FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended ........................ MARCH 31, 2001 -------------- [ ] 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 91-1691604 ------------ ------------ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 10 S. FIRST AVENUE WALLA WALLA, WASHINGTON 99362 ---------------------------------------------------------- (Address of principal executive offices and zip code) (509) 527-3636 ------------------ (Registrant's telephone number, including area code) (Former name, former address and former fiscal year, if changed since last report.) 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. (1) Yes [X] No [ ] APPLICABLE ONLY TO CORPORATE ISSUERS Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Title of class: As of April 30, 2001 --------------- -------------------- Common stock, $.01 par value 11,896,226 shares * * Includes 633,278 shares held by employee stock ownership plan (ESOP) that have not been released, committed to be released, or allocated to participant accounts.
BANNER CORPORATION AND SUBSIDIARIES Table of Contents PART I - FINANCIAL INFORMATION ITEM 1 - Financial Statements. The Consolidated Financial Statements of Banner Corporation and Subsidiaries filed as a part of the report are as follows: Consolidated Statements of Financial Condition as of March 31, 2001 and December 31, 2000............................... 2 Consolidated Statements of Income for the Quarters Ended March 31, 2001 and 2000........................... 3 Consolidated Statements of Comprehensive Income for the Quarters ended March 31, 2001 and 2000........................... 4 Consolidated Statements of Changes in Stockholders' Equity for the Quarters Ended March 31, 2001 and 2000............................5 Consolidated Statements of Cash Flows for the Quarters Ended March 31, 2001 and 2000........................... 7 Selected Notes to Consolidated Financial Statements...................... 9 ITEM 2 - Management's Discussion and Analysis of Financial Condition and Results of Operation General................................................................. 13 Recent Developments and Significant Events.............................. 14 Comparison of Financial Condition at March 31, 2001 and December 31, 2000...................................................... 14 Comparison of Results of Operations for the Quarters Ended March 31, 2001 and 2000.......................................................... 14 Asset Quality........................................................... 20 Market Risk and Asset/Liability Management.............................. 21 Liquidity and Capital Resources......................................... 24 Capital Requirements.................................................... 25 PART II - OTHER INFORMATION Item 1. Legal Proceedings............................................ 26 Item 2. Changes in Securities........................................ 26 Item 3. Defaults upon Senior Securities.............................. 26 Item 4. Submission of Matters to a Vote of Stockholders.............. 26 Item 5. Other Information............................................ 26 Item 6. Exhibits and Reports on Form 8-K............................. 26 SIGNATURES.................................................................. 27 1
BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (in thousands, except shares) March 31, 2001 and December 31, 2000 (Unaudited) March 31 December 31 ASSETS 2001 2000 ----------- ---------- Cash and due from banks $ 55,981 $ 67,356 Securities available for sale, cost $292,680 and $310,539 Encumbered 60,401 66,405 Unencumbered 233,836 242,393 ----------- ---------- 294,237 308,798 Securities held to maturity, fair value $17,141 and $18,269 17,064 17,717 Federal Home Loan Bank stock 29,269 28,807 Loans receivable: Held for sale, fair value $30,161 and $8,011 29,755 7,934 Held for portfolio 1,506,630 1,479,149 Allowance for loan losses (15,980) (15,314) ----------- ---------- 1,520,405 1,471,769 Accrued interest receivable 12,634 12,963 Real estate owned, held for sale, net 5,097 3,287 Property and equipment, net 17,687 17,746 Costs in excess of net assets acquired (goodwill), net 33,822 34,617 Deferred income tax asset, net 1,157 2,337 Bank owned life insurance 19,408 14,190 Other assets 4,244 3,244 ----------- ---------- $ 2,011,005 $1,982,831 LIABILITIES =========== ========== Deposits: Non-interest-bearing $ 133,318 $ 140,779 Interest-bearing 1,085,359 1,051,936 ----------- ---------- 1,218,677 1,192,715 Advances from Federal Home Loan Bank 502,583 507,098 Other borrowings 69,972 74,538 Accrued expenses and other liabilities 16,730 10,857 Deferred compensation 2,392 2,293 Income taxes payable 3,368 1,535 ----------- ---------- 1,813,722 1,789,036 STOCKHOLDERS' EQUITY Preferred stock - $0.01 par value, 500,000 shares authorized, no shares issued - -- Common stock - $0.01 par value, 27,500,000 shares authorized, 13,201,418 shares issued: 11,893,753 shares and 12,005,302 shares outstanding at March 31, 2001 and December 31, 2000, respectively 131,955 133,839 Retained earnings 69,889 66,893 Accumulated other comprehensive income: Unrealized gain (loss) on securities available for sale 993 (1,125) Unearned shares of common stock issued to Employee Stock Ownership Plan (ESOP) trust: 633,278 and 633,278 restricted shares outstanding at March 31, 2001 and December 31, 2000, respectively, at cost (5,234) (5,234) Carrying value of shares held in trust for stock related compensation plans (2,872) (3,130) Liability for common stock issued to deferred, stock related, compensation plan 2,552 2,552 ----------- ---------- (320) (578) ----------- ---------- 197,283 193,795 ----------- ---------- $ 2,011,005 $1,982,831 =========== ========== See notes to consolidated financial statements
2 BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (in thousands except for per share amounts) Quarters Ended March 31 --------------------- 2001 2000 INTEREST INCOME: ------ ------ Loans receivable $ 34,662 $ 29,932 Mortgage-backed securities 3,272 3,955 Securities and deposits 2,644 2,743 -------- -------- 40,578 36,630 INTEREST EXPENSE: Deposits 14,219 11,762 Federal Home Loan Bank advances 7,820 7,036 Other borrowings 1,068 1,187 -------- -------- 23,107 19,985 -------- -------- Net interest income before provision for loan losses 17,471 16,645 PROVISION FOR LOAN LOSSES 950 545 -------- -------- Net interest income 16,521 16,100 OTHER OPERATING INCOME: Loan servicing fees 310 232 Other fees and service charges 1,463 1,157 Gain on sale of loans 861 187 Gain (loss) on sale of securities -- -- Miscellaneous 231 55 -------- -------- Total other operating income 2,865 1,631 OTHER OPERATING EXPENSES: Salary and employee benefits 7,379 6,256 Less capitalized loan origination costs (1,065) (791) Occupancy and equipment 1,859 1,677 Information/computer data services 643 575 Advertising 203 160 Deposit insurance 56 54 Amortization of goodwill 795 792 Miscellaneous 2,241 2,087 -------- -------- Total other operating expenses 12,111 10,810 -------- -------- Income before provision for income taxes 7,275 6,921 PROVISION FOR INCOME TAXES 2,626 2,496 -------- -------- NET INCOME $ 4,649 $ 4,425 ======== ======== Net income per common share, see Note 5: Basic $ .41 $ .39 Diluted $ .40 $ .38 Cumulative dividends declared per common share: $ .14 $ .13 3
BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) (in thousands) Quarters Ended March 31 ------------------- 2001 2000 ------ ------ NET INCOME: $ 4,649 $ 4,425 OTHER COMPREHENSIVE INCOME (LOSS) NET OF INCOME TAXES: Unrealized holding gain (loss) during the period, net of deferred income tax (benefit) of $1,180 and $1, 2,118 20 respectively. Less adjustment for gains included in net income, net of income tax of $0 and $0 -- -- ------- ------- Other comprehensive income (loss) 2,118 20 ------- ------- COMPREHENSIVE INCOME $ 6,767 $ 4,445 ======= ======= 4
BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited) ( in thousands) For the Quarters Ended March 31, 2001 and 2000 2001 2000 --------- --------- COMMON STOCK AND ADDITIONAL PAID-IN CAPITAL: Balance, beginning of period $ 133,839 $ 123,204 Purchase of forfeited shares from MRP -- (11) Net proceeds (cost) of treasury stock reissued for exercised stock options 28 113 Purchase and retirement of treasury stock (1,912) (1,599) --------- --------- Balance, end of period 131,955 121,707 RETAINED EARNINGS: Balance, beginning of period 66,893 69,170 Net income 4,649 4,425 Cash dividends (1,653) (1,529) --------- --------- Balance, end of period 69,889 72,066 ACCUMULATED OTHER COMPREHENSIVE INCOME: Balance, beginning of period (1,125) (5,331) Other comprehensive income (loss), net of related income taxes 2,118 20 --------- --------- Balance, end of period 993 (5,311) UNEARNED, RESTRICTED ESOP SHARES AT COST: Balance, beginning of period (5,234) (6,162) Release of earned ESOP shares -- -- --------- --------- Balance, end of period (5,234) (6,162) CARRYING VALUE OF SHARES HELD IN TRUST FOR STOCK-RELATED COMPENSATION PLANS: Balance, beginning of period (578) (1,708) Net change in number and/or valuation of shares held in trust -- 11 Amortization of compensation related to MRP 258 280 --------- --------- Balance, end of period (320) (1,417) --------- --------- TOTAL STOCKHOLDERS' EQUITY $ 197,283 $ 180,883 ========= ========= 5
BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited) (continued) ( in thousands) For the Quarters Ended March 31, 2001 and 2000 2001 2000* --------- --------- COMMON STOCK , SHARES ISSUED: Number of shares, beginning of period 13,201 13,201 --------- --------- Number of shares, end of period 13,201 13,201 --------- --------- LESS TREASURY STOCK PURCHASED AND RETIRED: Number of shares, beginning of period (1,196) (864) Purchase of shares forfeited from MRP -- (1) Reissuance of treasury stock to deferred compensation plan and/or exercised stock options 3 25 Purchase and retirement of treasury stock (114) (124) --------- --------- Number of shares retired/repurchased, end of period (1,307) (964) --------- --------- Shares issued and outstanding, end of period 11,894 12,237 ========= ========= UNEARNED, RESTRICTED ESOP SHARES: Number of shares, beginning of period (633) (746) Release of earned shares -- -- --------- --------- Number of shares, end of period (633) (746) ========= ========= *Adjusted for stock dividend, see note 2 6
BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (in thousands) For the Quarters Ended March 31, 2001 and 2000 2001 2000 -------- -------- OPERATING ACTIVITIES Net income $ 4,649 $ 4,425 Adjustments to reconcile net income to net cash provided by operating activities: Deferred taxes -- -- Depreciation 686 628 Loss (gain) on sale of securities -- -- Net amortization of premiums and discounts on investments (32) 37 Increase in cash surrender value of bank owned life insurance (218) (44) Amortization of costs in excess of net assets acquired 795 792 Amortization of MRP compensation liability 258 280 Loss (gain) on sale of loans (805) (173) Net changes in deferred loan fees, premiums and discounts (60) 245 Loss (gain) on disposal of real estate held for sale 16 2 Loss (gain) on disposal of property and equipment (15) 8 Amortization of mortgage servicing rights 130 68 Capitalization of mortgage servicing rights from sale of mortgages with servicing retained (56) (14) Provision for losses on loans and real estate held for sale 950 554 FHLB stock dividend (462) (403) Net change in: Loans held for sale (21,821) (2,373) Accrued interest receivable 329 (1,404) Other assets (1,050) 589 Deferred compensation 99 141 Accrued expenses and other liabilities 5,889 4,644 Income taxes payable 1,833 2,343 -------- -------- Net cash provided (used) by operating activities (8,885) 10,345 -------- -------- INVESTING ACTIVITIES: Purchases of securities available for sale (8,000) (10,751) Principal repayments and maturities of securities available for sale 25,891 8,577 Proceeds from sales of securities available for sale -- - Purchases of securities held to maturity -- (3,249) Principal repayments and maturities of securities held to maturity 653 114 Net sales (purchases) of FHLB stock -- (866) Origination of loans, net of principal repayments (75,466) (61,246) Purchases of loans and participating interest in loans (489) (4,665) Proceeds from sales of loans and participating interest in loans 47,006 15,896 Purchases of property and equipment (635) (1,034) Proceeds from sale of property and equipment 23 10 Additional capitalized costs of real estate held for sale, net of insurance proceeds (71) (33) Proceeds from sale of real estate held for sale 397 369 Funds transferred to deferred compensation plan trusts (24) (61) Investment in bank owned life insurance (5,000) - -------- -------- Net cash used by investing activities (15,715) (56,939) -------- -------- (Continued on next page) 7
BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (in thousands) For the Quarters Ended March 31, 2001 and 2000 (Continued from prior page) 2001 2000 -------- -------- FINANCING ACTIVITIES Increase (decrease) in deposits $ 25,962 $ 45,570 Proceeds from FHLB advances 69,465 236,000 Repayment of FHLB advances (73,980) (206,172) Proceeds from repurchase agreement borrowings -- Repayments of repurchase agreement borrowings (5,432) (1,561) Increase (decrease) in other borrowings 763 (6,573) Cash dividends paid (1,669) (1,323) Net (cost) proceeds of exercised stock options 28 113 Repurchases of stock, net of forfeitures (1,912) (1,599) -------- -------- Net cash provided by financing activities 13,225 64,455 -------- -------- NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS (11,375) 17,861 CASH AND DUE FROM BANKS, BEGINNING OF PERIOD 67,356 44,769 -------- -------- CASH AND DUE FROM BANKS, END OF PERIOD $ 55,981 $ 62,630 ======== ======== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest paid $ 22,685 $ 19,251 Taxes paid $ 792 $ 150 Non-cash transactions: Loans, net of discounts, specific loss allowances and unearned income transferred to real estate owned $ 2,152 $ 605 Net change in accrued dividends payable $ 16 $ 206 Net change in unrealized gain (loss) in deferred compensation trust and related liability $ -- $ 59 Treasury stock forfeited by MRP $ -- $ 11 Treasury stock issued to MRP $ -- $ -- 8
BANNER CORPORATION AND SUBSIDIARIES SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1: BASIS OF PRESENTATION Banner Corporation (BANR or the Company) is a bank holding company incorporated in the State of Washington. The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly owned subsidiaries, Banner Bank (BB) and Banner Bank of Oregon (BBO) (together, the Banks). BB is a Washington-chartered commercial bank the deposits of which are insured by the Federal Deposit Insurance Corporation (FDIC) under both the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF). BB conducts business from its main office in Walla Walla, Washington, and its 32 branch offices and four loan production offices located in Washington, Oregon and Idaho. BBO is an Oregon-chartered commercial bank and its deposits are insured by the FDIC under BIF. BBO conducts business from its main office in Hermiston, Oregon, and its six branch offices and one loan production office located in northeast Oregon. The Company and its Bank subsidiaries are subject to regulation by the Federal Reserve Board (FRB) and the FDIC. In addition BB and BBO are subject to the state banking regulations applicable to their state charters. 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 reclassifications 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. Changes in these estimates and assumptions are considered reasonably possible and may have a material impact on the financial statements. Certain reclassifications have been made to the 2000 financial statements and/or schedules to conform to the 2001 presentation. These reclassifications may have affected certain ratios for the prior periods. The effect of such reclassifications is considered immaterial. All significant intercom any transactions and balances have been eliminated. The information included in this Form 10-Q should be read in conjunction with Banner Corporation's 2000 Annual Report on Form 10-K to the Securities and Exchange Commission. Interim results are not necessarily indicative of results for a full year. NOTE 2: RECENT DEVELOPMENTS AND SIGNIFICANT EVENTS Name Change/Consolidation of Banking Operations: On October 30, 2000 First Washington Bancorp, Inc. (FWWB) changed its name to Banner Corporation in conjunction with a consolidation of banking operations affecting its banking subsidiaries. Towne Bank (TB) merged with First Savings Bank of Washington (FSBW), FSBW converted from a Washington state-chartered savings bank to a Washington state-chartered commercial bank and changed its name, along with the names of its divisions, Whatcom State Bank and Seaport Citizens Bank, to