UNITED STATESSECURITIES AND EXCHANGE COMMISSION
FORM 10-K
GLACIER BANCORP, INC.
49 Commons Loop, Kalispell, MT 59901(Address of Principal Office)
Registrant’s telephone number, including area code: (406) 756-4200
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
Indicate by check mark whether the registrant (i) 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 (ii) has been subject to such filing requirements for the past 90 days. x
Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of regulation 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. o
Indicate by check mark whether the Registrant is an accelerated filer (as defined by Exchange Act Rule 12b-2). Yes x No o
The aggregate market value of the voting common equity held by non-affiliates of the Registrant at June 30, 2003 (the last business day of the most recent second quarter), was $439,998,423 (based on the average bid and ask price as quoted on the NASDAQ National Market at the close of business on that date).
As of March 2, 2004, there were issued and outstanding 19,537,242 shares of the Registrant’s common stock. No preferred shares are issued or outstanding.
Document Incorporated by Reference
Portions of the 2004 Annual Meeting Proxy Statement dated March 29, 2004 are incorporated by reference into Part III of this Form 10-K.
GLACIER BANCORP, INC.FORM 10-K ANNUAL REPORTFor the year ended December 31, 2003TABLE OF CONTENTS
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PART I.
This Annual Report and Form 10-K may be deemed to include forward looking statements, which management believes are a benefit to shareholders. These forward looking statements describe management’s expectations regarding future events and developments such as future operating results, growth in loans and deposits, continued success of the Company’s style of banking and the strength of the local economy. The words “will,” “believe,” “expect,” “should,” and “anticipate” and words of similar construction are intended in part to help identify forward looking statements. Future events are difficult to predict, and the expectations described above are subject to risk and uncertainty that may cause actual results to differ materially and adversely. In addition to discussions about risks and uncertainties set forth from time to time in the Company’s filings with the SEC, factors that may cause actual results to differ materially from those contemplated by such forward looking statements include, among others, the following possibilities: (1) local, national, and international economic conditions are less favorable than expected or have a more direct and pronounced effect on the Company than expected and adversely affect the Company’s ability to continue its internal growth at historical rates and maintain the quality of its earning assets; (2) changes in interest rates reduce interest margins more than expected and negatively affect funding sources; (3) projected business increases following strategic expansion or opening or acquiring new branches are lower than expected; (4) costs or difficulties related to the integration of acquisitions are greater than expected; (5) competitive pressure among financial institutions increases significantly; (6) legislation or regulatory requirements or changes adversely affect the businesses in which the Company is engaged; and (7) the Company’s ability to realize the efficiencies it expects to receive from its investments in personnel and infrastructure.
Item 1. Business
GENERAL DEVELOPMENT OF BUSINESS
Glacier Bancorp, Inc. headquartered in Kalispell, Montana (the “Company”), is a Delaware corporation incorporated in 1990, pursuant to the reorganization of Glacier Bank, FSB into a bank holding company. The Company is a regional multi-bank holding company providing commercial banking services from 54 banking offices throughout Montana, Idaho and Utah. The Company offers a wide range of banking products and services, including transaction and savings deposits, commercial, consumer, and real estate loans, mortgage origination services, and retail brokerage services. The Company serves individuals, small to medium-sized businesses, community organizations and public entities.
Subsidiaries
The Company is the parent holding company of its eight wholly owned subsidiaries, Glacier Bank (“Glacier”), First Security Bank of Missoula (“First Security”), Western Security Bank (“Western”), Mountain West Bank in Idaho (“Mountain West”), Big Sky Western Bank (“Big Sky”), Valley Bank of Helena (“Valley”), Glacier Bank of Whitefish (“Whitefish”), and Glacier Capital Trust I (“Glacier Trust”).
The Company provides full service brokerage services (selling products such as stocks, bonds, mutual funds, limited partnerships, annuities and other insurance products) through Raymond James Financial Services, a non-affiliated company. The Company shares in the commissions generated, without devoting significant management and staff time to this portion of the business.
The Company formed Glacier Capital Trust I (Glacier Trust) as a financing subsidiary on December 18, 2000. On January 25, 2001, Glacier Trust issued 1,400,000 preferred securities at $25 per preferred security. The purchase of the securities entitles the shareholder to receive cumulative cash distributions at an annual interest rate of 9.40% from payments on the junior subordinated debentures of Glacier Bancorp, Inc. The subordinated debentures will mature and the preferred securities must be redeemed by February 1, 2031. In exchange for the Company’s capital contribution, the Company owns all of the outstanding common securities of Glacier Trust.
Recent Acquisitions
The Company’s strategy has been to profitably grow its business through internal growth and selective acquisitions. The Company continues to look for profitable expansion opportunities in existing and contiguous markets. On July 15, 2003 Pend Oreille Bancorp was acquired and its branches became additional branches of Mountain West. On February 28, 2001, the Company acquired Western, through the purchase of WesterFed Financial Corporation, its parent company. On March 15, 2001, the Company acquired seven Wells Fargo & Company and First Security Corporation branches located in Idaho and Utah. The acquisitions were accounted for under the purchase method of accounting. Accordingly, the assets and liabilities of the acquired banks were recorded by the Company at their respective fair values at the date of the acquisition and the results of the banks operations had been included with those of the Company since the date of acquisition. The excess of the Company’s purchase price over the net fair value of the assets
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acquired and liabilities assumed, including identifiable intangible assets, was recorded as goodwill.
Mountain West was acquired February 4, 2000 and Big Sky was acquired on January 20, 1999. Both acquisitions were accounted for using the pooling of interests method of accounting. Under this method, financial information for each of the periods presented includes the combined companies as though the merger had occurred prior to the earliest date presented.
FDIC and FHLB
The Federal Deposit Insurance Corporation (“FDIC”) insures each subsidiary bank’s deposit accounts. Each subsidiary bank is a member of the Federal Home Loan Bank of Seattle (“FHLB”), which is one of twelve banks which comprise the Federal Home Loan Bank System and all subsidiaries, with the exception of Mountain West, are members of the Federal Reserve Bank of Minneapolis (“FRB”).
Bank Locations
Glacier Bancorp, Inc.’s office is located at 49 Commons Loop, Kalispell, MT 59901 and its telephone number is (406) 756-4200. Glacier’s address is 202 Main Street, Kalispell, MT 59901 (406) 756-4200, First Security’s address is 1704 Dearborn, Missoula, MT 59801 (406) 728-3115, Western’s address is 2929 3rd Avenue North, Billings, MT 59101 (406) 252-3700, Mountain West’s address is 125 Ironwood Drive, Coeur d’Alene, Idaho 83816 (208) 765-0284, Big Sky’s address is 47995 Gallatin Road, Big Sky, MT, 59716 (406) 995-2321, Valley’s address is 3030 North Montana Avenue, Helena, MT 59601 (406) 495-2400, and Whitefish’s address is 319 East 2nd Street, Whitefish, MT 59937 (406) 863-6300. See “Item 2. Properties.”
The following abbreviated organizational chart illustrates the various existing parent/subsidiary relationships at December 31, 2003:
FINANCIAL INFORMATION ABOUT SEGMENTS
The Company has seven wholly owned banking subsidiaries, Glacier Bank, First Security, Western, Mountain West, Big Sky, Valley, and Whitefish. For information regarding the holding company, as separate from the subsidiaries, see “Item 7 — Management’s Discussion & Analysis” and footnote 16 to the Consolidated Financial Statements in “Item 8 — Financial Statements and Supplementary Data”.
The business of the Company’s subsidiaries (collectively referred to hereafter as “Banks”) consists primarily of attracting deposit accounts from the general public and originating commercial, residential, installment and other loans. The Banks’ principal sources of income are interest on loans, loan origination fees, fees on deposit accounts and interest and dividends on investment securities. The principal expenses are interest on deposits, FHLB advances, and repurchase agreements, as well as general and administrative expenses.
Business Segment Results
The Company evaluates segment performance internally based on individual bank charter, and thus the operating segments are so defined. The following schedule provides selected financial data for the Company’s operating segments. Centrally provided services to the Banks are allocated based on estimated usage of those services. The operating segment identified as “Other” includes the Parent company, nonbank unit, and eliminations of transactions between segments. During the third quarter of 2001, certain branches of Western were transferred to other Company owned banks located in the same geographic area which accounted for the change in activity for certain segments.
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Internet Access
Copies of the Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through the Company’s website (www.glacierbancorp.com) as soon as reasonably practicable after the Company has filed the material with, or furnished it to, the Securities and Exchange Commission.
Market Area
The Company’s primary market area includes the four northwest Montana counties of Flathead, Lake, Lincoln and Glacier; the west central Montana counties of Missoula, Silver Bow, Lewis & Clark, Gallatin, and Yellowstone; in Idaho, the Company’s primary market area includes Kootenai and Blaine counties. Kalispell, the location of its home office, is the county seat of Flathead County, and is the primary trade center of what is known as the Flathead Basin. Glacier has its main office and a branch office in Kalispell, with branches in Columbia Falls, Evergreen, Bigfork, and Polson (the county seat of Lake County), Libby (the county seat of Lincoln County), Anaconda (the county seat of Deer Lodge County), and Butte (the county seat of Silver Bow County). First Security’s main office and seven of the branch locations are in Missoula (the county seat of Missoula County) and its ninth branch is in Hamilton (the county seat of Ravailli County). Western Security’s main office and five of its branches are located in Billings (the county seat of Yellowstone County) and two branches are located in Laurel and Lewistown (the county seat of Fergus County). Mountain West has eleven offices in Idaho, Coeur d’Alene, Post Falls, Hayden Lake, Nampa, Hailey, Ketchum, two offices in Sandpoint and three offices in Boise, two offices in Utah, Brigham City and Park City, and one office in Newport, Washington. Big Sky’s main office is in Bozeman (the county seat of Gallatin County), with two branches in Bozeman and a branch in Big Sky. Valley’s main office and five branch locations are in Helena (the state capital and the county seat of Lewis & Clark County). Whitefish’s main office is located in Whitefish with its one branch in Eureka.
Northwest Montana has a diversified economic base, primarily comprised of wood products, primary metal manufacturing, medical services, agriculture, high-tech related manufacturing and tourism. Tourism is heavily influenced by the close proximity of Glacier National Park, which has in excess of 1.5 million visitors per year. The area also contains the Big Mountain Ski Area, and Flathead
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Lake, the largest natural freshwater lake west of the Mississippi. Missoula, the home of the University of Montana, has a large population base with a diverse economy comprised of government services, transportation, medical services, forestry, technology, tourism, trade and education. Missoula is located on Interstate Highway 90, and has good air service. Helena, the county seat of Lewis and Clark County and the state capital, is highly dependent on state and federal government, but also has tourism, trade, transportation, and education contributing to its economy. Bozeman, the home of Montana State University, is the gateway to Yellowstone National Park and the Big Sky ski resort, both of which are very active tourist areas. Bozeman also has a high-tech center and is located on Interstate 90, and has good air service. Billings, the largest city in Montana, is located on Interstate 90 and is the western termination point of Interstate 94, and has very good air service. Agriculture, medical services, transportation, oil related industries and education are the primary economical activities. Coeur d’Alene, located in northern Idaho, is one of the fastest growing areas in the United States. Boise, the state capital, is also growing rapidly, with much of the growth related to high-tech manufacturing.
Competition
Glacier and Whitefish comprise the largest financial institution group in terms of total deposits in the three county area of northwest Montana, and have approximately 26% of the total deposits in this area. Glacier’s three Butte, Montana offices have approximately 21% of the deposits in Silver Bow County and Glacier’s Anaconda office has 22% of the deposits in Deer Lodge County. First Security has approximately 28% of the total deposits in Missoula County. Western has approximately 12% of the deposits in Yellowstone and Fergus counties combined. Big Sky has approximately 10% of Gallatin County’s deposits and Valley has approximately 19% of Lewis and Clark County’s total deposits. In Idaho, Mountain West has approximately 12% of the deposits in Kootenai and Blaine counties, 7% in Bonner County, and 2% in Ada and Canyon counties. In Utah, Mountain West has 5% of the deposits in the Box Elder and Summit counties combined. In Washington, Mountain West has 44% of the deposits in Pend Oreille County.
There are a large number of depository institutions including savings banks, commercial banks, and credit unions in the counties in which the Company has offices. The Banks, like other depository institutions, are operating in a rapidly changing environment. Non-depository financial service institutions, primarily in the securities and insurance industries, have become competitors for retail savings and investment funds. Mortgage banking/brokerage firms are actively competing for residential mortgage business. In addition to offering competitive interest rates, the principal methods used by banking institutions to attract deposits include the offering of a variety of services and convenient office locations and business hours. The primary factors in competing for loans are interest rates and rate adjustment provisions, loan maturities, loan fees, and the quality of service to borrowers and brokers.
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DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS’ EQUITY
Average Balance Sheet
The following three-year schedule provides (i) the total dollar amount of interest and dividend income of the Company for earning assets and the resultant average yield; (ii) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average rate; (iii) net interest and dividend income; (iv) interest rate spread; and (v) net interest margin.
AVERAGE BALANCE SHEET(Dollars in Thousands)
(1) Without tax effect on non-taxable securities income
(2) Net income divided by average total assets
(3) Net income divided by average equity
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Rate/Volume Analysis
Net interest income can be evaluated from the perspective of relative dollars of change in each period. Interest income and interest expense, which are the components of net interest income, are shown in the following table on the basis of the amount of any increases (or decreases) attributable to changes in the dollar levels of the Company’s interest-earning assets and interest-bearing liabilities (“Volume”) and the yields earned and rates paid on such assets and liabilities (“Rate”). The change in interest income and interest expense attributable to changes in both volume and rates has been allocated proportionately to the change due to volume and the change due to rate.
