-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ERUO/bQhp/HBGsUBKt+D0+RdSUHlVrTmGzUW6d6NkXyAH5GdTtMHPw7RMVOJPTIu NVSnG8a5MASRRVRuXN7QPg== 0000939057-02-000077.txt : 20020814 0000939057-02-000077.hdr.sgml : 20020814 20020814150815 ACCESSION NUMBER: 0000939057-02-000077 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20020630 FILED AS OF DATE: 20020814 FILER: COMPANY DATA: COMPANY CONFORMED NAME: BANNER CORP CENTRAL INDEX KEY: 0000946673 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTIONS, NOT FEDERALLY CHARTERED [6036] IRS NUMBER: 911691604 STATE OF INCORPORATION: WA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-26584 FILM NUMBER: 02735428 BUSINESS ADDRESS: STREET 1: 10 S FIRST AVENUE CITY: WALLA WALLA STATE: WA ZIP: 99362 BUSINESS PHONE: 5095273636 MAIL ADDRESS: STREET 1: 10 S FIRST AVENUE CITY: WALLA WALLA STATE: WA ZIP: 99362 FORMER COMPANY: FORMER CONFORMED NAME: FIRST SAVINGS BANK OF WASHINGTON BANCORP INC DATE OF NAME CHANGE: 19950614 FORMER COMPANY: FORMER CONFORMED NAME: FIRST WASHINGTON BANCORP INC /WA/ DATE OF NAME CHANGE: 19980727 10-Q 1 q2021048.txt BANNER CORPORATION FORM 10-Q FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended........................ June 30, 2002 ------------- [ X ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to -------------- -------------- Commission File Number 0-26584 ----------- BANNER CORPORATION ------------------ (Exact name of registrant as specified in its charter) Washington 91-1691604 - ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 10 S. First Avenue Walla Walla, Washington 99362 --------------------------------------------------------- (Address of principal executive offices and zip code) (509) 527-3636 -------------------------- (Registrant's telephone number, including area code) (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. (1) Yes X No ------- ------- APPLICABLE ONLY TO CORPORATE ISSUERS Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Title of class: As of July 31, 2002 --------------- ------------------- Common stock, $.01 par value 11,580,754 shares * * Includes 577,039 shares held by employee stock ownership plan (ESOP) that have not been released, committed to be released, or allocated to participant accounts. Banner Corporation and Subsidiaries Table of Contents PART I - FINANCIAL INFORMATION ITEM 1 - Financial Statements. The Consolidated Financial Statements of Banner Corporation and Subsidiaries filed as a part of the report are as follows: Consolidated Statements of Financial Condition as of June 30, 2002 and December 31, 2001.............................. 2 Consolidated Statements of Income for the Quarters and Six Months Ended June 30, 2002 and 2001........... 3 Consolidated Statements of Comprehensive Income for the Quarters and Six Months Ended June 30, 2002 and 2001........... 4 Consolidated Statements of Changes in Stockholders' Equity for the Six Months Ended June 30, 2002 and 2001........................ 5 Consolidated Statements of Cash Flows for the Quarters and Six Months Ended June 30, 2002 and 2001........... 8 Selected Notes to Consolidated Financial Statements.................... 10 ITEM 2 - Management's Discussion and Analysis of Financial Condition and Results of Operation General................................................................ 14 Recent Developments and Significant Events............................. 15 Comparison of Financial Condition at June 30, 2002 and December 31, 2001.................................................................. 15 Comparison of Results of Operations for the Quarters and Six Months Ended June 30, 2002 and 2001.......................................... 15 Asset Quality......................................................... 21 Liquidity and Capital Resources....................................... 22 Capital Requirements.................................................. 22 ITEM 3 - Quantitative and Qualitative Disclosures About Market Risk Market Risk and Asset/Liability Management............................ 23 PART II - OTHER INFORMATION Item 1. Legal Proceedings............................................. 27 Item 2. Changes in Securities......................................... 27 Item 3. Defaults upon Senior Securities............................... 27 Item 4. Submission of Matters to a Vote of Stockholders............... 27 Item 5. Other Information............................................. 27 Item 6. Exhibits and Reports on Form 8-K.............................. 27 SIGNATURES............................................................... 28 CERTIFICATION............................................................ 