Banner Bank. At the same time, Inland Empire Bank (IEB) changed its name to Banner Bank of Oregon. The combination was designed to strengthen the Company's commitment to community banking by more effectively sharing the resources of the existing subsidiaries, improving operating efficiency and developing a broader regional brand identity. Final integration of all data processing into a common system is scheduled for completion by December 31, 2001. In light of the new Gramm-Leach-Bliley financial modernization legislation, the Company chose to retain a separate charter for Banner Bank of Oregon (formerly IEB) and to operate two banking subsidiaries. That recent legislation enacts Federal Home Loan Bank System reforms that impact community financial institutions. A community financial institution is defined as a "member of the Federal Home Loan Bank (FHLB) System, the deposits of which are insured by the FDIC and that has average total assets (over the preceding three years) of less than $500 million." One provision of the reforms provides community financial institutions with the ability to obtain long-term FHLB advances to fund small business, small farm and small agribusiness loans. In addition, community financial institutions are able to offer these loans as collateral for such borrowings. This provision, which represents a change in policy from the previous requirement that these funds be securitized primarily by residential mortgage loans, will be available only to community financial institutions. As an independent subsidiary, Banner Bank of Oregon currently qualifies as a community financial institution. Merging BBO into BB would disqualify it and remove this favorable status. On the other hand, consolidation of support operations continues and the Company expects to receive long-term benefits from the proposed 9
efficiencies. The Banks use one name, Banner Bank, and are united under the leadership of an experienced management team. The same ten individuals serve as members of the Board of Directors of Banner Corporation and each of the Banks. Declaration of 10% Stock Dividend: On October 19, 2000 BANR's Board of Directors declared a 10% stock dividend payable November 10, 2000 to shareholders of record on October 31, 2000. All earnings per share and share data have been adjusted to reflect the 10% stock dividend. Mortgage Lending Subsidiary: On April 1, 2000 BB opened a new mortgage lending subsidiary, Community Financial Corporation (CFC), located in the Lake Oswego area of Portland, Oregon, with John Satterberg as President. Primary lending activities for CFC are in the area of construction and permanent financing for one- to four-family residential dwellings. CFC, an Oregon corporation, functions as a wholly owned subsidiary of Banner Bank. BB has capitalized CFC with $2 million of equity capital and provides funding support for CFC's lending operations. Recent Accounting Standard Not Yet Adopted: In September 2000, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 140 Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, which revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but carries over most of the provisions of SFAS No. 125 without reconsideration. SFAS No. 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. The provisions of this statement are not expected to have a material effect on the Company's financial position or results of operations. NOTE 3: BUSINESS SEGMENTS The Company presently is managed by legal entity or Bank, not by lines of business. Each Bank is managed by its management team that is responsible for its own lending, deposit operations, information systems and administration. Marketing support, sales training assistance, credit card administration and human resource services are provided from a central source at BB, and costs are allocated to the individual Banks using appropriate methods based on usage. In addition, corporate overhead and centralized administrative costs are allocated to each Bank. BB is a community oriented commercial bank chartered in the State of Washington. As explained above under Consolidation of Banking Operations in Note 2, BB includes the operation of the former First Saving Bank of Washington including its divisions Whatcom State Bank and Seaport Citizens Bank, and the former Towne Bank. BB offers a wide variety of deposit products to its consumer and commercial customers. Lending activities include the origination of real state, commercial/agriculture business and consumer loans. BB's primary business is that of a traditional banking institution, gathering deposits and originating loans for portfolio in its primary market area. BB is also an active participant in the secondary market, originating residential loans for sale on both a servicing released and servicing retained basis. In addition to interest income on loans and investment securities, BB receives other income from deposit servicing charges, loan servicing fees and from the sale of loans and investments. On April 1, 2000, BB opened a new mortgage lending subsidiary, Community Financial Corporation (CFC), located in the Lake Oswego area of Portland, Oregon. CFC's primary lending activities are in the area of construction and permanent financing for one- to four-family residential dwellings. BBO (formerly IEB) is a community oriented commercial bank chartered in the State of Oregon which historically has offered a wide variety of deposit and loan products to its consumer and commercial customers. Lending activities have included origination of consumer, commercial, agribusiness and real estate loans. BBO also has engaged in mortgage banking activity with respect to residential lending within its local markets and originating loans for sale generally on a servicing released basis. BBO operates a division, Inland Financial Services, which offers insurance and brokerage services to its customers. The performance of each Bank is reviewed by the Company's executive management team and the Board of Directors on a monthly basis. 10
NOTE 3: BUSINESS SEGMENTS (CONTINUED) Financial highlights by legal entity were as follows: Quarter Ended March 31, 2001 --------------------------------------------- (dollars in thousands) Condensed Income Statement BB BBO Other * Total ----------- --------- ------ ---------- Net interest income $ 14,783 $ 2,664 $ 24 $ 17,471 Provision for loan losses 905 45 -- 950 Other income 2,376 489 -- 2,865 Other expenses 9,719 1,858 534 12,111 ----------- --------- ------ ---------- Income (loss) before income taxes 6,535 1,250 (510) 7,275 Income taxes (benefit) 2,235 571 (180) 2,626 ----------- --------- ------ ---------- Net income (loss) $ 4,300 $ 679 $ (330) $ 4,649 =========== ========= ====== ========== March 31, 2001 -------------------------------------------- Total Assets $ 1,779,972 $ 230,120 $ 913 $2,011,005 =========== ========= ====== ========== Quarter Ended March 31, 2000 ---------------------------------------------------- (dollars in thousands) Condensed Income Statement TB Now merged BB BBO into BB Other* Total ---------- -------- -------- ------ -------- Net interest income $ 9,983 $ 2,605 $ 4,040 $ 17 $ 16,645 Provision for loan losses 275 70 200 -- 545 Other income 816 436 393 (14) 1,631 Other expenses 5,910 1,765 2,675 460 10,810 ---------- -------- -------- ------ -------- Income (loss) before income taxes 4,614 1,206 1,558 (457) 6,921 Income taxes (benefit) 1,429 558 669 (160) 2,496 ---------- -------- -------- ------ -------- Net income (loss) $ 3,185 $ 648 $ 889 $ (297) $ 4,425 ========== ======== ======== ====== ======== March 31, 2000 ----------------------------------------------------- Total Assets $1,350,352 $221,412 $324,113 $ 474 $1,896,351 ========== ======== ======== ====== ========== * Includes intercompany eliminations and holding company amounts. 11