Net interest income increased $5.885 million in 2003 over 2002. The increase was primarily due to increases in volumes and the decrease in rates on deposits. For additional information see “Item 7 — Management’s Discussion and Analysis”.
INVESTMENT ACTIVITIES
It has generally been the Company’s policy to maintain a liquidity portfolio only slightly above policy limits because higher yields can generally be obtained from loan originations than from short-term deposits and investment securities.
Liquidity levels may be increased or decreased depending upon yields on investment alternatives and upon management’s judgment as to the attractiveness of the yields then available in relation to other opportunities and its expectation of the level of yield that will be available in the future.
The Company’s investment securities are generally classified as available for sale and are carried at estimated fair value with unrealized gains or losses reflected as an adjustment to stockholders’ equity.
The Company uses an effective tax rate of 35% in calculating the tax equivalent yield. Approximately $279 million of the investment portfolio is comprised of tax exempt investments which is an increase of $77 million from the prior year. The increase in tax exempt investments is the result of higher after tax yields on tax exempt investment securities versus taxable investment securities and the availability to fund the investments.
For information about the Company’s equity investment in the stock of the FHLB of Seattle, see “Sources of Funds — Advances and Other Borrowings”.
For additional information, see “Item 7 — Management’s Discussion & Analysis” and footnote 3 to the Consolidated Financial Statements in “Item 8 — Financial Statements and Supplementary Data”.
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LENDING ACTIVITY
General
The Banks focus their lending activity primarily on several types of loans: 1) first-mortgage, conventional loans secured by residential properties, particularly single-family, 2) installment lending for consumer purposes (e.g., auto, home equity, etc.), and 3) commercial lending that concentrates on targeted businesses. “Item 7 — Management’s Discussion & Analysis” and footnote 4 to the Consolidated Financial Statements in “Item 8 — Financial Statements and Supplementary Data” contain more information about the lending portfolio.
Loan Portfolio CompositionThe following table summarizes the Company’s loan portfolio:
Loan Portfolio Maturities or Repricing TermThe stated maturities or first repricing term (if applicable) for the loan portfolio at December 31, 2003 was as follows:
Real Estate Lending
The Banks’ lending activities consist of the origination of both construction and permanent loans on residential and commercial real Estate. The Banks actively solicit mortgage loan applications from real estate brokers, contractors, existing customers, customer referrals, and walk-ins to their offices. The Banks’ lending policies generally limit the maximum loan-to-value ratio on residential
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mortgage loans to 80% of the lesser of the appraised value or purchase price or up to 90% of the loan if insured by a private mortgage insurance company. The Banks also provide interim construction financing for single-family dwellings, and make land acquisition and development loans on properties intended for residential use.
Consumer Lending
The majority of all consumer loans are secured by real estate, automobiles, or other assets. The Banks intend to continue lending for such loans because of their short-term nature, generally between three months and five years, with an average term of approximately two years. Moreover, interest rates on consumer loans are generally higher than on mortgage loans. The Banks also originate second mortgage and home equity loans, especially to its existing customers in instances where the first and second mortgage loans are less than 80% of the current appraised value of the property.
Commercial Loans
The Banks make commercial loans of various types including commercial real estate, operating loans, equipment loans and a relatively small amount of unsecured loans. The Company’s credit risk management includes stringent credit policies, regular credit examinations, management review of loans experiencing deterioration of credit quality, individual loan approval limits, and committee approval of larger loan requests. The Company has focused on increasing the mix of loans to include more commercial loans. Commercial lenders at each of the banks are actively seeking new and expanded lending relationships within their markets.
Loan Approval Limits
Individual loan approval limits have been established for each lender based on the loan type and experience of the individual. Each subsidiary bank has an Officer Loan Committee consisting of senior lenders and members of senior management. The Officer Loan Committee has approval authority up to $500,000 ($1,000,000 for Western Security Bank and Mountain West Bank). Loans between $500,000 and $2,000,000 ($3,500,000 for Glacier Bank of Kalispell and First Security Bank of Missoula) go to the individual Bank’s Board of Directors for approval. Loans over these limits up to $5,000,000 are approved by the Executive Loan Committee of the Company’s Board of Directors. The membership of the Executive Loan Committee consists of the bank’s senior loan officers and the Company’s Credit Administrator. Loans greater than $5,000,000 are approved by the Company’s Board of Directors. Under banking laws loans to one borrower and related entities are limited to a set percentage of the unimpaired capital and surplus of the bank.
Loan Purchases and Sales
Fixed-rate, long-term mortgage loans are generally sold in the secondary market. The Banks have been active in the secondary market, primarily through the origination of conventional FHA and VA residential mortgages for sale in whole, or in part, to savings associations, banks and other purchasers in the secondary market. The sale of loans in the secondary mortgage market reduces the Banks’ risk of increases in interest rates of holding long-term, fixed-rate loans in the loan portfolio and allows the Banks to continue to make loans during periods when deposit flows decline or funds are not otherwise available for lending purposes. In connection with conventional loan sales, the Banks typically sell a majority of mortgage loans originated, retaining servicing only on loans sold to certain lenders. The Banks have also been very active in generating commercial SBA loans, and other commercial loans, with a portion of those loans sold to other investors. As of December 31, 2003, loans serviced for others aggregated approximately $190 million.
Loan Origination and Other Fees
In addition to interest earned on loans, the Banks receive loan origination fees for originating loans. Loan fees generally are a percentage of the principal amount of the loan and are charged to the borrower for originating the loan, and are normally deducted from the proceeds of the loan. Loan origination fees are generally 1.0% to 1.5% on residential mortgages and .5% to 1.5% on commercial loans. Consumer loans require a flat fee as well as a minimum interest amount. The Banks also receive other fees and charges relating to existing loans, which include charges and fees collected in connection with loan modifications and tax service fees.
Non-Performing Loans and Asset Classification
Loans are reviewed on a regular basis and are placed on a non-accrual status when the collection of principal or interest is unlikely. The Banks typically place loans on non-accrual when principal or interest is due and has remained unpaid for 90 days or more unless the loan is secured by collateral having realizable value sufficient to discharge the debt in full. Once a loan has been classified as non-accrual previously accrued unpaid interest is reversed. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income. Subsequent payments are either applied to the outstanding principal balance or recorded as interest income, depending on the assessment of the ultimate repayment of the loan.
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The following table sets forth information regarding the Banks’ non-performing assets at the dates indicated:
NONPERFORMING ASSETS
Non-performing assets as a percentage of total assets at December 31, 2003 were .48 percent versus .51 percent at the same time as last year, which compares to the Peer Group average of .65 percent at September 30, 2003, the most recent information available. The reserve for loan losses was 184 percent of non-performing assets at December 31, 2003, up from 181 percent a year ago.
With the continuing change in loan mix from residential real estate to commercial and consumer loans, which historically have greater credit risk, the Company has increased the balance in the reserve for loan losses account. The reserve balance has increased $3,046,000, or 15 percent, to $23,990,000, which is 1.65 percent of total loans outstanding, up from 1.58 percent of loans at December 31, 2002.
Allowance for Loan Losses
The Allowance for Loan and Lease Losses (ALLL) is maintained at a level that allows for the absorption of loan losses inherent within the bank’s loan portfolios. The Company is committed to the early recognition of problem loans and to a strong conservative allowance.
Determining the adequacy of the ALLL involves a high degree of judgment and is inevitably imprecise. Accordingly, the ALLL is maintained within a range based upon a best estimate. The adequacy of the ALLL is based on management’s current judgment about the credit quality of the loan portfolio and considers all known relevant internal and external factors that affect loan losses. An evaluation of the adequacy of the ALLL is conducted at a minimum on a quarterly basis and is documented and approved by the subsidiary Banks’ Boards of Directors.
The primary responsibility for credit risk assessment and identification of problem loans rests with the loan officer of account. This continuous process, utilizing the bank’s credit risk rating process, is necessary to support management’s evaluation of adequacy of the ALLL. An independent loan review function verifying loan risk ratings validates the loan officer and management’s evaluation about the credit quality of the loan portfolio. The loan review function also assesses the evaluation process and provides an independent analysis of the adequacy of the ALLL.
The ALLL methodology is designed to reasonably estimate the probable loan and lease loss within the Bank’s loan portfolios. The methodology is based upon a process of estimating general, specific, and other allowance allocations.
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At a minimum, the process includes the following elements:
The Banks’ charge-off policy is generally consistent with bank regulatory standards. Consumer loans generally are charged off when the loan becomes over 120 days delinquent. Real estate acquired as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned (“REO”) until such time as it is sold. When such property is acquired, it is recorded at the lower of the unpaid principal balance or estimated fair value, not to exceed estimated net realizable value. Any write-down at the time of recording REO is charged to the allowance for loan losses. Any subsequent write-downs are a charge to current expenses.
Loan Loss Experience
(1) Acquisition of Pend Oreille Bank, WesterFed Financial Corporation and several branches
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Allocation of the Allowance for Loan Loss
SOURCES OF FUNDS
Deposits are the most important source of the Banks’ funds for lending and other business purposes. In addition, the Banks derive funds from loan repayments, advances from the FHLB of Seattle, repurchase agreements, and loan sales. Loan repayments are a relatively stable source of funds, while interest bearing deposit inflows and outflows are significantly influenced by general interest rate levels and money market conditions. Borrowings and advances may be used on a short-term basis to compensate for reductions in normal sources of funds such as deposit inflows at less than projected levels. They also may be used on a long-term basis to support expanded activities and to match maturities of longer-term assets. Deposits obtained through the Banks have traditionally been the principal source of funds for use in lending and other business purposes. Currently, the Banks have a number of different deposit programs designed to attract both short-term and long-term deposits from the general public by providing a wide selection of accounts and rates. These programs include regular statement savings, interest-bearing checking, money market deposit accounts, fixed rate certificates of deposit with maturities ranging form three months to five years, negotiated-rate jumbo certificates, non-interest demand accounts, and individual retirement accounts.
“Item 7 — Management’s Discussion and Analysis” contains information relating to changes in the overall deposit portfolio.
Deposits are obtained primarily from individual and business residents of the Banks’ market area. The Banks issue negotiated-rate certificate accounts with balances of $100,000, or more, and have paid a limited amount of fees to brokers to obtain deposits. The following table illustrates the amounts outstanding for deposits greater than $100,000, according to the time remaining to maturity:
For additional information, see “Item 7 — Management’s Discussion & Analysis” and footnote 7 to the Consolidated Financial Statements in “Item 8 — Financial Statements and Supplementary Data”.
In addition to funds obtained in the ordinary course of business, the Company formed Glacier Trust as a financing subsidiary. Glacier Trust issued 1,400,000 preferred securities at $25 per preferred security. The purchase of the securities entitles the shareholder to receive cumulative cash distributions at an annual interest rate of 9.40% from payments on the junior subordinated debentures of Glacier Bancorp, Inc. The subordinated debentures will mature and the preferred securities must be redeemed by February 1, 2031. In exchange for the Company’s capital contribution, the Company owns all of the outstanding common securities of the trust. The purpose of the issuance of the securities was to finance the acquisition of WesterFed Financial Corporation and seven Wells Fargo & Company and First Security Corporation branches in 2001. For additional information regarding the subordinated debentures and the acquisitions, see Notes 10 and 20 to the Consolidated Financial Statements “Item 8 — Financial Statements and Supplementary Data”.
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Advances and Other Borrowings
As a member of the Federal Home Loan Bank of Seattle (“FHLB”), the Banks may borrow from the FHLB on the security of stock which it is required to own in that bank and certain of its home mortgages and other assets (principally, securities which are obligations of, or guaranteed by, the United States), provided certain standards related to credit-worthiness have been met. Advances are made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an institution’s capital or on the FHLB’s assessment of the institution’s credit-worthiness. FHLB advances have been used from time to time to meet seasonal and other withdrawals of savings accounts and to expand lending by matching a portion of the estimated amortization and prepayments of retained fixed rate mortgages. All of the Banks are members in the FHLB.
From time to time, primarily as a short-term financing arrangement for investment or liquidity purposes, the Banks have made use of repurchase agreements with various securities dealers. This process involves the “selling” of one or more of the securities in the Banks’ portfolio and by entering into an agreement to “repurchase” that same security at an agreed upon later date. A rate of interest is paid to the dealer for the subject period of time. In addition, although the Banks have offered retail repurchase agreements to its retail customers, the Government Securities Act of 1986 imposed confirmation and other requirements which generally made it impractical for financial institutions to offer such investments on a broad basis. Through policies adopted by the Board of Directors, the Banks enter into repurchase agreements with local municipalities, and large balance customers, and have adopted procedures designed to ensure proper transfer of title and safekeeping of the underlying securities.
The following chart illustrates the average balances and the maximum outstanding month-end balances for FHLB advances and repurchase agreements:
For additional information concerning the Company’s advances and repurchase agreements, see footnotes 8 and 9 to the Consolidated Financial Statements in “Item 8 — Financial Statements and Supplementary Data”.
EMPLOYEES
As of December 31, 2003, the Company employed 885 persons, 729 of who were full time, none of whom were represented by a collective bargaining group. The Company provides its employees with a comprehensive benefit program, including medical insurance, dental plan, life and accident insurance, long-term disability coverage, sick leave, profit sharing plan and employee stock options. Prior to 2002, the Company had a noncontributory defined contribution retirement plan and an employee savings plan; however as of January 1, 2002, both plans were merged into the new profit sharing plan. The Company considers its employee relations to be excellent. See Note 13 in the Consolidated Financial Statements in “Item 8 — Financial Statements and Supplementary Data” for detailed information regarding profit sharing plan costs and eligibility.
