reserve has established capital adequacy guidelines for bank holding companies that generally parallel the capital requirements of the FDIC for Banner Bank, although the Federal Reserve regulations provide for the inclusion of certain trust preferred securities for up to 25% of Tier 1 capital in determining compliance with the guidelines. The Federal Reserve regulations provide that capital standards will be applied on a consolidated basis in the case of a bank holding company with $150 million or more in total consolidated assets. The guidelines require that a company's total risk-based capital must equal 8% of risk-weighted assets and one half of the 8% (4%) must consist of Tier 1 (core) capital. As of December 31, 2006, Banner Corporation's total risk-based capital was 11.80% of risk-weighted assets and its Tier 1 (core) capital was 9.53% of risk-weighted assets.
Stock Repurchases: A bank holding company, except for certain "well-capitalized" and highly rated bank holding companies, 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.. For information concerning our repurchase activities during the 2006 fiscal year and for the quarter ended December 31, 2006, see Item 5.
Executive Officers
The following table sets forth information with respect to the executive officers of Banner Corporation and Banner Bank as of December 31, 2006.
Name |
Age |
Position with Banner Corporation |
Position with Banner Bank |
|
|
|
|
|
|
D. Michael Jones |
64 |
President, Chief Executive Officer, |
President, Chief Executive Officer, |
|
|
|
Director |
Director |
|
|
|
|
|
|
Lloyd W. Baker |
58 |
Executive Vice President, |
Executive Vice President, |
|
|
|
Chief Financial Officer |
Chief Financial Officer |
|
|
|
|
|
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|
Michael K. Larsen |
64 |
|
President, |
|
|
|
|
Mortgage Division |
|
|
|
|
|
|
Cynthia D. Purcell |
49 |
|
Executive Vice President, |
|
|
|
|
Bank Operations |
|
|
|
|
|
|
Richard B. Barton |
63 |
|
Executive Vice President, |
|
|
|
|
Chief Credit Officer |
|
|
|
|
|
|
Paul E. Folz |
52 |
|
Executive Vice President, |
|
|
|
|
Community Banking |
|
|
|
|
|
|
John R. Neill |
58 |
|
Executive Vice President, |
|
|
|
|
Corporate Lending |
|
|
|
|
|
|
Douglas M. Bennett |
54 |
|
Executive Vice President, |
|
|
|
|
Real Estate Lending Operations |
|
|
|
|
|
|
Tyrone J. Bliss |
49 |
|
Executive Vice President, |
|
|
|
|
Risk Management and Compliance Officer |
Biographical Information
Set forth below is certain information regarding the executive officers of Banner Corporation and Banner Bank. There are no family relationships among or between the directors or executive officers.
D. Michael Jones joined Banner Bank in 2002 following an extensive career in banking, finance and accounting. Mr. Jones served as President and Chief Executive Officer from 1996 to 2001 for Source Capital Corporation, a lending company in Spokane, Washington. From 1987 to 1995, Mr. Jones served as President of West One Bancorp, a large regional banking franchise based in Boise, Idaho.
Lloyd W. Baker joined First Savings Bank of Washington (now Banner Bank) in 1995 as Asset/Liability Manager and has served as its Chief Financial Officer since 2000. His banking career began in 1972.
Michael K. Larsen joined First Savings Bank of Washington (now Banner Bank) in 1981 and has been Banner Bank's senior real estate lending officer since 1982.
Cynthia D. Purcell was formerly the Chief Financial Officer of Inland Empire Bank (now Banner Bank), which she joined in 1981, and has served in her current position since 2000.
Richard B. Barton joined Banner Bank in 2002. Mr. Barton's banking career began in 1972 with Seafirst Bank and Bank of America, where he served in a variety of commercial lending and credit risk management positions. In his last positions at Bank of America before joining Banner Bank, he served as the senior real estate risk management executive for the Pacific Northwest and as the credit risk management executive for the west coast home builder divisions.
Paul E. Folz joined Banner Bank in 2002. Mr. Folz, who has 28 years of commercial lending experience, served in his last position before joining Banner Bank as Washington Mutual's Senior Vice President for new market planning and development for the commercial banking division, where he spearheaded the expansion of business banking into new markets. Prior to that position, he served from 1989 as Washington Mutual's Senior Vice President in charge of commercial banking operations in the State of Oregon.
John R. Neill joined Banner Bank in 2002. Mr. Neill, who has over 27 years of commercial banking and community development experience, began his banking career with Seafirst Bank in 1975. From 1995 until he joined Banner Bank, he served as Senior Vice President and Senior Client Manager for Bank of America's central Washington commercial banking division.
Douglas M. Bennett, who joined Banner Bank in 1974, has over 31 years of experience in real estate lending. He has served as a member of Banner Bank's executive management committee since 2004.
Tyrone J. Bliss joined Banner Bank in 2002. Mr. Bliss is a Certified Regulatory Compliance Manager with more than 28 years of commercial banking experience. Prior to joining Banner Bank, his career included senior risk management and compliance positions with Bank of America's Consumer Finance Group, Barnett Banks, Inc., and Florida-based community banks.
Our principal executive offices are located at 10 South First Avenue, Walla Walla, Washington 99362. Our telephone number is (509) 527-3636. We maintain a website with the address www.bannerbank.com. The information contained on our 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, we make available free of charge through our website our 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 we have electronically filed such material with, or furnished such material to, the Securities and Exchange Commission.
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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. This report is qualified in its entirety by these risk factors.
The Maturity and Repricing Characteristics of Our Assets and Liabilities are Mismatched and Subject Us to Interest Rate Risk Which Could Adversely Affect Our Net Earnings and Economic Value.
Our financial condition and operations are influenced significantly by general economic conditions, including the absolute level of interest rates as well as changes in interest rates and the slope of the yield curve. Our profitability is dependent to a large extent on our net interest income, which is the difference between the interest received from our interest-earning assets and the interest expense incurred on our interest-bearing liabilities. Significant changes in market interest rates or errors or misjudgments in our interest rate risk management procedures could have a material adverse effect on our net earnings and economic value.
Our activities, like all financial institutions, inherently involve the assumption of interest rate risk. Interest rate risk is the risk that changes in market interest rates will have an adverse impact on our earnings and underlying economic value. Interest rate risk is determined by the maturity and repricing characteristics of our assets, liabilities and off-balance-sheet contracts. Interest rate risk is measured by the variability of financial performance and economic value resulting from changes in interest rates. The Company's interest rate risk is the primary market risk affecting financial performance.
The greatest source of interest rate risk to us results from the mismatch of maturities or repricing intervals for our rate sensitive assets, liabilities and off-balance-sheet contracts. This mismatch or gap is generally characterized by a substantially shorter maturity structure for interest-bearing liabilities than interest-earning assets. Additional interest rate risk results from mismatched repricing indices and formulae (basis risk and yield curve risk), and product caps and floors and early repayment or withdrawal provisions (option risk), which may be contractual or market driven, that are generally more favorable to customers than to us.
Our primary monitoring tool for assessing interest rate risk is asset/liability simulation modeling, which is designed to capture the dynamics of balance sheet, interest rate and spread movements and to quantify variations in net interest income and net market value of equity resulting from those movements under different rate environments. We update and prepare our simulation modeling at least quarterly for review by senior management and the directors. We believe the data and assumptions are realistic representations of our portfolio and possible outcomes under the various interest rate scenarios. Nonetheless, the interest rate sensitivity of our net interest income and net market value of our equity could vary substantially if different assumptions were used or if actual experience differs from the assumptions used and, as a result, our interest rate risk management strategies may prove to be inadequate.
See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Market Risk and Asset/Liability Management" for additional information concerning interest rate risk.
Our Loan Portfolio Includes Loans with a Higher Risk of Loss.
We originate construction and land loans, commercial and multifamily mortgage loans, commercial loans, consumer loans, agricultural mortgage loans and agricultural loans as well as residential mortgage loans primarily within our market areas. Generally, the types of loans other than the residential mortgage loans have a higher risk of loss than the residential mortgage loans. We had approximately $2.6 billion outstanding in these types of higher risk loans at December 31, 2006, which is a significant increase since December 31, 2005. These loans have greater credit risk than residential real estate for the following reasons and the reasons discussed under Item 1, "Business-Lending Activities":
| * | Construction and Land Loans.This type of lending contains the inherent difficulty in estimating both a property's value at completion of the project and the estimated cost (including interest) of the project. If the estimate of construction cost proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value upon completion proves to be inaccurate, we may be confronted at, or prior to, the maturity of the loan with a project the value of which is insufficient to assure full repayment. 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 to us than construction loans to individuals on their personal residences. Loans on land under development or held for future construction also poses additional risk because of the lack of income being produced by the property and the potential illiquid nature of the security. During the years ended December 31, 2006 and 2005, we significantly increased our origination of construction loans. |
| * | Commercial and Multifamily Mortgage Loans. These loans typically involve higher principal amounts than other types of loans, and repayment is dependent upon income being generated from the property securing the loan in amounts sufficient to cover operating expenses and debt service. Commercial and multifamily mortgage loans may expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans may not be sold as easily as residential real estate. |
| * | Commercial Business Loans. 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 |
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| may fluctuate in value. Most often, this collateral is accounts receivable, inventory, equipment or real estate. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. Other collateral securing loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. | |
| * | Agricultural Loans. Repayment is dependent upon the successful operation of the business, which is greatly dependent on many things outside the control of either us or the borrowers. These factors include weather, commodity prices, and interest rates among others. Collateral securing these loans may be difficult to evaluate, manage or liquidate and may not provide an adequate source of repayment. |
| * | Consumer Loans. Consumer loans (such as personal lines of credit) are collateralized, if at all, with assets that may not provide an adequate source of payment of the loan due to depreciation, damage, or loss. |
For additional information, see Item I, "Business-Lending" and Item 7, "Management's Discussion of Financial Condition and Results of Operations-Asset Quality."
If Our Allowance for Loan Losses Is Not Sufficient to Cover Actual Loan Losses, Our Earnings Could Decrease.
We make various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of or 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. If our assumptions 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. Material additions to the allowance could materially decrease our net income.
In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities may have a material adverse effect on our financial condition and results of operations.
We May Be Unable To Successfully Integrate F&M Bank's and San Juan Financial Holding Company's Operations and Retain Their Employees and Customers.
Our pending acquisitions of F&M Bank and San Juan Financial Holding Company involve the integration of three companies that have previously operated independently. The difficulties of combining the operations of the three companies include: integrating personnel with different business backgrounds; combining different corporate cultures; and retaining key employees. The process of integrating operations could cause an interruption of, or loss of momentum in, the activities of the business and the loss of customers and key personnel. The integration of the three companies will require the experience and expertise of certain key employees of both F&M Bank and San Juan Financial Holding Company whom we expect to retain. We may not be successful in retaining these employees for the time period necessary to successfully integrate their operations into ours. The diversion of management's attention and any delays or difficulties encountered in connection with the mergers and the integration of the three companies' operations could have an adverse effect on our business and results of operations following the acquisitions.
There Is No Assurance That the Change in the Mix of Our Assets and Liabilities Will Improve Our Operating Results.
In addition to lending and deposit gathering activities, we previously emphasized investments in government agency and mortgage-backed securities, funded with wholesale borrowings. This policy was designed to enhance profitability by allowing asset growth with low overhead expense, although securities generally have lower yields than loans, resulting in a lower interest rate spread and lower interest income. In recent years, we have pursued a strategy to change the mix of our assets and liabilities to have proportionately more loans and fewer securities and more customer deposits, particularly transaction and savings deposits, and fewer borrowings. Our implementation of this strategy has included significant loan and deposit growth and was accelerated by a series of balance-sheet restructuring transactions which we executed in the fourth quarter of 2005. While the objective of this strategy, including the balance-sheet restructuring, is to improve our net interest income and net income in future periods through an enhanced net interest margin, there is no assurance that this strategy will succeed. See Item 7, "Management Discussion and Analysis of Financial Condition and Results of Operations," for additional information concerning implementation of this strategy.
If We Are Not Able to Achieve Profitability on New Branches it May Negatively Affect Our Earnings.
We have expanded our presence throughout the market area, and intend to pursue further expansion by opening additional new branches. The profitability of our expansion strategy will depend on whether the income that we generate from the new branches will offset the increased expenses resulting from operating these branches. Largely as a result of this de novo branching strategy, our operating expenses have increased significantly, adversely affecting our operating efficiency. As a result, the efficiency ratio, which is the ratio of non-interest expense to net interest income and other income, is higher than many of our competitor institutions. We expect that it may take a period of time before certain of these branches can become profitable, especially in areas in which we do not have an established presence. During this period, the expense of operating these branches may negatively affect our net income.
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Our Wholesale Funding Source May Prove Insufficient To Replace Deposits and Support Our Future Growth.
We must maintain sufficient funds to respond to the needs of depositors and borrowers. As a part of our liquidity management, we use a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. As we continue to grow, we may become more dependent on these sources, which include brokered certificates of deposit, repurchase agreements, federal funds purchased and Federal Home Loan Bank advances. Adverse operating results or changes in industry conditions could lead to an inability to replace these additional funding sources at maturity. 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. 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. In this case, our operating margins and profitability would be adversely affected.
Our Growth May Require Us To Raise Additional Capital In the Future, But That Capital May Not Be Available When It Is Needed.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate that our existing capital resources will satisfy our capital requirements for the foreseeable future. We may at some point need to raise additional capital to support continued growth, both internally and through acquisitions.
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 performance. Accordingly, we cannot assure you of our ability to raise additional capital if needed or on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired.
Our Profitability Depends Significantly on Economic Conditions in the States of Washington, Oregon and Idaho.
Our success depends primarily on the general economic conditions of the States of Washington, Oregon and Idaho and the specific local markets in which we operate. Unlike larger national or other regional banks that are more geographically diversified, we provide banking and financial services to customers located primarily in 27 counties of Washington, Oregon and Idaho. The local economic conditions in our market areas have a significant impact on the demand for our products and services as well as the ability of our customers to repay loans, the value of the collateral securing loans and the stability of our deposit funding sources. Adverse economic conditions unique to these Northwest markets could have a material adverse effect on our financial condition and results of operations. Further, a significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences, unemployment, changes in securities markets or other factors could impact these state and local markets and, in turn, also have a material adverse effect on our financial condition and results of operations.
Strong Competition Within Our Market Area May Limit Our Growth and Profitability.
Competition in the banking and financial services industry is intense. We compete in our market areas with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Some of these competitors have substantially greater resources and lending limits than we do, have greater name recognition and market presence that benefit them in attracting business, and offer certain services that we do not or cannot provide. In addition, larger competitors may be able to price loans and deposits more aggressively than we do. Our profitability depends upon our continued ability to successfully compete in our market areas. The greater resources and deposit and loan products offered by some of our competitors may limit our ability to increase our interest-earning assets. For additional information see Item 1, "Business-Competition."
The Loss of Key Members of Our Senior Management Team Could Adversely Affect Our Business.
We believe that our success depends largely on the efforts and abilities of our senior management. Their experience and industry contacts significantly benefit us. The competition for qualified personnel in the financial services industry is intense, and the loss of any of our key personnel or an inability to continue to attract, retain and motivate key personnel could adversely affect our business.
We Are Subject to Extensive Government Regulation and Supervision.
We are subject to extensive federal and state regulation and supervision, primarily through Banner Bank and certain non-bank subsidiaries. Banking regulations are primarily intended to protect depositors' funds, federal deposit insurance funds and the banking system as a whole, not shareholders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur. See Item 1, "Business-Regulation."
19
<PAGE>
The Level Of Our Commercial Real Estate Loan Portfolio May Subject Us To Additional Regulatory Scrutiny.
The FDIC, the Federal Reserve and the Office of the Comptroller of the Currency, have recently promulgated joint guidance on sound risk management practices for financial institutions with concentrations in commercial real estate lending. Under the guidance, a financial institution actively involved in commercial real estate lending should perform a risk assessment to identify concentrations. A financial institution may have a concentration in commercial real estate lending if, among other factors, (i) total reported loans for construction, land development, and other land represent 100% or more of total capital or (ii) total reported loans secured by multifamily and non-farm residential properties, loans for construction, land development and other land and loans otherwise sensitive to the general commercial real estate market, including loans to commercial real estate related entities, represent 300% or more of total capital. Management should also employ heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing. While we believe we have implemented policies and procedures with respect to our commercial real estate loan portfolio consistent with the guidance, bank regulators could require us to implement additional policies and procedures consistent with their interpretation of the guidance which could result in additional costs to us.
Our Information Systems May Experience an Interruption or Breach in Security.
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 Rely on Dividends From Subsidiaries For Most of Our Revenue.
Banner Corporation is a separate and distinct legal entity from its subsidiaries. We receive substantially all of our revenue from dividends from our subsidiaries. These dividends are the principal source of funds to pay dividends on our common stock and interest and principal on our debt. Various federal and/or state laws and regulations limit the amount of dividends that Banner Bank and certain non-bank subsidiaries may pay to Banner Corporation. Also, our right to participate in a distribution of assets upon a subsidiary's liquidation or reorganization is subject to the prior claims of the subsidiary's creditors. In the event Banner Bank is unable to pay dividends to Banner Corporation, we may not be able to service debt, pay obligations or pay dividends on Banner Corporation's common stock. The inability to receive dividends from Banner Bank could have a material adverse effect on our business, financial condition and results of operations. See Item 1, "Business-Regulation."
If We Fail to Maintain an Effective System of Internal Control over Financial Reporting, We May Not Be Able to Accurately Report Our Financial Results or Prevent Fraud, and, as a Result, Investors and Depositors Could Lose Confidence in Our Financial Reporting, Which Could Adversely Affect Our Business, the Trading Price of Our Stock and Our Ability to Attract Additional Deposits.
In connection with the enactment of the Sarbanes-Oxley Act of 2002 ("Act") and the implementation of the rules and regulations promulgated by the SEC, we document and evaluate our internal control over financial reporting in order to satisfy the requirements of Section 404 of the Act. This requires us to prepare an annual management report on our internal control over financial reporting, including among other matters, management's assessment of the effectiveness of internal control over financial reporting and an attestation report by our independent auditors addressing these assessments. If we fail to identify and correct any significant deficiencies in the design or operating effectiveness of our internal control over financial reporting or fail to prevent fraud, current and potential shareholders and depositors could lose confidence in our internal controls and financial reporting, which could adversely affect our business, financial condition and results of operations, the trading price of our stock and our ability to attract additional deposits.
Item 1B - Unresolved Staff Comments
None.
Our home office, which is owned by us, is located in Walla Walla, Washington. Banner Bank has, in total, 62 branch offices located in Washington, Oregon and Idaho. These offices are located in the cities of Walla Walla (4), Kennewick (2), Richland, Pasco, Clarkston, Sunnyside, Yakima (4), Selah, Wenatchee, East Wenatchee, Dayton, Bellingham, Ferndale, Lynden, Blaine, Point Roberts, Burlington, Spokane (2), Vancouver, Woodinville, Bothell, Everett (2), Kirkland, Bellevue, Redmond, Renton, Federal Way, Kent, Edmonds, Lynnwood, Mercer Island and Seattle (2), Washington; Hermiston, Pendleton (2), Umatilla, Boardman, Stanfield, Lake Oswego, Beaverton, Hillsboro and Portland, Oregon; and Lewiston (2), Twin Falls (2) and Boise (2), Idaho. Of these offices, 30 are owned by us and 32 are leased. The leases expire from 2007 through 2022. In addition to these branch offices, we maintain various other leased premises for lending offices, administrative offices and one investment office. There are eleven leased locations for lending offices located in Bellevue, Bellingham, Kennewick, Moses Lake, Oak Harbor, Puyallup, Seattle and Spokane (2), Washington; Boise, Idaho and Lake Oswego, Oregon. We lease seven administrative offices located in Walla Walla, Bellingham, Bothell and Vancouver, Washington, Hermiston, Oregon and Boise, Idaho. Additionally, there is one leased premise in Walla Walla, Washington for an investment office. CFC, located in Lake Oswego, Oregon, leases space to operate its two loan production offices in Lake Oswego, Oregon
20
<PAGE>
and Vancouver, Washington. These leases expire from 2007 through 2022. Our net investment in our offices, premises, equipment, software and leaseholds was $58.0 million at December 31, 2006.
In the normal course of business, we have various legal proceedings and other contingent matters outstanding. These proceedings and the associated legal claims are often contested and the outcome of individual matters is not always predictable. These claims and counter-claims typically arise during the course of collection efforts on problem loans or with respect to action to enforce liens on properties in which we hold a security interest. We are not a party to any pending legal proceedings that they believe would have a material adverse effect on our financial condition or operations.
There have not been any Internal Revenue Service audits of our federal income tax returns during the past five years. We have not been required to pay any IRS penalties for failing to make disclosures with respect to certain transactions that have been identified by the IRS as abusive or that have a significant tax avoidance purpose.
Item 4 - Submission of Matters to a Vote of Security Holders
None.
21
<PAGE>
PART II
Stock Listing
Our common stock is traded on the Nasdaq Global Select Market under the symbol "BANR" and newspaper stock tables list us as "Banner Corp." Stockholders of record at December 31, 2006 totaled 926 based upon securities position listings furnished to us by our transfer agent. This total does not reflect the number of persons or entities who hold stock in nominee or "street" name through various brokerage firms. The following tables show the reported high and low closing sale prices of our common stock for the years ended December 31, 2006, 2005 and 2004.
Year Ended December 31, 2006 |
|
|
High |
|
|
Low |
|
|
Cash Dividend Declared |
|
|
First quarter |
$ |
35.16 |
$ |
31.05 |
$ |
0.18 |
|||||
|
Second quarter |
|
|
39.62 |
|
|
33.50 |
|
|
0.18 |
|
|
|
Third quarter |
|
|
41.80 |
|
|
37.59 |
|
|
0.18 |
|
|
|
Fourth quarter |
|
|
46.63 |
|
|
39.58 |
|
|
0.19 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
High |
|
|
Low |
|
|
Cash Dividend Declared |
|
|
||
|
First quarter |
$ |
30.44 |
$ |
26.58 |
$ |
0.17 |
|||||
|
Second quarter |
|
|
28.39 |
|
|
24.86 |
|
|
0.17 |
|
|
|
Third quarter |
|
|
30.99 |
|
|
26.15 |
|
|
0.17 |
|
|
|
Fourth quarter |
|
|
32.63 |
|
|
26.09 |
|
|
0.18 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
High |
|
|
Low |
|
|
Cash Dividend Declared |
|
|
||
|
First quarter |
|
$ |
29.29 |
|
$ |
24.80 |
|
$ |
0.16 |
|
|
|
Second quarter |
|
|
30.89 |
|
|
25.60 |
|
|
0.16 |
|
|
|
Third quarter |
|
|
31.16 |
|
|
26.08 |
|
|
0.16 |
|
|
|
Fourth quarter |
|
|
34.25 |
|
|
27.73 |
|
|
0.17 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends
Dividend payments by us depend primarily on dividends we receive from Banner Bank. Under federal regulations, the dollar amount of dividends Banner Bank may pay depends upon its capital position and recent net income. Generally, if Banner Bank satisfies its regulatory capital requirements, it may make dividend payments up to the limits prescribed under state law and FDIC regulations. However, an institution that has converted to a stock form of ownership may not declare or pay a dividend on, or repurchase any of, its common stock if the effect thereof would cause the regulatory capital of the institution to be reduced below the amount required for the liquidation account which was established in connection with the conversion. Under Washington law, we are prohibited from paying a dividend if, as a result of its payment, we would be unable to pay its debts as they become due in the normal course of business, or if our total liabilities would exceed our total assets.