NOTE 4: ADDITIONAL INFORMATION REGARDING INTEREST-BEARING DEPOSITS AND SECURITIES The following table sets forth additional detail on BANR's interest-bearing deposits and securities at the dates indicated (at carrying value) (in thousands): March 31 December 31 2001 2000 ---- ---- Interest-bearing deposits included in cash and due from banks $ 11,192 $ 15,661 Mortgage-backed securities 198,351 194,073 Other securities-taxable 81,160 100,261 Other securities-tax exempt 27,969 28,212 Other stocks with dividends 3,821 3,969 -------- -------- Total securities 311,301 326,515 Federal Home Loan Bank (FHLB) stock 29,269 28,807 -------- -------- $351,762 $370,983 ======== ======== The following table provides additional detail on income from deposits and securities for the periods indicated (in thousands): Quarters Ended March 31 ----------------------- 2001 2000 ------ ------ Mortgage-backed securities $3,272 $3,955 ------ ------ Taxable interest and dividends 1,766 1,865 Tax-exempt interest 416 476 Federal Home Loan Bank stock-dividends 462 402 ------ ------ 2,644 2,743 ------ ------ $5,916 $6,698 ====== ====== NOTE 5: CALCULATION OF WEIGHTED AVERAGE SHARES OUTSTANDING FOR EARNINGS PER SHARE (EPS) Calculation of Weighted Average Shares Outstanding for Earnings Per Share ----------------------- (in thousands) Quarters Ended March 31 -------------------------- 2001 2000 ------ ------ Total shares originally issued 13,201 13,201 Less retired shares and treasury stock plus unvested shares allocated to MRP (1,305) (1,071) Less unallocated shares held by the ESOP (633) (746) ------ ------ Basic weighted average shares outstanding 11,263 11,384 Plus unvested MRP and stock option incremental shares considered outstanding for diluted EPS calculations 359 192 ------ ------ Diluted weighted average shares outstanding 11,622 11,576 ====== ====== 12
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS Management's Discussion and Analysis (MD&A) and other portions of this report contain certain "forward-looking statements" concerning the future operations of Banner Corporation. Management desires to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 and is including this statement for the express purpose of availing the Company of the protections of such safe harbor with respect to all "forward-looking statements" contained in this report and our Annual Report. We have used "forward-looking statements" to describe future plans and strategies, including our expectations of the Company's future financial results. Management's ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors which could affect actual results include interest rate trends, the general economic climate in the Company's market area and the country as a whole, the ability of the Company to control costs and expenses, the ability of the Company to efficiently incorporate acquisitions into its operations, competitive products and pricing, loan delinquency rates, and changes in federal and state regulation. These factors should be considered in evaluating the "forward-looking statements," and undue reliance should not be placed on such statements. GENERAL Banner Corporation (the Company or BANR), a Washington corporation, is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly owned subsidiaries, Banner Bank (BB) and Banner Bank of Oregon (BBO). Prior to the consolidation and name change, which occurred on October 30, 2000, the Company's subsidiaries included First Savings Bank of Washington (FSBW), Inland Empire Bank (IEB) and Towne Bank (TB) (together, the Banks). As of March 31, 2001, Banner Bank is a Washington-chartered commercial bank the deposits of which are insured by the Federal Deposit Insurance Corporation (FDIC) under both the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF). As of March 31, 2001, BB conducted business from its main office in Walla Walla, Washington, and its 32 branch offices and four loan production offices located in Washington, Idaho and Oregon. Banner Bank of Oregon is an Oregon-chartered commercial bank and its deposits are insured by the FDIC, under the BIF. BBO conducts business from its main office in Hermiston, Oregon, and its six branch offices and one loan production office located in northeast Oregon. Prior to merging with FSBW on October 30, 2000, TB was a Washington-chartered commercial bank whose deposits were insured by the FDIC under BIF. As of October 30, 2000, TB conducted business from seven full service branches in the Seattle, Washington, metropolitan area. An eighth Seattle area office opened in November 2000. The operating results of BANR depend primarily on its 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 savings deposits and Federal Home Loan Bank (FHLB) advances. Net interest income is primarily a function of BANR's 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 balance of interest-earning assets as compared to the average balance of interest-bearing liabilities. As more fully explained below, BANR's net interest income increased for the quarter ended March 31, 2001, when compared to the same quarter one year prior. This increase in net interest income was due to the significant asset and liability growth, which occurred at BANR. The increase in net interest income occurred despite a 7 basis point reduction of the interest rate spread for the quarter, which resulted from changes in the mix of assets and liabilities and changes in the levels of various market interest rates. The net interest margin also declined 6 basis points for the quarter ended March 31, 2001, when compared to the same quarter one year prior reflecting the reduced interest rate spread and the increased use of interest-bearing liabilities relative to interest-earning assets as the Company continued to leverage its equity capital. BANR's net income also is affected by provisions for loan losses and the level of its 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 its non-interest operating expenses and income tax provisions. Management's discussion and analysis of results of operations is intended to assist in understanding the financial condition and results of operations of the Company. The information contained in this section should be read in conjunction with the Consolidated Financial Statements and accompanying Notes to the Consolidated Financial Statements. 13
RECENT DEVELOPMENTS AND SIGNIFICANT EVENTS See Note 2 to Financial Statements COMPARISON OF FINANCIAL CONDITION AT MARCH 31, 2001 AND DECEMBER 31, 2000 Total assets increased $28.2 million, or 1.4%, from $1.983 billion at December 31, 2000, to $2.011 billion at March 31, 2001. The growth of $28.2 million occurred mostly at BB and was funded primarily with deposit growth. This growth represented a continuation of management's plans to further leverage BANR's capital and reflects the solid economic conditions in the markets where BANR operates. Net loans receivable (gross loans less loans in process, deferred fees and discounts, and allowance for loan losses) grew $48.6 million, or 3.3%, from $1.472 billion at December 31, 2000, to $1.520 billion at March 31, 2001. This loan growth included an increase of $21.8 million in loans held for sale which increased to $29.8 million at March 31, 20001. The increase in net loans consisted of $4.0 million of residential mortgages, $13.7 million of mortgages secured by commercial and multifamily real estate, $26.7 million of construction and land loans and $5.0 million of non-mortgage loans such as commercial, agricultural and consumer loans. These balances reflect the Company's continuing effort to increase the portion of its assets invested in loans and more specifically the portion of loans invested in commercial real estate, construction and land development, and non-mortgage loans. While these loans are of inherently higher risk than residential mortgages, management believes they can produce higher credit adjusted returns to the Company and provide better opportunities to develop comprehensive banking relationships with the borrowers than most residential mortgages. The majority of the increase in assets was funded by a net increase of $26.0 million in deposits. Asset growth was also funded by net income from operations. Deposits grew $26.0 million, or 2.2%, from $1.193 billion at December 31, 2000, to $1.219 billion at March 31, 2001. FHLB advances decreased $4.5 million from $507.1 million at December 31, 2000, to $502.6 million at March 31, 2001. Other borrowings, primarily reverse repurchase agreements with securities dealers, decreased $4.6 million, from $74.5 million at December 31, 2000, to $70.0 million at March 31, 2001. Securities available for sale and held to maturity decreased $15.2 million, or 4.7%, from $326.5 million at December 31, 2000, to $311.3 million at March 31, 2001, as much of the proceeds from maturing or called securities and amortizations or prepayments on mortgage-related securities were used to fund loan growth. FHLB stock increased $462,000, as a result of the regular quarterly stock dividend paid by the FHLB. The Company's investment in bank owned life insurance increased by $5.2 