SUPERVISION AND REGULATION
Introduction
Banking is a highly regulated industry. Banking laws and regulations are primarily intended to protect depositors, not shareholders. The following discussion identifies some of the more significant state and federal laws and regulations affecting the banking industry. It is intended to provide a brief summary of these laws and regulations and, therefore, is not complete and is qualified by the statutes and regulations referenced in the discussion.
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Bank Holding Company Regulation
General. The Company is a bank holding company as defined in the Bank Holding Company Act of 1956, as amended, because of its ownership of Glacier Bank, First Security Bank of Missoula, Western Security Bank, Mountain West Bank, Big Sky Western Bank, Valley Bank of Helena, and Glacier Bank of Whitefish, all of which are Montana-state chartered commercial banks (with the exception of Mountain West Bank, an Idaho state-chartered bank), and all of which are members of the Federal Reserve (with the exception of Mountain West Bank, a non-Fed member FDIC-insured bank). As a bank holding company, the Company is subject to regulation, supervision and examination by the Federal Reserve. In general, the Bank Holding Company Act limits the business of bank holding companies to owning or controlling banks and engaging in other activities closely related to banking. The Company must also file reports and provide additional information with the Federal Reserve. Under the Financial Services Modernization Act of 1999, a bank holding company may apply to the Federal Reserve to become a financial holding company, and thereby engage (directly or through a subsidiary) in certain expanded activities deemed financial in nature, such as securities brokerage and insurance underwriting.
Holding Company Bank Ownership. The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before (1) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares, (2) acquiring all or substantially all of the assets of another bank or bank holding company, or (3) merging or consolidating with another bank holding company.
Holding Company Control of Nonbanks. With some exceptions, the Bank Holding Company Act also prohibits a bank holding company from acquiring or retaining direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by Federal Reserve regulation or order, have been identified as activities closely related to the business of banking or of managing or controlling banks.
Transactions with Affiliates. Subsidiary banks of a bank holding company are subject to restrictions imposed by the Federal Reserve Act on extensions of credit to the holding company or its subsidiaries, on investments in their securities, and on the use of their securities as collateral for loans to any borrower. These regulations and restrictions may limit the Company’s ability to obtain funds from the Bank for its cash needs, including funds for payment of dividends, interest and operational expenses.
Tying Arrangements. The Company is prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or furnishing of services. For example, with certain exceptions, neither the Company nor its subsidiaries may condition an extension of credit to a customer on either (1) a requirement that the customer obtain additional services provided by us or (2) an agreement by the customer to refrain from obtaining other services from a competitor.
Support of Subsidiary Banks. Under Federal Reserve policy, the Company is expected to act as a source of financial and managerial strength to the Bank. This means that the Company is required to commit, as necessary, resources to support the Bank. Any capital loans a bank holding company makes to its subsidiary banks are subordinate to deposits and to certain other indebtedness of those subsidiary banks.
State Law Restrictions. As a Delaware corporation, the Company is subject to certain limitations and restrictions under applicable Delaware corporate law. For example, state law restrictions in Delaware include limitations and restrictions relating to indemnification of directors, distributions to shareholders, transactions involving directors, officers or interested shareholders, maintenance of books, records, and minutes, and observance of certain corporate formalities.
The Subsidiaries
General. With the exception of Mountain West Bank, the Company’s subsidiaries are subject to extensive regulation and supervision by the Montana Department of Commerce’s Banking and Financial Institutions Division and the FRB as a result of their membership in the Federal Reserve System. Mountain West Bank is subject to regulation by the Idaho Department of Finance and by the FDIC as a state non-member commercial bank. In addition, Mountain West’s Utah and Washington branches are regulated to a limited extent by the Utah Department of Financial Institutions and the Washington Department of Financial Institutions, respectively.
The federal laws that apply to the Banks regulate, among other things, the scope of their business, their investments, their reserves against deposits, the timing of the availability of deposited funds and the nature and amount of and collateral for loans. Federal laws also regulate community reinvestment and insider credit transactions and impose safety and soundness standards.
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Community Reinvestment. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their jurisdiction, federal bank regulators must evaluate the record of financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those banks. These factors are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility.
Insider Credit Transactions. Banks are also subject to certain restrictions on extensions of credit to insiders—executive officers, directors, principal shareholders, and their related interests. Extensions of credit to insiders must be made on substantially the same terms, including interest rates and collateral, and follow credit underwriting procedures that are not less stringent than those prevailing at the time for comparable transactions with non-insiders. Also, extensions of credit to insiders must not involve more than the normal risk of repayment or present other unfavorable features.
Safety and Soundness Standards. Federal law imposes upon banks certain non-capital safety and soundness standards. These standards cover, among other things, internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation and benefits. Additional standards apply to asset quality, earnings and stock valuation. An institution that fails to meet these standards must develop a plan acceptable to its regulators, specifying the steps that the institution will take to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions.
Interstate Banking and Branching
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Interstate Act”) permits nationwide interstate banking and branching under certain circumstances. This legislation generally authorizes interstate branching and relaxes federal law restrictions on interstate banking. Currently, bank holding companies may purchase banks in any state, and states may not prohibit such purchases. Additionally, banks are permitted to merge with banks in other states as long as the home state of neither merging bank has opted out. The Interstate Act requires regulators to consult with community organizations before permitting an interstate institution to close a branch in a low-income area.
Federal bank regulations prohibit banks from using their interstate branches primarily for deposit production and have implemented a loan-to-deposit ratio screen to ensure compliance with this prohibition.
With regard to interstate bank mergers, Montana “opted-out” of the Interstate Act. Subject to certain conditions, an in-state bank that has been in existence for at least 5 years may merge with an out-of-state bank. Banks, bank holding companies, and their respective subsidiaries cannot acquire control of a bank located in Montana if, after the acquisition, the acquiring institution, together with its affiliates, would directly or indirectly control more than 22% of the total deposits of insured depository institutions and credit unions located in Montana. Montana law does not authorize the establishment of a branch bank in Montana by an out-of-state bank.
Idaho has enacted “opting in” legislation in accordance with the Interstate Act provisions allowing banks to engage in interstate merger transactions subject to certain “aging” requirements. Branches may not be acquired or opened separately in Idaho by an out-of-state bank, but once an out-of-state bank has acquired a bank within Idaho, either through merger or acquisition of all or substantially all of the bank’s assets, the out-of-state bank may open additional branches within Idaho.
Utah and Washington have each enacted “opting in” legislation similar in certain respects to that enacted by Idaho, allowing banks to engage in interstate merger transactions subject to certain aging requirements. De novo branching by an out of state bank is generally prohibited; however, once an out of state bank has acquired a Utah or Washington branch, that bank may establish additional branches within that state.
Deposit Insurance
The deposits of the Banks are currently insured to a maximum of $100,000 per depositor through the Bank Insurance Fund (“BIF”) administered by the FDIC. All insured banks are subject to semi-annual deposit insurance premium assessments by the FDIC. The FDIC has implemented a risk-based insurance premium system under which banks are assessed insurance premiums based on how much risk they present to the Bank Insurance Fund. Banks with higher levels of capital and a low degree of supervisory concern are assessed lower premiums than banks with lower levels of capital or a higher degree of supervisory concern.
Dividends
The principal source of the Company’s cash revenues is dividends received from the Company’s subsidiary Banks. The payment of dividends is subject to government regulation, in that regulatory authorities may prohibit banks and bank holding companies from paying dividends which would constitute an unsafe or unsound banking practice. In addition, a bank may not pay cash dividends if
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that payment could reduce the amount of its capital below that necessary to meet minimum applicable regulatory capital requirements.
Capital Adequacy
Regulatory Capital Guidelines. Federal bank regulatory agencies use capital adequacy guidelines in the examination and regulation of bank holding companies and banks. The guidelines are “risk-based,” meaning that they are designed to make capital requirements more sensitive to differences in risk profiles among banks and bank holding companies.
Tier I and Tier II Capital. Under the guidelines, an institution’s capital is divided into two broad categories, Tier I capital and Tier II capital. Tier I capital generally consists of common shareholders’ equity, surplus and undivided profits. Tier II capital generally consists of the allowance for loan losses, hybrid capital instruments, and subordinated debt. The sum of Tier I capital and Tier II capital represents an institution’s total capital. The guidelines require that at least 50% of an institution’s total capital consist of Tier I capital.
Risk-based Capital Ratios. The adequacy of an institution’s capital is gauged primarily with reference to the institution’s risk-weighted assets. The guidelines assign risk weightings to an institution’s assets in an effort to quantify the relative risk of each asset and to determine the minimum capital required to support that risk. An institution’s risk-weighted assets are then compared with its Tier I capital and total capital to arrive at a Tier I risk-based ratio and a total risk-based ratio, respectively. The guidelines provide that an institution must have a minimum Tier I risk-based ratio of 4% and a minimum total risk-based ratio of 8%.
Leverage Ratio. The guidelines also employ a leverage ratio, which is Tier I capital as a percentage of total assets, less intangibles. The principal objective of the leverage ratio is to constrain the maximum degree to which a bank holding company may leverage its equity capital base. The minimum leverage ratio is 3%; however, for all but the most highly rated bank holding companies and for bank holding companies seeking to expand, regulators expect an additional cushion of at least 1% to 2%.
Prompt Corrective Action. Under the guidelines, an institution is assigned to one of five capital categories depending on its total risk-based capital ratio, Tier I risk-based capital ratio, and leverage ratio, together with certain subjective factors. The categories range from “well capitalized” to “critically undercapitalized.” Institutions that are “undercapitalized” or lower are subject to certain mandatory supervisory corrective actions.
Corporate Governance and Accounting Legislation
Sarbanes-Oxley Act of 2002. On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of 2002 (the “Act”) to address corporate and accounting fraud. The Act establishes a new accounting oversight board to enforce auditing standards and restricts the scope of services that accounting firms may provide to their public company audit clients. Among other things, the Act also (i) requires chief executive officers and chief financial officers to certify to the accuracy of periodic reports filed with the Securities and Exchange Commission (the “SEC”); (ii) imposes new disclosure requirements regarding internal controls, off-balance-sheet transactions, and pro forma (non-GAAP) disclosures; (iii) accelerates the time frame for reporting of insider transactions and periodic disclosures by public companies; and (iv) requires companies to disclose whether or not they have adopted a code of ethics for senior financial officers and whether the audit committee includes at least one “audit committee financial expert.”
The Act also requires the SEC, based on certain enumerated factors, to regularly and systematically review corporate filings. To deter wrongdoing, the Act: (i) subjects bonuses issued to top executives to disgorgement if a restatement of a company’s financial statements was due to corporate misconduct; (ii) prohibits an officer or director from misleading or coercing an auditor; (iii) prohibits insider trades during pension fund “blackout periods”; (iv) imposes new criminal penalties for fraud and other wrongful acts; and (v) extends the period during which certain securities fraud lawsuits can be brought against a company or its officers.
As a publicly reporting company, we are subject to the requirements of the Act and related rules and regulations issued by the SEC and NASDAQ. We anticipate that we will incur additional expense as a result of the Act, but we do not expect that such compliance will have a material impact on our business.
Anti-Terrorism Legislation
On October 26, 2001, President Bush signed the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (“USA Patriot Act”) of 2001. Among other things, the USA Patriot Act (1) prohibits banks from providing correspondent accounts directly to foreign shell banks; (2) imposes due diligence requirements on banks opening or holding accounts for foreign financial institutions or wealthy foreign individuals (3) requires financial institutions to establish an anti-money- laundering compliance program, and (4) generally eliminates civil liability for persons who file suspicious activity reports. The Act also increases governmental powers to investigate terrorism, including expanded government access to account records. The
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Department of the Treasury is empowered to administer and make rules to implement the Act. While the USA Patriot Act may, to some degree, affect the Company’s record-keeping and reporting expenses, the Company does not believe that the Act will have a material adverse effect on its business and operations.
Financial Services Modernization
Gramm-Leach-Bliley Act of 1999. The Financial Services Modernization Act of 1999, also known as the Gramm-Leach-Bliley Act, brought about significant changes to the laws affecting banks and bank holding companies. Generally, the Act (i) repealed the historical restrictions on preventing banks from affiliating with securities firms, (ii) provided a uniform framework for the activities of banks, savings institutions and their holding companies, (iii) broadened the activities that may be conducted by national banks and banking subsidiaries of bank holding companies, (iv) provided an enhanced framework for protecting the privacy of consumer information and (v) addressed a variety of other legal and regulatory issues affecting both day-to-day operations and long-term activities of financial institutions.
Bank holding companies that qualify and elect to become financial holding companies can engage in a wider variety of financial activities than permitted under previous law, particularly with respect to insurance and securities underwriting activities. In addition, in a change from previous law, bank holding companies will be in a position to be owned, controlled or acquired by any company engaged in financially related activities, so long as the company meets certain regulatory requirements. The act also permits national banks (and, in states with wildcard statutes, certain state banks), either directly or through operating subsidiaries, to engage in certain non-banking financial activities.
The Company does not believe that the act will negatively affect our operations in the short term. However, to the extent the legislation permits banks, securities firms and insurance companies to affiliate, the financial services industry may experience further consolidation. This consolidation could result in a growing number of larger financial institutions that offer a wider variety of financial services than we currently offer, and these companies may be able to aggressively compete in the markets we currently serve.
Effects of Government Monetary Policy
The Company’s earnings and growth are affected by general economic conditions, and by the fiscal and monetary policies of the federal government, particularly the Federal Reserve. The Federal Reserve implements a national monetary policy for such purposes as curbing inflation and combating recession, but its open market operations in U.S. government securities, control of the discount rate applicable to borrowings from the Federal Reserve, and establishment of reserve requirements against certain deposits, influence the growth of bank loans, investments and deposits, and also affect interest rates charged on loans or paid on deposits. The Company cannot predict with certainty the nature and impact of future changes in monetary policies and their impact on the Company or its subsidiary Banks.