Payments of the distributions on our trust preferred securities from the special purpose subsidiary trusts we sponsored are fully and unconditionally guaranteed by us. The junior subordinated debentures that we have issued to our subsidiary trusts are senior to our shares of common stock. As a result, we must make required payments on the junior subordinated debentures before any dividends can be paid on our common stock and, in the event of our bankruptcy, dissolution or liquidation, the interest and principal obligations under the junior subordinated debentures must be satisfied before any distributions can be made on our common stock. We may defer the payment of interest on each of the junior subordinated 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 we may not pay cash dividends to the holders of shares of our common stock.
22
<PAGE>
Issuer Purchases of Equity Securities
The following table sets forth information for the three months ended December 31, 2006 with respect to repurchases of our outstanding common shares:
Period |
Total Number of Shares Purchased (1) |
Average Price Paid per Share |
Total Number of Shares Purchased as Part of Publicly Announced Plan |
Maximum Number of Shares that May Yet be Purchased Under the Plan |
|||||||||||
Beginning |
Ending |
|
|
|
|
|
|
||||||||
|
October 1, 2006 |
October 31, 2006 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
|
|
|
|
November 1, 2006 |
November 30, 2006 |
|
|
2,000 |
|
|
45.995 |
|
|
-- |
|
|
|
|
|
December 1, 2006 |
December 31, 2006 |
|
|
220 |
|
|
43.390 |
|
|
-- |
|
|
|
|
|
Total |
|
|
|
2,200 |
|
$ |
45.737 |
|
|
-- |
|
|
100,000 |
(2) |
|
(1) Shares indicated as purchased during the periods presented were acquired at current market values as consideration for the exercise of certain fully vested options.
(2) On July 26, 2006, our Board of Directors authorized the repurchase of up to 100,000 shares of our outstanding common stock over the next twelve months. As of December 31, 2006, no shares had been repurchased under this program.
Equity Compensation Plan Information
The equity compensation plan information presented under Part III, Item 12 of this report is incorporated herein by reference.
Performance Graph. The following graph compares the cumulative total shareholder return on the Common Stock with the cumulative total return on the Nasdaq (U.S. Stock) Index, a peer group of the SNL $1 Billion to $5 Billion Asset Bank Index and a peer group of the SNL Nasdaq Bank Index. Total return assumes the reinvestment of all dividends.
| |
Period Ending |
|||||
|
Index |
12/31/01 |
12/31/02 |
12/31/03 |
12/31/04 |
12/31/05 |
12/31/06 |
|
Banner Corporation |
100.00 |
114.06 |
157.81 |
200.02 |
205.08 |
296.84 |
|
NASDAQ Composite |
100.00 |
68.76 |
103.67 |
113.16 |
115.57 |
127.58 |
|
SNL $1B-$5B Bank Index |
100.00 |
115.44 |
156.98 |
193.74 |
190.43 |
220.36 |
|
SNL NASDAQ Bank Index |
100.00 |
102.85 |
132.76 |
152.16 |
147.52 |
165.62 |
*Assumes $100 invested in the Common Stock at the closing price per share and each index on December 31, 2001 and that all dividends were reinvested. Information for the graph was provided by SNL Financial L. C. © 2007.
23
<PAGE>
Item 6 - Selected Consolidated Financial and Other Data
The following condensed consolidated statements of operations and financial condition and selected performance ratios as of December 31, 2006, 2005, 2004, 2003, and 2002 and for the years then ended have been derived from our audited consolidated financial statements. The information below is qualified in its entirety by the detailed information included elsewhere herein and should be read along with "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Item 8. Financial Statement and Supplementary Data."
FINANCIAL CONDITION DATA: |
|||||||||||||||
|
At December 31 |
||||||||||||||
(Dollars in thousands) |
|
2006 |
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
2002 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
$ |
3,495,566 |
|
$ |
3,040,555 |
|
$ |
2,897,067 |
|
$ |
2,635,313 |
|
$ |
2,263,172 |
|
|
Loans receivable, net |
|
2,930,455 |
|
|
2,408,833 |
|
|
2,063,238 |
|
|
1,700,865 |
|
|
1,546,927 |
|
|
Cash and securities (1) |
|
347,410 |
|
|
427,681 |
|
|
649,516 |
|
|
779,472 |
|
|
567,385 |
|
|
Deposits |
|
2,794,592 |
|
|
2,323,313 |
|
|
1,925,909 |
|
|
1,670,940 |
|
|
1,497,778 |
|
|
Borrowings |
|
404,330 |
|
|
459,821 |
|
|
723,842 |
|
|
738,699 |
|
|
546,945 |
|
|
Stockholders' equity |
|
250,227 |
|
|
221,665 |
|
|
215,220 |
|
|
202,800 |
|
|
190,377 |
|
|
Shares outstanding excluding unearned, restricted shares held in ESOP |
|
12,074 |
|
|
11,782 |
|
|
11,482 |
|
|
11,039 |
|
|
10,791 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OPERATING DATA: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31 |
||||||||||||||
(In thousands) |
|
2006 |
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
2002 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income |
$ |
243,019 |
|
$ |
190,160 |
|
$ |
156,230 |
|
$ |
140,441 |
|
$ |
144,276 |
|
Interest expense |
|
116,114 |
|
|
81,377 |
|
|
59,915 |
|
|
59,848 |
|
|
65,969 |
|
| Net interest income |
|
126,905 |
|
|
108,783 |
|
|
96,315 |
|
|
80,593 |
|
|
78,307 |
|
Provision for loan losses |
|
5,500 |
|
|
4,903 |
|
|
5,644 |
|
|
7,300 |
|
|
21,000 |
|
| Net interest income after provision for loan losses |
|
121,405 |
|
|
103,880 |
|
|
90,671 |
|
|
73,293 |
|
|
57,307 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage banking operations |
|
5,824 |
|
|
5,647 |
|
|
5,522 |
|
|
9,447 |
|
|
6,695 |
|
|
Gain (loss) on sale of securities |
|
65 |
|
|
(7,302 |
) |
|
141 |
|
|
63 |
|
|
27 |
|
|
Other operating income |
|
14,686 |
|
|
12,199 |
|
|
11,305 |
|
|
10,071 |
|
|
9,155 |
|
|
Insurance recovery, net proceeds |
|
(5,350 |
) |
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
FHLB prepayment penalties |
|
-- |
|
|
6,077 |
|
|
-- |
|
|
-- |
|
|
-- |
|
Other operating expenses |
|
99,731 |
|
|
91,471 |
|
|
79,714 |
|
|
69,876 |
|
|
60,445 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Income before provision for income taxes |
|
47,599 |
|
|
16,876 |
|
|
27,925 |
|
|
22,998 |
|
|
12,739 |
|
Provision for income taxes |
|
15,436 |
|
|
4,432 |
|
|
8,585 |
|
|
6,891 |
|
|
3,479 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
$ |
32,163 |
|
$ |
12,444 |
|
$ |
19,340 |
|
$ |
16,107 |
|
$ |
9,260 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
PER SHARE DATA: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At or for the Years Ended December 31 |
||||||||||||||
|
|
2006 |
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
2002 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
$ |
2.70 |
|
$ |
1.08 |
|
$ |
1.74 |
|
$ |
1.49 |
|
$ |
0.85 |
|
|
Diluted |
|
2.63 |
|
|
1.04 |
|
|
1.65 |
|
|
1.44 |
|
|
0.82 |
|
|
Stockholders' equity (2) |
|
20.72 |
|
|
18.81 |
|
|
18.74 |
|
|
18.37 |
|
|
17.64 |
|
|
Cash dividends |
|
0.73 |
|
|
0.69 |
|
|
0.65 |
|
|
0.61 |
|
|
0.60 |
|
|
Dividend payout ratio (basic) |
|
27.04 |
% |
|
63.89 |
% |
|
37.36 |
% |
|
40.94 |
% |
|
70.59 |
% |
|
Dividend payout ratio (diluted) |
|
27.76 |
% |
|
66.35 |
% |
|
39.39 |
% |
|
42.36 |
% |
|
73.17 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(footnotes follow tables) |
|||||||||||||||
24
<PAGE>
KEY FINANCIAL RATIOS:
|
At or For the Years Ended December 31 |
||||||||||||||
|
|
2006 |
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
2002 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Performance Ratios: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Return on average assets (3) |
|
0.97 |
% |
|
0.41 |
% |
|
0.70 |
% |
|
0.66 |
% |
|
0.43 |
% |
|
Return on average equity (4) |
|
13.54 |
|
|
5.62 |
|
|
9.22 |
|
|
8.21 |
|
|
4.71 |
|
|
Average equity to average assets |
|
7.20 |
|
|
7.26 |
|
|
7.62 |
|
|
8.03 |
|
|
9.13 |
|
|
Interest rate spread (5) |
|
3.97 |
|
|
3.72 |
|
|
3.65 |
|
|
3.47 |
|
|
3.80 |
|
|
Net interest margin (6) |
|
4.08 |
|
|
3.79 |
|
|
3.71 |
|
|
3.53 |
|
|
3.91 |
|
|
Non-interest income to average assets |
|
0.62 |
|
|
0.35 |
|
|
0.62 |
|
|
0.80 |
|
|
0.74 |
|
|
Non-interest expense to average assets |
|
2.86 |
|
|
3.20 |
|
|
2.90 |
|
|
2.86 |
|
|
2.81 |
|
|
Efficiency ratio (7) |
|
64.00 |
|
|
81.75 |
|
|
70.37 |
|
|
69.75 |
|
|
64.18 |
|
Average interest-earning assets to interest- |
|
102.81 |
|
|
102.66 |
|
|
102.92 |
|
|
102.31 |
|
|
103.14 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset Quality Ratios: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for loan losses as a percent of |
|
1.20 |
|
|
1.27 |
|
|
1.41 |
|
|
1.51 |
|
|
1.69 |
|
|
Net charge-offs as a percent of average |
|
0.03 |
|
|
0.16 |
|
|
0.11 |
|
|
0.47 |
|
|
0.78 |
|
|
Non-performing assets as a percent of total assets |
|
0.43 |
|
|
0.36 |
|
|
1.20 |
|
|
1.20 |
|
|
1.86 |
|
Ratio of allowance for loan losses to |
|
2.53 |
|
|
2.96 |
|
|
1.86 |
|
|
0.92 |
|
|
0.74 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated Capital Ratios: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total capital to risk-weighted assets |
|
11.80 |
|
|
12.29 |
|
|
12.24 |
|
|
12.77 |
|
|
12.96 |
|
|
Tier 1 capital to risk-weighted assets |
|
9.53 |
|
|
10.17 |
|
|
10.94 |
|
|
11.48 |
|
|
11.66 |
|
|
Tier 1 leverage capital to average assets |
|
8.76 |
|
|
8.59 |
|
|
8.93 |
|
|
8.73 |
|
|
8.77 |
|
| (1) | Includes securities available for sale and held to maturity. |
| (2) | Calculated using shares outstanding excluding unearned restricted shares held in ESOP. |
| (3) | Net income divided by average assets |
| (4) | Net income divided by average equity |
| (5) | Difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. |
| (6) | Net interest income before provision for loan losses as a percent of average interest-earning assets. |
| (7) | Other operating expenses divided by the total of net interest income before loan losses and other operating income (non-interest income). |
| (8) | Non-performing loans consist of nonaccrual and 90 days past due loans. |
25
<PAGE>
Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations
We are a bank holding company incorporated in the State of Washington. We are primarily engaged in the business of planning, directing and coordinating the business activities of our wholly owned subsidiary, Banner Bank. Banner Bank is a Washington-chartered commercial bank that conducts business from its main office in Walla Walla, Washington and its 62 branch offices and 12 loan production offices located in 27 counties in Washington, Oregon and Idaho. We are subject to regulation by the Board of Governors of the Federal Reserve System, and Banner Bank is subject to regulation by the State of Washington Department of Financial Institutions, Division of Banks and the Federal Deposit Insurance Corporation. As of December 31, 2006 we had total consolidated assets of $3.5 billion, total deposits of $2.8 billion and total stockholders' equity of $250 million.
Over the past three years, we have invested significantly in expanding our branch and distributions systems with a primary emphasis on expanding our presence in the four largest areas of commerce in the Northwest: the Puget Sound region of Washington; and the greater Boise, Idaho; Portland, Oregon; and Spokane, Washington markets. From March 2004 through December 2006, we have opened 16 new branch offices, relocated five additional branch offices and significantly refurbished our main office in Walla Walla. This expansion has continued with the opening of four new branches so far in 2007; one in Boise, Idaho and one each in Portland, La Grande and Baker City, Oregon. This branch expansion is a significant element in our strategy to grow loans, deposits and customer relationships. This emphasis on growth has resulted in an elevated level of operating expenses; however, management believes that over time these new branches should help improve profitability by providing lower cost core deposits which will allow us to proportionately reduce higher cost borrowings as a source of funds. We are committed to continuing this branch expansion strategy for the next two to three years and have plans and projects in process for six additional new offices expected to open in the next 12 months and are exploring other opportunities. In addition to organic branch expansion, we recently signed definitive merger agreements for the acquisition of F&M Bank, a 13 branch commercial bank in the Spokane, Washington market and with San Juan Financial Holding Company, the parent company of Islanders Bank, a three branch commercial bank in the north Puget Sound region. Both acquisitions increase our presence within desirable marketplaces and allow us to better serve existing and future customers.
Our operating results depend primarily on our net interest income, which is the difference between interest income on interest-earning assets, consisting of loans and investment securities, and interest expense on interest-bearing liabilities, composed primarily of customer deposits, FHLB advances, other borrowings and junior subordinated debentures. Net interest income is primarily a function of our interest rate spread, which is the difference between the yield earned on interest-earning assets and the rate paid on interest-bearing liabilities, as well as a function of the average balances of interest-earning assets and interest-bearing liabilities. As more fully explained below, our net interest income before provision for loan losses increased $18.1 million for the year ended December 31, 2006, compared to the prior year, primarily as a result of strong growth in interest-earning assets and interest-bearing liabilities and changes in the mix of both interest-earning assets and interest-bearing liabilities, including the effects of certain balance-sheet restructuring transactions completed in the quarter ended December 31, 2005.
Our net income also is affected by provisions for loan losses and the level of our other income, including deposit service charges, loan origination and servicing fees, and gains and losses on the sale of loans and securities, as well as our operating expenses and income tax provisions. In 2006 our net income was increased by a $3.4 million net after-tax insurance recovery which significantly reduced other operating expenses, as explained below. In 2005, our net income was also materially affected by certain balance-sheet restructuring transactions which were executed late in the fourth quarter and designed to reposition portions of our balance sheet in order to improve our net interest income, net interest margin and net income in future periods. The total cost of the restructuring transactions resulted in an $8.6 million net after-tax charge to net income.
The provision for loan losses was $5.5 million for the year ended December 31, 2006, an increase of $600,000 compared to the prior year. The provision in the current year reflects significantly lower net charge-offs balanced against modestly higher levels of non-performing loans, growth in the size of the loan portfolio and continuing changes in the loan mix.
Other operating income increased by $10.0 million to $20.6 million for the year ended December 31, 2006, from $10.5 million for the prior year. Much of the increase is a result of the $7.3 million loss on the sale of securities in relation to the balance-sheet restructuring transaction in December of 2005. The remaining increase is primarily a result of increased deposit fees and other service charges.
Other operating expenses decreased $3.2 million to $94.4 million for the year ended December 31, 2006, from $97.5 million for 2005. However, this decrease reflects the effects of both the $5.4 million net proceeds from the insurance recovery in 2006 and the $6.1 million of prepayment penalties associated with the balance-sheet restructuring in 2005. Excluding the insurance recovery and the prepayment penalties, recurring other operating expenses would have increased to $99.7 million from $91.5 million in 2005, a 9% increase that is largely reflective of our continued growth.
Net income increased by $19.7 million to $32.2 million for the year ended December 31, 2006; however, earnings from recurring operations (see following paragraph), exclusive of the insurance recovery and balance-sheet restructuring transactions noted above, increased by $7.7 million to $28.7 million, compared to $21.0 million for the year ended December 31, 2005. The increase in earnings from recurring operations reflects growth in our operations, including customer deposits and earning assets, an improving mix of assets and liabilities and lower credit costs when compared to prior periods.
Earnings from recurring operations and other earnings information excluding the restructuring charges represent non-GAAP (Generally Accepted Accounting Principles) financial measures. Management has presented these non-GAAP financial measures in this discussion and analysis because it believes that they provide more useful and comparative information to assess trends in our core operations reflected in the current year results. Where applicable, we have also presented comparable earnings information using GAAP financial measures.
26
<PAGE>
Management's discussion and analysis of results of operations is intended to assist in understanding our financial condition and results of operations. The information contained in this section should be read in conjunction with the Consolidated Financial Statements and accompanying Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K.
Critical Accounting Policies
In the opinion of management, the accompanying consolidated statements of financial condition and related interim consolidated statements of income, comprehensive income, changes in stockholders' equity and cash flows reflect all adjustments (which include reclassification and normal recurring adjustments) that are necessary for a fair presentation in conformity with Generally Accepted Accounting Principles (GAAP). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements.
Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, management has identified several accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of our financial statements. These policies relate to the methodology for the recognition of interest income, determination of the provision and allowance for loan and lease losses and the valuation of goodwill, mortgage servicing rights and real estate held for sale. Management believes that the judgments, estimates and assumptions used in the preparation of the financial statements are appropriate based on the factual circumstances at the time. However, because of the sensitivity of the financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in the results of operations or financial condition. These policies and the judgments, estimates and assumptions are described in greater detail in subsequent sections of Management's Discussion and Analysis of Financial Condition and Results of Operations and in Note 1 of the Notes to the Consolidated Financial Statements. Management believes that the judgments, estimates and assumptions used in the preparation of the financial statements are appropriate based on the factual circumstances at the time. However, because of the sensitivity of the financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in the results of operations or financial condition.
Adoption and Pending Adoption of Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004), "Share-Based Payment", which is a revision of SFAS No. 123. SFAS No. 123(R) supersedes APB Opinion No. 25. Generally, the approach to accounting for share-based payments in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their grant date fair values (i.e., pro forma disclosure is no longer an alternative to financial statement recognition). We adopted SFAS No. 123(R) on January 1, 2006 using a modified version of prospective application ("modified prospective application"). Under modified prospective application, as it is applicable to us, SFAS No. 123(R) applies to new awards and to awards modified, repurchased, or cancelled after January 1, 2006. Additionally, compensation cost for the portion of awards for which the requisite service has not been rendered (generally referring to non-vested awards) that are outstanding as of January 1, 2006 must be recognized as the remaining requisite service is rendered over periods after the adoption of SFAS No. 123(R). The attribution of compensation cost for those earlier awards will be based on the same method and on the same grant-date fair values previously determined for the pro forma disclosures required for companies that did not adopt the fair value accounting method for stock-based employee compensation.
Additional stock-based compensation expense, related to options, included in our consolidated statement of income for the year ended December 31, 2006 was approximately $553,000 ($512,000, net of tax, or $0.04 per diluted share). For additional information, see Notes 1, 2 and 17 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of Financial Assets". This statement amends SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities", with respect to the accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 requires companies to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract. The statement permits a company to choose either the amortized cost method or fair value measurement method for each class of separately recognized servicing assets. This statement is effective for us on January 1, 2007. We do not expect the adoption of SFAS No. 156 to have a material impact on our financial condition or results of operations.
In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 establishes a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition requirements. FIN 48 is effective for us on January 1, 2007. We are currently evaluating the impact of the adoption of FIN 48 on our financial condition and results of operations; however, it is not expected to have a material effect.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements". This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement applies whenever assets or liabilities are required or permitted to be measured at fair value under currently existing standards. No additional fair value measurements are required under this Statement. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We plan to apply the disclosure provisions of SFAS No. 157 to all fair value measurements.
27
<PAGE>
Comparison of Financial Condition at December 31, 2006 and 2005
General: Total assets increased $455 million, or 15%, from $3.041 billion at December 31, 2005, to $3.496 billion at December 31, 2006. The increase largely resulted from growth in our loan portfolio and was funded primarily by deposit growth. Net loans receivable (gross loans less loans in process, deferred fees and discounts, and allowance for loan losses) increased $522 million, or 22%, from $2.409 billion at December 31, 2005, to $2.931 billion at December 31, 2006. Reflecting continued strong demand for and sales of new homes in many of our markets, by far the most significant growth occurred in construction and land loans. Loans to finance the construction of one- to four-family residential real estate increased by $222 million, or 64%, and land and development loans increased by $174 million, or 76%, since December 31, 2005. In addition, loans for the construction of commercial real estate increased by $46 million, or 89%. Loan growth also included increases in loans to finance existing commercial real estate, which increased by $41 million, or 7%, in consumer loans, which increased by $26 million, or 28%, in commercial loans, which increased by $26 million, or 6%, and in agricultural loans, which increased by $16 million, or 11%. Loans to finance existing one- to four-family residential properties decreased by $4 million, or 1%, compared to December 31, 2005, as we completed the sale of approximately $79 million of loans previously included in the loans held for portfolio portion of our balance sheet. This sale, which was in addition to our normal mortgage banking activity, was designed to modestly improve our liquidity position and adjust our interest rate risk profile. Additional details of this sale are included below in the Other Operating Income section of this discussion.
Securities available for sale and held to maturity decreased $37 million, or 12%, from $311 million at December 31, 2005, to $274 million at December 31, 2006, primarily as a result of scheduled principal reductions and prepayments on mortgage-backed securities. Property and equipment increased by $7 million to $58 million at December 31, 2006, from $50 million at December 31, 2005. The increase included additional site, construction and equipment costs associated with new facilities recently opened or in progress as part of our continuing branch expansion strategy.