29 1 BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (in thousands, except shares) (Unaudited) June 30 December 31 ASSETS 2002 2001 ----------- ----------- Cash and due from banks $ 93,276 $ 67,728 Securities available for sale, cost $357,674 and $298,332 Encumbered 61,877 64,126 Unencumbered 299,727 237,721 ----------- ----------- 361,604 301,847 Securities held to maturity, fair value $14,625 and $14,902 14,435 14,828 Federal Home Loan Bank stock 31,800 30,840 Loans receivable: Held for sale, fair value $10,677 and $43,647 10,491 43,235 Held for portfolio 1,558,176 1,549,742 Allowance for loan losses (16,646) (17,552) ----------- ----------- 1,552,021 1,575,425 Accrued interest receivable 13,994 12,929 Real estate owned, held for sale, net 6,253 3,011 Property and equipment, net 18,502 18,151 Costs in excess of net assets acquired (goodwill and intangibles), net 36,817 31,437 Deferred income tax asset, net 1,910 1,443 Bank owned life insurance 30,895 20,304 Other assets 3,191 9,151 ----------- ----------- $ 2,164,698 $ 2,087,094 =========== =========== LIABILITIES Deposits: Non-interest-bearing $ 196,221 $ 180,813 Interest-bearing 1,230,667 1,114,998 ----------- ----------- 1,426,888 1,295,811 Advances from Federal Home Loan Bank 431,183 501,982 Trust preferred securities 25,000 -- Other borrowings 68,723 76,715 Accrued expenses and other liabilities 12,406 17,591 Deferred compensation 2,960 2,655 Income taxes payable 555 -- ----------- ----------- 1,967,715 1,894,754 STOCKHOLDERS' EQUITY Common stock - $0.01 par value, 27,500,000 shares authorized, 13,201,418 shares issued: 11,671,937 shares and 11,634,159 shares outstanding at June 30, 2002 and December 31, 2001, respectively. 127,250 126,844 Retained earnings 72,054 68,104 Accumulated other comprehensive income: Unrealized gain (loss) on securities available for sale 2,534 2,264 Unearned shares of common stock issued to Employee Stock Ownership Plan (ESOP) trust: 577,039 and 577,039 restricted shares outstanding at June 30, 2002 and December 31, 2001, respectively, at cost (4,769) (4,769) Carrying value of shares held in trust for stock related compensation plans (2,523) (2,870) Liability for common stock issued to deferred, stock related, compensation plan 2,437 2,767 ----------- ----------- (86) (103) ----------- ----------- 196,983 192,340 ----------- ----------- $ 2,164,698 $ 2,087,094 =========== =========== See selected notes to consolidated financial statements 2 BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (in thousands except for per share amounts) Quarters Ended Six Months Ended *Restated (See Note 7) June 30 June 30 -------------------- ------------------ 2002 2001* 2002 2001* -------- -------- -------- -------- INTEREST INCOME: Loans receivable $ 30,702 $ 34,257 $ 61,953 $ 68,919 Mortgage-backed securities 2,886 3,005 5,442 6,277 Securities and deposits 2,688 2,477 4,899 5,121 -------- -------- -------- -------- 36,276 39,739 72,294 80,317 INTEREST EXPENSE: Deposits 9,874 13,992 20,018 28,211 Federal Home Loan Bank advances 6,231 7,686 12,699 15,506 Trust preferred securities 338 -- 338 -- Other borrowings 400 867 892 1,935 -------- -------- -------- -------- 16,843 22,545 33,947 45,652 -------- -------- -------- -------- Net interest income before provision for loan losses 19,433 17,194 38,347 34,665 PROVISION FOR LOAN LOSSES 4,000 2,950 7,000 3,900 -------- -------- -------- -------- Net interest income 15,433 14,244 31,347 30,765 OTHER OPERATING INCOME: Loan servicing fees 413 285 757 595 Other fees and service charges 1,548 1,468 2,806 2,931 Gain on sale of loans 1,128 1,222 2,419 2,083 Gain (loss) on sale of securities 12 360 17 360 Miscellaneous 448 300 768 531 -------- -------- -------- -------- Total other operating income 3,549 3,635 6,767 6,500 OTHER OPERATING EXPENSES: Salary and employee benefits 9,090 7,625 17,784 15,004 Less capitalized loan origination costs (1,292) (1,371) (2,605) (2,436) Occupancy and equipment 2,039 1,885 4,122 3,744 Information/computer data services 724 859 1,337 1,502 Advertising 298 215 597 418 Check kiting loss -- 2,600 -- 6,200 Amortization of goodwill and CDI 53 795 128 1,590 Miscellaneous 2,928 2,593 5,803 4,890 -------- -------- -------- -------- Total other operating expenses 13,840 15,201 27,166 30,912 -------- -------- -------- -------- Income before provision for income taxes 5,142 2,678 10,948 6,353 PROVISION FOR INCOME TAXES 1,615 1,059 3,512 2,425 -------- -------- -------- -------- NET INCOME $ 3,527 $ 1,619 $ 7,436 $ 3,928 ======== ======== ======== ======== Net income per common share, see Note 5: Basic $ .32 $ .14 $ .67 $ .35 Diluted $ .30 $ .14 $ .65 $ .34 Cumulative dividends declared per common share: $ .15 $ .14 $ .30 $ .28 See selected notes to consolidated financial statements 3 BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) (in thousands) Quarters Ended Six Months Ended June 30 June 30 ------------------- ------------------- *Restated (See Note 7) 2002 2001* 2002 2001* ------- -------- ------- ------- NET INCOME $ 3,527 $ 1,619 $ 7,436 $ 3,928 OTHER COMPREHENSIVE INCOME (LOSS), NET OF INCOME TAXES: Unrealized holding gain (loss) during the period, net of deferred income tax (benefit) of $1,297, $102, $151 and $1,282, respectively 2,409 199 281 2,317 Less adjustment for (gains)/ losses included in net income, net of income tax (benefit) of $4, $126, $6 and $126, respectively (8) (234) (11) (234) ------- ------- ------- ------- Other