TAXATION
Federal Taxation
The Company files consolidated federal, Montana, Idaho, and Utah income tax returns, using the accrual method of accounting. All required tax returns have been filed.
Financial institutions are subject to the provisions of the Internal Revenue Code of 1986, as amended in the same general manner as other corporations. See note 12 to the Consolidated Financial Statements in “Item 8 — Financial Statements and Supplementary Data” for additional information.
State Taxation
Under Montana and Idaho law, financial institutions are subject to a corporation license tax, which incorporates or is substantially similar to applicable provisions of the Internal Revenue Code. The corporation license tax is imposed on federal taxable income, subject to certain adjustments. State taxes are incurred at the rate of 6.75% in Montana, 8% in Idaho, and 5% in Utah.
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Item 2. Properties
At December 31, 2003, the Company owned 40 of its 54 offices, including its headquarters and other property having an aggregate book value of approximately $43 million, and leased the remaining branches. 9 offices are leased in Montana, 4 offices are leased in Idaho, and 1 office is leased in Utah. The following schedule provides property information for the Company’s operating segments as of December 31, 2003.
The Company believes that all of its facilities are well maintained, adequate and suitable for the current operations of its business, as well as fully utilized.
For additional information concerning the Company’s premises and equipment and lease obligations, see Note 5 and 19 to the Consolidated Financial Statements in “Item 8 — Financial Statements and Supplementary Data”.
Item 3. Legal Proceedings
The Company and its subsidiaries are parties to various claims, legal actions and complaints in the ordinary course of their businesses. In the Company’s opinion, all such matters are adequately covered by insurance, are without merit or are of such kind, or involve such amounts, that unfavorable disposition would not have a material adverse effect on the consolidated financial position or results of operations of the Company.
Item 4. Submission of Matter to a Vote of Security Holders
No matters were submitted to a vote of security holders in the fourth quarter of 2003.
PART II
Item 5. Market Price of and Dividends on Registrant’s Common Equity & Related Stockholder Matters
The Company’s stock trades on the NASDAQ National Market under the symbol: GBCI. The primary market makers are: D.A. Davidson & Company, Inc., Archipelago, LLC, Knight Securities LP, Piper Jaffray Companies, Inc., Morgan Stanley & Co., Inc., Cincinnati Stock Exchange, Goldman, Sachs & Co., and Keafe, Bruyette & Woods, Inc.
The market range of high and low bid prices for the Company’s common stock for the periods indicated are shown below. The sale price information has been adjusted retroactively for all stock dividends and splits previously issued. As of December 31, 2003, there were approximately 9,669 shareholders of Company common stock. Following is a schedule of quarterly common stock price ranges:
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The Company paid cash dividends on its common stock of $.75 and $.61 per share for the years ended December 31, 2003 and 2002, respectively.
Unregistered Securities
On September 26, 2001, the Company’s Board of Directors approved the issuance of 33,024 shares of Company common stock, to be issued in exchange for outstanding debentures issued by Big Sky Western Bank with a principal amount of $350,000 (the “Debentures”). The Debentures were scheduled to mature on December 31, 2001, and were convertible into common stock at that time. In connection with the Company’s acquisition of Big Sky on January 20, 1999 (the “Acquisition”), the Company assumed the obligation to deliver shares of Company common stock to those Debenture holders that elect to convert their Debentures into stock upon maturity. Based on the conversion provision in the Debentures and the exchange ratio for the Acquisition, the Debentures were convertible into an aggregate of 27,993 shares of Company common stock at the time of the Acquisition. As adjusted for subsequent stock dividends by the Company, the Debentures were convertible into an aggregate of 33,024 shares of Company common stock.
In issuing the Shares, the Company relied upon the exemption from registration set forth in Section 3(a)(9) of the Securities Act of 1933, as amended (“1933 Act”). Section 3(a)(9) of the 1933 Act applies when securities are exchanged “by the issuer with its existing securities holders exclusively where no commission or other remuneration is paid or given directly or indirectly for soliciting such exchange.” No commission or other consideration was paid or given, directly or indirectly, for soliciting the conversion of the Debentures. Further, the exchange was available exclusively to existing securities holders.
With respect to the “same issuer” requirement of Section 3(a)(9) of the 1933 Act, the Company recognized that Big Sky issued the Debentures and that the Company was issuing the common stock upon conversion. The Company, however, relied on “no-action positions” taken by SEC Commission Staff with respect to Section 3(a)(9) in which a bank holding company in a reorganization has assumed joint and several responsibility for the due payment of principal and interest of the convertible debt securities of the acquired operating subsidiary and substituted the holding company’s common stock for the operating subsidiary’s common stock as the underlying security for conversion purposes, the bank holding company was allowed to issue its common stock upon conversion of the debt securities, without registration under the 1933 Act.
The Company, with the assistance of legal counsel, confirmed with SEC Staff that the issuance of the Shares in exchange for the Debentures was an exempt transaction under Section 3(a)(9) of the Securities Act.
Item 6. Selected Financial Data
The following financial data of the Company are derived from the Company’s historical audited financial statements and related footnotes. The information set forth below should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the financial statements and related footnotes contained elsewhere in this report.
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Summary of Operations and Selected Financial Data
*revised for stock splits and dividends
All amounts have been restated to include mergers using the pooling of interests accounting method.
Acquisitions using the purchase method of accounting include the operations since the acquisition date.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of OperationsYear ended December 31, 2003 Compared to December 31, 2002
The following discussion is intended to provide a more comprehensive review of the Company’s operating results and financial condition than can be obtained from reading the Consolidated Financial Statements alone. The discussion should be read in conjunction with the audited financial statements and the notes thereto included later in this report. All numbers, except per share data, are expressed in thousands of dollars.
Management Highlights
The past year the Company experienced strong asset growth. The steep slope of the yield curve and a strong capital base provided an opportunity to significantly increase the investment securities portfolio. Commercial loan growth was also very positive increasing $168 million. The historical low interest rates for mortgage loans during most of 2003 resulted in a large volume of residential loans being refinanced which reduced the amount of residential real estate loans held by the Company and also created a large volume of prepayments of the mortgage related securities held in the investment portfolio.
The refinancing activity resulted in the loss of higher rate mortgage loans which reduced interest income. In addition the earnings on other types of loans also declined due to refinancing and new loans booked at substantially reduced rates. Securities prepayment activity resulted in a high level of premium amortization, which reduced the earnings on the existing securities, and the reinvestment of funds was generally at lower rates. Offsetting the reduced interest income was further reduction in interest expense on deposits and borrowed funds as maturing items were replaced with lower rate liabilities. The net interest margin declined through much of the year until the fourth quarter when the margin increased.
Non-interest bearing deposits increased 25% during the year providing a stable low-cost funding source for a portion of the asset growth. Non-interest bearing deposits also ended the year with increased totals. Asset growth that exceeded the increase in deposits was funded with Federal Home Loan Bank advances which also were at low interest rates.
With the very low mortgage loan rates the origination of residential loans was at an all time high which resulted in an increase of nearly $5 million in gain-on-sale of loans. Service charges and fee income also increased nicely in 2003. The Company also took the opportunity to record a net gain on the sale of securities of $1 million during the year.
Total revenue from net interest income and non-interest income increased $13.5 million, or 12%, over the prior year, the cumulative effect of the above described items.
Non-interest expense increased $8 million, or 14%, from last year with the largest increase occurring in compensation and benefits expense. Additional locations and related staffing, commissions on residential loan originations, and merit increases were the primary reasons for this increase. Other operating expenses also increased reflecting the increased volume of activities in loan and deposit operations.
Looking forward, our future performance will depend on many factors including economic conditions, interest rate changes, increasing competition for deposits and quality loans, and regulatory burden. Increasing interest rates slow the volume of real estate loan originations which reduces the fee income from that activity while at the same time reducing commission expense for loan originators. Increasing rates result in increased earnings on assets, however, the cost of interest bearing funds also increase. The Company goal of asset and liability management practices is to maintain or increase the level of net interest income within an acceptable level of interest rate risk. During 2003 the earnings on the mortgage-backed securities investments was reduced significantly by the premium amortization expense. Higher interest rates result in a reduction of premium amortization which adds substantially to the investment earnings and the net interest margin.
Regulatory burden seems to be never-ending as additional regulations continue to add cost. The Sarbanes-Oxley Act will result in substantial increases in audit and consulting fees during 2004, and future years, to assure compliance.
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Financial ConditionAssets
The following table summarizes the asset balances as of December 31, 2003 and 2002, the amount of change, and percentage change during 2003:
The year was very good in terms of total asset growth with assets increasing $458 million, or 20 percent over the December 31, 2002 balances. The Pend Oreille bank acquisition by the Mountain West Bank subsidiary on July 15, 2003 contributed $66 million of that growth. Without the acquisition assets increased $392 million, or 17 percent. The majority of the increase in assets was in the investment portfolio which increased $310 million or 42 percent over the prior year end balances. Investments were acquired to use the funding derived from increasing deposits, and borrowing capacity, that exceeded quality loan growth opportunities.
Loans, including $50 million from the acquisition, increased $133 million, or 10 percent. Commercial loans increased $168 million, or 25 percent, during the period and continues to be the focus of our lending.
Real estate loan volume was at record levels during 2003 with originations of $805 million, up from $588 million in 2002. Most of the residential loans originated were sold in the secondary market, which coupled with the refinancing of loans existing in our portfolio, resulted in a reduction of $44 million in real estate loans outstanding at December 31, 2003 compared to the December 31, 2002 balances. Of the $44 million decrease, $35 million was attributed to a reduction in loans held for sale from one year end to the next, with the remaining $9 million reduction coming from loans held for investment.
Consumer loans showed an increase of $8 million during the year, a 3 percent increase from last year. The type of loans contained in the consumer loan portfolio is changing. With extremely low, or zero, interest rates offered by automobile manufacturers the number of loans for motor vehicles made by the banks is quite small. The balances for those loans continues to decline while home equity loans continue to increase. During 2003 home equity loans increased approximately $26 million, or 15 percent, and now comprise 68 percent of the consumer loan amount outstanding.
The following table summarizes the major asset components as a percentage of total assets as of December 31, 2003, 2002, and 2001:
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The percentage of assets held as Cash, and cash equivalents, Investment Securities, FHLB and Federal Reserve Stock has increased from 30.8 percent at December 31, 2001 to 43.2 percent at December 31, 2003. Most of this increase is attributed to investment securities which increased by $310 million during 2003. Several factors have influenced this increase including 1) declining yields on the loan portfolio; 2) increasing levels of non-interest earning deposits which has provided additional low cost funding; 3) strong capital position to support larger asset base; 4) growth rate in loans insufficient to use available liquidity; 5) very steep slope in the short end of the yield curve; and 6) well structured asset/liability mix with limited interest rate risk.
With the low interest rates, and resulting refinance activity, coupled with the decision to not hold fixed rate long term mortgages, residential real estate loans have declined which moved the percentage of assets from 20.1 to 11.5 percent.
Although the balances in commercial loans have continued to increase the percentage of loans to total assets has only increased approximately 1 percent due to the large increase in investment securities added to the asset totals.
The total consumer loans ratio also declined in 2003 due to the significant increase in total assets.
Liabilities
The following table summarizes the liability balances as of December 31, 2003 and 2002, the amount of change, and percentage change during 2003:
Non-interest bearing deposits increased $74 million, or 25 percent, during the year with $10 million coming from the Pend Oreille acquisition. A High Performance Checking program was implemented during 2003 at the four banks not previously using the program, which contributed to the deposit growth. Interest bearing deposits increased $64 million of which $49 million was from the Pend Oreille acquisition. Interest rates offered by the bank subsidiaries have been mid-market which has resulted in small growth in interest bearing deposits. The company balances its funding needs between deposits and borrowings to minimize interest expense.
Advances from the Federal Home Loan Bank of Seattle (FHLB) increased $294 million during 2003. Proceeds were used to acquire investment securities with a resulting increase in net interest income, although at a lower level than the interest spread experienced on the core asset base. The difference in interest rates between the very short maturities, 30 days, and the two to five year maturity (slope of the yield curve) has provided this opportunity. Reduction in the difference in rates between maturities (a flattening of the yield curve) could result in curtailment of this strategy with a resulting reduction in investments and advances.
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With the significant increase in FHLB advances used to fund asset growth in the form of investment securities, the advances as a percentage of assets increased during 2003 and the percentage of assets funded by deposits decreased even with the substantial increase in deposit balances.
Stockholders’ equity
Total equity and book value per share have increased substantially from the prior year, primarily the result of earnings retention, and stock options exercised. Net unrealized gains on securities declined from a year ago, primarily the result of increasing intermediate term interest rates. Total average diluted shares outstanding were 19,620,458 in 2003 compared to the 10 percent stock dividend adjusted 19,188,934 in 2002. The increase in diluted shares was the result of stock options exercised and the effect of the increase in stock price from December 31, 2002 of $21.42 (stock dividend adjusted) to the December 31, 2003 closing price of $32.47.
Results of Operations
Operating results include amounts related to the operation of the three branches acquired in the Pend Oreille acquisition as of July 15, 2003.
Net income of $38.008 million was a $5.606 million increase over the $32.402 million for the year ended December 31, 2002, an increase of 17 percent. The following narrative provides additional information on those results.