Deposits grew $471 million, or 20%, from $2.323 billion at December 31, 2005, to $2.795 billion at December 31, 2006. Non-interest-bearing deposits increased $4 million, or 1%, to $332 million, while interest-bearing deposits increased $468 million, or 23%, to $2.462 billion from the prior year. It is our belief that the modest increase in non-interest-bearing deposit balances, despite a significant increase in the number of accounts, in part reflects changes in customer behavior in response to the increasing interest rate environment during this period. In particular, as interest rates on new certificates of deposits have increased, certain customers have moved balances from both non-interest-bearing and interest-bearing transaction and savings accounts into higher yielding certificate accounts. In addition, certain customers are more effectively utilizing our sweep account products to increase investments retail repurchase agreements or to pay down loan balances. Nonetheless, the aggregate total of transaction and savings accounts, including money market accounts, increased by $117 million to $1.238 billion, reflecting our focused efforts to grow these important core deposits. Increasing core deposits is a key element of our expansion strategy including the recent and planned addition and renovation of branch locations, as explained in more detail below. FHLB advances decreased $88 million from $265 million at December 31, 2005, to $177 million at December 31, 2006, while other borrowings increased $6 million to $103 million at December 31, 2006. The increase in other borrowings reflects an increase of $25 million in retail repurchase agreements that are primarily related to customer cash management accounts, as well as an increase of $8 million of repurchase agreement borrowings from securities dealers, which were partially offset by repayment of a $26 million short-term federal funds purchased position that had been established on December 31, 2005
Investments:At December 31, 2006, our consolidated investment portfolio totaled $274 million and consisted principally of U.S. Government agency obligations, mortgage-backed and mortgage-related securities, municipal bonds, corporate debt obligations, and Freddie Mac stock. From time to time, our investment levels may be increased or decreased depending upon yields available on investment alternatives and management's projections as to the demand for funds to be used in our loan origination, deposit and other activities. During the year ended December 31, 2006, investment securities decreased by $37 million as we redeployed cash flow from securities to fund loan growth and pay down borrowings. Holdings of mortgage-backed securities decreased $29 million and U.S. Treasury and agency obligations increased $2 million. Ownership of corporate and other securities decreased $6 million, while municipal bonds decreased $4 million.
Mortgage-Backed Obligations: At December 31, 2006, our mortgage-backed and mortgage-related securities totaled $150 million, or 55% of the consolidated investment portfolio. Included within this amount were collateralized mortgage obligations (CMOs) with a net carrying value of $70 million. The estimated fair value of the mortgage-backed and mortgage-related securities at December 31, 2006 was $150 million, which is $5 million less than the amortized cost of $155 million. At December 31, 2006, our portfolio of mortgage-backed and mortgage-related securities had a weighted average coupon rate of 4.79%. At that date, 71% of the mortgage-backed and mortgage-related securities pay interest at a fixed rate and 29% pay at an adjustable-interest rate. The estimated weighted average remaining life of the portfolio was 3.9 years.
Municipal Bonds: Our tax-exempt municipal bond portfolio at December 31, 2006 totaled $43 million at estimated fair value ($43 million at amortized cost), and was comprised of general obligation bonds (i.e., backed by the general credit of the issuer) and revenue bonds (i.e., backed by revenues from the specific project being financed) issued by cities and counties and various housing authorities, and hospital, school, water and sanitation districts located in the states of Washington, Oregon and Idaho, our primary service area. We also had taxable bonds in our municipal bond portfolio, which at December 31, 2006 totaled $5 million at estimated fair value ($5 million at amortized cost). At December 31, 2006, general obligation bonds and revenue bonds had total estimated fair values of $34 million and $14 million, respectively. Many of our qualifying municipal bonds are not rated by a nationally recognized credit rating agency due to the smaller size of the total issuance and a portion of these bonds have been acquired through direct private placement by the issuers. At December 31, 2006, our municipal bond portfolio had a weighted average maturity of approximately 11.2 years, an average coupon rate of 4.69% and an average taxable equivalent yield of 6.08%. The largest principal balance of any security in the municipal portfolio was a general obligation bond issued by the Public Hospital District No. 1, Columbia and Walla Walla Counties, Washington, with an amortized cost of $5.5 million and a fair value of $5.5 million.
Corporate Bonds: Our corporate bond portfolio, which totaled $46 million at fair value ($46 million at amortized cost) at December 31, 2006, was comprised principally of intermediate-term fixed-rate securities issued by a finance company and long-term fixed- and adjustable-rate capital securities issued by financial institutions. At December 31, 2006, the portfolio had a weighted average maturity of 23.3 years and a weighted average coupon rate of 7.29%.
28
<PAGE>
U.S. Government and Agency Obligations: Our portfolio of U.S. Government and agency obligations had a fair value of $27 million ($28 million at amortized cost) at December 31, 2006, a weighted average maturity of 3.7 years and a weighted average coupon rate of 4.56%. Most of the U.S. Government and agency obligations we own include call features which allow the issuing agency the right to call the securities at various dates prior to the final maturity.
29
<PAGE>
The following tables set forth certain information regarding carrying values and percentage of total carrying values of our consolidated portfolio of securities classified as available for sale, carried at estimated fair market value, and held to maturity, carried at amortized cost (dollars in thousands):
| Table 1: Securities Available for Sale | |||||||||||||||||||||||||
|
At December 31 |
|
|||||||||||||||||||||||
|
2006 |
|
2005 |
|
2004 |
|
2003 |
|
|||||||||||||||||
|
|
|
|
|
Percent |
|
|
|
|
|
Percent |
|
|
|
|
|
Percent |
|
|
|
|
|
Percent |
|
|
U.S. Government Treasury and |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Municipal bonds: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable |
|
4,555 |
|
|
2.0 |
|
|
5,334 |
|
|
2.0 |
|
|
5,565 |
|
|
1.0 |
|
|
5,132 |
|
|
0.8 |
|
|
|
Tax exempt |
|
3,044 |
|
|
1.4 |
|
|
3,323 |
|
|
1.3 |
|
|
4,526 |
|
|
0.8 |
|
|
20,588 |
|
|
3.0 |
|
|
|
Corporate bonds |
|
37,382 |
|
|
16.5 |
|
|
44,115 |
|
|
17.0 |
|
|
61,993 |
|
|
11.3 |
|
|
69,511 |
|
|
10.3 |
|
|
Mortgage-backed or related securities: |
|||||||||||||||||||||||||
|
Mortgage-backed securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GNMA |
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
8,078 |
|
|
1.5 |
|
|
14,086 |
|
|
2.1 |
|
|
|
FHLMC |
|
37,412 |
|
|
16.5 |
|
|
43,613 |
|
|
16.8 |
|
|
63,532 |
|
|
11.6 |
|
|
63,783 |
|
|
9.4 |
|
|
|
FNMA |
|
42,943 |
|
|
19.0 |
|
|
50,054 |
|
|
19.2 |
|
|
88,967 |
|
|
16.2 |
|
|
82,784 |
|
|
12.3 |
|
|
|
Other |
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
7,911 |
|
|
1.4 |
|
|
7,968 |
|
|
1.2 |
|
|
Total mortgage-backed |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage-related securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CMOs-agency backed |
|
43,998 |
|
|
19.5 |
|
|
54,936 |
|
|
21.0 |
|
|
111,601 |
|
|
20.4 |
|
|
147,441 |
|
|
21.8 |
|
|
|
CMOs-non-agency |
|
25,814 |
|
|
11.4 |
|
|
30,303 |
|
|
11.6 |
|
|
51,853 |
|
|
9.5 |
|
|
98,564 |
|
|
14.6 |
|
|
Total mortgage-related |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
150,167 |
|
|
66.4 |
|
|
178,906 |
|
|
68.6 |
|
|
331,942 |
|
|
60.6 |
|
|
414,626 |
|
|
61.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities |
|
3,710 |
|
|
1.6 |
|
|
3,685 |
|
|
1.5 |
|
|
3,937 |
|
|
0.7 |
|
|
3,744 |
|
|
0.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total securities available |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Table 2: Securities Held to Maturity |
|||||||||||||||||||||||||
|
Municipal bonds: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable |
$ |
99 |
|
|
0.2 |
% |
$ |
1,611 |
|
|
3.2 |
% |
$ |
1,647 |
|
|
3.3 |
% |
$ |
104 |
|
|
0.4 |
% |
|
|
Tax exempt |
|
39,773 |
|
|
83.1 |
|
|
41,521 |
|
|
81.5 |
|
|
40,276 |
|
|
80.7 |
|
|
17,890 |
|
|
65.7 |
|
|
|
Corporate bonds |
|
8,000 |
|
|
16.7 |
|
|
7,750 |
|
|
15.2 |
|
|
7,750 |
|
|
15.5 |
|
|
7,000 |
|
|
25.7 |
|
|
|
Mortgage-backed securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FHLMC certificates |
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
216 |
|
|
0.8 |
|
|
|
FNMA certificates |
|
-- |
|
|
-- |
|
|
67 |
|
|
0.1 |
|
|
241 |
|
|
0.5 |
|
|
319 |
|
|
1.2 |
|
|
|
Total mortgage-backed |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset-backed securities |
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
| Common capital securities issued by unconsolidated financing subsidiary of the Company |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
$ |
47,872 |
|
|
100.0 |
% |
$ |
50,949 |
|
|
100.0 |
% |
$ |
49,914 |
|
|
100.0 |
% |
$ |
27,232 |
|
|
100.0 |
% |
|
Estimated market value |
$ |
49,008 |
$ |
52,398 |
$ |
51,437 |
$ |
28,402 |
|||||||||||||||||
30
<PAGE>
The following table shows the maturity or period to repricing of our consolidated portfolio of securities available for sale (dollars in thousands):
Table 3: Securities-Available for Sale-Maturity/Repricing and Rates
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Available for Sale at December 31, 2006 |
|
||||||||||||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
One Year or Less |
|
Over One to Five Years |
|
Over Five to Ten Years |
|
Over Ten to Twenty Years |
|
Over Twenty Years |
|
Total |
|
||||||||||||||||||||||||||||
|
Carrying Value |
|
Weighted Average Yield |
|
Carrying Value |
|
Weighted Average Yield |
|
Carrying Value |
|
Weighted Average Yield |
|
Carrying Value |
|
Weighted Average Yield |
|
Carrying Value |
|
Weighted Average Yield |
|
Carrying Value |
|
Weighted Average Yield (1) |
|
||||||||||||||||
| U.S. Government Treasury and agency obligations: |
|
|
||||||||||||||||||||||||||||||||||||||
Fixed-rate |
$ |
2,568 |
|
|
5.42 |
% |
$ |
7,633 |
|
|
4.50 |
% |
$ |
5,391 |
|
|
3.69 |
% |
$ |
-- |
|
|
-- |
% |
$ |
-- |
|
|
-- |
% |
$ |
15,592 |
|
|
4.37 |
% |
||||
Adjustable-rate |
|
9,761 |
|
|
4.25 |
|
|
-- |
|
|
-- |
|
|
1,942 |
|
|
3.21 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
11,703 |
|
|
4.08 |
|
||||
|
|
|
12,329 |
|
|
4.49 |
|
|
7,633 |
|
|
4.50 |
|
|
7,333 |
|
|
3.56 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
27,295 |
|
|
4.25 |
|
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Municipal bonds: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Taxable |
|
3,308 |
|
|
3.70 |
|
|
1,247 |
|
|
7.06 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
4,555 |
|
|
4.62 |
|
||||
|
Tax exempt |
|
1,320 |
|
|
2.20 |
|
|
1,654 |
|
|
4.99 |
|
|
70 |
|
|
5.70 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
3,044 |
|
|
3.80 |
|
||||
|
|
|
4,628 |
|
|
3.27 |
|
|
2,901 |
|
|
5.88 |
|
|
70 |
|
|
5.70 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
7,599 |
|
|
4.29 |
|
||||
|
Corporate bonds: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Fixed-rate |
|
-- |
|
|
-- |
|
|
2,949 |
|
|
4.08 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
3,131 |
|
|
7.31 |
|
|
6,080 |
|
|
5.74 |
|
||||
|
Adjustable-rate |
|
21,386 |
|
|
7.26 |
|
|
9,916 |
|
|
5.43 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
31,302 |
|
|
6.68 |
|
||||
|
|
|
21,386 |
|
|
7.26 |
|
|
12,865 |
|
|
5.12 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
3,131 |
|
|
7.31 |
|
|
37,382 |
|
|
6.52 |
|
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
Mortgage-backed obligations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
|
Fixed-rate |
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
36,230 |
|
|
4.64 |
|
|
39,324 |
|
|
4.96 |
|
|
75,554 |
|
|
4.81 |
|
||||
|
Adjustable-rate |
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
4,801 |
|
|
5.59 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
4,801 |
|
|
5.59 |
|
||||
|
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
4,801 |
|
|
5.59 |
|
|
36,230 |
|
|
4.64 |
|
|
39,324 |
|
|
4.96 |
|
|
80,355 |
|
|
4.85 |
|
||||
Mortgage-related obligations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
|
Fixed-rate |
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
34,692 |
|
|
4.62 |
|
|
32,917 |
|
|
4.82 |
|
|
67,609 |
|
|
4.72 |
|
||||
|
Adjustable-rate |
|
2,203 |
|
|
4.74 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
2,203 |
|
|
4.74 |
|
||||
|
|
|
2,203 |
|
|
4.74 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
34,692 |
|
|
4.62 |
|
|
32,917 |
|
|
4.82 |
|
|
69,812 |
|
|
4.72 |
|
||||
| Total mortgage-backed or related obligations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Equity securities |
|
3,710 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
3,710 |
|
|
-- |
|
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
| Total securities available for sale - carrying value |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
| Total securities available for sale - amortized cost |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
(1) Yields on tax-exempt municipal bonds are not calculated as tax equivalent.
31
<PAGE>
The following table shows the maturity or period to repricing of our consolidated portfolio of securities held to maturity (dollars in thousands):
Table 4: Securities-Held to Maturity--Maturity/Repricing and Rates
|
|
Held to Maturity at December 31, 2006 |
|
||||||||||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
|
One Year or Less |
|
Over One to Five Years |
|
Over Five to Ten Years |
|
Over Ten to Twenty Years |
|
Over Twenty Years |
|
Total |
|
|||||||||||||||||||||||||||
|
Carrying Value |
|
Weighted Average Yield |
|
Carrying Value |
|
Weighted Average Yield |
|
Carrying Value |
|
Weighted Average Yield |
|
Carrying Value |
|
Weighted Average Yield |
|
Carrying Value |
|
Weighted Average Yield |
|
Carrying Value |
|
Weighted Average Yield (1) |
|
|||||||||||||||
Municipal bonds: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
|
Taxable |
$ |
-- |
|
|
-- |
% |
$ |
-- |
|
|
-- |
% |
$ |
-- |
|
|
-- |
% |
$ |
-- |
|
|
-- |
% |
$ |
99 |
|
|
5.08 |
% |
$ |
99 |
|
|
5.08 |
% |
|||
Tax exempt |
|
-- |
|
|
-- |
|
|
4,055 |
|
|
4.15 |
|
|
11,235 |
|
|
4.35 |
|
|
15,830 |
|
|
4.30 |
|
|
8,653 |
|
|
5.35 |
|
|
39,773 |
|
|
4.52 |
|
|||
|
|
|
-- |
|
|
-- |
|
|
4,055 |
|
|
4.15 |
|
|
11,235 |
|
|
4.35 |
|
|
15,830 |
|
|
4.30 |
|
|
8,752 |
|
|
5.35 |
|
|
39,872 |
|
|
4.53 |
|
|||
|
Corporate bonds: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
|
Fixed-rate |
|
-- |
|
|
|
|
|
-- |
|
|
-- |
|
|
1,000 |
|
|
2.75 |
|
|
-- |
|
|
-- |
|
|
7,000 |
|
|
10.36 |
|
|
8,000 |
|
|
9.41 |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Total securities held to |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Total securities held to |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
(1) Yields on tax-exempt municipal bonds are not calculated as tax equivalent.
32
<PAGE>
Loans/Lending: Our net loan portfolio increased $522 million, or 22%, during the year ended December 31, 2006, compared to an increase of $346 million, or 17%, during the year ended December 31, 2005 and an increase of $362 million in the year ended December 31, 2004. While we originate a variety of loans, our ability to originate each type of loan is dependent upon the relative customer demand and competition in each market we serve. During the past three years, the low level of market interest rates and increasing real estate values led to very strong demand for new real estate loans, including construction loans; however, the low rates also resulted in relatively high levels of prepayments on existing loans. For the years ended December 31, 2006, 2005 and 2004, we originated, net of repayments, $921 million, $720 million and $696 million of loans, respectively.
In recent years, we generally have sold most of its newly originated one- to four-family residential mortgage loans to secondary market purchasers. Proceeds from sales of loans for the years ended December 31, 2006, 2005 and 2004 totaled $442 million, $397 million and $338 million, respectively. We sell loans on both a servicing-retained and a servicing-released basis. See "Loan Servicing Portfolio" below. The decision to hold or sell loans is based on asset/liability management goals and policies and market conditions. Loans held for sale increased slightly to $5.1 million at December 31, 2006, compared to $4.8 million at December 31, 2005.
At various times, we also purchase whole loans and participation interests in loans. During the years ended December 31, 2006, 2005 and 2004, we purchased $45 million, $23 million and $18 million, respectively, of loans and loan participation interests.
One- to Four-Family Residential Real Estate Lending: At December 31, 2006, $362 million, or 12.2% of our loan portfolio, consisted of permanent loans on one- to four-family residences. We are active originators of one- to four-family residential loans in communities where they have established offices in Washington, Oregon and Idaho. Despite the adverse effect of rising home prices, continued in-migration and strong employment gains in the Northwest and the still relatively low mortgage interest rate environment in 2006 kept demand for residential loans stable, permitting us to originate a combined total of $504 million of one- to four-family residential loans for the year. However, the loan sales noted above, coupled with principal repayments, more than offset this significant origination activity for the year, leading to a slight $4 million decrease in the balance of loans on one- to four-family residences compared to the prior year.
Construction and Land Lending: A significant proportion of our loan portfolio consists of residential construction loans to professional home builders and, to a lesser extent, land loans and construction loans for commercial and multifamily real estate. In 2006, strong housing markets and low mortgage rates provided continued favorable conditions for construction and development lending. In response to these favorable market conditions, we significantly increased originations and balances of construction and land loans during the year. At December 31, 2006, construction and land loans totaled $1.111 billion (including $403 million of land or land development loans and $138 million of commercial and multifamily real estate construction loans), or 37.4% of total loans, compared to $692 million, or 28.4%, at December 31, 2005. Construction and land development loan originations totaled $1.294 billion for the year ended December 31, 2006, compared to $1.078 billion for the year ended December 31, 2005.
Commercial and Multifamily Real Estate Lending: We also originate loans secured by multifamily and commercial real estate. Multifamily and commercial real estate loans originated by us are both fixed- and adjustable-rate loans generally with intermediate terms of five to ten years. Our commercial real estate portfolio consists of loans on a variety of property types with no significant concentrations by property type, borrowers or locations. We experienced reasonable demand for both multifamily and commercial real estate loans in 2006; however, growth in these loan types was somewhat limited as certain competitors were willing to offer longer-term fixed-rate loans at interest rate levels that were lower than our investment objectives. Combined growth for these loan types was $43 million for the year and, at December 31, 2006, our loan portfolio included $147 million in multifamily and $596 million in commercial real estate loans. Multifamily and commercial real estate loans comprised 25.1% of total loans at December 31, 2006, compared to 28.7% a year earlier.
Commercial Lending: We are active in small- to medium-sized business lending. While strengthening our commitment to small business lending, in recent years we have added experienced officers and staff focused on middle market corporate lending opportunities for borrowers with credit needs generally in a $3 million to $15 million range. We have leveraged the past success of these officers with responsive local decision making authority to continue to expand this market niche. In addition to providing earning assets, this type of lending has helped increase the deposit base. Expanding commercial lending and related commercial banking services has been an area of significant focus and staffing has been increased in the areas of credit administration, business development, and loan and deposit operations. Reflecting this effort, for the year ended December 31, 2006, commercial loans increased by 6%. At December 31, 2006, commercial loans totaled $468 million, or 15.8% of total loans, compared to $442 million, or 18.1%, at December 31, 2005. Loan terms, including the fixed or adjustable interest rate, the loan maturity and the collateral considerations, vary significantly and are negotiated on an individual loan basis.
Agricultural Lending: Agriculture is a major industry in many Washington, Oregon and Idaho locations in our service area. While agricultural loans are not a large part of its portfolio, we intend to continue to make agricultural loans to borrowers with a strong capital base, sufficient management depth, proven ability to operate through agricultural cycles, reliable cash flows and adequate financial reporting. Payments on agricultural loans depend, to a large degree, on the results of operation of the related farm entity. The repayment is also subject to other economic and weather conditions as well as market prices for agricultural products, which can be highly volatile at times. At December 31, 2006, agricultural loans totaled $164 million, or 5.5% of the loan portfolio, compared to $148 million, or 6.0%, at December 31, 2005.
Consumer and Other Lending: We originate a variety of consumer loans, including home equity lines of credit, automobile loans and loans secured by deposit accounts and, although the balances are not currently significant, we have recently reintroduced credit card lending to our consumer loan products. While consumer lending has traditionally been a small part of our business with loans made primarily to accommodate our existing customer base, it has received renewed emphasis in 2005 and 2006. This increased effort allowed non-real estate-related consumer loans to increase modestly despite continuing high levels of prepayments in the current low interest rate environment. At December 31, 2006, we had $51 million, or 1.7% of our loans receivable, in outstanding non-real-estate-secured consumer loans, compared to $43 million, or 1.8%, at December 31, 2005. More importantly, consumer loans secured by one- to four-family real estate, including home equity lines of credit, increased by $18 million to $67
33
<PAGE>
million, or 2.3% of total loans, at December 31, 2006, compared to $49 million, or 2.0%, at December 31, 2005. While consumer loans remain a relatively small portion of the loan portfolio, aggregate growth was 28% in 2006 and we anticipate increased consumer loan activity in future periods as our branch network and retail customer base continue to grow.
Loan Servicing Portfolio: At December 31, 2006, we were servicing $361 million of loans for others, compared to $239 million at December 31, 2005. During the year ended December 31, 2006, we executed a larger portion of our loan sales on a servicing retained basis, leading to this significant growth in the servicing portfolio, as well as the increase in mortgage servicing right noted below. The loan servicing portfolio at December 31, 2006 included $197 million of Freddie Mac mortgage loans, $22 million of Fannie Mae mortgage loans and $142 million of loans serviced for a variety of private investors. The portfolio included loans secured by property located primarily in the states of Washington and Oregon. For the year ended December 31, 2006, $1.3 million of loan servicing fees, net of $518,000 of servicing rights amortization, was recognized in operations. For the prior year, net loan servicing fees were $1.5 million. The decreased servicing income for the current year primarily reflects a significant decrease in early prepayment fee income on certain commercial real estate loans.