million reflecting accumulated earnings from increased cash surrender value and an initial premium of $5.0 million for the purchase of additional insurance. COMPARISON OF RESULTS OF OPERATIONS FOR THE QUARTERS ENDED MARCH 31, 2001 AND 2000 GENERAL. Net income for the quarter ended March 31, 2001 was $4.6 million, or $.40 per share (diluted), compared to net income of $4.4 million, or $.38 per share (diluted), for the quarter ended March 31, 2000. Net income for the quarter ended March 31, 2001 increased $224,000 from the comparable quarter ended March 31, 2000. BANR's improved operating results primarily reflect the significant growth of assets and liabilities which was offset somewhat by the decline in net interest margin and increased operating expenses. Compared to levels a year ago, total assets increased 6.0% to $2.011 billion at March 31, 2001, net loans rose 11.8% to $1.520 billion, deposits grew 8.5% to $1.219 billion and borrowings increased 0.5% to $572.6 million. Average equity was 9.93% of average assets for the quarter ended March 31, 2001, compared to 9.80% of average assets for the quarter ended March 31, 2000. In addition to other activity reflected in the capital accounts, average equity increased significantly from the quarter ended March 31, 2000 as a result of changes in the market value of securities accounted for as available for sale. In accordance with FAS 115, changes in the market value of those securities, net of a related tax effect, are recorded in equity as accumulated other comprehensive income. Net interest margin declined 6 basis points for the quarter reflecting changes in the level of market rates and the mix of assets and liabilities. Over the past eighteen months the Company encountered a period of very volatile market interest rates. The effects of this volatility were generally adverse to the Company's interest rate spread and net interest margin, causing interest expense to increase by 40 basis points compared to the same quarter a year earlier. Interest income also increased, up 33 basis points compared to the March 31, 2000 quarter; however, in contrast to interest expense, much of this increase reflects changes in the asset mix. Continued pressure on net interest margin appears likely over the near term as decreases in funding costs are expected to lag declines in asset yields, which reflect in particular the lower level of the prime rate. Changes in the level of interest rates also impacted mortgage banking activity resulting in significantly greater gain on sale of loans in the most recent quarter compared to the same period a year earlier. Results for the quarter ended March 31, 2001, also reflect a substantially higher provision for loan losses than was recognized in the same quarter a year ago. 14
INTEREST INCOME. Interest income for the quarter ended March 31, 2001 was $40.6 million compared to $36.6 million for the quarter ended March 31, 2000, an increase of $3.9 million, or 15.8%. The increase in interest income was a result of a $130.2 million, or 7.5%, growth in average balances of interest-earning assets, and a 33 basis point increase in the average yield on those assets. The yield on average interest-earning assets increased to 8.78% for the quarter ended March 31, 2001 compared to 8.45% for the same period a year earlier. Average loans receivable for the quarter ended March 31, 2001 increased by $174.4 million, or 13.0%, when compared to the quarter ended March 31, 2000, reflecting the Banks' significant internal growth. Interest income on loans increased by $4.7 million, or 15.8%, compared to the prior year, reflecting the impact of the increase in average loan balances and a 30 basis point increase in the average yield. The increase in average loan yield resulted largely from the changes in the mix of the loan portfolio. In particular, the portion of the portfolio invested in lower yielding one- to four-family residential loans declined, while the portion invested in higher yielding construction, land development and commercial loans increased. Adding to this effect was the higher level of market interest rates in the nine months immediately preceding the current quarter than existed during the nine months preceding the quarter ending March 31, 2000. Those higher market rates in preceding periods resulted in higher yields for certain fixed and adjustable rate loans during the March 31, 2001 quarter than were realized in the March 31, 2000 quarter. On the other hand, the average prime rate, which affects many of the Company's floating rate loans, while trending in opposite directions, was nearly the same for the two quarters being compared. Loans yielded 9.27% for the quarter ended March 31, 2001 compared to 8.97% for the quarter ended March 31, 2000. The average balance of mortgage-backed securities, investment securities, daily interest-bearing deposits and FHLB stock decreased by $44.2 million for the quarter ended March 31, 2001, while the interest and dividend income from those investments decreased $782,000 compared to the quarter ended March 31, 2000. The average yield on mortgage-backed securities decreased from 6.74% for the quarter ended March 31, 2000, to 6.71% for the comparable period in 2001. Yields on mortgage-backed securities were lower in the 2001 period reflecting the impact of lower market rates on the interest rates paid on the significant portion of those securities that have adjustable interest rates. The average yield on investment securities and short term cash investments increased from 6.65% for the quarter ended March 31, 2000 to 6.72% for the comparable quarter in 2001, reflecting a modest change in the mix of the securities portfolio which was generally offset by the lower level of market rates. Earnings on FHLB stock increased by $60,000, resulting from an increase of $3.9 million in the average balance of FHLB stock for the quarter ended March 31, 2001. The dividend yield on FHLB stock was 6.50% for both the quarter ended March 31, 2001, and the quarter ended March 31, 2000. Dividends on FHLB stock are established on a quarterly basis by vote of the Directors of the FHLB. INTEREST EXPENSE. Interest expense for the quarter ended March 31, 2001 was $23.1 million compared to $20.0 million for the comparable period in 2000, an increase of $3.1 million, or 15.6%. The increase in interest expense was due to the $127.7 million growth in average interest-bearing liabilities and the increase in the average cost of all interest-bearing liabilities from 4.88% to 5.28%. The $99.1 million increase in average interest-bearing deposits for the quarter ended March 31, 2001 reflects the solid deposit growth throughout the Company over the past twelve months. Deposit interest expense increased $2.5 million for the quarter ended March 31, 2001 compared to the same quarter a year ago. Average deposit balances increased from $1.093 billion for the quarter ended March 31, 2000, to $1.193 billion for the quarter ended March 31, 2001, while, at the same time, the average rate paid on deposit balances increased 51 basis points. The increase in the rate paid on deposits reflects the significant increase in market interest rates in the periods just prior to the current quarter compared to the levels that prevailed in the same periods a year earlier. To a significant degree deposit costs for a quarter reflect market interest rates and pricing decisions made three to twelve months prior to the end of that quarter. Generally, market interest rates were higher for the nine months preceding the quarter ended March 31, 2001 than for the same period preceding the March 31, 2000 quarter. Average FHLB advances totaled $508.8 million during the quarter ended March 31, 2001, compared to $476.4 million during the quarter ended March 31, 2000, an increase of $32.4 million that, combined with a 29 basis point increase in average cost of advances, resulted in a $784,000 increase in related interest expense. The average rate paid on those advances increased to 6.23% for the quarter ended March 31, 2001 from 5.94% for the quarter ended March 31, 2000. Other borrowings consist of retail repurchase agreements wit customers and repurchase agreements with investment banking firms secured by certain investment securities. The average balance for other borrowings decreased $3.7 million from $78.4 million for the quarter ended March 31, 2000, to $74.7 million for the same period in 2001, while the related interest expense decreased $119,000 from $1.2 million to $1.1 million for the respective periods. The average rate paid on other borrowings was 5.8% in the quarter ended March 31, 2001 compared to 6.09% for the same quarter in 2000. Similar to deposits, the cost of FHLB advances reflects to a degree a lagged effect from prior period market interest rate levels, while the Company's other borrowings generally have relatively short terms and therefore reprice to current market levels more quickly. 15