Interest Income -Historical low interest rates during most of the year resulted in a $3 million reduction in interest income even though the earning assets of the Company increased significantly. With the sustained low rates throughout the year many loans of all types were refinanced with the rate on the new loans substantially lower than the prepaid loans. New loans also were at much lower rates than the average rates earned on the existing loans. Mortgage related investment securities experienced much of the same results as the loan portfolio. Investments were prepaid which negatively impacted interest income in two ways: 1) securities that were purchased at a premium that experienced prepayments had an acceleration of the amortization of the premium which reduced the
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income; 2) reinvestment of the proceeds was at a lower rate than previously enjoyed on the amounts invested. The weighted average yield on earning assets (tax free income adjusted for tax effects) decreased from 6.91 percent for the year 2002 to 5.86 percent in 2003. Increased balances in earning assets offset much of the rate impact.
Interest expense — Interest expense decreased even more with total interest expense $9 million, or 19 percent, lower in 2003. Most of the expense reduction came from deposits as rates continued to decline during the year. In addition higher rate certificates of deposits matured which further reduced interest expense. These rate reductions coupled with increasing balances in non-interest bearing deposits resulted in the deposit expense reduction. The balance in FHLB advances increased $294 million during the year, however, with a combination of maturing higher cost advances and lower rates on new advances the interest expense on total advances decreased by $99,000 from the prior year. The weighted average rate on advances decreased from 4.15 percent for 2002 to 2.80 for 2003. The weighted rate on total advances outstanding at December 31, 2003 was 2.19 percent.
The prolonged low interest rates have resulted in a reduction in the net interest margin (ratio of net interest income divided by average earning assets) from 4.51 percent in 2002 to 4.20 percent in 2003 with the third quarter of 2003 being the lowest level at 4.12 percent. The ratio increased to 4.17 percent in the fourth quarter of 2003 primarily due to increased earnings on investments. With the low interest rates many real estate loans have either been refinanced which lowers the future earnings rate on the loans that are retained, or the loan is paid off which also lowers future earnings. To remain competitive it has become necessary to reduce rates to market levels on all loan types which reduces interest income on those loans. Investment income also is lower on securities purchased during this low rate period than on securities previously held in the portfolio. Prepayment of mortgage-backed securities also has occurred as underlying mortgage loans have been prepaid. This prepayment not only reduced the level of assets with higher rates but also resulted in much faster amortization of premiums associated with the securities further reducing interest income. To offset the reduction in interest income, rates on interest bearing deposits have been reduced and matured borrowings have been renewed at lower rates. The increased level of non-interest bearing deposits has reduced the need for additional borrowings which also has resulted in lower interest expense.
Non-interest income – Total non-interest income increased $8 million, or 29 percent over the prior year. $2 million of the increase was from increased volumes in loan and deposit activity and the resulting fees. $1 million of the increase was contributed by net gains on sale of investment securities. The largest portion of the increase was from a $5 million increase in the gain on sale of loans, the majority of which was from residential real estate loans. The low interest rates during 2003 resulted in a very large increase in the number of loans being refinanced to obtain low long term financing, and an increase in new home loans because of affordable monthly payments.
Increasing rates affect the level of fee income created from the origination and sale of mortgage loans as the refinance of loans is substantially reduced or eliminated. Purchases of homes can also be affected because of reduced affordability due to higher monthly payments with higher interest rates. The subsidiary banks are located in areas of robust population growth which somewhat mitigates the risk of significant reduction in home purchases. Reduction in refinance activity also reduces the variable expenses such as commissions for loan origination and could result in additional reductions in expense.
Non-interest expense — Non-interest expense also increased $8 million, a 14 percent increase, with $6 million of the increase in the compensation and benefits classification. The Pend Oreille acquisition, additional branches in the Boise and Bozeman markets, commissions paid to mortgage loan originators, normal increases for job performance, and some benefits that are tied to the Company stock price performance account for the majority of the increase. Advertising and marketing, start up expenses for the High Performance Checking program, and other volume related expenses made up most of the remainder of the increased expense.
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The efficiency ratio, which measures the cost per dollar of revenue generated, increased from 51 percent in 2002 to 52 percent in 2003. Although this increased from the prior year it is still significantly less than the 61 percent average of similar sized banking companies.
Provision for loan losses – The provision for loan losses was $3.809 million in 2003 which was a reduction of $1.936 million from 2002. Charged off loans, net of recoveries of loans previously charged off, were $1.733 million lower in 2003 than the prior year. The balance in the allowance for loan losses increased $3.046 million from the prior year end. At December 31, 2003 non-performing assets (non-accrual loans, accruing loans 90 days or more overdue, real estate acquired by foreclosure, and repossessed personal property) totaled $13.068 million, or .48 percent of total assets; compared to $11.582 million, or .51 percent at December 31, 2002. The peer group average according to the Federal Reserve Bank Performance Report as of September 30, 2003, the most recent information available, for banking companies similar to our size was .65 percent of total assets. The allowance for loan losses was 184 percent of non-performing assets, and 1.65 percent of total loans as of December 31, 2003 which compares to 181 percent and 1.58 percent, respectively, at December 31, 2002.
Effect of inflation and changing prices
Generally accepted accounting principles require the measurement of financial position and operating results in terms of historical dollars, without consideration for change in relative purchasing power over time due to inflation. Virtually all assets of a financial institution are monetary in nature; therefore, interest rates generally have a more significant impact on a company’s performance than does the effect of inflation.
Commitments
In the normal course of business, there are various outstanding commitments to extend credit, such as letter of credit and un-advanced loan commitments, which are not reflected in the accompanying consolidated financial statements. Management does not anticipate any material losses as a result of these transactions. The Company has outstanding debt maturities, the largest of which are the advances from the Federal Home Loan Bank. See footnote 8 for the maturity schedule of the advances.
The following table represents our contractual obligations as of December 31, 2003:
Market Risk
Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices such as interest rates, foreign currency exchange rates, commodity prices, and equity prices. The Company’s primary market risk exposure is interest rate risk. The ongoing monitoring and management of this risk is an important component of the Company’s asset/liability management process which is governed by policies established by its Board of Directors that are reviewed and approved annually. The Board of
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Directors delegates responsibility for carrying out the asset/liability management policies to the Asset/Liability Committee (ALCO). In this capacity ALCO develops guidelines and strategies impacting the Company’s asset/liability management related activities based upon estimated market risk sensitivity, policy limits and overall market interest rate levels/trends.
Interest Rate Risk
The objective of interest rate risk management is to contain the risks associated with interest rate fluctuations. The process involves identification and management of the sensitivity of net interest income to changing interest rates. Managing interest rate risk is not an exact science. The interval between repricing of interest rates of assets and liabilities changes from day to day as the assets and liabilities change. For some assets and liabilities contractual maturity and the actual cash flows experienced are not the same. A good example is residential mortgages that have long term contractual maturities but may be repaid well in advance of the maturity when current prevailing interest rates become lower than the contractual rate. Interest-bearing deposits without a stated maturity could be withdrawn after seven days, however, the Bank’s experience indicates that these funding pools have a much longer duration and are not as sensitive to interest rate changes as other financial instruments. Prime based loans generally have rate changes when the Federal Reserve Bank changes short term interest rates, however, depending on the magnitude of the rate change and the relationship of the current rates to rate floors and rate ceilings that may be in place on the loans, the loan rate may not change.
GAP analysis
The following table gives a description of our GAP position for various time periods. As of December 31, 2003, we had a negative GAP position at six months and a positive GAP position at twelve months. The cumulative GAP as a percentage of total assets for six months is a negative 4.00% which compares to a negative 2.77% at December 31, 2002 and a negative 12.52% at December 31, 2001. The table also shows the GAP earnings sensitivity, and earnings sensitivity ratio, along with a brief description as to how they are calculated. The methodology used to compile this GAP information is based on our mix of assets and liabilities and the historical experience accumulated regarding their rate sensitivity.
(1) Gap Earnings Sensitivity is the estimated effect on income, after taxes of 39%, of a 1% increase or decrease in interest rates (1% of ($17,777 — $6,933))
(2) Gap Earnings Sensitivity Ratio is Gap Earnings Sensitivity divided by the estimated yearly earnings of $38,008. A 1% increase in
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interest rates has this estimated percentage decrease effect on annual income.
This table estimates the repricing maturities of the Company’s assets and liabilities, based upon the Company’s assessment of the repricing characteristics of the various instruments. Interest-bearing checking and regular savings are included in the more than 5 years category. Money market balances are included in the less than 6 months category. Mortgage-backed securities are at the anticipated principal payments based on the weighted-average-life.
Net interest income simulation
The traditional one-dimensional view of GAP is not sufficient to show a bank’s ability to withstand interest rate changes. Because of limitations in GAP modeling the Asset/Liability Management Committee (ALCO) of the Company uses a detailed and dynamic simulation model to quantify the estimated exposure of net interest income (NII) to sustained interest rate changes. While ALCO routinely monitors simulated NII sensitivity over a rolling two-year horizon, it also utilizes additional tools to monitor potential longer-term interest rate risk. The simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all assets and liabilities reflected on the Company’s statement of financial condition. This sensitivity analysis is compared to ALCO policy limits which specify a maximum tolerance level for NII exposure over a one year horizon, assuming no balance sheet growth, given a 200 or 100 basis point (bp) upward and downward shift in interest rates. A parallel and pro rata shift in rates over a 12-month period is assumed as a benchmark. Other non-parallel rate movement scenarios are also modeled to determine the potential impact on net interest income. The following reflects the Company’s NII sensitivity analysis as of December 31, 2003 and 2002 as compared to the 10% Board approved policy limit.
The preceding sensitivity analysis does not represent a forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of assets and liability cash flows, and others. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change. Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will also differ due to prepayment/refinancing levels likely deviating from those assumed, the varying impact of interest rate change caps or floors on adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early withdrawals and product preference changes, and other internal/external variables. Furthermore, the sensitivity analysis does not reflect actions that ALCO might take in responding to or anticipating changes in interest rates.
Liquidity Risk
Liquidity risk is the possibility that the Company will not be able to fund present and future obligations. The objective of liquidity management is to maintain cash flows adequate to meet current and future needs for credit demand, deposit withdrawals, maturing liabilities and corporate operating expenses. Core deposits, FHLB credit lines, available-for-sale investment securities, and net income are the key elements in meeting these objectives. All seven subsidiaries are members of the FHLB. This membership provides for established lines of credit in the form of advances that are a supplemental source of funds for lending and other general business purposes. As of year ended December 31, 2003, the Company had $965 million of available FHLB line of which $777 million was utilized. Accordingly, management of the Company has a wide range of versatility in managing the liquidity and asset/liability mix for each individual institution as well as the Company as a whole. During 2003, all seven financial institutions maintained liquidity levels in excess of regulatory requirements and deemed sufficient to meet operating cash needs.
Capital Resources and Adequacy
Maintaining capital strength has been a long term objective. Ample capital is necessary to sustain growth, provide protection against unanticipated declines in asset values, and to safeguard the funds of depositors. Capital also is a source of funds for loan demand and enables the Company to effectively manage its assets and liabilities. Shareholders’ equity increased $25.590 million during 2003, or
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12 percent the net result of earnings of $38.008 million, less cash dividend payments and a decline of $3.495 million in the net unrealized gains on available-for-sale investment securities. For additional information see footnote 11 in the Consolidated Financial Statements. Dividend payments were increased by $.14 per share, or 23 percent in 2003. The payment of dividends is subject to government regulation, in that regulatory authorities may prohibit banks and bank holding companies from paying dividends which would constitute an unsafe or unsound banking practice.
Critical Accounting Policies
Companies may apply certain critical accounting policies requiring management to make subjective or complex judgments, often as a result of the need to estimate the effect of matters that are inherently uncertain. The Company considers its only material critical accounting policy to be the allowance for loan losses. The allowance for loan losses is established through a provision for loan losses charged against earnings. The balance of allowance for loan losses is maintained at the amount management believes will be adequate to absorb known and inherent losses in the loan portfolio. The appropriate balance of allowance for loan losses is determined by applying estimated loss factors to the credit exposure from outstanding loans. Estimated loss factors are based on subjective measurements including management’s assessment of the internal risk classifications, changes in the nature of the loan portfolio, industry concentrations and the impact of current local, regional and national economic factors on the quality of the loan portfolio. Changes in these estimates and assumptions are reasonably possible and may have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.
For additional information regarding the allowance for loan losses, its relation to the provision for loans losses and risk related to asset quality, see Note 4 to the Consolidated Financial Statements in “Item 8 – Financial Statements and Supplementary Data”.
Impact of Recently Issued Accounting Standards
In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46 (FIN46), Consolidation of Variable Interest Entities and, in December 2003, issued Revised Interpretation No. 46 (FIN 46R), Consolidation of Variable Interest Entities, which replaced FIN 46. Variable interest entities are entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. On December 31, 2003, the Company adopted FIN 46R for its existing variable interest entities. The adoption of FIN 46 and FIN 46R did not have a material effect on the Company’s financial statements, except as described below.
Historically, issuer trusts that issued trust preferred securities have been consolidated by their parent companies and trust preferred securities have been treated as eligible for Tier 1 capital treatment by bank holding companies under Federal Reserve rules and regulations relating to minority interest in equity accounts of consolidated subsidiaries. Applying the provisions of FIN 46R, the Company is no longer permitted to consolidate the issuer trust, beginning on December 31, 2003. Although the Federal Reserve has stated in its July 2, 2003 Supervisory Letter that trust preferred securities will be treated as Tier 1 capital until notice is given to the contrary, the Supervisory Letter also indicates that the Federal Reserve will review the regulatory implications of any accounting treatment changes and will provide further guidance if necessary or warranted.