Mortgage Servicing Rights: We record mortgage servicing rights (MSRs) with respect to loans we originate and sell in the secondary market on a servicing retained basis. The cost of MSRs is capitalized and amortized in proportion to, and over the period of, the estimated future net servicing income. For the years ended December 31, 2006, 2005 and 2004, we capitalized $1.6 million, $502,000 and $78,000, respectively, of MSRs relating to loans sold with servicing retained. Amortization of MSRs for the years ended December 31, 2006, 2005 and 2004, was $518,000, $507,000 and $489,000, respectively. Management periodically evaluates the estimates and assumptions used to determine the carrying values of MSRs and the amortization of MSRs. These carrying values are adjusted when the valuation indicates the carrying value is impaired. MSRs generally are adversely affected by current and anticipated prepayments resulting from decreasing interest rates. At December 31, 2006 and 2005, MSRs were carried at a value, net of amortization, of $2.7 and $1.6 million, respectively.
34
<PAGE>
The following table sets forth the composition of our loan portfolio (including loans held for sale) by type of loan as of the dates indicated (dollars in thousands):
Table 5: Loan Portfolio Analysis
|
December 31 |
|
||||||||||||||||||||||||||||
|
2006 |
|
2005 |
|
2004 |
|
2003 |
|
2002 |
|
||||||||||||||||||||
|
Amount |
|
Percent of Total |
|
Amount |
|
Percent of Total |
|
Amount |
|
Percent of Total |
|
Amount |
|
Percent of Total |
|
Amount |
|
Percent of Total |
|
||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Loans : |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Commercial real estate |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Multifamily real estate |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Construction and land |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Commercial business |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Agricultural business, including secured by farmland |
|
163,518 |
|
|
5.5 |
|
|
147,562 |
|
|
6.0 |
|
|
148,343 |
|
|
7.1 |
|
|
118,903 |
|
|
6.9 |
|
|
102,626 |
|
|
6.5 |
|
| One- to four-family real estate |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Consumer |
|
50,826 |
|
|
1.7 |
|
|
42,573 |
|
|
1.8 |
|
|
36,556 |
|
|
1.8 |
|
|
35,887 |
|
|
2.1 |
|
|
39,152 |
|
|
2.5 |
|
| Consumer secured by one- to four- family real estate |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total Consumer |
|
118,005 |
|
|
4.0 |
|
|
91,981 |
|
|
3.8 |
|
|
79,814 |
|
|
3.8 |
|
|
67,164 |
|
|
3.9 |
|
|
65,347 |
|
|
4.2 |
|
| Total loans |
|
2,965,990 |
|
|
100.0 |
% |
|
2,439,731 |
|
|
100.0 |
% |
|
2,092,848 |
|
|
100.0 |
% |
|
1,726,925 |
|
|
100.0 |
% |
|
1,573,466 |
|
|
100.0 |
% |
| Less allowance for loan losses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net loans at |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
35
<PAGE>
The following table sets forth certain information at December 31, 2006 regarding the dollar amount of loans maturing in our portfolio based on their contractual terms to maturity, but does not include scheduled payments or 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 net of loans in progress (undisbursed loan proceeds), unamortized premiums and discounts, include loans held for sale and exclude the allowance for loan losses (in thousands):
Table 6: Loan Maturity
|
|
Maturing Within One Year |
|
|
Maturing After 1 to 3 Years |
|
|
Maturing After 3 to 5 Years |
|
|
Maturing After 5 to 10 Years |
|
|
Maturing After 10 Years |
|
|
Total |
|
|
Loans: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate |
$ |
28,233 |
|
$ |
65,619 |
|
$ |
49,842 |
|
$ |
408,919 |
|
$ |
43,875 |
|
$ |
596,488 |
|
|
Multifamily real estate |
|
11,569 |
|
|
13,327 |
|
|
11,741 |
|
|
67,514 |
|
|
43,160 |
|
|
147,311 |
|
|
Construction and land |
|
504,206 |
|
|
214,705 |
|
|
17,840 |
|
|
5,051 |
|
|
369,496 |
|
|
1,111,298 |
|
|
Commercial business |
|
258,651 |
|
|
69,750 |
|
|
86,666 |
|
|
44,987 |
|
|
7,691 |
|
|
467,745 |
|
Agricultural business, including |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One- to four-family real estate |
|
52,658 |
|
|
5,292 |
|
|
3,032 |
|
|
8,102 |
|
|
292,541 |
|
|
361,625 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer |
|
14,609 |
|
|
5,987 |
|
|
7,688 |
|
|
5,919 |
|
|
16,623 |
|
|
50,826 |
|
|
Consumer secured by one- to |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total consumer |
|
16,337 |
|
|
7,535 |
|
|
10,309 |
|
|
8,524 |
|
|
75,300 |
|
|
118,005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total loans |
$ |
969,920 |
|
$ |
398,515 |
|
$ |
196,871 |
|
$ |
564,980 |
|
$ |
835,704 |
|
$ |
2,965,990 |
|
Contractual maturities of loans do not necessarily reflect the actual life of such assets. The average life of loans typically is substantially less than their contractual maturities because of principal repayments and prepayments. In addition, due-on-sale clauses on certain mortgage loans generally give us the right to declare loans immediately due and payable in the event that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase, however, when current mortgage loan market rates are substantially higher than rates on existing mortgage loans and, conversely, decreases when rates on existing mortgage loans are substantially higher than current mortgage loan market rates.
The following table sets forth the dollar amount of all loans due after December 31, 2006 which have fixed interest rates and floating or adjustable interest rates (in thousands):
Table 6(a): Loans Maturing after One Year
|
Fixed Rates |
|
Floating or Adjustable Rates |
|
Total |
|
|||
|
Loans: |
|
|
|
|
|
|
|
|
|
Commercial real estate |
$ |
152,962 |
|
$ |
415,293 |
|
$ |
568,255 |
|
Multifamily real estate |
|
41,102 |
|
|
94,640 |
|
|
135,742 |
|
Construction and land |
|
28,802 |
|
|
578,290 |
|
|
607,092 |
|
Commercial business |
|
115,065 |
|
|
94,029 |
|
|
209,094 |
|
Agricultural business, including |
|
|
|
|
|
|
|
|
|
One- to four-family real estate |
|
258,091 |
|
|
50,876 |
|
|
308,967 |
|
|
|
|
|
|
|
|
|
|
|
|
Consumer |
34,149 |
2,068 |
36,217 |
||||||
Consumer secured by one- to four |
|
|
|
|
|
|
|
|
|
Total consumer |
|
44,546 |
|
|
57,122 |
|
|
101,668 |
|
|
|
|
|
|
|
|
|
|
|
|
Total |
$ |
659,460 |
|
$ |
1,336,610 |
|
$ |
1,996,070 |
|
36
<PAGE>
Deposit Accounts:
Deposits generally are attracted from within our primary market areas through the offering of a broad selection of deposit instruments, including demand checking accounts, NOW accounts, money market deposit accounts, regular savings accounts, certificates of deposit, cash management services and retirement savings plans. 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. At December 31, 2006, we had $2.795 billion of deposits, including $1.238 billion of transaction and savings accounts and $1.556 billion in time deposits, of which $1.352 billion had remaining maturities of one year or less. Total deposits increased by $471 million, or 20%, for the year ended December 31, 2006. As illustrated in the following table, certificates of deposit have accounted for a larger percentage of the deposit portfolio than have transaction accounts and in 2006 certificates of deposit increased 29%. By contrast, non-interest-bearing transaction accounts only increased by 1%, or $4 million, over the same time period. However, also as reflected in the table, we added significantly to total transaction accounts (demand, NOW, savings and money market accounts) since 2004. Total transaction accounts increased by $117 million or 10% for the year ended December 31, 2006. In addition, we offer a money market certificate of deposit which has limited withdrawal features but functions much like a savings account and competes effectively with our competitors' money market accounts. At December 31, 2006, we had $179 million in three-month maturity money market certificates of deposit, compared to $152 million at December 31, 2005. Further, although not included in deposit balances, in 2006 we had an increase of $25 million in retail repurchase agreements, which are customer funds that are primarily associated with sweep account arrangements tied to transaction accounts. While increased use of these cash management services has the effect of reducing transaction account balances, it contributes to increased deposit fee revenues. Deposit balances at December 31, 2006 also included $257 million of public funds owned by various counties, municipalities and other public entities (public funds) in Washington, Oregon and Idaho, compared to $171 million at December 31, 2005. Growing deposits in general and transaction accounts in particular is a core element of our business plan and is a primary focus of our recent and ongoing branch expansion, relocation and renovation activities as well as the increased advertising and marketing campaigns. Our strong deposit growth performance over the past two years reflects the success of these efforts.37
<PAGE>
The following table sets forth the balances of deposits in the various types of accounts offered by the Bank at the dates indicated (dollars in thousands):
Table 7: Deposits
|
At December 31 |
|
||||||||||||||||||||||
|
2006 |
|
2005 |
|
2004 |
|
||||||||||||||||||
|
Amount |
|
Percent of Total |
|
Increase (Decrease) |
|
Amount |
|
Percent of Total |
|
Increase (Decrease) |
|
Amount |
|
Percent of Total |
|
||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Demand and NOW checking |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Regular savings accounts |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Money market accounts |
|
212,953 |
|
|
7.6 |
|
|
(132,804 |
) |
|
345,757 |
|
|
14.9 |
|
|
103,539 |
|
|
242,218 |
|
|
12.6 |
|
Certificates which |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Within 1 year |
|
1,351,922 |
|
|
48.4 |
|
|
452,305 |
|
|
899,617 |
|
|
38.7 |
|
|
235,242 |
|
|
664,375 |
|
|
34.5 |
|
| After 1 year, but within 2 years |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| After 2 years, but within 5 years |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
After 5 years |
|
12,546 |
|
|
0.5 |
|
|
(619 |
) |
|
13,165 |
|
|
0.6 |
|
|
(2,164 |
) |
|
15,329 |
|
|
0.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
$ |
2,794,592 |
|
|
100.0 |
% |
$ |
471,279 |
|
$ |
2,323,313 |
|
|
100.0 |
% |
$ |
397,404 |
|
$ |
1,925,909 |
|
|
100.0 |
% |
The following table indicates the amount of the Bank's certificates of deposit with balances equal to or greater than $100,000 by time remaining until maturity as of December 31, 2005.
(in thousands):
Table 8: Maturity Period-$100,000 or greater CDs
|
Certificates of Deposit $100,000 or Greater |
|
|
Due in three months or less |
$ |
290,388 |
|
Due after three months through six months |
|
186,599 |
|
Due after six months through twelve months |
|
324,133 |
|
Due after twelve months |
|
94,095 |
|
|
|
|
|
Total |
$ |
895,215 |
|
38
<PAGE>
Borrowings:
The FHLB-Seattle serves as our primary borrowing source. To access funds, we are required to own capital stock in the FHLB-Seattle and may apply for advances on the security of such stock and certain of our mortgage loans and securities provided certain credit worthiness standards have been met. At December 31, 2006, we had $177 million of borrowings from the FHLB-Seattle at a weighted average rate of 5.01%, a decrease of $88 million compared to a year earlier. Also at that date, we had an investment of $36 million in FHLB-Seattle capital stock.Table 9: FHLB Advances Outstanding at December 31, 2006
(dollars in thousands)
|
Adjustable-rate advances |
|
Fixed-rate advances |
|
Total advances |
|
|||||||||
Rate* |
|
|
Amount |
|
Rate* |
|
|
Amount |
|
Rate* |
|
|
Amount |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Due in one year or less |
5.63 |
% |
$ |
13,500 |
|
5.16 |
% |
$ |
146,930 |
|
5.20 |
% |
$ |
160,430 |
|
Due after one year through two years |
-- |
|
|
-- |
|
3.24 |
|
|
17,000 |
|
3.24 |
|
|
17,000 |
|
|
5.63 |
% |
$ |
13,500 |
|
4.96 |
% |
$ |
163,930 |
|
5.01 |
% |
$ |
177,430 |
|
*Weighted average interest rate
We also issue retail repurchase agreements to customers and borrow funds through the use of secured wholesale repurchase agreements with securities brokers. In each case, the repurchase agreements are generally due within 90 days. At December 31, 2006, retail repurchase agreements totaling $77 million, with a weighted average rate of 3.67%, were secured by a pledge of certain mortgage-backed securities and agency securities with a market value of $90 million. Retail repurchase agreement balances increased by $25 million during 2006, largely as a result of increased use of our cash management services by commercial deposit customers. Our outstanding borrowings under wholesale repurchase agreements at December 31, 2006 totaled $26 million at a weighted average rate of 5.38%, with a weighted average maturity of seven days, and were collateralized by mortgage-backed securities with a fair value of $27 million.
Additional short-term funds are also available through $95 million of commercial bank credit lines. At December 31, 2006, we had no balances advanced on these credit lines.
We have issued an aggregate of $120 million of trust preferred securities (TPS) since 2002, including $25 million issued in 2006. The Junior Subordinated Debentures associated with the TPS have been recorded as liabilities on our statement of financial condition, although portions of the TPS qualify as Tier 1 or Tier II capital for regulatory capital purposes. See Note 1 and Note 13 of the Notes to the Consolidated Financial Statements for additional information with respect to the TPS. At December 31, 2006, the TPS had a weighted average rate of 7.86%.
Asset Quality:During the year ended December 31, 2002, we experienced significant deterioration in asset quality, which had a material adverse effect on operating results, primarily through increased loan loss provisioning and increased loan collection costs. Collection costs remained high in the ensuing three years; however, during the years ended December 31, 2003, 2004 and 2005, we achieved meaningful improvement in asset quality, resulting in a significant decrease in loan loss provisioning. Table 10 highlights the earlier deterioration and subsequent improvement in our asset quality during the five-year period. While asset quality has been very good for the past two years, for the year ended December 31, 2006, we experienced a modest increase in non-performing assets, although net charge-offs declined significantly. Non-performing assets increased to $15 million, or 0.43% of total assets, at December 31, 2006, compared to $11 million, or 0.36% of total assets, at December 31, 2005, and $17 million, or 0.60% of total assets at December 31, 2004.
Problem loans in earlier years were primarily due from borrowers located in the Puget Sound region and were the result of poor risk assessment at the time they were originated, coupled with weakened economic conditions in that area at that time. Generally, non-performing loans and assets reflect unique operating difficulties for the individual borrower rather than weakness in the overall economy of the Pacific Northwest, housing or real estate markets, or depressed farm commodity prices or adverse growing conditions. In fact, in recent years economic conditions in the markets we serve have been quite good, contributing to the low level of net charge-offs and credit costs experienced in 2006. At December 31, 2006, our largest non-performing loan exposure was for commercial loans totaling $2.4 million to a non-farm operating business, which are primarily secured by ranch land in western Idaho and processing equipment. The second largest non-performing loan exposure was for loans to a cold storage business totaling $2.1 million primarily secured by commercial real estate in northwestern Washington. The third largest non-performing loan exposure was for loans totaling $1.6 million to an agricultural-related business operating in northeastern Oregon which are primarily secured by non-farm real estate and processing equipment. Real estate owned and other repossessed assets increased by $412,000 from $506,000 in the prior year to $918,000 at December 31, 2006, representing the book value of a parcel of undeveloped land awarded to us in the third quarter of 2006. We were awarded the undeveloped land as a result of litigation relative to certain previously charged off loans. While this award resulted in an increase in real estate owned, since those loans had been fully charged off in prior periods, it also was recognized as a recovery in the third quarter of 2006. We are optimistic about the prospects for a near-term disposal of this property. Although experiencing an increase in the most recent quarter, we have made very meaningful progress in the past three years in reducing non-performing loans and improving our asset quality, which has contributed significantly to our improved operating performance.
39
<PAGE>
The following table sets forth information with respect to our non-performing assets and restructured loans within the meaning of SFAS No. 15, Accounting by Debtors and Creditors for Troubled Debt Restructuring, at the dates indicated (dollars in thousands):
Table 10: Non-Performing Assets
|
At December 31 |
|
|||||||||||||
|
|
2006 |
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
2002 |
|
Nonaccrual loans: (1) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Loans secured by real estate: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| One- to four-family | $ |
1,198 |
|
$ |
1,137 |
|
$ |
393 |
|
$ |
1,048 |
|
$ |
455 |
|
| Commercial |
|
4,215 |
|
|
1,363 |
|
|
2,212 |
|
|
6,624 |
|
|
7,421 |
|
| Multifamily |
|
792 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
| Construction/land |
|
2,056 |
|
|
479 |
|
|
2,219 |
|
|
5,741 |
|
|
16,030 |
|
| Commercial business |
|
4,498 |
|
|
2,543 |
|
|
3,167 |
|
|
7,232 |
|
|
9,894 |
|
| Agricultural business |
|
703 |
|
|
4,598 |
|
|
7,407 |
|
|
7,320 |
|
|
194 |
|
| Consumer |
|
1 |
|
|
229 |
|
|
18 |
|
|
45 |
|
|
255 |
|
| Total loans outstanding |
|
13,463 |
|
|
10,349 |
|
|
15,416 |
|
|
28,010 |
|
|
34,249 |
|
| Loans more than 90 days delinquent, still on accrual: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Loans secured by real estate: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| One- to four-family |
|
593 |
|
|
104 |
|
|
419 |
|
|
109 |
|
|
343 |
|
| Commercial |
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
| Multifamily |
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
| Construction/land |
|
-- |
|
|
-- |
|
|
-- |
|
|
288 |
|
|
1,283 |
|
| Commercial business |
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
163 |
|
| Agricultural business |
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
| Consumer |
|
-- |
|
|
-- |
|
|
53 |
|
|
24 |
|
|
70 |
|
| Total loans outstanding |
|
593 |
|
|
104 |
|
|
472 |
|
|
421 |
|
|
1,859 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total non-performing loans |
|
14,056 |
|
|
10,453 |
|
|
15,888 |
|
|
28,431 |
|
|
36,108 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Real estate/repossessed assets held for sale (2) |
|
918 |
|
|
506 |
|
|
1,559 |
|
|
3,132 |
|
|
6,062 |
|
| Total non-performing assets | $ |
14,974 |
|
$ |
10,959 |
|
$ |
17,447 |
|
$ |
31,563 |
|
$ |
42,170 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Restructured loans (3) | $ |
-- |
|
$ |
-- |
|
$ |
-- |
|
$ |
656 |
|
$ |
2,057 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total non-performing loans to net loans before allowance for loan losses |
|
0.47 |
% |
|
0.43 |
% |
|
0.76 |
% |
|
1.65 |
% |
|
2.29 |
% |
| Total non-performing loans to total assets |
|
0.40 |
% |
|
0.34 |
% |
|
0.55 |
% |
|
1.08 |
% |
|
1.60 |
% |
| Total non-performing assets to total assets |
|
0.43 |
% |
|
0.36 |
% |
|
0.60 |
% |
|
1.20 |
% |
|
1.86 |
% |
(1) For the year ended December 31, 2006, $1.3 million in interest income would have been recorded had nonaccrual loans been current, and no interest income on these loans was included in net income for this period.
(2) Real estate acquired by us as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate held for sale until it is sold. When property is acquired, it is recorded at the lower of its cost (the unpaid principal balance of the related loan plus foreclosure costs) or net realizable value. Subsequent to foreclosure, the property is carried at the lower of the foreclosed amount or net realizable value. Upon receipt of a new appraisal and market analysis, the carrying value is written down through the establishment of a specific reserve to the anticipated sales price, less selling and holding costs. At December 31, 2006, we had $918,000 of real estate owned, which consisted of one parcel of undeveloped land in western Washington.
(3) These loans are performing under their restructured terms but are classified substandard.
In addition to the non-performing loans noted in Table 10, as of December 31, 2006, we had loans with an aggregate outstanding balance of $17 million with respect to which known information concerning possible credit problems with the borrowers or the cash flows of the properties securing the respective loans has caused management to be concerned about the ability of the borrowers to comply with present loan repayment terms. This may result in the future inclusion of such loans in the nonaccrual loan category.
40
<PAGE>
Comparison of Results of Operations for the Years Ended December 31, 2006 and 2005
General. For the year ended December 31, 2006, we had net income of $32.2 million, or $2.63 per share (diluted), compared to net income of $12.4 million, or $1.04 per share (diluted), for the prior year. Our improved operating results reflect significant growth of assets and liabilities, as well as changes in the mix of those assets and liabilities, including the effects of certain balance-sheet restructuring transactions completed in the quarter ended December 31, 2005, which have resulted in a significant expansion in our net interest margin as more fully explained below. The current year earnings were also positively affected by the collection of a $5.5 million insurance settlement relating to a loss incurred in 2001. The net amount of the settlement, following costs, resulted in a $5.4 million credit to other operating expense and contributed approximately $3.4 million, or $.28 per share, to net income for the year ended December 31, 2006. Our operating results also reflect substantial increases in other operating expenses, particularly compensation, occupancy, information services, advertising and miscellaneous expenses, reflecting the growth in locations, operations and staff as we continue to expand. Twelve new or relocated branches contributed to the higher level of operating expenses in the current year compared to the prior year. During 2006, we opened two new branches in Boise, Idaho, and during 2005 we opened an additional Boise branch, as well as new or relocated branches in Twin Falls, Idaho, Beaverton, Oregon and Mercer Island, Alderwood, East Wenatchee, Lynden, Vancouver, Pasco and Walla Walla, Washington.
Net Interest Income. Net interest income before provision for loan losses increased to $126.9 million for the year ended December 31, 2006, compared to $108.8 million for the prior year, largely as a result of the growth in average interest-earning assets noted above and the net interest margin expansion as discussed in the remainder of this paragraph. The net interest margin of 4.08% in the current year improved 29 basis points from the prior year, reflecting the balance-sheet restructuring and our success in attracting higher yielding loans and growing deposits. While this improvement in the net interest margin primarily reflects changes in both the asset and liability mix, including those resulting from the balance-sheet restructuring, the lagging effect of increasing market interest rates on deposit costs, as more fully explained below, also contributed to the improvement. In particular, the average asset mix for the year ended December 31, 2006 reflected proportionately more loans, including more higher yielding commercial, construction and land development loans, and fewer investment securities than a year earlier. At the same time, the average funding liability base had proportionately more deposits, and proportionately fewer borrowings than in the prior year. Reflecting higher market interest rates as well as these mix changes, the yield on earning assets for the year ended December 31, 2006 increased by 118 basis points, compared to a year ago, while funding costs for the year increased by 93 basis points over the same period.