The following tables provide additional comparative data on the Company's operating performance: Quarters Ended Average Balances March 31 ---------------- --------------------------- (in thousands) 2001 2000 ----------- ----------- Investment securities and deposits $ 131,710 $ 141,498 Mortgage-backed obligations 197,634 235,986 Loans 1,516,361 1,341,942 FHLB stock 28,817 24,873 ----------- ----------- Total average interest-earning asset 1,874,522 1,744,299 Non-interest-earning assets 114,086 94,054 ----------- ----------- Total average assets $ 1,988,608 $ 1,838,353 =========== =========== Deposits $ 1,192,515 $ 1,093,444 Advances from FHLB 508,785 476,415 Other borrowings 74,704 78,411 ----------- ----------- Total average interest-bearing liabilities 1,776,004 1,648,270 Non-interest-bearing liabilities 15,212 9,858 ----------- ----------- Total average liabilities 1,791,216 1,658,128 Equity 197,392 180,225 ----------- ----------- Total average liabilities and equity $ 1,988,608 $ 1,838,353 =========== =========== Interest Rate Yield/Expense (Rates Are Annualized) -------------------------------------------------- Interest Rate Yield: Investment securities and deposits 6.72% 6.65% Mortgage-backed obligations 6.71% 6.74% Loans 9.27% 8.97% FHLB stock 6.50% 6.50% ----------- ----------- Total interest rate yield on interest- earning assets 8.78% 8.45% ----------- ----------- Interest Rate Expense: Deposits 4.84% 4.33% Advances from FHLB 6.23% 5.94% Other borrowings 5.80% 6.09% ----------- ----------- Total interest rate expense on interest-bearing liabilities 5.28% 4.88% ----------- ----------- Interest spread 3.50% 3.57% ============ =========== Net interest margin on interest earning assets 3.78% 3.84% ----------- ----------- Additional Key Financial Ratios (Ratios Are Annualized) ------------------------------------------------------- Return on average assets 0.95% 0.97% Return on average equity 9.55% 9.88% Average equity / average assets 9.93% 9.80% Average interest-earning assets / interest-bearing liabilities 105.55% 105.83% Non-interest [other operating] expenses/average assets Excluding amortization of costs in excess of net assets acquired (goodwill) 2.35% 2.24% Including amortization of costs in excess of net assets acquired (goodwill) 2.47% 2.37% Efficiency ratio [non-interest (other operating) expenses/revenues] Excluding amortization of costs in excess of net assets acquired (goodwill) 55.65% 54.82% Including amortization of costs in excess of net assets acquired (goodwill) 59.55% 59.15% 16
PROVISION FOR LOAN LOSSES. During the quarter ended March 31, 2001, the provision for loan losses was $950,000, compared to $545,000 for the quarter ended March 31, 2000, an increase of $405,000. The increase in the provision for 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 in the following paragraphs. The higher provision in the current quarter reflects changes in the portfolio mix, slightly higher levels of non-performing loans and net charge offs, and concerns about the current economic environment. Non-performing loans increased modestly to $5.5 million at March 31, 2001, compared to $5.4 million at March 31, 2000. Net charge offs were $284,000 for the current quarter compared to $135,000 for the same quarter a year earlier. A comparison of the allowance for loan losses at March 31, 2001 and 2000 shows an increase of $2.0 million from $14.0 million at March 31, 2000 to $16.0 million at March 31, 2001. The allowance for loan losses as a percentage of net loans (loans receivable excluding allowance for losses) was 1.04% and 1.02% at March 31, 2001 and March 31, 2000, respectively. The allowance for loan losses equaled 292% of non-performing loans at March 31, 2001 compared to 259% of non-performing loans at March 31, 2000. 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, 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. Additions to the allowance are charged to earnings. Provisions for losses that are related to specific assets are usually 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. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Banks' allowance for loan losses. Such agencies may require the Banks to provide additions to the allowance based upon judgments different from management. Although management uses the best information available, future adjustments to the allowance may be necessary due to economic, operating, regulatory and other conditions beyond the Banks' 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. Large groups of smaller-balance homogeneous loans are collectively evaluated for impairment. Loans that are collectively evaluated for impairment by the Banks include residential real estate and consumer loans. Smaller balance non-homogeneous loans also may be evaluated collectively for impairment. 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 the Bank 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 o impaired loans are 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. The Company's 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 the Banks' loan portfolios 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 the Company's historical loss experience adjusted for significant factors including the experience of other banking organizations that, in management's judgment, affect th 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. 17
The following tables are provided to disclose additional detail on the Banks' loans and allowance for loan losses (in thousands): March 31 December 31 2001 2000 -------- ----------- Loans (including loans held for sale): Secured by real estate One- to four-family $ 412,582 $ 408,613 Commercial 381,301 366,071 Multifamily 82,709 84,282 Construction and land 297,969 271,273 Commercial business 235,186 228,676 Agricultural business 68,255 67,809 Consumer 58,383 60,359 ----------- ----------- Total Loans $ 1,536,385 $ 1,487,083 Less allowance for loan losses 15,980 15,314 ----------- ----------- Total net loans at end of period $ 1,520,405 $ 1,471,769 =========== =========== Allowance for loan losses as a percentage of net loans outstanding 1.04% 1.03% Quarters Ended March 31 --------------------------- 2001 2000 ----------- ----------- Balance, beginning of the year $ 15,314 $ 13,541 Allowances added through business combinations -- -- Provision 950 545 Recoveries of loans previously charged off: Secured by real estate One- to four-family -- -- Commercial -- 1 Multifamily -- -- Construction and land -- 4 Commercial business 6 11 Agricultural business -- -- Consumer 5 3 ----------- ----------- 11 19 Loans charged off: Secured by real estate One- to four-family (32) (6) Commercial -- -- Multifamily -- -- Construction and land -- -- Commercial business (102) (59) Agricultural business (100) -- Consumer (61) (89) ----------- ----------- (295) (154) ----------- ----------- Net charge offs (284) (135) ----------- ----------- Balance, end of period $ 15,980 $ 13,951 =========== =========== Net charge-offs as a percentage of average net book value of loans outstanding for the period 0.02% 0.01% ----------- ----------- 18