Year Ended December 31, 2002 Compared to December 31, 2001
Financial Condition
Total assets increased $195,597,000, or 9.4%, over the December 31, 2001 asset level. Total gross loans outstanding decreased 1.4%, or $19,384,000. Residential real estate loans held for investment decreased $85,058,000, or 21.6%. With the continued decline in interest rates during 2002 a large number of real estate loans were refinanced which combined with the Company strategy of selling long term real estate loans as they are originated has resulted in a net reduction in real estate loans outstanding. Consumer loans, including home equity loans, also decreased 12,032,000, or 4.2%. The majority of the consumer loan decrease is attributed to dealer originated loans. Commercial loans, which continue to be our lending focus, increased $53,123,000 or 8.6%. Investment securities increased $231,383,000, or 45.5%, the result of redeploying the cash received from the residential real estate loans to mortgage related investment securities, and the investment of other liquid funds.
Total liabilities increased $160,331,000, or 8.4%, primarily the result of the increase in FHLB and other borrowings which increased $144,013,000 or 36%. Total deposits decreased $13,859,000 or 1.0% however, there was a significant shift from interest bearing deposits to non-interest bearing deposits. Non-interest bearing deposits increased $60,698,000 or 26% and interest bearing deposits decreased $46,839,000 or 3.9%. Federal Home Loan Bank advances increased $116,365,000, or 31.7% and securities sold under repurchase agreements and other borrowed funds were up $27,648,000, or 82.2%.
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During 2002, the Company increased dividends per share to $.67, an increase of 11.7% over the prior year. Stockholders’ equity, excluding accumulated other comprehensive income, increased $26,911,000, or 15.4% the result of earnings retention and the exercise of stock options. Accumulated other income, which is comprised of unrealized gains on securities available-for-sale, increased $8,355,000 or 475.8%.
The 2002 results of operations include the full year impact of the first quarter 2001 acquisitions of WesterFed Financial Corporation and branch purchases in Idaho and Utah.
Interest Income — Interest income was $133,989,000 and $137,920,000 for the years ended December 31, 2002 and 2001, respectively, a $3,931,000, or 2.9% decrease, primarily the result of continuing low interest rates. The weighted average yield on the loan and investment portfolios decreased from 7.8% to 6.9%, also the result of lower interest rates.
Interest Expense — Interest expense was $47,522,000 for the year ended December 31, 2002, down from $65,546,000 in 2001, a $18,024,000, or 27.50%, decrease. The increase in non-interest bearing deposits and significant reductions in rates paid on interest bearing deposits and borrowed funds, are the primary reasons for the decreased interest expense. The cost of interest bearing liabilities decreased from 4.3% in 2002 to 2.8% in 2001.
Net Interest Income — Net interest income was $86,467,000 compared to $72,374,000 in 2001, an increase of $14,093,000, or 19.5%, the net result of the items discussed in the above paragraphs.
Provision for Loan Losses — The provision for loan losses was $5,745,000 for 2002, up from $4,525,000 for 2001. Total loans charged off, net of recoveries, were $3,455,000 in 2002, up from the $2,563,000 experienced in 2001. The allowance for loan losses balance was $20,944,000 at year end 2002, up from $18,654,000 at year end 2001, an increase of $2,290,000. With the continual change in loan mix from residential real estate to commercial and consumer loans, which historically have greater credit risk, the Company has increased the balance in the reserve for loan losses account. At December 31, 2002, the non-performing assets (non-accrual loans, accruing loans 90 days or more overdue, real estate acquired by foreclosure or deed-in-lieu thereof, and repossessed personal property) totaled $11,582,000 or .51% of total assets; compared to $11,275,000 or .53% of total assets at December 31, 2001. The peer group average, according to the Federal Reserve Bank Performance Report as of September 30, 2002, the most recent information available, for banking companies similar to our size was .63% of total assets. The allowance for loan losses was 181% of non-performing assets at December 31, 2002, up from 165% the prior year end. The allowance for loan losses as a percentage of loans increased to 1.58% from 1.39 % at the 2002 and 2001 year ends, respectively.
Non-interest income — Total non-interest income of $25,917,000 was up $2,666,000, or 11.5% from 2001. Loan fees and charges and gain on sale of loans increased $138,000 and $1,324,000, respectively, from the prior year, the result of increased loan originations and refinancing in the low interest rate environment. Service charges and other fees increased $1,721,000 or 14.0% from 2001. Other income decreased $691,000, primarily from the 2001 $511,000 gain on sale of Glacier Bank Cutbank office included in other income. The gain on sale of investments was $238,000 in 2002, up from $64,000 in 2001, the result of repositioning certain investments.
Non-interest expense – Total non-interest expense was $57,813,000 compared to $57,385,000 for the year ended December 31, 2001. Prior year includes $1,975,000 of merger expenses and $1,699,000 in goodwill amortization, and current year includes a reversal of a merger related accrual of $323,000. Compensation, employee benefits, and related expenses increased $2,507,000, or 9.0% from 2001. Outsourced data processing expense has decreased $548,000, or 21.1%, a result of converting Western Security Bank’s data processing functions to the Company’s system, which also was a reason for the increase in compensation expense. Occupancy and equipment expense increased $912,000, or 10.5% from 2001. Other expenses increased $1,152,000, or 8.8%.
The efficiency ratio (non-interest expense)/(net interest income + non-interest income), was 51.4% in 2002, down from 60.0% in 2000, which compares favorably with similar sized bank holding companies nationally which average approximately 60.5%.
Item 7a. Quantitative and Qualitative Disclosures about Market Risk
Information regarding “Quantitative and Qualitative Disclosures about Market Risk” is set fourth under “Item 7 — Management’s Discussion and Analysis”.
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Item 8. Financial Statements and Supplementary Data
The following audited consolidated financial statements and related documents are set forth in the Annual Report on Form 10-K on the pages indicated.
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Independent Auditors’ Report
The Board of Directors and StockholdersGlacier Bancorp, Inc.:
We have audited the accompanying consolidated statements of financial condition of Glacier Bancorp, Inc. and subsidiaries as of December 31, 2003 and 2002 and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Glacier Bancorp, Inc. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Notes 1 and 6 to the consolidated financial statements, the Company changed its accounting for goodwill in accordance with Statements of Financial Accounting Standards No. 142, Goodwill and Other Intangibles, and No. 147, Acquisitions of Certain Financial Institutions, effective January 1, 2002.
/s/ KPMG
Billings, MontanaFebruary 4, 2004
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Glacier Bancorp, Inc.Consolidated Statements of Financial Condition
See accompanying notes to consolidated financial statements.
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Glacier Bancorp, Inc.Consolidated Statements of Operations
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Glacier Bancorp, Inc.Consolidated Statements of Stockholders’ Equityand Comprehensive IncomeYears ended December 31, 2003, 2002, and 2001
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Consolidated Statements of Cash Flows
See accompanying notes to consolidated financial statements
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1. Summary of Significant Accounting Policies
(a) General
Glacier Bancorp, Inc. (the “Company”), a Delaware corporation organized in 1990, is a multi-bank holding company that provides a full range of banking services to individual and corporate customers in Montana, Idaho, Utah and Washington through its subsidiary banks. The subsidiary banks are subject to competition from other financial service providers. The subsidiary banks are also subject to the regulations of certain government agencies and undergo periodic examinations by those regulatory authorities.
The accounting and consolidated financial statement reporting policies of the Company conform with accounting principles generally accepted in the United States of America. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported and disclosed amounts of assets and liabilities as of the date of the statement of financial condition and income and expenses for the period. Actual results could differ significantly from those estimates.
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the subsidiary banks’ allowance for loan losses. Such agencies may require the subsidiary banks to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
(b) Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its eight wholly owned operating subsidiaries, Glacier Bank (“Glacier”), First Security Bank of Missoula (“First Security”), Western Security Bank (“Western”), Mountain West Bank in Idaho, (“Mountain West”), Big Sky Western Bank, (“Big Sky”), Valley Bank of Helena (“Valley”), Glacier Bank of Whitefish (“Whitefish”), and Glacier Capital Trust I (“Glacier Trust”). All significant inter-company transactions have been eliminated in consolidation.
Pend Oreille Bancorp was acquired July 15, 2003 and its branches became additional branches of Mountain West. Western was acquired on February 28, 2001 through the purchase of WesterFed Financial Corporation, its parent company. On March 15, 2001, the Company acquired seven Wells Fargo & Company and First Security Corporation subsidiary banks located in Idaho and Utah. The acquisitions were accounted for using the purchase method of accounting. Accordingly, the financial information presented includes the operations since the date of the acquisitions. See footnote 20 for additional information related to these transactions.
On July 31, 2001, Glacier Bank of Eureka was merged into Whitefish and the minority interest of both banks was redeemed.
(c) Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, cash held as demand deposits at various banks and regulatory agencies, interest bearing deposits and federal funds sold with original maturities of three months or less.
(d) Investment Securities
Debt securities for which the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity and are stated at amortized cost. Debt and equity securities held primarily for the purpose of selling in the near term are classified as trading securities and are reported at fair market value, with unrealized gains and losses included in income. Debt and equity securities not classified as held-to-maturity or trading are classified as available-for-sale and are reported at fair value with unrealized gains and losses, net of income taxes, shown as a separate component of stockholders’ equity. Currently, the Company only holds available-for-sale securities.
Premiums and discounts on investment securities are amortized or accreted into income using a method that approximates the level-yield interest method. The cost of any investment, if sold, is determined by specific identification. Declines in the fair value of securities below carrying value that are other than temporary are charged to expense as realized losses and the related carrying value is reduced to fair value.
(e) Loans Receivable
Loans that are intended to be held to maturity are reported at their unpaid principal balance less charge-offs, specific valuation accounts, and any deferred fees or costs on originated loans. Purchased loans are reported net of unamortized premiums or discounts. Discounts and premiums on purchased loans and net loan fees on originated loans are amortized over the expected life of loans using methods that approximate the effective interest method.
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1. Summary of Significant Accounting Policies ... continued
Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. Accrual of interest on loans is discontinued either when reasonable doubt exists as to the full, timely collection of interest or principal or when a loan becomes contractually past due by ninety days or more with respect to interest or principal unless such past due loan is well secured and in the process of collection. When a loan is placed on nonaccrual status, interest previously accrued but not collected is reversed against current period interest income. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest.
(f) Loans Held for Sale
Mortgage and commercial loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are recognized by charges to income. A sale is recognized when the Company surrenders control of the loan and consideration, other than beneficial interests in the loan, is received in exchange. A gain is recognized to the extent the selling price exceeds the carrying value.
(g) Allowance for Loan Losses
Management’s periodic evaluation of the adequacy of the allowance is based on factors such as the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, current economic conditions, and independent appraisals.
The Company also provides an allowance for losses on impaired loans. Groups of small balance homogeneous loans (generally consumer and residential real estate loans) are evaluated for impairment collectively. A loan is considered impaired when, based upon current information and events, it is probable that the Company will be unable to collect, on a timely basis, all principal and interest according to the contractual terms of the loan’s original agreement. When a specific loan is determined to be impaired, the allowance for loan losses is increased through a charge to expense for the amount of the impairment. The amount of the impairment is measured using cash flows discounted at the loan’s effective interest rate, except when it is determined that the sole source of repayment for the loan is the operations or liquidation of the underlying collateral. In such cases, impairment is measured by determining the current value of the collateral, reduced by anticipated selling costs. The Company recognizes interest income on impaired loans only to the extent the cash payments are received.
(h) Premises and Equipment
Premises and equipment are stated at cost less depreciation. Depreciation is computed on a straight-line method over the estimated useful lives or the term of the related lease. The estimated useful life for office building is 15-40 years and the estimated useful life for furniture, fixtures, and equipment is 3-10 years.
i) Real Estate Owned
Property acquired by foreclosure or deed in lieu of foreclosure is carried at the lower of cost or estimated fair value, less selling costs. Costs, excluding interest, relating to the improvement of property are capitalized, whereas those relating to holding the property are charged to expense. Fair value is determined as the amount that could be reasonably expected in a current sale (other than a forced or liquidation sale) between a willing buyer and a willing seller. If the fair value of the asset minus the estimated cost to sell is less than the cost of the property, a loss is recognized and the asset carrying value is reduced.
(j) Restricted Stock Investments
The Company holds stock in the Federal Home Loan Bank of Seattle (FHLB) and the Federal Reserve Bank (FRB). FHLB and FRB stocks are restricted because they may only be sold to another member institution or the FHLB or FRB at their par values. Due to restrictive terms, and the lack of a readily determinable market value, FHLB and FRB stocks are carried at cost.
(k) Goodwill
The excess of purchase price over the fair value of net assets from acquisitions (“Goodwill”), prior to January 1, 2002, was being amortized using the straight-line method over periods of primarily 5 to 25 years. As of January 1, 2002, the Company ceased amortization of goodwill as a result of Financial Accounting Standards Board (FASB) Statement 142, Goodwill and Other Intangible Assets and Statement 147, Acquisition of Certain Financial Institutions. As of January 1, 2002, on an annual basis, the Company tests goodwill for impairment at the subsidiary level during the third quarter. In addition, goodwill is tested for impairment on an interim basis if an event or circumstance indicates that it is more likely than not that an impairment loss has occurred. As of December 31, 2003 and 2002 the accumulated amortization of goodwill was $3,001,000.
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(l) Core Deposit Intangibles
Core deposit intangibles represent the intangible value of depositor relationships resulting from deposit liabilities assumed in acquisitions and are amortized using an accelerated method based on an estimated runoff of the related deposits, not exceeding 10 years. The useful life of the core deposit intangible is reevaluated on an annual basis, with any changes in estimated useful life being accounted for prospectively over the revised remaining life.
(m) Income Taxes
Deferred tax assets and liabilities are recognized for estimated future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
(n) Stock-based Compensation
Compensation cost for stock-based compensation to employees is measured at the grant date using the intrinsic value method. Under the intrinsic value method, compensation cost is the excess of the market price of the stock at the grant date over the amount an employee must pay to ultimately acquire the stock and is recognized over any related service period.