Interest Income. Interest income for the year ended December 31, 2006 was $243.0 million, compared to $190.2 million for the prior year, an increase of $52.9 million, or 28%. The increase in interest income that occurred was a result of the 118 basis point increase in the average yield on interest-earning assets as well as significant growth in these assets. The yield on average interest-earning assets increased to 7.81% for the year ended December 31, 2006, compared to 6.63 a year earlier. Average loans receivable for the year ended December 31, 2006 increased by $495 million, or 22%, to $2.768 billion, compared to $2.273 billion in the prior year. Interest income on loans for the year ended December 31, 2006 increased by $62.3 million, or 38%, to $227.7 million from $165.4 million for the prior year, reflecting the impact of the increase in average loan balances combined with a 95 basis point increase in the average yield on loans. The increase in average loan yield reflects the increases in the level of market interest rates during the past year, particularly in short-term interest rates including the prime rate and LIBOR indices which affect the yield on large portions of our construction, land development, commercial and agricultural loans. However, following the Federal Reserve's decision to stop increasing short-term interest rates in June 2006, the average yield on these types of loans generally stabilized in the second half of the year. The increase in average loan yields also reflects changes in the mix of the loan portfolio. The average yield on loans was 8.23% for the year ended December 31, 2006, compared to 7.28% in the prior year. While the recent level of market interest rates was significantly higher than a year earlier, loan yields did not change to the same degree as previously originated fixed-rate loans do not adjust upward to market rates. In addition, competitive pricing pressure resulted in lower yields on new loan originations. These factors were somewhat offset by changes in the loan mix, as growth has been most significant in some of the higher yielding adjustable-rate loan categories, particularly construction and land development loans.
The combined average balance of mortgage-backed securities, investment securities, daily interest-bearing deposits and FHLB stock decreased by $254 million for the year ended December 31, 2006, primarily reflecting the 2005 fourth quarter balance-sheet restructuring transactions, and the interest and dividend income from those investments decreased by $9.4 million compared to the prior year. The average yield on our investment securities increased to 4.48% for the year ended December 31, 2006, from 4.15% for the prior year, largely reflecting the sale of lower yielding securities and the effect of higher market rates on certain adjustable-rate securities and interest-bearing deposits. While insignificant in amount, we received $36,000 in dividend income on our FHLB of Seattle stock in the fourth quarter of 2006, as the FHLB of Seattle received approval to resume paying its members cash dividends on a quarterly basis. The FHLB of Seattle restricted payment of dividends in the fourth quarter of 2004 in a move to improve its capital position. Management is hopeful that the FHLB of Seattle dividend rate will increase modestly in future periods.
Interest Expense. Interest expense for the year ended December 31, 2006 was $116.1 million, compared to $81.4 million for the prior year, an increase of $34.7 million, or 43%. The increase in interest expense was the result of the growth in interest-bearing liabilities combined with a 93 basis point increase in the average cost of all interest-bearing liabilities to 3.84% for the year ended December 31, 2006, from 2.91% in the prior year, reflecting the higher levels of market interest rates and the maturity of certain lower-costing certificates of deposit and fixed-rate borrowings. Deposit interest expense increased $37.7 million, or 72%, to $90.0 million for the year ended December 31, 2006 compared to $52.3 million for the year ended December 31, 2005, as a result of the significant deposit growth during the past twelve months as well as an increase in the cost of interest-bearing deposits. Reflecting our branch expansion and other growth initiatives, average deposit balances increased $414 million, or 20%, to $2.536 billion for the year ended December 31, 2006, from $2.122 billion for the prior year, while the average rate paid on deposit balances increased 109 basis points to 3.55%. Although deposit costs are significantly affected by changes in the level of market interest rates, changes in the average rate paid for interest-bearing deposits tend to be less severe and to lag changes in market interest rates. In addition, non-interest-bearing deposits help mitigate the effect of higher market rates on our cost of deposits. This lower degree of volatility and lag effect for deposit pricing has been evident in the relatively modest increase in deposit costs as the Federal Reserve has increased short-term interest rates by 425 basis points from June 2004 to June 2006, including an increase of 100 basis points since December 31, 2005. Nonetheless, competitive pricing pressure for interest-bearing deposits has become quite intense in recent months, as many financial institutions have experienced strong loan growth and related funding needs. In addition, customers have become more effective in
41
<PAGE>
managing their non-interest-bearing transaction account balances as demonstrated by our recent deposit growth being concentrated in certificates of deposit. As a result, management expects that the cost of deposits will continue to increase in the near term regardless of any changes in market interest rates.
Average FHLB advances decreased to $295 million for the year ended December 31, 2006, compared to $523 million during the prior year, reflecting the fourth quarter 2005 restructuring transactions and resulting in a $7.6 million decrease in the related interest expense. The average rate paid on FHLB advances increased to 4.86%, just 67 basis points higher than the prior year, as the effect of significantly higher market interest rates on the floating rate and short-term portions of the advances was partially offset by the prepayment of $142 million of higher fixed-rate, fixed-term advances in connection with the balance-sheet restructuring transactions completed in the quarter ended December 31, 2005. Junior subordinated debentures which were issued in connection with trust preferred securities had an average balance of $99 million and an average cost of 8.10% (including amortization of prepaid underwriting costs) for the year ended December 31, 2006. Junior subordinated debentures outstanding in the prior year had an average balance of $81 million with a lower average rate of 6.71%. The junior subordinated debentures are adjustable-rate instruments with repricing frequencies of three to six months. The increased cost of the junior subordinated debentures reflects recent increases in short-term market interest rates. Other borrowings consist of retail repurchase agreements with customers and reverse repurchase agreements with investment banking firms secured by certain investment securities. The average balance for other borrowings increased $26 million, or 38%, to $95 million for the year ended December 31, 2006, from $68 million in the prior year, while the related interest expense increased $2.0 million, to $3.7 million from $1.8 million for 2005. Reflecting growth in our customer cash management services, the average balance of customer retail repurchase agreements increased $28 million while the average balance of the wholesale borrowings from brokers decreased $2 million. The average rate paid on other borrowings was 3.96% in the year ended December 31, 2006, compared to 2.58% in 2005. Other borrowings generally have relatively short terms and therefore reprice to current market levels more quickly than deposits and FHLB advances, which generally lag current market rates, although, similar to deposits, customer retail repurchase agreements have a lower degree of volatility than most market rates.
Provision and Allowance for Loan Losses. During the year ended December 31, 2006, the provision for loan losses was $5.5 million compared to $4.9 million from the prior year. As discussed in Note 1 of the Notes to the Consolidated Financial Statements, the provision and allowance for loan losses is one of the most critical accounting estimates included in the Company's Consolidated Financial Statements. The provision for loan losses reflects the amount required to maintain the allowance for losses at an appropriate level based upon management's evaluation of the adequacy of general and specific loss reserves as more fully explained below.
The provision in the current year reflects a reduced amount of net charge-offs, balanced against modestly higher levels of non-performing loans, growth in the size of our loan portfolio and continuing changes in the loan mix. There were net charge-offs of $863,000 for the current year, compared to $3.6 million of charges for the prior year, and non-performing loans increased $3.6 million to $14 million at December 31, 2006, compared to $10 million at December 31, 2005. Generally, these non-performing loans reflect unique operating difficulties for the individual borrower rather than weakness in the overall economy of the Pacific Northwest, housing or real estate markets, or depressed farm commodity prices or adverse growing conditions. A comparison of the allowance for loan losses at December 31, 2006 and 2005 shows an increase of $4.6 million to $35 million at December 31, 2006, from $31 million at December 31, 2005. The allowance for loan losses as a percentage of total loans (loans receivable excluding allowance for losses) was 1.20% and 1.27% at December 31, 2006 and 2005, respectively. The allowance as a percentage of non-performing loans decreased to 253% at December 31, 2006, compared to 296% a year earlier.
In originating loans, we recognize that losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the collateral for the loan. As a result, we maintain an allowance for loan losses consistent in all material respects with the GAAP guidelines outlined in SFAS No. 5, Accounting for Contingencies. We have established systematic methodologies for the determination of the adequacy of our allowance for loan losses. The methodologies are set forth in a formal policy and take into consideration the need for an overall general valuation allowance as well as specific allowances that are tied to individual problem loans. We increase our allowance for loan losses by charging provisions for probable loan losses against our income and value impaired loans consistent with the guidelines in SFAS No. 114, Accounting by Creditors for Impairment of a Loan, and SFAS No. 118, Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosure.
The allowance for losses on loans is maintained at a level sufficient to provide for estimated losses based on evaluating known and inherent risks in the loan portfolio and upon management's continuing analysis of the factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, delinquency rates, actual loan loss experience, current and anticipated economic conditions, detailed analysis of individual loans for which full collectibility may not be assured, and determination of the existence and realizable value of the collateral and guarantees securing the loans. Realized losses related to specific assets are applied as a reduction of the carrying value of the assets and charged immediately against the allowance for loan loss reserve. Recoveries on previously charged off loans are credited to the allowance. The reserve is based upon factors and trends identified by management at the time financial statements are prepared. Although management uses the best information available, future adjustments to the allowance may be necessary due to economic, operating, regulatory and other conditions beyond our control. The adequacy of general and specific reserves is based on management's continuing evaluation of the pertinent factors underlying the quality of the loan portfolio, including changes in the size and composition of the loan portfolio, delinquency rates, actual loan loss experience and current economic conditions, as well as individual review of certain large balance loans. Large groups of smaller-balance homogeneous loans are collectively evaluated for impairment. Loans that are collectively evaluated for impairment include residential real estate and consumer loans and, as appropriate, smaller balance non-homogeneous loans. Larger balance non-homogeneous residential construction and land, commercial real estate, commercial business loans and unsecured loans are individually evaluated for impairment. Loans are considered impaired when, based on current information and events, management determines that it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Factors involved in determining impairment include, but are not limited to, the financial condition of the borrower, value of the underlying collateral and current status of the economy. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of collateral if the loan is collateral dependent. Subsequent changes in the value of impaired loans are
42
<PAGE>
included within the provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the provision that would otherwise be reported. As of December 31, 2006, we had identified $13.5 million of impaired loans as defined by SFAS No. 114 and had established $2.6 million of loss allowances related to these loans.
Our methodology for assessing the appropriateness of the allowance consists of several key elements, which include specific allowances, an allocated formula allowance and an unallocated allowance. Losses on specific loans are provided for when the losses are probable and estimable. General loan loss reserves are established to provide for inherent loan portfolio risks not specifically provided for. The level of general reserves is based on analysis of potential exposures existing in our loan portfolio including evaluation of historical trends, current market conditions and other relevant factors identified by management at the time the financial statements are prepared. The formula allowance is calculated by applying loss factors to outstanding loans, excluding loans with specific allowances. Loss factors are based on our historical loss experience adjusted for significant factors including the experience of other banking organizations that, in management's judgment, affect the collectibility of the portfolio as of the evaluation date. The unallocated allowance is based upon management's evaluation of various factors that are not directly measured in the determination of the formula and specific allowances. This methodology may result in losses or recoveries differing significantly from those provided in the financial statements.
Management believes that the allowance for loan losses as of December 31, 2006 was adequate to absorb the known and inherent risks of loss in the loan portfolio at that date. While management believes the estimates and assumptions used in its determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. In addition, the determination of the amount of Banner Bank's allowance for loan losses is subject to review by bank regulators as part of the routine examination process, which may result in the establishment of additional reserves based upon their judgment of information available to them at the time of their examination.
The following table sets forth an analysis of the Company's allowance for loan losses for the periods indicated (dollars in thousands):
Table 11: Changes in Allowance for Loan Losses
|
|
Years Ended December 31 |
|
||||||||||||
|
|
2006 |
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
2002 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, beginning of period |
$ |
30,898 |
|
$ |
29,610 |
|
$ |
26,060 |
|
$ |
26,539 |
|
$ |
17,552 |
|
Allowances added through business combinations |
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
460 |
|
Provision |
|
5,500 |
|
|
4,903 |
|
|
5,644 |
|
|
7,300 |
|
|
21,000 |
|
Recoveries of loans previously charged off: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Secured by real estate: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| One- to four-family |
|
77 |
|
|
-- |
|
|
3 |
|
|
14 |
|
|
-- |
|
| Commercial |
|
75 |
|
|
187 |
|
|
519 |
|
|
-- |
|
|
-- |
|
| Multifamily |
|
-- |
|
|
6 |
|
|
-- |
|
|
-- |
|
|
-- |
|
| Construction and land |
|
507 |
|
|
259 |
|
|
14 |
|
|
80 |
|
|
39 |
|
| Commercial business |
|
1,112 |
|
|
713 |
|
|
986 |
|
|
924 |
|
|
209 |
|
| Agricultural business |
|
72 |
|
|
70 |
|
|
15 |
|
|
13 |
|
|
3 |
|
| Consumer |
|
55 |
|
|
91 |
|
|
50 |
|
|
44 |
|
|
74 |
|
|
|
1,898 |
|
|
1,326 |
|
|
1,587 |
|
|
1,075 |
|
|
325 |
|
|
Loans charged off: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Secured by real estate: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| One- to four-family |
|
(62 |
) |
|
(135 |
) |
|
(100 |
) |
|
(357 |
) |
|
(102 |
) |
| Commercial |
|
-- |
|
|
(521 |
) |
|
(1,313 |
) |
|
(2,289 |
) |
|
(103 |
) |
| Multifamily |
|
-- |
|
|
(8 |
) |
|
-- |
|
|
-- |
|
|
-- |
|
| Construction and land |
|
-- |
|
|
(218 |
) |
|
(347 |
) |
|
(986 |
) |
|
(1,129 |
) |
| Commercial business |
|
(1,632 |
) |
|
(1,692 |
) |
|
(1,518 |
) |
|
(4,496 |
) |
|
(10,643 |
) |
| Agricultural business |
|
(759 |
) |
|
(1,886 |
) |
|
(41 |
) |
|
(214 |
) |
|
(157 |
) |
| Consumer |
|
(308 |
) |
|
(481 |
) |
|
(362 |
) |
|
(512 |
) |
|
(664 |
) |
|
|
(2,761 |
) |
|
(4,941 |
) |
|
(3,681 |
) |
|
(8,854 |
) |
|
(12,798 |
) |
| Net charge-offs |
|
(863 |
) |
|
(3,615 |
) |
|
(2,094 |
) |
|
(7,779 |
) |
|
(12,473 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Balance, end of period | $ |
35,535 |
|
$ |
30,898 |
|
$ |
29,610 |
|
$ |
26,060 |
|
$ |
26,539 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratio of allowance to net loans before allowance for loan losses |
|
1.20 |
% |
|
1.27 |
% |
|
1.41 |
% |
|
1.51 |
% |
|
1.69 |
% |
|
Ratio of net loan charge-offs to the average net book value of loans outstanding during the period |
|
0.03 |
% |
|
0.16 |
% |
|
0.11 |
% |
|
0.47 |
% |
|
0.78 |
% |
|
Ratio of allowance for loan losses to non-performing loans |
|
253 |
% |
|
296 |
% |
|
186 |
% |
|
92 |
% |
|
74 |
% |
43
<PAGE>
The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated (dollars in thousands):
Table 12: Allocation of Allowance for Loan Losses
|
At December 31 |
|||||||||||||||||||||||||||||
|
2006 |
|
2005 |
|
2004 |
|
2003 |
|
2002 |
|||||||||||||||||||||
|
Amount |
|
Percent of Loans in Each Category to Total Loans |
|
|
|
Percent of Loans in Each Category to Total Loans |
|
|
|
Percent of Loans in Each Category to Total Loans |
|
|
|
Percent of Loans in Each Category to Total Loans |
|
|
|
Percent of Loans in Each Category to Total Loans |
|
||||||||||
| Specific or allocated loss allowances (1): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
| Loans secured by real estate: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
| Commercial/multifamily | $ |
6,015 |
|
|
25.1 |
% |
$ |
5,405 |
|
|
28.7 |
% |
$ |
5,585 |
|
|
31.3 |
% |
$ |
5,503 |
|
|
31.6 |
% |
$ |
5,645 |
|
|
28.7 |
% |
| Construction and land |
|
11,717 |
|
|
37.4 |
|
|
7,223 |
|
|
28.4 |
|
|
5,556 |
|
|
24.2 |
|
|
5,207 |
|
|
23.1 |
|
|
5,892 |
|
|
21.6 |
|
| One- to four-family including consumer |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Commercial/agricultural business |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Consumer |
|
903 |
|
|
1.7 |
|
|
561 |
|
|
1.8 |
|
|
464 |
|
|
1.8 |
|
|
482 |
|
|
2.1 |
|
|
698 |
|
|
2.5 |
|
| Unallocated general loss allowance (1) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total allowance for loan losses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) | We establish specific loss allowances when individual loans are identified that present a possibility of loss (i.e., that full collectibility is not reasonably assured). The remainder of the allocated and unallocated allowance for loan losses is established for the purpose of providing for estimated losses which are inherent in the loan portfolio. |
44
<PAGE>
Other Operating Income. Other operating income was $20.6 million for the year ended December 31, 2006, an increase of $10.0 million from the prior year. However, in the fourth quarter of 2005, as a part of our balance sheet restructuring initiatives, we recorded $7.3 million of net loss on the sale of securities. Excluding the net loss on the sale of securities relating to the balance-sheet restructuring transactions, total other operating income would have been $17.8 million for the year ended December 31, 2005, resulting in a $2.7 million increase in recurring other operating income for 2006 as compared to 2005. Deposit fees and other service charge income increased by $1.9 million, or 20%, to $11.4 million for the year ended December 31, 2006, compared to $9.5 million for the prior year, primarily reflecting growth in customer transaction accounts and increased merchant credit card services, although changes in certain pricing schedules also contributed to the increase. Loan servicing fees decreased by $153,000 to $1.3 million for the current year, from $1.5 million for the year ended December 31, 2005, when we received a higher amount of prepayment fees. Gain on sale of loans was relatively unchanged, increasing by $177,000 to $5.8 million for the year ended December 31, 2006, compared to $5.6 million for the prior year as our mortgage banking activity maintained a similar pace despite modestly higher mortgage rates. Gain on sale of loans was adversely affected by continued competitive pressures in the mortgage market which tended to reduce the margin on sales compared to the prior year. However, in addition to normal mortgage banking activity, gain on sale of loans was augmented modestly in the third quarter of 2006 by the sale of approximately $79 million of one- to four-family loans that had previously been included in the held for portfolio portion of loans receivable. This sale was initiated for liquidity and interest rate risk management purposes; however, it generated a gain of $159,000. Loan sales for the year ended December 31, 2006 totaled $442.4 million, compared to $397.0 million for the prior year. Gain on sale of loans in 2006 included $789,000 of fees on $92.2 million of loans which were brokered and are not reflected in the volume of loans sold. The current year also included a gain of $353,000 on the sale of the guaranteed portion of certain SBA-guaranteed loans, while no similar sales activity occurred in the previous year.
Other Operating Expenses. Other operating expenses decreased $3.2 million, or 3%, to $94.4 million for the year ended December 31, 2006, from $97.5 million for the prior year. Our total operating expenses in 2006 were significantly reduced by a net $5.4 million insurance recovery which occurred in the second quarter of 2006, while previous year total operating expenses include $6.1 million of FHLB prepayment penalties associated with our balance-sheet restructuring in the fourth quarter of 2005. Excluding the insurance recovery and prior year prepayment penalties, recurring operating expenses were $99.7 million and $91.5 million for the years ended December 31, 2006 and 2005, respectively. This increase of 9% largely results from our branch expansion strategy and increased loan origination activity. The increase in expenses includes operating costs associated with the opening of two new offices in 2006 and eight offices in 2005 that in each case contributed less than a full year's expense during the year in which they opened. Further, during the third quarter of 2005, we increased staffing to support our Small Business Administration (SBA) lending activities and to more effectively market cash management services. In addition, compensation was higher as a result of increased mortgage loan commissions and general wage and salary increases, as well as increased costs associated with employee benefit programs and employer-paid taxes. These increases were mitigated to a degree by an increase in the amount of capitalized loan origination costs, which reflects increases in both the cost to produce and the volume of new loan originations. We also continued our strong commitment to advertising and marketing expenditures, which were $7.4 million in the year ended December 31, 2006, an increase of $938,000 compared to the prior year. Reflecting the current year insurance recovery and the prior year FHLB prepayment penalty, as well as significant growth in the average asset base, other operating expenses as a percentage of average assets decreased to 2.86% for the year ended December 31, 2006, from 3.20% for the prior year. Our efficiency ratio also decreased to 64.00% for the year ended December 31, 2006 from 81.75% for 2005, as a higher level of revenues more than offset the increased operating expenses. Excluding the effects of the insurance recovery and the balance sheet restructuring charges, the ratio of recurring operating expenses to average assets was nearly unchanged at 3.02% for 2006 compared to 3.00% for 2005, while the efficiency ratio decreased to 67.62% from 72.23%, respectively, despite continuing start-up costs associated with branch growth. We expect continued increases in the absolute level of operating expenses as a result of our announced expansion plans; however, over time, management believes that this investment in our branch network may lead to a lower relative cost of funds and enhanced revenues which should result in an improved efficiency ratio and stronger operating results.
Income Taxes. Income tax expense was $15.4 million for the year ended December 31, 2006, compared to $4.4 million for the prior year. The Company's effective tax rates for the years ended December 31, 2006 and 2005 were 32.4% and 26.3%, respectively. The effective tax rates in both years reflect the recording of tax credits related to certain Community Reinvestment Act (CRA) investments. The higher effective tax rate in the current year was primarily a result of a decrease in the relative combined effect of the tax credits from CRA investments and tax-exempt income from interest on municipal securities and earnings on bank-owned life insurance, compared to other taxable net revenue sources which increased substantially reflecting the growth in loans and deposits and the effects of the current year insurance recovery and prior year balance-sheet restructuring.
45
<PAGE>
Comparison of Results of Operations for the Years Ended December 31, 2005 and 2004
General: Net income for the year ended December 31, 2005 was $12.4 million, or $1.04 per share (diluted), compared to net income of $19.3 million, or $1.65 per share (diluted), for the year ended December 31, 2004. Late in the fourth quarter of 2005, we completed a balance-sheet restructuring designed to pay down high interest rate FHLB borrowings and reduce the size of the investment portfolio. To effect the restructuring, we sold $207 million of securities at a $7.3 million loss before tax and used a portion of the proceeds of the sale to prepay $142 million of high-cost fixed-term FHLB borrowings, incurring pre-tax prepayment penalties of $6.1 million. The total cost of the transactions was $13.4 million, with a tax benefit of $4.8 million, resulting in an after-tax cost of $8.6 million or $0.72 per diluted share. For the year ended December 31, 2005, earnings from recurring operations, exclusive of the balance-sheet restructuring transactions noted above, increased to $21.0 million, or $1.76 per share (diluted), compared to net income of $19.3 million, or $1.65 per share, for the year ended December 31, 2004. Aside from the balance-sheet restructuring transactions, our 2005 operating results reflect significant growth of loans and deposits, as well as an increase in the net interest margin, and a lower level of loan loss provision. In addition, our operating results reflect that other operating income, exclusive of the net loss on sale of securities relating to the balance-sheet restructuring, increased primarily as a result of an increase in deposit fees and other service charges, and that other operating expenses, excluding the FHLB prepayment penalties, also significantly increased, particularly compensation, occupancy, information services and advertising expenses.