The following is a schedule of the Company's allocation of the allowance for loan losses: March 31 December 31 2001 2000 ----------- ----------- Specific or allocated loss allowances: Secured by real estate: One- to four-family $ 2,289 $ 2,256 Commercial 4,146 4,556 Multifamily 765 731 Construction and land 2,842 2,738 Commercial business 3,195 2,859 Agricultural business 758 851 Consumer 966 879 ----------- ----------- Total allocated 14,961 14,870 Unallocated 1,019 444 ----------- ----------- Total allowance for loan losses $ 15,980 $ 15,314 =========== ========== Ratio of allowance for loan losses to non- performing loans 2.92 1.83 Allowance for loan losses as a percent of net loans (loans receivable excluding allowance for losses) 1.04% 1.03% OTHER OPERATING INCOME. Other operating income at $2.9 million for the quarter ended March 31, 2001, increased by $1.2 million compared to the quarter ended March 31, 2000. This included a $674,000 increase in the gain on sale of loans and a $306,000 increase in other fees and service charges in the current quarter. Loan sales for the quarter ended March 31, 2001 totaled $47.0 million, including $9.4 million of loans sold by CFC, compared to $15.9 million for the quarter ended March 31, 2000. Gain on sale of loans for BANR included $66,000 of fees on $5.5 million of loans brokered by CFC, which are not reflected in the volume of loans sold. In addition to selling fewer loans, gains on loan sales in the year earlier period also were lower as a result of the adverse impact of rising interest rates on the profitability of those sales. Other fee and service charge income increased at BANR, reflecting deposit growth and pricing adjustments. Miscellaneous income increased by $176,000 in large part reflecting the Company's increased investment in bank owned life insurance and the resulting increase in cash surrender value. OTHER OPERATING EXPENSES. Other operating expenses increased $1.3 million from $10.8 million for the quarter ended March 31, 2000, to $12.1 million for the quarter ended March 31, 2001. Increases in other operating expenses reflect the overall growth in assets and liabilities, customer relationships and complexity of operations as BANR continues to expand. The increase in expenses reflects the inclusion of two new bank branches opened subsequent to March 31, 2000. The increase also reflects expenses associated with the new lending subsidiary, CFC. The increase in other operating expenses was partially offset by a $274,000 increase in capitalized loan origination costs. The higher operating expenses associated with BANR's transition to more of a commercial bank profile, coupled with pressure on net interest margin, caused BANR's efficiency ratio, excluding the amortization of goodwill, to increase to 55.65% (59.55% including goodwill), for the quarter ended March 31, 2001, from 54.82% (59.15% including goodwill) for the comparable period ended March 31, 2000. Other operating expenses as a percentage of average assets increased to 2.47% (2.35% excluding the amortization of goodwill) for the quarter ended March 31, 2001, compared to 2.24% (2.37% excluding the amortization of goodwill) for the quarter ended March 31, 2000. INCOME TAXES. Income tax expense was $2.6 million for the quarter ended March 31, 2001, compared to $2.5 million for the comparable period in 2000. The Company's effective tax rates for the quarters ended March 31, 2001 and 2000, were 36% and 36%, respectively. 19
ASSET QUALITY The following tables are provided to disclose additional details on asset quality (in thousands): March 31 December 31 2001 2000 ----------- ----------- Non-performing assets at end of the period: Nonaccrual Loans: Secured by real estate One- to four-family $ 571 $ 873 Multifamily real estate 62 1,741 Commercial real estate -- -- Construction and land 1,884 2,937 Commercial business 958 1,734 Agricultural business 829 529 Consumer 115 18 ----------- ----------- 4,419 7,832 Loans more than 90 days delinquent, still on accrual: Secured by real estate One- to four-family -- 20 Multifamily real estate -- -- Commercial real estate -- -- Construction and land -- -- Commercial business 59 1 Agricultural business 878 467 Consumer 121 54 ----------- ----------- 1,058 542 ----------- ----------- Total non-performing loans 5,477 8,374 Real estate owned, held for sale, net (REO), and other repossessed assets 5,097 3,287 ----------- ----------- Total non-performing assets at the end of the period $ 10,574 $ 11,661 =========== =========== Non-performing loans as a percentage of total net loans before allowance for loan losses at end of the period 0.36% 0.56% Ratio of allowance for loan losses to non- performing loans at end of the period 292% 183% Non-performing assets as a percentage of total assets at end of the period. 0.53% 0.59% Troubled debt restructuring [TDRs] at end of the period $ 311 $ 337 =========== =========== Troubled debt restructuring as a percentage of: Total gross principal of loans outstanding at end of the period 0.02% 0.02% Total assets at end of the period 0.02% 0.02% 20
MARKET RISK AND ASSET/LIABILITY MANAGEMENT The financial condition and operation of the Company 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. The Company's profitability is dependent to a large extent on its net interest income, which is the difference between the interest received from its interest-earning assets and the interest expense incurred on its interest-bearing liabilities. The activities of the Company, 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 impacting the Company's financial performance. The greatest source of interest rate risk to the Company 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 the Company. The principal objectives of asset/liability management are to evaluate the interest-rate risk exposure of the Company; to determine the level of risk appropriate given the Company's operating environment, business plan strategies, performance objectives, capital and liquidity constraints, and asset and liability allocation alternatives; and to manage the Company's interest rate risk consistent with regulatory guidelines and approved policies of the Board of Directors. Through such management the Company seeks to reduce the vulnerability of its earnings and capital position to changes in the level of interest rates. The Company's actions in this regard are taken under the guidance of the Asset/Liability Management Committee, which is comprised of members of the Company's senior management. The committee closely monitors the Company's 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 of the Company to maximize earnings within acceptable risk tolerances. The Company's 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. The Company also utilizes 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 the Company's 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 the Company 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. The Company updates and prepares simulation modeling at least quarterly for review by senior management and the directors. The Company believes the data and assumptions are realistic representations of its portfolio and possible outcomes under the various interest rate scenarios. Nonetheless, the interest rate sensitivity of the Company's net interest income and net market value of equity could vary substantially if different assumptions were used or if actual experience differs from the assumptions used. 21
SENSITIVITY ANALYSIS The table of Interest Rate Risk Indicators sets forth, as of March 31, 2001, the estimated changes in the Company's 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 OF INTEREST RATE RISK INDICATORS Estimated Change in ------------------------------------------ Change (In Basis Points) Net Interest Income in Interest Rates (1) Next 12 Months Net Market Value - ------------------------ ------------------- ---------------- (Dollars in thousands) +400 $ 1,864 2.6% $(66,272) (34.3%) +300 1,503 2.1% (50,570) (26.2%) +200 1,162 1.6% (31,393) (16.3%) +100 751 1.0% (12,583) (6.5%) 0 0 0 0 0 -100 (1,927) (2.6%) 633 0.3% -200 (4,702) (6.4%) (11,060) (5.7%) -300 (8,477) (11.6%) (29,980) (15.5%) -400 (12,168) (16.7%) (47,599) (24.7%) - ---------- (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 such 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. The table of Interest Sensitivity Gap presents the Company's interest sensitivity gap between interest-earning assets and interest-bearing liabilities at March 31, 2001. The table sets forth the amounts of interest-earning assets and interest-bearing liabilities which are anticipated by the Company, based upon certain assumptions, to reprice or mature in each of the future periods shown. At March 31, 2001, total interest-bearing liabilities maturing or repricing within one year exceeded total interest-earning assets maturing or repricing in the same time period by $38.8 million, representing a one-year gap to total assets ratio of (1.93%). 22