The per share weighted-average fair value of stock options granted during 2003, 2002 and 2001 was $2.12, $3.26, and $2.81, respectively, on the date of grant using the Black Scholes option-pricing model with the following assumptions: 2003 – expected dividend yield of 3.01%, risk-free interest rate of 3.25%, volatility ratio of 21%, and expected life of 4.8 years: 2002 – expected dividend yield of 3.02%, risk-free interest rate of 2.73%, volatility ratio of 23%, and expected life of 4.8 years: 2001 – expected dividend yield of 3.60%, risk-free interest rate of 4.44%, volatility ratio of 25%, and expected life of 4.8 years.
The exercise price of all options granted has been equal to the fair market value of the underlying stock at the date of grant and, accordingly, no compensation cost has been recognized for its stock options in the financial statements. Had the Company determined compensation cost based on the fair value of the option itself at the grant date for its stock options under FASB Statement 123, Accounting for Stock-Based Compensation, the Company’s net income would have been reduced to the pro forma amounts indicated below:
(o) Long-lived Assets
Long-lived assets, including core deposit intangibles, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An asset is deemed impaired if the sum of the expected future cash flows is less than the carrying amount of the asset. If impaired, an impairment loss is recognized to reduce the carrying value of the asset to fair value. At December 31, 2003 and 2002 there were no assets that were considered impaired.
(p) Mortgage Servicing Rights
The Company recognizes the rights to service mortgage loans for others, whether acquired or internally originated. Loan servicing rights are initially recorded at fair value based on comparable market quotes and are amortized as other expense in proportion to and
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over the period of estimated net servicing income. Loan servicing rights are evaluated quarterly for impairment by discounting the expected future cash flows, taking into consideration the estimated level of prepayments based on current industry expectations and the predominant risk characteristics of the underlying loans including loan type, note rate and loan term. Impairment adjustments, if any, are recorded through a valuation allowance.
As of December 31, 2003 and 2002 the carrying value of servicing rights was approximately $1,388,000 and $1,973,000, respectively. Amortization expense of $729,000, $480,000, and $314,000 was recognized in the years ended December 31, 2003, 2002, and 2001, respectively. The servicing rights are included in other assets on the balance sheet and are amortized over the period of estimated net servicing income. There was no impairment of carrying value at December 31, 2003 or 2002. At December 31, 2003, the fair value of mortgage servicing rights was approximately $1,957,000.
(q) Earnings Per Share
Basic earnings per share is computed by dividing net earnings available to common stockholders by the weighted average number of shares of common stock outstanding during the year. Diluted earnings per share is computed by dividing such net earnings by the weighted average number of common shares used to compute basic EPS plus the incremental amount of potential common stock determined by the treasury stock method. Previous period amounts are restated for the effect of stock dividends and splits.
(r) Stock Dividend
On April 30, 2003, the Board of Directors declared a 10 percent stock dividend, payable in common stock of the Company to shareholders of record on May 13, 2003, payable on May 22, 2003. All prior period amounts have been restated to reflect the stock dividend.
(s) Comprehensive Income
Comprehensive income includes net income, as well as other changes in stockholders’ equity that result from transactions and economic events other than those with stockholders. The Company’s only significant element of other comprehensive income is unrealized gains and losses on available-for-sale securities.
(t) Reclassifications
Certain reclassifications have been made to the 2002 and 2001 financial statements to conform to the 2003 presentation.
2. Cash on Hand and in Banks
The subsidiary banks are required to maintain an average reserve balance with either the Federal Reserve Bank or in the form of cash on hand. The amount of this required reserve balance at December 31, 2003 was $7,957,000.
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3. Investment Securities, Available for Sale
A comparison of the amortized cost and estimated fair value of the Company’s investment securities, available for sale, is as follows.
INVESTMENTS AS OF DECEMBER 31, 2003
INVESTMENTS AS OF DECEMBER 31, 2002
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3. Investment Securities, Available for Sale...continued
The book value of securities was as follows at:
Investments with an unrealized loss position at December 31, 2003:
Most of the unrealized loss is the result of changing market values due to changes in intermediate term (10 year) interest rates. The value of real estate mortgage investment conduits and mortgage-backed securities is also affected by the level of mortgage refinancing activity and resulting prepayment of the underlying mortgages. During periods of rapid prepayments, values decline because of shortening of the expected maturity and reduced earning potential. During 2003 an impairment charge for $2,249,000, for the impairment of value on collateralized mortgage obligations was recorded as a reduction in the net gain on sale of investments.
Maturities of securities do not reflect repricing opportunities present in adjustable rate securities, nor do they reflect expected shorter maturities based upon early prepayment of principal. Weighted yields on tax-exempt investment securities exclude the tax effect. The Real Estate Mortgage Investment Conduits are backed by the FNMA, GNMA, or FHLMC.
Interest Income includes tax-exempt interest for the years ended December 31, 2003, 2002, and 2001 of $11,410,000, $8,074,000, and $4,624,000, respectively.
Gross proceeds from sales of investment securities for the years ended December 31, 2003, 2002, and 2001 were approximately $19,603,000, $31,695,000 and $86,311,000 respectively, resulting in gross gains of approximately $3,502,000, $451,000 and $71,000 and gross losses of approximately $0, $213,000 and $7,000, respectively. The cost of any investment sold is determined by specific identification.
At December 31, 2003, the Company had investment securities with carrying values of approximately $177,663,000 pledged as security for deposits of several local government units, securities sold under agreements to repurchase, and as collateral for treasury tax and loan borrowings.
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4. Loans Receivable, Net and Loans Held for Sale
The following is a summary of loans receivable, net and loans held for sale at:
The following is a summary of activity in allowance for losses on loans:
The following is the allocation of allowance for loan losses and percent of loans in each category at:
Substantially all of the Company’s loan receivables are with customers within the Company’s market area. Although the Company has a diversified loan portfolio, a substantial portion of its customers’ ability to honor their contracts is dependent upon the economic performance in the Company’s market areas. At December 31, 2003, no individual borrower had outstanding loans or commitments exceeding 10% of the Company’s consolidated stockholders’ equity.
Impaired loans, which consists of those reported as non-accrual, for the years ended December 31, 2003, 2002, and 2001 were approximately $10,062,000, $8,042,000, and $9,232,000, respectively, of which no impairment allowance was deemed necessary. The average recorded investment in impaired loans for the years ended December 31, 2003, 2002, and 2001 was approximately
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4. Loans Receivable, Net and Loans Held for Sale ... continued
$8,620,000, $8,275,000, and $7,842,000, respectively. Interest income that would have been recorded on impaired loans if such loans had been current for the entire period would have been approximately $665,000, $596,000, and $658,000 for the years ended December 31, 2003, 2002, and 2001, respectively. Interest income recognized on impaired loans for the years ended December 31, 2003, 2002, and 2001 was not significant. Loans ninety days overdue and still accruing for the years ended December 31, 2003, 2002, and 2001 were approximately $2,419,000, $1,998,000, and $1,437,000, respectively.
The weighted average interest rate on loans was 6.74% and 7.48% at December 31, 2003 and 2002, respectively.
At December 31, 2003, 2002 and 2001 loans sold and serviced for others were $189,601,000, $253,063,000, and $286,996,000, respectively.
At December 31, 2003 the Company had $846,312,000 in variable rate loans and $610,318,000 in fixed rate loans.
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and letters of credit, and involve, to varying degrees, elements of credit risk. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. The Company did not have any outstanding commitments on impaired loans as of December 31, 2003.
The Company had outstanding commitments as follows:
Substantially all of the loans held for sale at December 31, 2003 and 2002 were committed to be sold.
The Company has entered into transactions with its executive officers, directors, significant shareholders, and their affiliates. The aggregate amount of loans to such related parties at December 31, 2003 was approximately $27,313,000. During 2003, new loans to such related parties were approximately $24,652,000 and repayments were approximately $18,525,000.
5. Premises and Equipment, Net
Premises and equipment, net consist of the following at:
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6. Goodwill and Other Intangible Assets
The following table sets forth information regarding the Company’s core deposit intangibles and mortgage servicing rights:
(1) Gross carrying value and accumulated amortization are not readily available
As of January 1, 2002, the Company no longer amortizes goodwill as a result of the FASB Statements 142 and 147. The following pro forma information presents the consolidated results of operations as if the adoption of Statements 142 and 147 had occurred on January 1, 2001.
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7. Deposits
Deposits consist of the following at:
At December 31, 2003, scheduled maturities of certificate accounts are as follows:
Interest expense on deposits is summarized as follows:
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8. Advances from Federal Home Loan Bank of Seattle
Advances from the Federal Home Loan Bank of Seattle (FHLB) consist of the following:
These advances are collateralized by the FHLB stock held by the Company and a blanket assignment of the Bank’s unpledged qualifying real estate loans and investments. The total amount of advances available, subject to collateral availability, as of December 31, 2003 was approximately $267,897,000.
The weighted average interest rate on these advances was 2.80% and 4.15% at December 31, 2003 and 2002, respectively.
The Federal Home Loan Bank of Seattle holds callable options, which may be exercised after a predetermined time as shown below as of December 31, 2003:
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9. Securities Sold Under Agreements to Repurchase and Other Borrowed Funds
Securities sold under agreements to repurchase consist of the following at:
The securities, consisting of agency issued or guaranteed mortgage backed securities, underlying agreements to repurchase entered into by the Company are for the same securities originally sold, and are held in a custody account by a third party. For the year ended December 31, 2003 and 2002 securities sold under agreements to repurchase averaged approximately $61,609,000 and $35,480,000, respectively, and the maximum outstanding at any month end during the year was approximately $74,808,000 and $46,206,000, respectively.
The Company also has a treasury tax and loan account note option program which provides short term funding with no fixed maturity date up to $19,500,000 at federal funds rates minus 25 basis points. At December 31, 2003 and 2002 the outstanding balance under this program was approximately $7,309,000 and $15,087,000. The borrowings are secured with investment securities with a par value of approximately $26,415,000 and a market value of approximately $28,722,000. For the year ended December 31, 2003, the maximum outstanding at any month end was approximately $15,052,000 and the average balance was approximately $4,235,000.
During 1999, the Company assumed Big Sky’s subordinated convertible debentures as part of the merger transaction. The outstanding balance at December 31, 2000 was $350,000. The interest rate was 7.5 percent, payable quarterly. On December 31, 2001, the debentures became due and were exchanged for 33,257 shares of Company stock and $8,508 in cash.
10. Subordinated Debentures
On January 25, 2001, 1,400,000 shares of trust preferred shares were issued by Glacier Trust whose common equity is wholly owned by the Company. The Trust Preferred Securities bear a cumulative fixed interest rate of 9.40% and mature on February 1, 2031. Interest distributions are payable quarterly. The Trust Preferred Securities are subject to mandatory redemption upon repayment of the Subordinated Debentures of $35,000,000 at their stated maturity date or their earlier redemption in an amount equal to their liquidation amount plus accumulated and unpaid distributions to the date of redemption. The Company guaranteed the payment of distributions and payments for redemption or liquidation of the Trust Preferred Securities to the extent of funds held by the Trust. The obligations of the Company under the Subordinated Debentures together with the guarantee and other back-up obligations, in the aggregate, constitute a full and unconditional guarantee by the Company of the obligations of the Trust under the Trust Preferred Securities.
As a result of the adoption of FIN 46R, the Company deconsolidated the Trust. The $35,000,000 of subordinated debentures issued by the Company to the Trust are reflected in the consolidated balance sheets as of December 31, 2003 and 2002.
The Subordinated Debentures are unsecured, bear interest at a rate of 9.40% per annum and mature on February 1, 2031. Interest is payable quarterly. The Company may defer the payment of interest at any time from time to time for a period not exceeding 20 consecutive quarters provided that the deferral period does not extend past the stated maturity. During any such deferral period,
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10. Subordinated Debentures... continued
distributions on the Trust Preferred Securities will also be deferred and the Company’s ability to pay dividends on its common shares will be restricted.
Subject to approval by the Federal Reserve Bank, the Trust Preferred Securities may be redeemed prior to maturity at the Company’s option on or after February 1, 2006 at par. The Trust Preferred Securities may also be redeemed at any time in whole (but not in part) in the event of unfavorable changes in laws or regulations that result in (1) Glacier Trust becoming subject to federal income tax on income received on the Subordinated Debentures, (2) interest payable by Parent Company on the Subordinated Debentures becoming non-deductible for federal tax purposes, (3) the requirement for Glacier Trust to register under the Investment Company Act of 1940, as amended, or (4) loss of the ability to treat the Trust Preferred Securities as “Tier 1 Capital” under the Federal Reserve capital adequacy guidelines.
11. Regulatory Capital
The Federal Reserve Board has adopted capital adequacy guidelines pursuant to which it assesses the adequacy of capital in supervising a bank holding company. The following table illustrates the Federal Reserve Board’s adequacy guidelines and the Company’s compliance with those guidelines as of December 31, 2003:
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11. Regulatory Capital... continued
The following table illustrates the Federal Reserve Board’s adequacy guidelines and the Company’s compliance with those guidelines as of December 31, 2002:
The Federal Deposit Insurance Corporation Improvement Act generally restricts a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding Company if the institution would thereafter be capitalized at less than 8% of total risk-based capital, 4% of Tier I capital, or a 4% leverage ratio. At December 31, 2003 and 2002, the subsidiary banks’ capital measures exceed the highest supervisory threshold, which requires total Tier II capital of at least 10%, Tier I capital of at least 6%, and a leverage ratio of at least 5%. Each of the subsidiaries was considered well capitalized by the respective regulator as of December 31, 2003 and 2002.