Compared to levels a year earlier, total assets increased 5.0%, to $3.041 billion at December 31, 2005, net loans increased 16.8%, to $2.409 billion, deposits grew 20.6%, to $2.323 billion, and borrowings, including junior subordinated debentures, decreased 36.5%, to $459.8 million. Average interest earning assets were $2.869 billion for the year ended December 31, 2005, an increase of $275.7 million, or 10.6%, compared to the same period a year earlier. Average equity was 7.26% of average assets for the year ended December 31, 2005, compared to 7.62% of average assets for the year ended December 31, 2004, reflecting increased balance sheet leverage.
Net Interest Income. Net interest income before provision for loan losses increased to $108.8 million for the year ended December 31, 2005, compared to $96.3 million for the year ended December 31, 2004, largely as a result of the growth in average interest-earning assets noted above. For the year ended December 31, 2005, the net interest margin increased to 3.79% from 3.71% for the prior year. This improvement in the net interest margin primarily reflects changes in both the asset and liability mix, although the lagged effect of increasing market interest rates on deposit costs also contributed to the improvement. In particular, the average asset mix for the year ended December 31, 2005 reflected proportionately more loans, including more higher yielding commercial, construction and land development loans, and fewer investment securities than for the year ended December 31, 2004. At the same time, the average funding liability base had proportionately more deposits, including more non-interest bearing deposits, and proportionately fewer borrowings than in the prior year. The balance-sheet restructuring transactions that we completed late in the fourth quarter had only a minor effect on the 2005 net interest margin; however, they furthered these changes in the asset and liability mix and significantly contributed to expansion of the net interest margin in 2006. In contrast with the prior year and as more fully explained below, for the year ended December 31, 2005 we did not record any dividend income on its investment in stock of the FHLB. Dividend income on the FHLB stock contributed five basis points to the net interest margin in the year ended December 31, 2004. This loss of dividend income on FHLB stock masked to a degree the progress we made in 2005 in improving the net interest margin from our core businesses of making loans to and collecting deposits from banking customers.
Interest Income. Interest income for the year ended December 31, 2005 was $190.2 million, compared to $156.2 million for the year ended December 31, 2004, an increase of $33.9 million, or 21.7%. The increase in interest income occurred as a result of a 60 basis point increase in the average yield on interest-earning assets, as well as significant growth in those assets. The yield on average interest-earning assets increased to 6.63% for the year ended December 31, 2005, compared to 6.03% for the prior year. Average loans receivable for the year ended December 31, 2005 increased by $374.0 million, or 19.7%, to $2.273 billion, compared to $1.899 billion for the year ended December 31, 2004. Interest income on loans for the year increased by $38.4 million, or 30.2%, to $165.4 million from $127.0 million for the prior year, reflecting the impact of the increase in average loan balances combined with a 59 basis point increase in the average yield. The increase in average loan yield reflects the increases in the level of market interest rates during the year, particularly in short-term interest rates including the prime rate and LIBOR indices which affect large portions of construction, land development, commercial and agricultural loans. The increase in average loan yields also reflects changes in the mix of the loan portfolio. The average yield on loans was 7.28% for the year ended December 31, 2005, compared to 6.69% for the year ended December 31, 2004. While the level of short-term market interest rates was significantly higher than a year earlier, loan yields did not change to the same degree, as existing fixed-rate loans did not adjust upward and offering rates for new fixed-rate loans remained relatively low as the yield curve continued to flatten. In addition, changes in the average credit risk profile of new borrowers and competitive pricing pressure resulted in lower spreads and yields on new loan originations. These factors were somewhat offset by changes in the loan mix, as growth was most significant in some of the higher yielding adjustable-rate loan categories.
The combined average balance of mortgage-backed securities, investment securities, daily interest-bearing deposits and FHLB stock decreased by $98.3 million for the year ended December 31, 2005, and the interest and dividend income from those investments decreased by $4.5 million compared to the year ended December 31, 2004. The average yield on mortgage-backed securities increased to 4.50% for the year ended December 31, 2005, from 4.37% for the prior year, reflecting reduced amortization of purchase premiums on certain portions of the portfolio as well as a reduction in the adverse effects of delayed receipt of principal payments on mortgage-backed securities as a result of slower prepayments and modestly higher rates on the small portion of mortgage-backed securities that have adjustable interest rates. The average yield on other investment securities and cash equivalents increased to 4.34% for the year ended December 31, 2005, from 4.10% for the prior year, largely reflecting the effect of higher market rates on certain adjustable rate securities. Despite a $600,000 increase in the average balance invested, we did not record any dividend income from FHLB stock for the year ended December 31, 2005. By contrast, FHLB stock dividend income in the prior year was $1.2 million. Previously, dividends on FHLB stock had been established on a quarterly basis by vote of the Directors of the FHLB of Seattle; however, during the quarter ended December 31, 2004, the FHLB of Seattle announced that future dividends would be restricted while the FHLB attempted to improve its capital position. In the fourth quarter of 2006, the FHLB resumed paying dividends, although at a much reduced level compared to what was paid in 2004 and earlier periods.
Interest Expense. Interest expense for the year ended December 31, 2005 was $81.4 million, compared to $59.9 million for the prior year, an increase of $21.5 million, or 35.8%. The increase in interest expense was the result of the significant growth in interest-bearing liabilities
46
<PAGE>
combined with a 53 basis point increase in the average cost of all interest-bearing liabilities to 2.91% for the year ended December 31, 2005, from 2.38% for the prior year, reflecting the higher levels of market interest rates and the maturity of certain lower-costing certificates of deposit and fixed-rate borrowings. Deposit interest expense increased $17.2 million, or 49.0%, to $52.3 million for the year ended December 31, 2005 compared to $35.1 million for the prior year, as a result of the significant deposit growth as well as an increase in the cost of interest-bearing deposits. Reflecting the branch expansion and other growth initiatives, average deposit balances increased $313.1 million, or 17.3%, to $2.122 billion for the year ended December 31, 2005, from $1.809 billion for the year ended December 31, 2004, while the average rate paid on deposit balances increased 52 basis points to 2.46%. Although deposit costs are significantly affected by changes in the level of market interest rates, changes in the average rate paid for deposits tend to be less severe and to lag changes in market interest rates. This lower degree of volatility and lag effect for deposit pricing was evident in the modest increase in deposit costs as the Federal Reserve moved to increase short-term interest rates by 325 basis points from June 2003 to December 2005.
Average FHLB advances totaled $522.6 million during the year ended December 31, 2005, compared to $568.9 million during the year ended December 31, 2004, a decrease of $46.3 million, or 8.1%, which was offset by the effects of a 62 basis point increase in the average cost of advances, resulting in a $1.6 million increase in related interest expense. The average rate paid on FHLB advances increased to 4.19% for the year ended December 31, 2005, from 3.57% for year ended December 31, 2004. While FHLB advances are generally fixed-rate, fixed-term borrowings, many of our more recent advances carried relatively shorter terms and were established in periods when market rates were lower. Reflecting the maturity and repricing of these short-term advances, the increased cost in 2005 reflects new advances at then higher current market rates. Junior subordinated debentures had an average balance of $81.2 million and an average cost of 6.71% (including amortization of prepaid underwriting costs) for the year ended December 31, 2005. Junior subordinated debentures outstanding at the end of the prior year had an average balance of $68.6 million but a much lower average rate of 5.04%. The junior subordinated debentures are adjustable-rate instruments with repricing frequencies of three to six months. The increased cost of the junior subordinated debentures reflects increases in short-term market interest rates. Other borrowings primarily consist of retail repurchase agreements with customers and reverse repurchase agreements with investment banking firms secured by certain investment securities. The average balance for other borrowings decreased $4.6 million, or 6.3%, to $68.3 million for the year ended December 31, 2005, from $72.9 million for the same period in 2004, while the related interest expense increased $714,000, to $1.8 million from $1.1 million for the respective periods. The average balance of the wholesale borrowings from brokers decreased $15.9 million, which was nearly offset by a $11.4 million increase in the average balance of customer retail repurchase agreements and other short-term borrowings. The average rate paid on other borrowings was 2.58% in the year ended December 31, 2005, compared to 1.44% for 2004.
Provision and Allowance for Loan Losses. During the year ended December 31, 2005, the provision for loan losses was $4.9 million, compared to $5.6 million for the year ended December 31, 2004, a decrease of $741,000. The provision in the current year reflects lower levels of non-performing loans, improvement in the economic environment and strengthening in the prospects for collection on previously identified non-performing loans, balanced against changes in the mix and growth in the size of the loan portfolio. While net charge-offs were $3.6 million in 2005, compared to $2.1 million for the prior year, non-performing loans decreased $5.4 million to $10.5 million at December 31, 2005, compared to $15.9 million at December 31, 2004. For the two-year period, non-performing loans were primarily concentrated in a few agricultural loans and agricultural-related business loans due from borrowers located in northeastern Oregon. Generally, these problem loans reflected unique operating difficulties for the individual borrower rather than a weakness in the overall economy of the area, farm commodity prices or growing conditions. A comparison of the allowance for loan losses at December 31, 2005 and 2004 shows an increase of $1.3 million to $30.9 million at December 31, 2005, from $29.6 million at December 31, 2004. The allowance for loan losses as a percentage of total loans (loans receivable excluding allowance for losses) was 1.27% and 1.41% at December 31, 2005 and 2004, respectively. The allowance as a percentage of non-performing loans increased to 296% at December 31, 2005, compared to 186% a year earlier. As of December 31, 2005, we had identified $10.3 million of impaired loans as defined by SFAS No. 114 and had established $1.7 million of specific reserves for these loans.
Other Operating Income. Other operating income was $10.5 million for the year ended December 31, 2005, a decrease of $6.4 million from the prior year. However, as noted above, in the fourth quarter of 2005, as a part of its balance-sheet restructuring initiatives, we recorded $7.3 million of net loss on the sale of securities. Excluding the net loss on the sale of securities relating to the balance-sheet restructuring transactions, total other operating income increased to $17.8 million for the year ended December 31, 2005 compared to $17.0 million for the year ended December 31, 2004. Importantly, deposit fee and service charge income increased by $1.3 million, or 16.5%, to $9.5 million for the year ended December 31, 2005, compared to $8.1 million for the prior year, primarily reflecting growth in customer transaction accounts and increased merchant credit card services, although changes in certain pricing schedules also contributed to the increase. On the other hand, loan servicing fees declined by $289,000 to $1.5 million for the current year, from $1.7 million for the year ended December 31, 2004, as the portfolio of serviced loans decreased modestly and prepayment fees and other servicing charges declined. Partially offsetting the decline in loan servicing fees was a small improvement in the gain on sale of loans, which increased by $125,000 to $5.6 million for the year ended December 31, 2005, compared to $5.5 million for the prior year as mortgage banking activity improved modestly. Gain on sale of loans was somewhat adversely affected by the increase in capitalized loan origination costs discussed in the following paragraph, which had the effect of increasing the cost basis in loans held for sale, as well as by competitive pressures in the mortgage market which tended to reduce the margin on sales compared to the prior year. Loan sales for the year ended December 31, 2005 totaled $397.0 million, compared to $338.4 million for the year ended December 31, 2004. Gain on sale of loans included $531,000 of fees on $48.8 million of loans which were brokered and are not reflected in the volume of loans sold. Other miscellaneous income decreased $161,000, principally due to a decrease in the earnings from life insurance policies.
Other Operating Expenses. Other operating expenses increased $17.8 million, or 22.4%, to $97.5 million for the year ended December 31, 2005, from $79.7 million for the year ended December 31, 2004. Included in this amount is $6.1 million in penalties for the early prepayment of certain FHLB advances incurred in connection with the balance-sheet restructuring initiatives. Excluding these prepayment penalties, other operating expense increase $11.7 million, or 14.7%, compared to the prior year Other operating expenses reflect the growth in assets and liabilities, customer relationships and complexity of operations as we continued to expand. The higher level of operating expenses in 2005 included significant increases in compensation, occupancy and information services for additional branch, deposit services and commercial loan expansion to position us for future growth. In addition, compensation was higher as a result of increased mortgage loan commissions and general wage and salary increases, as well as increased costs associated with employee benefit programs and employer-paid taxes. These
47
<PAGE>
increases were mitigated to a degree by an increase in the amount of capitalized loan origination costs, which reflected increases in both the cost to produce and the volume of new loan originations. We also continued to increase our commitment to advertising and marketing, as expenditures for these items were $1.6 million greater in the year ended December 31, 2005 than in the prior year. The increase in expenses included operating costs associated with the opening of fourteen new branch offices at various times during 2004 and 2005, as well as costs associated with relocating or upgrading five additional offices over the same period. Our efficiency ratio increased to 81.75% for the year ended December 31, 2005 from 70.37% for the prior year, in large part reflecting the FHLB prepayment penalties and the related loss on sale of securities, but also reflecting the start up costs associated with this branch growth. Other operating expenses as a percentage of average assets increased to 3.20% for the year ended December 31, 2005 from 2.90% in the prior year. Excluding the effects of the balance-sheet restructuring charges, for the year ended December 31, 2005, the efficiency ratio and ratio of other operating expense to average assets would have been 72.23% and 3.00%, respectively.
Income Taxes: Income tax expense was $4.4 million for the year ended December 31, 2005, compared to $8.6 million for the prior year. Our effective tax rates for the years ended December 31, 2005 and 2004 were 26.3% and 30.7%, respectively. The lower effective tax rate in 2005 was primarily a result of a decrease in the relative amount of taxable income versus tax-exempt income compared to the prior year which occurred as a result of the charges associated with the balance-sheet restructuring transactions.
48
<PAGE>
Table 13, Analysis of Net Interest Spread, presents, for the periods indicated, our condensed average balance sheet information, together with interest income and yields earned on average interest earning assets and interest expense and rates paid on average interest bearing liabilities. Average balances are computed using daily average balances. (See footnotes.)
Table 13: Analysis of Net Interest Spread
(dollars in thousands)
|
Year Ended December 31, 2006 |
|
Year Ended December 31, 2005 |
|
Year Ended December 31, 2004 |
|
|||||||||||||||||||||
|
Interest-earning assets: |
Average Balance |
|
Interest & Dividends |
|
Yield/ Cost |
|
Average Balance |
|
Interest & Dividends |
|
Yield/ Cost |
|
Average Balance |
|
Interest & Dividends |
|
Yield/ Cost |
|
|||||||||
|
Mortgage loans |
$ |
2,109,162 |
|
$ |
172,908 |
|
|
8.20 |
% |
$ |
1,664,918 |
|
$ |
122,198 |
|
|
7.34 |
% |
$ |
1,374,037 |
|
$ |
95,483 |
|
|
6.95 |
% |
|
Commercial/agricultural loans |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer and other loans |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total loans (1) |
|
2,767,585 |
|
|
227,661 |
|
|
8.23 |
|
|
2,272,676 |
|
|
165,398 |
|
|
7.28 |
|
|
1,898,664 |
|
|
126,992 |
|
|
6.69 |
|
|
Mortgage-backed securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Securities and deposits |
|
137,543 |
|
|
7,462 |
|
|
5.43 |
|
|
263,789 |
|
|
11,455 |
|
|
4.34 |
|
|
272,446 |
|
|
11,176 |
|
|
4.10 |
|
|
FHLB stock dividends (reversal) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investment securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-earning assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest-earning assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
$ |
3,301,598 |
|
|
|
|
|
|
|
$ |
3,049,032 |
|
|
|
|
|
|
|
$ |
2,751,920 |
|
|
|
|
|
|
|
Interest-bearing liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Savings accounts |
$ |
243,275 |
|
|
9,188 |
|
|
3.78 |
|
$ |
159,842 |
|
|
3,474 |
|
|
2.17 |
|
$ |
71,466 |
|
|
973 |
|
|
1.36 |
|
|
Checking and NOW accounts (2) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Money market accounts |
|
283,814 |
|
|
10,891 |
|
|
3.84 |
|
|
300,059 |
|
|
7,524 |
|
|
2.51 |
|
|
240,723 |
|
|
4,243 |
|
|
1.76 |
|
| Certificates of deposit |
|
1,404,790 |
|
|
62,314 |
|
|
4.44 |
|
|
1,119,702 |
|
|
37,137 |
|
|
3.32 |
|
|
1,032,736 |
|
|
27,339 |
|
|
2.65 |
|
| Total deposits |
|
2,536,154 |
|
|
89,987 |
|
|
3.55 |
|
|
2,122,216 |
|
|
52,253 |
|
|
2.46 |
|
|
1,809,072 |
|
|
35,067 |
|
|
1.94 |
|
| Other interest-bearing liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
| FHLB advances |
|
295,228 |
|
|
14,354 |
|
|
4.86 |
|
|
522,624 |
|
|
21,906 |
|
|
4.19 |
|
|
568,908 |
|
|
20,336 |
|
|
3.57 |
|
| Other borrowings |
|
94,613 |
|
|
3,744 |
|
|
3.96 |
|
|
68,339 |
|
|
1,765 |
|
|
2.58 |
|
|
72,916 |
|
|
1,051 |
|
|
1.44 |
|
| Junior subordinated debentures |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total borrowings |
|
488,984 |
|
|
26,127 |
|
|
5.34 |
|
|
672,170 |
|
|
29,124 |
|
|
4.33 |
|
|
710,443 |
|
|
24,848 |
|
|
3.50 |
|
| Total interest-bearing liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Non-interest-bearing liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total liabilities |
|
3,064,027 |
|
|
|
|
|
|
|
|
2,827,542 |
|
|
|
|
|
|
|
|
2,542,210 |
|
|
|
|
|
|
|
| Stockholders' equity |
|
237,571 |
|
|
|
|
|
|
|
|
221,490 |
|
|
|
|
|
|
|
|
209,710 |
|
|
|
|
|
|
|
| Total liabilities and stockholders' equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Net interest income/rate spread |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Net interest margin |
|
|
|
|
|
|
|
4.08 |
% |
|
|
|
|
|
|
|
3.79 |
% |
|
|
|
|
|
|
|
3.71 |
% |
| Ratio of average interest- earning assets to average interest-bearing liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(footnotes follow tables)
49
<PAGE>
Table 13: Analysis of Net Interest Spread (dollars in thousands) (continued)
|
Year Ended December 31, 2003 |
|
Year Ended December 31, 2002 |
|
|
|
|||||||||||||||||||||
Interest-earning assets: |
Average Balance |
|
Interest & Dividends |
|
Yield/ Cost |
|
Average Balance |
|
Interest & Dividends |
|
Yield/ Cost |
|
|
|
|
|
|
|
|||||||||
| Mortgage loans | $ |
1,189,034 |
|
$ |
87,914 |
|
|
7.39 |
% |
$ |
1,180,199 |
|
$ |
95,342 |
|
|
8.08 |
% |
|
|
|
|
|
|
|
|
|
| Commercial/agricultural loans |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Consumer and other loans |
|
37,075 |
|
|
3,139 |
|
|
8.47 |
|
|
42,230 |
|
|
3,692 |
|
|
8.74 |
|
|
|
|
|
|
|
|
|
|
| Total loans (1) |
|
1,654,344 |
|
|
116,211 |
|
|
7.02 |
|
|
1,589,035 |
|
|
123,352 |
|
|
7.76 |
|
|
|
|
|
|
|
|
|
|
| Mortgage-backed securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Securities and deposits |
|
253,901 |
|
|
10,048 |
|
|
3.96 |
|
|
172,339 |
|
|
8,226 |
|
|
4.77 |
|
|
|
|
|
|
|
|
|
|
| FHLB stock |
|
33,581 |
|
|
1,863 |
|
|
5.55 |
|
|
31,587 |
|
|
1,960 |
|
|
6.21 |
|
|
|
|
|
|
|
|
|
|
| Total investment securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total interest-earning assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Non-interest-earning assets |
|
163,481 |
|
|
|
|
|
|
|
|
148,706 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total assets | $ |
2,443,629 |
|
|
|
|
|
|
|
$ |
2,151,160 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Interest-bearing liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
| Savings accounts | $ |
45,975 |
|
|
500 |
|
|
1.09 |
|
$ |
43,383 |
|
|
225 |
|
|
1.07 |
|
|
|
|
|
|
|
|
|
|
| Checking and NOW accounts (2) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Money market accounts |
|
176,855 |
|
|
3,161 |
|
|
1.79 |
|
|
146,504 |
|
|
1,592 |
|
|
2.18 |
|
|
|
|
|
|
|
|
|
|
| Certificates of deposit |
|
997,689 |
|
|
29,385 |
|
|
2.95 |
|
|
903,329 |
|
|
36,745 |
|
|
3.79 |
|
|
|
|
|
|
|
|
|
|
| Total deposits |
|
1,619,297 |
|
|
34,984 |
|
|
2.16 |
|
|
1,404,426 |
|
|
39,206 |
|
|
2.79 |
|
|
|
|
|
|
|
|
|
|
| Other interest-bearing liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
| FHLB advances |
|
513,819 |
|
|
21,842 |
|
|
4.25 |
|
|
451,816 |
|
|
24,094 |
|
|
5.33 |
|
|
|
|
|
|
|
|
|
|
| Other borrowings |
|
51,715 |
|
|
789 |
|
|
1.53 |
|
|
66,578 |
|
|
1,518 |
|
|
2.28 |
|
|
|
|
|
|
|
|
|
|
| Junior subordinated debentures |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total borrowings |
|
609,356 |
|
|
24,864 |
|
|
4.08 |
|
|
537,079 |
|
|
26,763 |
|
|
4.98 |
|
|
|
|
|
|
|
|
|
|
| Total interest-bearing liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Non-interest-bearing liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total liabilities |
|
2,247,388 |
|
|
|
|
|
|
|
|
1,954,682 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Stockholders' equity |
|
196,241 |
|
|
|
|
|
|
|
|
196,478 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total liabilities and stockholders' equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Net interest income/ rate spread |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Net interest margin |
|
|
|
|
|
|
|
3.53 |
% |
|
|
|
|
|
|
|
3.91 |
% |
|
|
|
|
|
|
|
|
|
Ratio of average interest- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) | Average balances include loans accounted for on a nonaccrual basis and loans 90 days or more past due. Amortized net deferred loan fees are included with interest and dividends on loans. |
| (2) | Average balances include non-interest-bearing deposits. |
50
<PAGE>
Table 14, Rate/Volume Analysis, sets forth the effects of changing rates and volumes on our net interest income. Information is provided with respect to (i) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate) and (ii) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume). Effects on interest income attributable to changes in rate and volume (changes in rate multiplied by changes in volume) have been allocated between changes in rate and changes in volume.