<TABLE> TABLE OF INTEREST SENSITIVITY GAP As of March 31, 2001 6 Months Within to 1-3 3-5 5-10 Over 10 6 Months One Year Years Years Years Years Total -------- -------- ----- ----- ----- ----- ----- (dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> Interest-earning assets(1): Construction loans $150,336 $ 66,059 $ 2,223 $ 1,116 $ -- $ -- $ 219,734 Fixed-rate mortgage loans 59,378 50,585 159,870 120,371 160,931 81,496 632,631 Adjustable-rate mortgage loans 180,303 57,807 80,004 6,000 -- -- 324,114 Fixed-rate mortgage-backed securities 10,393 11,629 52,443 20,340 10,595 4,483 109,883 Adjustable-rate mortgage-backed securities 89,643 4,164 -- -- -- -- 93,807 Fixed-rate commercial/agriculture loans 13,621 7,719 20,456 25,615 8,141 2,788 78,340 Adjustable-rate commercial/ agriculture loans 224,986 -- -- -- -- -- 224,986 Consumer and other loans 22,093 5,478 16,676 13,274 1,328 2,668 61,517 Investment securities and interest- bearing deposits 47,425 6,535 22,965 5,490 10,400 55,851 148,666 -------- --------- -------- -------- -------- -------- ---------- Total rate-sensitive assets 798,178 209,976 354,637 192,206 191,395 147,286 1,893,678 -------- --------- -------- -------- -------- -------- ---------- Interest-bearing liabilities(2): Regular savings and NOW accounts 18,136 18,135 42,315 42,315 -- -- 120,901 Money market deposit accounts 66,644 39,986 26,658 -- -- -- 133,288 Certificates of deposit 425,885 215,565 164,005 18,268 7,412 34 831,169 FHLB advances 110,500 86,600 166,054 60,500 78,079 849 502,582 Other borrowings 57,958 -- -- -- -- -- 57,958 Retail repurchase agreements 7,308 208 1,215 1,354 1,929 1 12,015 -------- --------- -------- -------- -------- -------- ---------- Total rate-sensitive liabilities 686,431 360,494 400,247 122,437 87,420 884 1,657,913 -------- --------- -------- -------- -------- -------- ---------- Excess (deficiency) of interest- sensitive assets over interest- sensitive liabilities $111,747 $(150,518) (45,610) 69,769 103,975 $146,402 $ 235,765 ======== ========= ======== ======== ======== ======== ========== Cumulative excess (deficiency) of interest-sensitive assets $111,747 $ (38,771) (84,381) (14,612) 89,363 $235,765 $ 235,765 ======== ========= ======== ======== ======== ======== ========== Cumulative ratio of interest-earning assets to interest-bearing liabilities 116.28% 96.30% 94.17% 99.07% 105.39% 114.22% 114.22% ======== ========= ======== ======== ======== ======== ========== Interest sensitivity gap to total assets 5.56% (7.48%) (2.27%) 3.47% 5.17% 7.28% 11.72% ======== ========= ======== ======== ======== ======== ========== Ratio of cumulative gap to total assets 5.56% (1.93%) (4.20%) (0.73%) 4.44% 11.72% 11.72% ======== ========= ======== ======== ======== ======== ========== (footnotes on following page) </TABLE> 23
Footnotes for Table of 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 periods 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- and variable-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 the Banks' regular savings, demand, NOW, and money market deposit accounts are subject to immediate withdrawal, 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 negative $150.1 million or (7.46%) of total assets. Interest-bearing liabilities for this table exclude certain non-interest bearing deposits which are included in the average balance calculations in the earlier Table I, Analysis of Net Interest Spread. LIQUIDITY AND CAPITAL RESOURCES The Company's 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 prepayment are greatly influenced by market interest rates, economic conditions and competition. The primary investing activity of the Company, through its subsidiaries, is the origination and purchase of loans. During th quarter ended March 31, 2001, the Company purchased loans in the amount of $489,000 while loan origination, net of repayments totaled $75.5 million. This activity was funded primarily by principal repayments on securities, sales of loans, and deposit growth. During the quarter ended March 31, 2001, the Company sold $47.0 million of loans. Net deposit growth was $26.0 million for the quarter ended March 31, 2001. FHLB advances decreased $4.5 million for the quarter ended March 31, 2001. Other borrowings also decreased $4.6 million for the quarter ended March 31, 2001. The Banks 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 quarter ended March 31, 2001, the Banks used their sources of funds primarily to fund loan commitments, to purchase securities, to repay FHLB advances and other borrowings, and to pa maturing savings certificates and deposit withdrawals. At March 31, 2001, the Banks had outstanding loan commitments totaling $159.4 million and undisbursed loans in process totaling $121.1 million. The Banks generally maintain sufficient cash and readily marketable securities to meet short-term liquidity needs. BB maintains a credit facility with the FHLB-Seattle, which provides for advances which, in aggregate, may equal the lesser of 45% of B s assets or unencumbered qualifying collateral, which as of March 31, 2001 could give a maximum total credit line of $801 million. Advances under this credit facility totaled $481.5 million, or 27% of BB's assets at March 31, 2001. BBO also maintains credit lines with various institutions, including the FHLB-Seattle, that would allow them to borrow up to $16.5 million. At March 31, 2001, savings certificates amounted to $830.9 million or 68.0%, of the Banks' total deposits, including $639.5 million which were scheduled to mature by March 31, 2002. Historically, the Banks have been able to retain a significant amount of their deposits as they mature. Management believes it has adequate resources to fund all loan commitments from savings deposits, FHLB Seattle advances, other borrowings and sale of mortgage loans and that it can adjust the offering rates for savings certificates to retain deposits in changing interest rate environments. 24
CAPITAL REQUIREMENTS Federally-insured state-chartered banks are required to maintain minimum levels of regulatory capital. Under current FDIC regulations, insured state-chartered banks generally must maintain (i) a ratio of Tier 1 leverage capital to total assets of at least 3.0% (4.0% to 5.0% for all but the most highly rated banks), (ii) a ratio of Tier 1 capital to risk-weighted assets of at least 4.0% and (iii) a ratio of total capital to risk-weighted assets of at least 8.0%. At March 31, 2001, BANR's banking subsidiaries exceeded all current regulatory capital requirements to be classified as well capitalized institutions, the highest regulatory standard. In order to be categorized as a well capitalized institution, the FDIC requires banks it regulates to maintain a leverage ratio, defined as Tier 1 capital divided by total regulatory assets, of at least 5.00%; Tier 1 (or core) capital of at least 6.00% of risk-weighted assets; and total capital of at least 10.00% of risk-weighted assets. BANR, as a bank holding company, is regulated by the Federal Reserve Board (FRB). The FRB has established capital requirements for bank holding companies that generally parallel the capital requirements of the FDIC for banks with $150 million or more in total consolidated assets. BANR's total regulatory capital must equal 8% of risk-weighted assets and one half of the 8% (4%) must consist of Tier 1 (core) capital. The actual regulatory capital ratios calculated for BANR along with the minimum capital amounts and ratios for capital adequacy purposes were as follows (dollars in thousands): Minimum for capital Actual adequacy purposes ---------------- ------------------- Amount Ratio Amount Ratio ------ ----- ------- ----- MARCH 31, 2001: BANR--consolidated Total capital to risk- weighted assets $179,396 12.83% $111,901 8.00% Tier 1 capital to risk- weighted assets 162,303 11.61 55,950 4.00 Tier 1 leverage capital average assets 162,303 8.31 78,145 4.00 25
PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS From time to time BANR or its subsidiaries are engaged in legal proceedings in he ordinary course of business, none of which is considered to have a material mpact on the BANR's financial position or results of operations. ITEM 2. CHANGES IN SECURITIES Not Applicable ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not Applicable ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS None ITEM 5. OTHER INFORMATION Not Applicable ITEM 6. EXHIBITS AND REPORTS ON FORM 8K Report (s) on Form 8-K filed during the quarter ended March 31, 2001, are as follows: Date Filed Purpose ---------- ------- NONE 26
SIGNATURES - ----------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Banner Corporation May 15, 2001 /s/ Gary Sirmon ---------------- Gary Sirmon President and Chief Executive Officer May 15, 2001 /s/ Lloyd W. Baker ------------------- Lloyd W. Baker Treasurer and Executive Vice President 27