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12. Federal and State Income Taxes
The following is a summary of consolidated income tax expense for:
The tax effect of temporary differences which give rise to a significant portion of deferred tax assets and deferred tax liabilities are as follows:
There is no valuation allowance at December 31, 2003 and 2002 because management believes that it is more likely than not that the Company’s deferred tax assets will be realized by offsetting future taxable income from reversing taxable temporary differences and anticipated future taxable income.
Retained earnings at December 31, 2003 includes approximately $3,600,000 for which no provision for Federal income tax has been made. This amount represents the base year bad debt reserve, which is essentially an allocation of earnings to pre-1988 bad debt deductions for income tax purposes only. This amount is treated as a permanent difference and deferred taxes are not recognized
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12. Federal and State Income Taxes... continued
unless it appears that this reserve will be reduced and thereby result in taxable income in the foreseeable future. The Company is not currently contemplating any changes in its business or operations which would result in a recapture of this federal bad debt reserve into taxable income.
13. Employee Benefit Plans
Prior to 2002, the Company had a noncontributory defined contribution retirement plan covering substantially all employees. The Company followed the policy of funding retirement plan contributions as accrued. As of January 1, 2002, the retirement plan was merged with the employee savings plan as a profit sharing plan. The plan has a 3% “safe harbor” provision which is a non-elective contribution by the Company. In addition, elective contributions, depending on the Company’s profitability, are made to the plan. The total plan expense for the years ended December 31, 2003, 2002, and 2001 was approximately $3,072,000, $2,691,000 and $1,599,000 respectively.
The Company also has an employees’ savings plan. The plan allows eligible employees to contribute up to 25% of their monthly salaries. The Company matches an amount equal to 50% of the employee’s contribution, up to 6% of the employee’s total pay. Participants are at all times fully vested in all contributions. The Company’s contribution to the savings plan for the years ended December 31, 2003, 2002 and 2001 was approximately $693,000, $577,000, and $511,000, respectively.
The Company has a Supplemental Executive Retirement Plan (SERP) which provides retirement benefits at the savings and retirement plan levels, for amounts that are limited by IRS regulations under those plans. The Company’s contribution to the SERP for the years ended December 31, 2003, 2002 and 2001 was approximately $53,000, $28,000, and $9,000, respectively.
The Company has a non-funded deferred compensation plan for directors and senior officers. The plan provides for the deferral of cash payments of up to 25% of a participants’ salary, and for 100% of bonuses and directors fees, at the election of the participant. The total amount deferred was approximately $236,000, $67,000, and $59,000, for the years ending December 31, 2003, 2002, and 2001, respectively. The participant receives an earnings credit at a one year certificate of deposit rate, or at the total return rate on Company stock, on the amount deferred, as elected by the participant at the time of the deferral election. The total earnings for the years ended 2003, 2002, and 2001 were approximately $364,000, $72,000, and 164,000, respectively. In connection with the WesterFed acquisition (See note 20), the Company assumed the obligations of a deferred compensation plan for certain key employees. The plan provides predetermined periodic payments over 10 to 15 years upon retirement or death. As of December 31, 2003, the liability related to the obligation was approximately $2,029,000 and was included in other liabilities of the Consolidated Statements of Financial Condition. The amount expensed related to the obligation during 2003 was insignificant.
The Company has entered into employment contracts with ten senior officers that provide benefits under certain conditions following a change in control of the Company.
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14. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share:
There were no options excluded from the diluted share calculation for December 31, 2003 and 2002 due to market price exceeding the option exercise price as of the end of the year. Approximately 276,000 option shares in 2001 were not included because the option exercise price exceeded the market value.
15. Stock Option Plans
In the year ended June 30, 1990, Incentive Stock Option Plans were approved which provided for the grant of options limited to 29,445 shares to outside Directors and 166,860 shares to certain full time employees of the Company. In the year ended December 31, 1994 a Stock Option Plan was approved which provided for the grant of options to outside Directors of the Company, limited to 50,000 shares. In the year ended December 31, 1995 a Stock Option Plan was approved which provided for the grant of options limited to 279,768 shares to certain full-time employees of the Company. In April 1999 the Directors 1994 Stock Option Plan, and the Employees 1995 Stock Option Plan, were amended to provide 100,000 and 600,000 additional shares for the Directors and Employees Plans, respectively. In April, 2002, the Directors 1994 Stock Option Plan and the Employees 1995 Stock Option Plan were amended to provide 500,000 and 1,000,000 additional shares to the director’s and employee’s plans, respectively. The option price at which the Company’s common stock may be purchased upon exercise of options granted under the plans must be at least equal to the per share market value of such stock at the date the option is granted.
The fiscal 1990 and 1995 plans also contain provisions authorizing the grant of limited stock rights, which permit the optionee, upon a change in control of the Company, to surrender his or her options for cancellation and receive cash or common stock equal to the difference between the exercise price and the fair market value of the shares on the date of the grant. All option shares are adjusted for stock splits and stock dividends. The term of the options may not exceed five years from the date the options are granted. The employee options vest over a period of two years and the director options vest over a period of six months.
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15. Stock Option Plans... continued
At December 31, 2003, total shares available for option grants to employees and directors are 1,745,438. Changes in shares granted for stock options for the years ended December 31, 2003, 2002, and 2001, are summarized as follows:
The range of exercise prices on options outstanding at December 31, 2003 is as follows:
The options exercised during the year ended December 31, 2003 were at prices from $5.14 to $22.14.
In connection with the acquisition of WesterFed Financial Corporation, outstanding options for employees and directors of WesterFed for 947,979 were exchanged for options outstanding of Company stock at a weighted exercise price of $7.45.
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16. Parent Company Information (Condensed)
The following condensed financial information is the unconsolidated (parent company only) information for Glacier Bancorp, Inc.:
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16. Parent Company Information (Condensed)...continued
17. Unaudited Quarterly Financial Data
Summarized unaudited quarterly financial data is as follows (in thousands except per share amounts):
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17. Unaudited Quarterly Financial Data...continued
18. Fair Value of Financial Instruments
Financial instruments have been defined to generally mean cash or a contract that implies an obligation to deliver cash or another financial instrument to another entity. For purposes of the Company’s Consolidated Statement of Financial Condition, this includes the following items:
Financial assets and financial liabilities other than securities are not traded in active markets. The above estimates of fair value require subjective judgments and are approximate. Changes in the following methodologies and assumptions could significantly affect the estimates. These estimates may also vary significantly from the amounts that could be realized in actual transactions.
Financial Assets – The estimated fair value approximates the book value of cash and interest bearing cash deposits. For investment and mortgage-backed securities, the fair value is based on quoted market prices. The fair value of loans is estimated by discounting future cash flows using current rates at which similar loans would be made. The fair value of FHLB and Federal Reserve Bank stock approximates the book value.
Financial Liabilities – The estimated fair value of demand and savings deposits approximates the book value since rates are periodically adjusted to market rates. Certificate accounts fair value is estimated by discounting the future cash flows using current rates for similar deposits. Advances from the FHLB of Seattle fair value is estimated by discounting future cash flows using current rates for advances with similar weighted average maturities. Repurchase agreements and other borrowed funds have variable interest rates, or are short term, so fair value approximates book value. The subordinated debentures’ fair value is based on quoted market prices.
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18. Fair Value of Financial Instruments...continued
Off-balance sheet financial instruments – Commitments to extend credit and letters of credit represent the principal categories of off-balance sheet financial instruments. Rates for these commitments are set at time of loan closing, so no adjustment is necessary to reflect these commitments at market value. See Note 4 to consolidated financial statements.
19. Contingencies and Commitments
The company leases certain land, premises and equipment from third parties under operating leases. Total rent expense for the year ended December 31, 2003, 2002, and 2001 was approximately $1,025,000 $926,000, and $865,000, respectively. The total future minimum rental commitments required under operating leases that have initial or remaining noncancelable lease terms in excess of one year at December 31, 2003 are as follows (Dollars in thousands):
The Company is a defendant in legal proceedings arising in the normal course of business. In the opinion of management, the disposition of pending litigation will not have a material effect on the Company’s consolidated financial position, results of operations or liquidity.
20. Acquisitions
On July 15, 2003, the Company completed the acquisition of Pend Oreille Bancorp, and its subsidiary Pend Oreille Bank which operates from two locations in Sandpoint, Idaho and one location in Newport, Washington. The bank has approximately $66 million in total assets with deposits of $59 million and gross loans of $50 million. The Company paid $10.4 million and recorded $3.8 million in goodwill. The locations became additional branches of Mountain West Bank, the Company’s Idaho based subsidiary.
On February 28, 2001 the Company completed the acquisition of WesterFed Financial Corporation (WesterFed). The Company issued 4,530,462 shares and $37.3 million cash to shareholders as consideration for the merger.
On March 15, 2001, the Company acquired seven Wells Fargo & Company and First Security Corporation branches located in Idaho and Utah.
All three acquisitions were accounted for under the purchase method of accounting. Accordingly, the assets and liabilities of the acquired banks or branches were recorded by the Company at their respective fair values at the date of the acquisition and the results of operations have been included with those of the Company since the date of acquisition. The excess of the Company’s purchase price over the net fair value of the assets acquired and liabilities assumed, including identifiable intangible assets, was recorded as goodwill.
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21. Sale of Branches
On June 23, 2001 the Company completed the sale of six branch locations in north central Montana with assets of $23,500,000 to Stockman Bank of Montana (“Stockman”). Stockman acquired five Western Security Bank offices and one Glacier Bank office. Included in the sale were loans of approximately $21,800,000, property and equipment with a book value of approximately $1,700,000, and deposits of $81,700,000. A gain of $511,000 was recognized on the sale.
22. Operating Segment Information
FASB Statement 131, Financial Reporting for Segments of a Business Enterprise, requires that a public business enterprise report financial and descriptive information about its reportable operating segments. According to the statement, operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.
The Company evaluates segment performance internally based on individual bank charter, and thus the operating segments are so defined. All segments, except for the segment defined as “other,” are based on commercial banking operations. The operating segment defined as “other” includes the Parent company, non-bank operating units, and eliminations of transactions between segments.
The accounting policies of the individual operating segments are the same as those of the Company described in note 1. Transactions between operating segments are primarily conducted at fair value, resulting in profits that are eliminated for reporting consolidated results of operations. Expenses for centrally provided services are allocated based on the estimated usage of those services.
The following is a summary of selected operating segment information for the years ended and as of December 31, 2003, 2002, and 2001. During the third quarter of 2001, certain branches of Western were transferred to other Company owned banks located in the same geographic area which accounted for much of the change in activity for certain segments.
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23. Operating Segment Information...continued
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Item 9. Changes in and disagreements with Accountants on Accounting and Financial Disclosure
There have been no changes in or disagreements with accountants on accounting and financial disclosure.
Item 9a. Disclosure of Controls and Procedures
Evaluation of Disclosure Controls and Procedures. An evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures. Based on that evaluation, the CEO and CFO have concluded that as of the end of the period covered by this report, our disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and timely reported as provided in the SEC’s rules and forms.
Changes in Internal Controls. No changes occurred in the quarter and year ended December 31, 2003 in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART III
Item 10. Directors and Executive Officers of the Registrant
Information regarding “Directors and Executive Officers of the Registrant” is set forth under the headings “Business of the Meeting — Election of Directors – Information with Respect to Nominees and Other Directors — Background of Directors” and “Security Ownership of Certain Beneficial Owners and Management – Executive Officers who are not Directors” of the Company’s 2004 Annual Meeting Proxy Statement (“Proxy Statement”) and is incorporated herein by reference.
Information regarding “Compliance with Section 16(a) of the Exchange Act” is set forth under the section “Compliance with Section 16 (a) Filing Requirements” of the Company’s Proxy Statement and is incorporated herein by reference.
Information regarding the Company’s audit committee financial expert is set forth under the heading “Meetings and Committees of Board of Directors–Committee Membership” in our Proxy Statement and is incorporated by reference.
On February 25, 2004, consistent with the requirements of Sarbanes-Oxley, the Company adopted a Code of Ethics applicable to senior financial officers including the principal executive officer. The Code of Ethics is filed as Exhibit 99 to our Report and can be accessed electronically by visiting the Company’s website at www.glacierbancorp.com.
Item 11. Executive Compensation
Information regarding “Executive Compensation” is set forth under the headings “Meetings and Committees of the Board of Directors — Compensation of Directors” and “Executive Compensation” of the Company’s Proxy Statement and is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information regarding “Security Ownership of Certain Beneficial Owners and Management” is set forth under the headings “Information with Respect to Nominees and Other Directors,” “Security Ownership of Certain Beneficial Owners and Management – Executive Officers who are not Directors” and “Beneficial Owners” of the Company’s Proxy Statement and is incorporated herein by reference.
Information regarding “Equity Compensation Plan Information” is set forth under the heading “Equity Compensation Plan Information” of the Company’s Proxy Statement and is incorporated herein by reference.
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Item 13. Certain Relationships and Related Transactions
Information regarding “Certain Relationships and Related Transactions” is set forth under the heading “Transactions with Management” of the Company’s Proxy Statement and is incorporated herein by reference.
Item 14. Principal Accounting Fees and Services
Information regarding “Principal Accounting Fees and Services” is set forth under the heading “Auditors” of the Company’s Proxy Statement and is incorporated herein by reference.
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
List of Financial Statements and Financial Statement Schedules
The financial statements and related documents listed in the index set forth in Item 8 of this report are filed as part of this report.
All other schedules to the consolidated financial statements required by Regulation S-X are omitted because they are not applicable, not material or because the information is included in the consolidated financial statements or related notes.
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NONE
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SIGNATURES
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