Table 14: Rate/Volume Analysis (in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||
|
Year Ended December 31, 2006 Compared to Year Ended December 31, 2005 Increase (Decrease) Due to |
|
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004 Increase (Decrease) Due to |
|
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003 Increase (Decrease) Due to |
|
||||||||||||||||||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||
Rate |
Volume |
Net |
Rate |
Volume |
Net |
Rate |
Volume |
Net |
||||||||||||||||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||
| Interest-earning assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||
| Mortgage loans | $ |
15,473 |
|
$ |
35,237 |
|
$ |
50,710 |
|
$ |
5,598 |
|
$ |
21,117 |
|
$ |
26,715 |
|
$ |
(5,473 |
) |
$ |
13,042 |
|
$ |
7,569 |
|
|||||||||||||||||||||||
| Commercial/agricultural loans |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||
| Consumer and other loans |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||
| Total loans (1) |
|
23,234 |
|
|
39,029 |
|
|
62,263 |
|
|
11,906 |
|
|
26,500 |
|
|
38,406 |
|
|
(5,687 |
) |
|
16,468 |
|
|
10,781 |
|
|||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||
| Mortgage-backed securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||
| Securities and deposits |
|
2,397 |
|
|
(6,390 |
) |
|
(3,993 |
) |
|
641 |
|
|
(362 |
) |
|
279 |
|
|
368 |
|
|
760 |
|
|
1,128 |
|
|||||||||||||||||||||||
| FHLB stock |
|
65 |
|
|
-- |
|
|
65 |
|
|
(1,229 |
) |
|
20 |
|
|
(1,209 |
) |
|
(769 |
) |
|
86 |
|
|
(683 |
) |
|||||||||||||||||||||||
| Total investment securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||
| Total net change in interest income on interest-earning assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||
| Interest-bearing liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||
| Deposits |
|
26,200 |
|
|
11,534 |
|
|
37,734 |
|
|
10,442 |
|
|
6,744 |
|
|
17,186 |
|
|
(3,773 |
) |
|
3,856 |
|
|
83 |
|
|||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||
| FHLB advances |
|
3,092 |
|
|
(10,644 |
) |
|
(7,552 |
) |
|
3,319 |
|
|
(1,749 |
) |
|
1,570 |
|
|
(3,705 |
) |
|
2,199 |
|
|
(1,506 |
) |
|||||||||||||||||||||||
| Junior subordinated debentures |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||
| Other borrowings |
|
1,247 |
|
|
1,329 |
|
|
2,576 |
|
|
1,014 |
|
|
(300 |
) |
|
714 |
|
|
(569 |
) |
|
831 |
|
|
262 |
|
|||||||||||||||||||||||
| Total borrowings |
|
6,102 |
|
|
(9,099 |
) |
|
(2,997 |
) |
|
5,615 |
|
|
(1,339 |
) |
|
4,276 |
|
|
(4,300 |
) |
|
4,284 |
|
|
(16 |
) |
|||||||||||||||||||||||
| Total net change in interest expense on interest-bearing liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||
| Net change in net interest income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||
| (1) | Average balances include loans accounted for on a nonaccrual basis and loans 90 days or more past due. Amortized net deferred loan fees are included with interest and dividends on loans. |
| (2) | Average balances include non-interest-bearing deposits. |
51
<PAGE>
Market Risk and Asset/Liability Management
Our financial condition and operations are influenced significantly by general economic conditions, including the absolute level of interest rates as well as changes in interest rates and the slope of the yield curve. Our profitability is dependent to a large extent on our net interest income, which is the difference between the interest received from our interest-earning assets and the interest expense incurred on our interest-bearing liabilities.
Our activities, like all financial institutions, inherently involve the assumption of interest rate risk. Interest rate risk is the risk that changes in market interest rates will have an adverse impact on the institution's earnings and underlying economic value. Interest rate risk is determined by the maturity and repricing characteristics of an institution's assets, liabilities and off-balance-sheet contracts. Interest rate risk is measured by the variability of financial performance and economic value resulting from changes in interest rates. Interest rate risk is the primary market risk affecting our financial performance.
The greatest source of interest rate risk to us results from the mismatch of maturities or repricing intervals for rate sensitive assets, liabilities and off-balance-sheet contracts. This mismatch or gap is generally characterized by a substantially shorter maturity structure for interest-bearing liabilities than interest-earning assets. Additional interest rate risk results from mismatched repricing indices and formulae (basis risk and yield curve risk), and product caps and floors and early repayment or withdrawal provisions (option risk), which may be contractual or market driven, that are generally more favorable to customers than to us. An exception to this generalization is the beneficial effect of interest rate floors on many of our floating-rate loans, which help us maintain higher loan yields in periods when market interest rates decline significantly. However, as of December 31, 2006, we have very few floating-rate loans with interest rates that had not increased to levels above their floors and therefore these loans should be responsive to modest decreases or increases in market rates should they occur. An additional exception to the generalization has been the beneficial effect of lagging and somewhat inelastic pricing adjustments for interest rates on certain deposit products in the current rising market interest rate environment. This beneficial effect is particularly relevant to the administered rates paid on certain checking, savings and money market accounts and contributed to our expanded net interest margin for the years ended December 31, 2004 and 2005. However, since the Federal Reserve ceased increasing market interest rates in June 2006, this lag effect has contributed to the recent narrowing of the net interest spread as deposit costs have continued to increase while asset yields have stabilized.
The principal objectives of asset/liability management are: to evaluate the interest rate risk exposure; to determine the level of risk appropriate given our operating environment, business plan strategies, performance objectives, capital and liquidity constraints, and asset and liability allocation alternatives; and to manage our interest rate risk consistent with regulatory guidelines and policies approved by the Board of Directors. Through such management, we seek to reduce the vulnerability of our earnings and capital position to changes in the level of interest rates. Our actions in this regard are taken under the guidance of the Asset/Liability Management Committee, which is comprised of members of our senior management. The Committee closely monitors our interest sensitivity exposure, asset and liability allocation decisions, liquidity and capital positions, and local and national economic conditions and attempts to structure the loan and investment portfolios and funding sources to maximize earnings within acceptable risk tolerances.
Sensitivity Analysis
Our primary monitoring tool for assessing interest rate risk is asset/liability simulation modeling, which is designed to capture the dynamics of balance sheet, interest rate and spread movements and to quantify variations in net interest income resulting from those movements under different rate environments. The sensitivity of net interest income to changes in the modeled interest rate environments provides a measurement of interest rate risk. We also utilize market value analysis, which addresses changes in estimated net market value of equity arising from changes in the level of interest rates. The net market value of equity is estimated by separately valuing our assets and liabilities under varying interest rate environments. The extent to which assets gain or lose value in relation to the gains or losses of liability values under the various interest rate assumptions determines the sensitivity of net equity value to changes in interest rates and provides an additional measure of interest rate risk.
The interest rate sensitivity analysis performed by us incorporates beginning-of-the-period rate, balance and maturity data, using various levels of aggregation of that data, as well as certain assumptions concerning the maturity, repricing, amortization and prepayment characteristics of loans and other interest-earning assets and the repricing and withdrawal of deposits and other interest-bearing liabilities into an asset/liability computer simulation model. We update and prepare simulation modeling at least quarterly for review by senior management and the directors. We believe the data and assumptions are realistic representations of our portfolio and possible outcomes under the various interest rate scenarios. Nonetheless, the interest rate sensitivity of our net interest income and net market value of equity could vary substantially if different assumptions were used or if actual experience differs from the assumptions used.
52
<PAGE>
Tables 15 and 15(a), Interest Rate Risk Indicators, set forth as of December 31, 2006 and 2005, the estimated changes in our net interest income over a one-year time horizon and the estimated changes in market value of equity based on the indicated interest rate environments.
Table 15: Interest Rate Risk Indicators (dollars in thousands) |
|
|||||||||||||||||||
|
|
|||||||||||||||||||
|
|
|
As of December 31, 2006 Estimated Change in |
|
||||||||||||||||
| Change (in Basis Points) in Interest Rates (1) |
|
|
Net Interest Income Next 12 Months |
|
Net Market Value |
|
||||||||||||||
|
+300 |
|
$ |
3,109 |
|
|
2.3 |
% |
$ |
(60,723 |
) |
|
(19.1 |
)% |
|||||||
|
+200 |
|
|
2,834 |
|
|
2.1 |
|
|
(38,829 |
) |
|
(12.2 |
) |
|||||||
|
+100 |
|
|
2,247 |
|
|
1.6 |
|
|
(17,010 |
) |
|
(5.3 |
) |
|||||||
|
0 |
|
|
0 |
|
|
0.0 |
|
|
0 |
|
|
0.0 |
|
|||||||
|
-100 |
|
|
(2,912 |
) |
|
(2.1 |
) |
|
10,808 |
|
|
3.4 |
|
|||||||
|
-200 |
|
|
(6,145 |
) |
|
(4.5 |
) |
|
199 |
|
|
0.1 |
|
|||||||
|
-300 |
|
|
(7,599 |
) |
|
(5.5 |
) |
|
(13,529 |
) |
|
(4.2 |
) |
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||
Table 15(a): Interest Rate Risk Indicators (dollars in thousands) |
|
|||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||
|
|
|
As of December 31, 2005 Estimated Change in |
|
||||||||||||||||
Change (in Basis Points) |
|
|
Net Interest Income Next 12 Months |
|
Net Market Value |
|
||||||||||||||
|
+300 |
|
$ |
2,517 |
|
|
2.1 |
% |
$ |
(70,641 |
) |
|
(25.0 |
)% |
|||||||
|
+200 |
|
|
2,269 |
|
|
1.9 |
|
|
(46,060 |
) |
|
(16.3 |
) |
|||||||
|
+100 |
|
|
1,301 |
|
|
1.1 |
|
|
(19,586 |
) |
|
(6.9 |
) |
|||||||
|
0 |
|
|
0 |
|
|
0.0 |
|
|
0 |
|
|
0.0 |
|
|||||||
|
-50 |
|
|
(949 |
) |
|
(0.8 |
) |
|
5,506 |
|
|
2.0 |
|
|||||||
|
-100 |
|
|
(2,464 |
) |
|
(2.1 |
) |
|
7,870 |
|
|
2.8 |
|
|||||||
|
-200 |
|
|
(5,257 |
) |
|
(4.5 |
) |
|
(3,307 |
) |
|
(1.2 |
) |
|||||||
(1) Assumes an instantaneous and sustained uniform change in market interest rates at all maturities.
Another although less reliable monitoring tool for assessing interest rate risk is "gap analysis." The matching of the repricing characteristics of assets and liabilities may be analyzed by examining the extent to which assets and liabilities are "interest sensitive" and by monitoring an institution's interest sensitivity "gap." An asset or liability is said to be interest sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets anticipated, based upon certain assumptions, to mature or reprice within a specific time period and the amount of interest-bearing liabilities anticipated to mature or reprice, based upon certain assumptions, within that same time period. A gap is considered positive when the amount of interest-sensitive assets exceeds the amount of interest-sensitive liabilities. A gap is considered negative when the amount of interest-sensitive liabilities exceeds the amount of interest-sensitive assets. Generally, during a period of rising rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to adversely affect net interest income.
Certain shortcomings are inherent in gap analysis. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as ARM loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Finally, the ability of some borrowers to service their debt may decrease in the event of a severe interest rate increase.
Tables 16 and 16(a), Interest Sensitivity Gap, present our interest sensitivity gap between interest-earning assets and interest-bearing liabilities at December 31, 2006 and 2005. The tables set forth the amounts of interest-earning assets and interest-bearing liabilities which are anticipated by us, based upon certain assumptions, to reprice or mature in each of the future periods shown. At December 31, 2006, total interest-bearing liabilities maturing or repricing within one year exceeded total interest-earning assets maturing or repricing in the same time period by $ 110 million, representing a one-year cumulative gap to total assets ratio of (3.15%).
Management is aware of the sources of interest rate risk and in its opinion actively monitors and manages it to the extent possible. The interest rate risk indicators and interest sensitivity gaps as of December 31, 2006 and 2005 are within our internal policy guidelines and management considers that our current level of interest rate risk is reasonable.
53
<PAGE>
Table 16: Interest Sensitivity Gap as of December 31, 2006
Within 6 Months |
|
After 6 Months Within 1 Year |
|
After 1 Year Within 3 Years |
|
After 3 Years Within 5 Years |
|
After 5 Years Within 10 Years |
|
Over 10 Years |
|
Total |
|
||||||||
|
(dollars in thousands) |
|
|||||||||||||||||||
Interest-earning assets: (1) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Construction loans |
$ |
738,442 |
|
$ |
3,185 |
|
$ |
9,360 |
|
$ |
1,058 |
|
$ |
-- |
|
$ |
-- |
|
$ |
752,045 |
|
| Fixed-rate mortgage loans |
|
79,519 |
|
|
59,703 |
|
|
165,946 |
|
|
91,286 |
|
|
99,725 |
|
|
50,380 |
|
|
546,559 |
|
| Adjustable-rate mortgage loans |
|
493,709 |
|
|
85,323 |
|
|
288,437 |
|
|
107,593 |
|
|
293 |
|
|
467 |
|
|
975,822 |
|
| Fixed-rate mortgage-backed securities |
|
8,014 |
|
|
8,724 |
|
|
25,377 |
|
|
19,528 |
|
|
26,291 |
|
|
23,169 |
|
|
111,103 |
|
| Adjustable-rate mortgage-backed securities |
|
4,113 |
|
|
4,346 |
|
|
12,243 |
|
|
8,906 |
|
|
16,262 |
|
|
-- |
|
|
45,870 |
|
| Fixed-rate commercial/agricultural loans |
|
44,426 |
|
|
27,168 |
|
|
54,535 |
|
|
23,201 |
|
|
3,797 |
|
|
107 |
|
|
153,234 |
|
| Adjustable-rate commercial/agricultural loans |
|
409,771 |
|
|
10,504 |
|
|
12,695 |
|
|
9,095 |
|
|
136 |
|
|
41 |
|
|
442,242 |
|
| Consumer and other loans |
|
51,021 |
|
|
7,539 |
|
|
13,503 |
|
|
22,182 |
|
|
5,493 |
|
|
5,904 |
|
|
105,642 |
|
| Investment securities and interest- earning deposits |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total rate sensitive assets |
|
1,863,835 |
|
|
220,402 |
|
|
627,317 |
|
|
288,595 |
|
|
160,593 |
|
|
129,110 |
|
|
3,289,852 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Interest-bearing liabilities: (2) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Regular savings and NOW accounts |
|
176,641 |
|
|
91,086 |
|
|
212,533 |
|
|
212,533 |
|
|
-- |
|
|
-- |
|
|
692,793 |
|
| Money market deposit accounts |
|
106,476 |
|
|
63,886 |
|
|
42,591 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
212,953 |
|
| Certificates of deposit |
|
754,149 |
|
|
610,268 |
|
|
141,230 |
|
|
38,303 |
|
|
12,016 |
|
|
508 |
|
|
1,556,474 |
|
| FHLB advances |
|
143,500 |
|
|
21,930 |
|
|
12,000 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
177,430 |
|
| Other borrowings |
|
26,359 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
26,359 |
|
| Junior subordinated debentures |
|
123,716 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
123,716 |
|
| Retail repurchase agreements |
|
76,397 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
428 |
|
|
-- |
|
|
76,825 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total rate sensitive liabilities |
|
1,407,238 |
|
|
787,170 |
|
|
408,354 |
|
|
250,836 |
|
|
12,444 |
|
|
508 |
|
|
2,866,550 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Excess (deficiency) of interest-sensitive assets over interest-sensitive liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Cumulative excess (deficiency) of interest- sensitive assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Cumulative ratio of interest-earning assets to interest-bearing liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Interest sensitivity gap to total assets |
|
13.06 |
% |
|
(16.21 |
)% |
|
6.26 |
% |
|
1.08 |
% |
|
4.24 |
% |
|
3.68 |
% |
|
12.11 |
% |
| Ratio of cumulative gap to total assets |
|
13.06 |
% |
|
(3.15 |
)% |
|
3.11 |
% |
|
4.19 |
% |
|
8.43 |
% |
|
12.11 |
% |
|
12.11 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(footnotes follow Table 16(a)
54
<PAGE>
Table 16(a): Interest Sensitivity Gap as of December 31, 2005
| Within 6 Months |
|
After 6 Months Within 1 Year |
|
After 1 Year Within 3 Years |
|
After 3 Years Within 5 Years |
|
After 5 Years Within 10 Years |
|
Over 10 Years |
|
Total |
|
||||||||
|
(dollars in thousands) |
|
|||||||||||||||||||
| Interest-earning assets: (1) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Construction loans |
$ |
452,056 |
|
$ |
4,028 |
|
$ |
3,405 |
|
$ |
520 |
|
$ |
311 |
|
$ |
63 |
|
$ |
460,383 |
|
| Fixed-rate mortgage loans |
|
84,444 |
|
|
51,036 |
|
|
144,571 |
|
|
104,386 |
|
|
105,529 |
|
|
36,253 |
|
|
526,219 |
|
| Adjustable-rate mortgage loans |
|
356,734 |
|
|
71,484 |
|
|
232,897 |
|
|
155,430 |
|
|
230 |
|
|
230 |
|
|
817,005 |
|
| Fixed-rate mortgage-backed securities |
|
15,480 |
|
|
11,456 |
|
|
35,772 |
|
|
24,071 |
|
|
32,035 |
|
|
14,666 |
|
|
133,480 |
|
| Adjustable-rate mortgage-backed securities |
|
3,950 |
|
|
3,638 |
|
|
11,960 |
|
|
10,117 |
|
|
22,367 |
|
|
-- |
|
|
52,032 |
|
| Fixed-rate commercial/agricultural loans |
|
49,335 |
|
|
18,706 |
|
|
45,458 |
|
|
17,298 |
|
|
3,632 |
|
|
70 |
|
|
134,499 |
|
| Adjustable-rate commercial/agricultural loans |
|
402,555 |
|
|
4,804 |
|
|
13,770 |
|
|
9,233 |
|
|
93 |
|
|
40 |
|
|
430,495 |
|
| Consumer and other loans |
|
46,609 |
|
|
6,755 |
|
|
13,836 |
|
|
8,284 |
|
|
5,545 |
|
|
533 |
|
|
81,562 |
|
| Investment securities and interest- earning deposits |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total rate sensitive assets |
|
1,472,708 |
|
|
177,736 |
|
|
532,625 |
|
|
357,930 |
|
|
192,609 |
|
|
91,140 |
|
|
2,824,748 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Interest-bearing liabilities: (2) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Regular savings and NOW accounts |
|
66,992 |
|
|
66,992 |
|
|
156,314 |
|
|
156,314 |
|
|
-- |
|
|
-- |
|
|
446,612 |
|
| Money market deposit accounts |
|
172,879 |
|
|
103,727 |
|
|
69,151 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
345,757 |
|
| Certificates of deposit |
|
594,720 |
|
|
304,896 |
|
|
250,606 |
|
|
38,716 |
|
|
13,143 |
|
|
22 |
|
|
1,202,103 |
|
| FHLB advances |
|
221,100 |
|
|
5,000 |
|
|
38,930 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
265,030 |
|
| Other borrowings |
|
44,683 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
44,683 |
|
| Junior subordinated debentures |
|
97,942 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
97,942 |
|
| Retail repurchase agreements |
|
51,497 |
|
|
107 |
|
|
134 |
|
|
-- |
|
|
428 |
|
|
-- |
|
|
52,166 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total rate sensitive liabilities |
|
1,249,813 |
|
|
480,722 |
|
|
515,135 |
|
|
195,030 |
|
|
13,571 |
|
|
22 |
|
|
2,454,294 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Excess (deficiency) of interest-sensitive assets over interest-sensitive liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Cumulative excess (deficiency) of interest- sensitive assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Cumulative ratio of interest-earning assets to interest-bearing liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Interest sensitivity gap to total assets |
|
7.33 |
% |
|
(9.96 |
)% |
|
(0.58 |
)% |
|
5.36 |
% |
|
5.89 |
% |
|
3.00 |
% |
|
12.18 |
% |
| Ratio of cumulative gap to total assets |
|
7.33 |
% |
|
(2.63 |
)% |
|
(2.06 |
)% |
|
3.30 |
% |
|
9.19 |
% |
|
12.18 |
% |
|
12.18 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(footnotes follow table)
55
<PAGE>
Footnotes for Tables 16 and 16(a): Interest Sensitivity Gap
(1) Adjustable-rate assets are included in the period in which interest rates are next scheduled to adjust rather than in the period in which they are due to mature, and fixed-rate assets are included in the period in which they are scheduled to be repaid based upon scheduled amortization, in each case adjusted to take into account estimated prepayments. Mortgage loans and other loans are not reduced for allowances for loan losses and non-performing loans. Mortgage loans, mortgage-backed securities, other loans and investment securities are not adjusted for deferred fees and unamortized acquisition premiums and discounts.
(2) Adjustable-rate liabilities are included in the period in which interest rates are next scheduled to adjust rather than in the period they are due to mature. Although regular savings, demand, NOW, and money market deposit accounts are subject to immediate withdrawal, based on historical experience management considers a substantial amount of such accounts to be core deposits having significantly longer maturities. For the purpose of the gap analysis, these accounts have been assigned decay rates to reflect their longer effective maturities. If all of these accounts had been assumed to be short-term, the one-year cumulative gap of interest-sensitive assets would have been $(577.8) million, or (16.5%) of total assets at December 31, 2006, and $(461.9) million, or (15.2%), at December 31, 2005. Interest-bearing liabilities for this table exclude certain non-interest-bearing deposits that are included in the average balance calculations reflected in Table 13, Analysis of Net Interest Spread.
Liquidity and Capital Resources
Our primary sources of funds are deposits, borrowings, proceeds from loan principal and interest payments and sales of loans, and the maturity of and interest income on mortgage-backed and investment securities. While maturities and scheduled amortization of loans and mortgage-backed securities are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by market interest rates, economic conditions and competition.
Our primary investing activity is the origination and purchase of loans. During the years ended December 31, 2006, 2005 and 2004, we purchased loans of $45 million, $23 million and $18 million, respectively, while loan originations, net of repayments, totaled $921 million, $720 million and $696 million, respectively. This activity was funded primarily by principal repayments on loans and securities, sales of loans, and deposit growth. During the years ended December 31, 2006, 2005 and 2004, we sold $442 million, $397 million and $338 million, respectively, of loans. Net deposit growth was $471 million, $397 million and $255 million for the years ended December 31, 2006, 2005 and 2004, respectively. FHLB advances decreased $88 million, $29.0 million and $29.0 million for the years ended December 31, 2006, 2005 and 2004, respectively. Other borrowings, including junior subordinated debentures, increased $32 million for the year ended December 31, 2006, increased $55 million for the year ended December 31, 2005, and increased $14 million for the year ended December 31, 2004.
We must maintain an adequate level of liquidity to ensure the availability of sufficient funds to accommodate deposit withdrawals, to support loan growth, to satisfy financial commitments and to take advantage of investment opportunities. During the years ended December 31, 2006, 2005 and 2004, we used our sources of funds primarily to fund loan commitments, to purchase securities, and to pay maturing savings certificates and deposit withdrawals. At December 31, 2006, we had outstanding loan commitments totaling $1.073 billion, including undisbursed loans in process and unused credit lines totaling $1.041 billion. While reflecting growth in the loan portfolio and lending activities, this level of commitments is proportionally consistent with our historical experience and does not represent a departure from normal operations. We generally maintain sufficient cash and readily marketable securities to meet short-term liquidity needs; however, our primary liquidity management practice is to increase or decrease short-term borrowings, including FHLB advances. We maintain a credit facility with the FHLB-Seattle, which provides for advances that in the aggregate may equal the lesser of 35% of Banner Bank's assets or adjusted qualifying collateral, up to a total possible credit line of $587 million at December 31, 2006. Advances under this credit facility totaled $177 million, or 5% of our assets, at December 31, 2006. We also have in place borrowing lines with certain correspondent banks with in aggregate total $95 million, none of which was drawn upon as of December 31, 2006.
At December 31, 2006, certificates of deposit amounted to $1.556 billion, or 56% of our total deposits, including $1.352 billion which were scheduled to mature within one year. While no assurance can be given as to future periods, historically, we have been able to retain a significant amount of its deposits as they mature. Management believes it has adequate resources and funding potential to meet our foreseeable liquidity requirements.
Banner Corporation is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended (BHCA), and the regulations of the Federal Reserve. Banner Bank, as a state-chartered, federally insured commercial bank, is subject to the capital requirements established by the FDIC.
The capital adequacy requirements are quantitative measures established by regulation that require Banner Corporation and Banner Bank to maintain minimum amounts and ratios of capital. The Federal Reserve requires Banner Corporation to maintain capital adequacy that generally parallels the FDIC requirements. The FDIC requires Banner Bank to maintain minimum ratios of Tier 1 total capital to risk-weighted assets as well as Tier 1 leverage capital to average assets. At December 31, 2006, Banner Corporation and Banner Bank exceeded all current regulatory capital requirements. (See Item 1, "Business-Regulation," and Note 18 of the Notes to the Consolidated Financial Statements for additional information regarding Banner Corporation's and Banner Bank's regulatory capital requirements.
56
<PAGE>
Table 17, Regulatory Capital Ratios, shows the regulatory capital ratios of Banner Corporation and its subsidiary, Banner Bank, as of December 31, 2006 and minimum regulatory requirements for Banner Bank to be categorized as "well-capitalized."
Table 17: Regulatory Capital Ratios
| Capital Ratios |
|
Banner Corporation |
|
Banner Bank |
|
"Well-capitalized" Minimum Ratio |
|
Total capital to risk-weighted assets |
|
11.80 |
% |
10.73 |
% |
10.00 |
% |
Tier 1 capital to risk-weighted assets |
|
9.53 |
|
9.58 |
|
6.00 |
|
Tier 1 leverage capital to average assets |
|
8.76 |
|
8.80 |
|
5.00 |
|
Effect of Inflation and Changing Prices
The Consolidated Financial Statements and related financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars, without considering the changes in relative purchasing power of money over time due to inflation. The primary effect of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant effect on a financial institution's performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
Contractual Obligations at December 31, 2006
|
Total |
|
Due In One Year Or Less |
|
Due In One to Three Years |
|
Due In Three To Five Years |
|
Due In More Than Five Years |
|
|||||
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Advances from Federal Home Loan Bank |
$ |
177,430 |
|
$ |
160,430 |
|
$ |
17,000 |
|
$ |
-- |
|
$ |
-- |
|
|
Junior subordinated debentures |
|
123,716 |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
123,716 |
|
|
Other borrowings |
|
103,184 |
|
|
102,756 |
|
|
-- |
|
|
-- |
|
|
428 |
|
|
Capital lease obligations |
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
Operating lease obligations |
|
27,461 |
|
|
5,216 |
|
|
7,640 |
|
|
4,108 |
|
|
10,497 |
|
|
Operating lease obligations-Termination |
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
-- |
|
|
Purchase obligations |
|
402 |
|
|
402 |
|
|
-- |
|
|
-- |
|
|
-- |
|
Construction-related obligations |
|
4,547 |
|
|
4,547 |
|
|
-- |
|
|
-- |
|
|
-- |
|
Total |
$ |
436,740 |
|
$ |
273,351 |
|
$ |
24,640 |
|
$ |
4,108 |
|
$ |
134,641 |
|
ITEM 7A - Quantitative and Qualitative Disclosures about Market Risk
See pages 52-56 of Management's Discussion and Analysis of Financial Condition and Results of Operations.
ITEM 8 - Financial Statements and Supplementary Data
For financial statements, see index on page 63.
ITEM 9 - Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Not applicable.
ITEM 9A - Controls and Procedures
The management of Banner Corporation is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Securities Exchange Act of 1934 (Exchange Act). A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that its objectives are met. Also, because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. As a result of these inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Further, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
57
<PAGE>
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) was carried out under the supervision and with the participation of our Chief Executive Officer, Chief Financial Officer and several other members of our senior management as of the end of the period covered by this report. Our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2006, our disclosure controls and procedures were effective in ensuring that the information required to be disclosed by us in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to our management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms.
(b) Changes in Internal Controls: In the quarter ended December 31, 2006, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Management's Annual Report on Internal Control over Financial Reporting: Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we included a report of management's assessment of the design and effectiveness of its internal controls as part of this Annual Report on Form 10-K for the year ended December 31, 2006. Our independent registered public accounting firm also attested to, and reported on, management's assessment of the effectiveness of internal control over financial reporting. Management's report and the independent registered public accounting firm's attestation report are included in out 2006 Financial Statements under the captions entitled "Management Report on Internal Control over Financial Reporting" and "Report of Independent Registered Public Accounting Firm."
None.
58
<PAGE>
ITEM 10 - Directors and Executive Officers of the Registrant
The information required by this item contained under the section captioned "Proposal - Election of Directors," "Meetings and Committees of the Board of Directors" and "Shareholder Proposals" in the Proxy Statement for the Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days after the end of our fiscal year, is incorporated herein by reference.
Information regarding the executive officers of the Registrant is provided herein in Part I, Item 1 hereof.
The information regarding our Audit Committee and Financial Expert included under the sections captioned "Meetings and Committees of the Board of Directors" and "Audit Committee Matters" in the Proxy Statement for the Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days after the end of our fiscal year, is incorporated herein by reference.
Reference is made to the cover page of this Annual Report and the section captioned "Section 16(a) Beneficial Ownership Reporting Compliance" of the Proxy Statement for the Annual Meeting of the Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days after the end of our fiscal year, regarding compliance with Section 16(a) of the Securities Exchange Act of 1934.
The Board of Directors adopted a Code of Business Conduct and Ethics for our officers (including its senior financial officers), directors, and employees. The Code of Business Conduct and Ethics requires our officers, directors, and employees to maintain the highest standards of professional conduct. A copy of the Code of Business Conduct and Ethics was filed as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2004.
Whistleblower Program and Protections
We subscribe to the Ethicspoint reporting system and encourage employees, customers, and vendors to call the Ethicspoint hotline at 1-866-ETHICSP (384-4277) or visit its website at www.Ethicspoint.com to report any concerns regarding financial statement disclosures, accounting, internal controls, or auditing matters. We will not retaliate against any of our officers or employees who raise legitimate concerns or questions about an ethics matter or a suspected accounting, internal control, financial reporting, or auditing discrepancy or otherwise assists in investigations regarding conduct that the employee reasonably believes to be a violation of Federal Securities Laws or any rule or regulation of the Securities Exchange Commission, Federal Securities Laws relating to fraud against shareholders or violations of applicable banking laws. Non-retaliation against employees is fundamental to our Code of Ethics and there are strong legal protections for those who, in good faith, raise an ethical concern or a complaint about their employer.
ITEM 11 - Executive Compensation
Information required by this item regarding management compensation and employment contracts, director compensation, and Compensation Committee interlocks and insider participation in compensation decisions is incorporated by reference to the sections captioned "Executive Compensation," "Directors' Compensation," and "Compensation Committee Matters," respectively, in the Proxy Statement for the Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days after the end of our fiscal year.
59
<PAGE>
The following table summarizes share and exercise price information about our equity compensation plans as of December 31, 2006.
| Plan Category: |
|
(a) Number of securities to be issued upon exercise of outstanding options warrants and rights |
|
(b) Weighted average exercise price of outstanding options, warrants and rights |
|
(c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a) |
|
||
Equity compensation plans approved by security holders: |
|
713,460 |
|
$ |
20.49 |
|
53,747 |
|
|
|
|
|
|
|
|
|
|
|
||
Equity compensation plans not approved by security holders: |
|
none |
|
n/a |
|
none |
|
||
|
|
|
|
|
|
|
|
|
||
|
Total |
|
713,460 |
|
|
|
53,747 |
|
|
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by reference to the section captioned "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement for the Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days after the end of our fiscal year.
(b) Security Ownership of Management
Information required by this item is incorporated herein by reference to the section captioned "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement for the Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days after the end of our fiscal year.
(c) Changes in Control
We are not aware of any arrangements, including any pledge by any person of our securities, the operation of which may at a subsequent date result in a change in control of Banner Corporation.
ITEM 13 - Certain Relationships and Related Transactions
The information required by this item contained under the section captioned "Transactions with Management" in the Proxy Statement for the Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days after the end of our fiscal year, is incorporated herein by reference.
ITEM 14 - Principal Accounting Fees and Services
The information required by this item contained under the section captioned "Independent Auditors" in the Proxy Statement for the Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days after the end of our fiscal year, is incorporated herein by reference.
60
<PAGE>
ITEM 15 - Exhibits and Financial Statement Schedules
|
(a) |
(1) |
Financial Statements |
|
|
|
|
|
|
|
|
|
See Index to Consolidated Financial Statements on page 63. |
|
|
|
|
|
|
|
|
(2) |
Financial Statement Schedules |
|
|
|
|
|
|
|
|
|
All financial statement schedules are omitted because they are not applicable or not required, or because the required information is included in the Consolidated Financial Statements or the Notes thereto or in Part 1, Item 1. |
|
|
|
|
|
|
(3) |
Exhibits |
|
|
|
|
|
|
|
See Index of Exhibits on page 109. |
|
|
|
|
|
(b) |
|
Exhibits |
|
|
|
|
|
|
|
See Index of Exhibits on page 109. |
|
61
<PAGE>
Signatures
|
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. |
||
|
|
|
|
|
Banner Corporation |
|
|
|
Date: March 14, 2007 |
|
/s/ D. Michael Jones |
|
|
|
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. |
||
|
|
|
|
|
|
/s/ D. Michael Jones |
|
/s/ Lloyd W. Baker |
|
|
|
Date: March 14, 2007 |
|
Date: March 14, 2007 |
|
|
|
|
|
|
/s/ David Casper |
|
/s/ Robert D. Adams |
|
|
|
Date: March 14, 2007 |
|
Date: March 14, 2007 |
|
|
|
|
|
|
/s/ Edward L. Epstein |
|
/s/Jesse G. Foster |
|
|
|
Date: March 14, 2007 |
|
Date: March 14, 2007 |
|
|
|
|
|
|
/s/ Gary Sirmon |
|
/s/ Dean W. Mitchell |
|
|
|
Date: March 14, 2007 |
|
Date: March 14, 2007 |
|
|
|
|
|
|
/s/ Brent A. Orrico |
|
/s/Wilber Pribilsky |
|
|
|
Date: March 14, 2007 |
|
Date: March 14, 2007 |
|
|
|
|
|
|
/s/ Michael M. Smith |
|
/s/Gordon E. Budke |
|
|
|
Date: March 14, 2007 |
|
Date: March 14, 2007 |
|
|
|
|
|
|
/s/ Constance H. Kravas |
|
|
|
|
|
Date: March 14, 2007 |
|
|
62
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
BANNER CORPORATION AND SUBSIDIARIES
(Item 8 and Item 15(a)(1))
63
<PAGE>
Report of Management
To the Stockholders:
The management of Banner Corporation (the Company) is responsible for the preparation, integrity, and fair presentation of its published financial statements and all other information presented in this annual report. The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and, as such, include amounts based on informed judgments and estimates made by management. In the opinion of management, the financial statements and other information herein present fairly the financial condition and operations of the Company at the dates indicated in conformity with accounting principles generally accepted in the United States of America.
Management is responsible for establishing and maintaining an effective system of internal control over financial reporting. The internal control system is augmented by written policies and procedures and by audits performed by an internal audit staff (assisted in certain instances by contracted external audit resources other than the independent registered public accounting firm), which reports to the Audit Committee of the Board of Directors. Internal auditors monitor the operation of the internal and external control system and report findings to management and the Audit Committee. When appropriate, corrective actions are taken to address identified control deficiencies and other opportunities for improving the system. The Audit Committee provides oversight to the financial reporting process. There are inherent limitations in the effectiveness of any system of internal control, including the possibility of human error and circumvention or overriding of controls. Accordingly, even an effective internal control system can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of an internal control system may vary over time.
The Audit Committee of the Board of Directors is comprised entirely of outside directors who are independent of the Company's management. The Audit Committee is responsible for the selection of the independent auditors. It meets periodically with management, the independent auditors and the internal auditors to ensure that they are carrying out their responsibilities. The Committee is also responsible for performing an oversight role by reviewing and monitoring the financial, accounting, and auditing procedures of the Company in addition to reviewing the Company's financial reports. The independent auditors and the internal auditors have full and free access to the Audit Committee, with or without the presence of management, to discuss the adequacy of the internal control structure for financial reporting and any other matters which they believe should be brought to the attention of the Committee.
D. Michael Jones, Chief Executive Officer
Lloyd W. Baker, Chief Financial Officer
Management Report on Internal Control over Financial Reporting
March 14, 2007
The management of Banner Corporation is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f).
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding controls. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Also, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management with the participation of the Chief Executive Officer and Chief Financial Officer assessed the effectiveness of Banner Corporation's internal control over financial reporting as of December 31, 2006. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.
Based on its assessment, Management concluded that Banner Corporation maintained effective internal control over financial reporting as of December 31, 2006.
Management's assessment of the effectiveness of internal control over financial reporting as of December 31, 2006 and 2005 has been audited by Moss Adams LLP, an independent registered public accounting firm, as stated in their attestation report that is included herein.
64
<PAGE>
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Banner Corporation and Subsidiaries
Walla Walla, Washington
We have audited the accompanying consolidated statements of financial condition of Banner Corporation and subsidiaries (the Company) as of December 31, 2006 and 2005, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity, and cash flows for the three years in the period ended December 31, 2006. We also have audited management's assessment included in the accompanying Management Report on Internal Control over Financial Reporting that Banner Corporation maintained effective internal control over financial reporting as of December 31, 2006 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements, an opinion on management's assessment, and an opinion on the effectiveness of the Banner Corporation and subsidiaries' internal control over financial reporting based on our audits.
We conducted our audits in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement in all material respects. Our audit of financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinion.
The Company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A Company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and Directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Banner Corporation and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, management's assessment that Banner Corporation and subsidiaries maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Furthermore, in our opinion, Banner Corporation and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
/s/Moss Adams LLP
Moss Adams LLP
Spokane, Washington
March 14, 2007
65
<PAGE>
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(in thousands, except shares)
December 31, 2006 and 2005
|
|
2006 |
|
|
2005 |
|
ASSETS |
|
|
|
|
|
|
Cash and due from banks |
$ |
73,385 |
|
$ |
116,448 |
|
Securities available for sale, cost $230,189 and $264,087 |
|
|
|
|
|
|
Encumbered |
|
27,107 |
|
|
19,579 |
|
Unencumbered |
|
199,046 |
|
|
240,705 |
|
|
|
226,153 |
|
|
260,284 |
|
|
|
|
|
|
|
|
Securities held to maturity, fair value $49,008 and $52,398 |
|
47,872 |
|
|
50,949 |
|
|
|
|
|
|
|
|
Federal Home Loan Bank stock |
|
35,844 |
|
|
35,844 |
|
Loans receivable: |
|
|
|
|
|
|
Held for sale, fair value $5,136 and $4,802 |
|
5,080 |
|
|
4,779 |
|
Held for portfolio |
|
2,960,910 |
|
|
2,434,952 |
|
Allowance for loan losses |
|
(35,535 |
) |
|
(30,898 |
) |
|
|
2,930,455 |
|
|
2,408,833 |
|
|
|
|
|
|
|
|
Accrued interest receivable |
|
23,272 |
|
|
17,395 |
|
Real estate owned held for sale, net |
|
918 |
|
|
315 |
|
Property and equipment, net |
|
58,003 |
|
|
50,205 |
|
Goodwill and other intangibles, net |
|
36,287 |
|
|
36,280 |
|
Deferred income tax asset, net |
|
7,533 |
|
|
7,606 |
|
Bank-owned life insurance |
|
38,527 |
|
|
36,930 |
|
Other assets |
|
17,317 |
|
|
19,466 |
|
|
$ |
3,495,566 |
|
$ |
3,040,555 |
|
LIABILITIES |
|
|
|
|
|
|
Deposits: |
|
|
|
|
|
|
Non-interest-bearing |
$ |
332,372 |
|
$ |
328,840 |
|
Interest-bearing transactions and savings accounts |
|
905,746 |
|
|
792,370 |
|
Interest-bearing certificates |
|
1,556,474 |
|
|
1,202,103 |
|
|
|
2,794,592 |
|
|
2,323,313 |
|
|
|
|
|
|
|
|
Advances from Federal Home Loan Bank |
|
177,430 |
|
|
265,030 |
|
Other borrowings |
|
103,184 |
|
|
96,849 |
|
| Junior subordinated debentures (issued in connection with Trust Preferred Securities) |
|
|
|
|
|
|
Accrued expenses and other liabilities |
|
36,888 |
|
|
29,503 |
|
Deferred compensation |
|
7,025 |
|
|
6,253 |
|
Income taxes payable |
|
2,504 |
|
|
-- |
|
|
|
3,245,339 |
|
|
2,818,890 |
|
COMMITMENTS AND CONTINGENCIES |
|
|
|
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS' EQUITY |
|
|
|
|
|
|
Preferred stock - $0.01 par value, 500,000 shares authorized, none issued |
|
-- |
|
|
-- |
|
| Common stock - $0.01 par value, 25,000,000 shares authorized, 13,201,418 shares issued: |
|
|
|
|
|
|
| 12,073,889 shares and 11,782,356 shares outstanding at December 31, 2006 and 2005, respectively |
|
135,149 |
|
|
130,573 |
|
Retained earnings |
|
120,206 |
|
|
96,783 |
|
Accumulated other comprehensive income (loss): |
|
|
|
|
|
|
| Unrealized gain (loss) on securities available for sale |
|
(2,852 |
) |
|
(2,736 |
) |
Unearned shares of common stock issued to Employee Stock Ownership Plan (ESOP) trust: at cost |
|
|
|
|
|
|
| 240,381 and 300,120 restricted shares outstanding at December 31, 2006 and 2005, respectively |
|
(1,987 |
) |
|
(2,480 |
) |
|
|
|
|
|
|
|
Carrying value of shares held in trust for stock related compensation plans |
|
(7,262 |
) |
|
(8,464 |
) |
Liability for common stock issued to deferred, stock related, compensation plan |
|
6,973 |
|
|
7,989 |
|
|
|
(289 |
) |
|
(475 |
) |
|
|
|
|
|
|
|
|
|
250,227 |
|
|
221,665 |
|
|
$ |
3,495,566 |
|
$ |
3,040,555 |
|
See notes to consolidated financial statements
66
<PAGE>
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except for per share data)
For the Years Ended December 31, 2006, 2005 and 2004
|
|
2006 |
|
|
2005 |
|
|
2004 |
|
INTEREST INCOME: |
|
|
|
|
|
|
|
|
|
Loans receivable |
$ |
227,661 |
|
$ |
165,398 |
|
$ |
126,992 |
|
Mortgage-backed securities |
|
7,860 |
|
|
13,336 |
|
|
16,882 |
|
Securities and cash equivalents |
|
7,498 |
|
|
11,426 |
|
|
12,356 |
|
|
|
243,019 |
|
|
190,160 |
|
|
156,230 |
|
INTEREST EXPENSE: |
|
|
|
|
|
|
|
|
|
Deposits |
|
89,987 |
|
|
52,253 |
|
|
35,067 |
|
Federal Home Loan Bank advances |
|
14,354 |
|
|
21,906 |
|
|
20,336 |
|
Other borrowings |
|
3,744 |
|
|
1,765 |
|
|
1,051 |
|
Junior subordinated debentures |
|
8,029 |
|
|
5,453 |
|
|
3,461 |
|
|
|
116,114 |
|
|
81,377 |
|
|
59,915 |
|
Net interest income before provision for loan losses |
|
126,905 |
|
|
108,783 |
|
|
96,315 |
|
|
|
|
|
|
|
|
|
|
|
PROVISION FOR LOAN LOSSES |
|
5,500 |
|
|
4,903 |
|
|
5,644 |
|
Net interest income |
|
121,405 |
|
|
103,880 |
|
|
90,671 |
|
|
|
|
|
|
|
|
|
|
|
|
OTHER OPERATING INCOME: |
|
|
|
|
|
|
|
|
|
Deposit fees and other service charges |
|
11,417 |
|
|
9,476 |
|
|
8,132 |
|
Mortgage banking operations |
|
5,824 |
|
|
5,647 |
|
|
5,522 |
|
Loan servicing fees |
|
1,299 |
|
|
1,452 |
|
|
1,741 |
|
Gain (loss) on sale of securities |
|
65 |
|
|
(7,302 |
) |
|
141 |
|
Miscellaneous |
|
1,970 |
|
|
1,271 |
|
|
1,432 |
|
Total other operating income |
|
20,575 |
|
|
10,544 |
|
|
16,968 |
|
|
|
|
|
|
|
|
|
|
|
|
OTHER OPERATING EXPENSES: |
|
|
|
|