comprehensive income (loss) 2,401 (35) 270 2,083 ------- ------- ------- ------- COMPREHENSIVE INCOME $ 5,928 $ 1,584 $ 7,706 $ 6,011 ======= ======= ======= ======= See selected notes to consolidated financial statements 4 BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited) (in thousands) For the Six Months Ended June 30, 2002 and 2001 Carrying Value, Net of Liability, Of Shares Held Common Stock Accumulated Unearned in Trust for And Additional Other Restricted Stock-Related Total Paid-in Retained Comprehensive ESOP Shares Compensation Stockholders' Restated (See Note 7) Capital Earnings Income at cost Plans Equity --------- -------- -------- -------- ------ --------- BALANCE, January 1, 2001 $ 133,839 $ 66,893 $ (1,125) $ (5,234) $ (578) $ 193,795 Net income 3,928 3,928 Change in valuation of securities available for sale, net of income taxes 2,083 2,083 Cash dividend on common stock ($.28/share cumulative) (3,298) (3,298) Purchase and retirement of common stock (5,429) (5,429) Proceeds from issuance of common stock for exercise of stock options 1,384 1,384 Release of treasury stock for MRP grant 52 (52) Amortization of compensation related to MRP 516 516 Forfeiture or net change in the number and/or carrying value of shares held in trust for compensation plans (3) 3 -- --------- -------- -------- -------- ------ --------- BALANCE, June 30, 2001 $ 129,843 $ 67,523 $ 958 $ (5,234) $ (111) $ 192,979 ========= ======== ======== ========= ======= ========== Continued
5 BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited) (in thousands) For the Six Months Ended June 30, 2002 and 2001 Carrying Value, Net of Liability, Of Shares Held Common Stock Accumulated Unearned in Trust for And Additional Other Restricted Stock-Related Total Paid-in Retained Comprehensive ESOP Shares Compensation Stockholders' Restated (See Note 7) Capital Earnings Income at cost Plans Equity --------- -------- ------- -------- ------ --------- BALANCE, January 1, 2002 $ 126,844 $ 68,104 $ 2,264 $ (4,769) $ (103) $ 192,340 Net income 7,436 7,436 Change in valuation of securities available for sale, net of income taxes 270 270 Cash dividend on common stock ($.30/share cumulative) (3,486) (3,486) Purchase and retirement of common stock (738) (738) Proceeds from issuance of common stock for exercise of stock options 1,144 1,144 Amortization of compensation related to MRP 17 17 --------- -------- ------- -------- ------ --------- BALANCE, June 30, 2002 $ 127,250 $ 72,054 $ 2,534 $ (4,769) $ (86) $ 196,983 ========= ======== ======= ======== ====== ========= See selected notes to consolidated financial statements 6
BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited) (continued) (in thousands) For the Six Months Ended June 30, 2002 and 2001 2002 2001 ------ ------ COMMON STOCK, SHARES ISSUED: Number of shares, beginning of period 13,201 13,201 ------ ------ Number of shares, end of period 13,201 13,201 ------ ------ LESS COMMON stock PURCHASED AND RETIRED: Number of shares, beginning of period (1,567) (1,196) Purchase and retirement of common stock (40) (288) Issuance of common stock to deferred compensation plan and/or exercised stock options 78 123 ------ ------ Number of shares repurchased/retired, end of period (1,529) (1,361) ------ ------ Shares issued and outstanding, end of period 11,672 11,840 ====== ====== UNEARNED, RESTRICTED ESOP SHARES: Number of shares, beginning of period (577) (633) Release of earned shares -- -- ------ ------ Number of shares, end of period (577) (633) ====== ====== See selected notes to consolidated financial statements 7 BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (in thousands) For the Six Months Ended June 30, 2002 and 2001 *Restated (See Note 7) 2002 2001* --------- --------- OPERATING ACTIVITIES Net income $ 7,436 $ 3,928 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,484 3,335 Loss (gain) on sale of securities (17) (360) Increase in cash surrender value of bank owned life insurance (591) (492) Loss (gain) on sale of loans (1,933) (1,991) Loss (gain) on disposal of real estate held for sale and property and equipment 130 (8) Provision for losses on loans and real estate held for sale 7,000 3,991 FHLB stock dividend (926) (973) Change, net of acquisition, in: Loans held for sale 32,744 (18,205) Other assets 4,516 (1,274) Other liabilities (4,565) (216) --------- --------- Net cash provided (used) by operating activities 45,278 (12,265) --------- --------- INVESTING ACTIVITIES: Purchases of securities (140,429) (32,118) Principal repayments and maturities of securities 78,025 62,123 Proceeds from sales of securities 4,541 1,372 Origination of loans, net of principal repayments (140,857) (212,170) Purchases of loans and participating interest in loans (3,919) (1,311) Proceeds from sales of loans and participating interest in loans 160,413 134,418 Purchases of property and equipment-net (1,618) (1,793) Proceeds from sale of real estate held for sale-net 626 2,383 Investment in bank owned life insurance (10,000) (5,000) Cash (used for) provided by acquisitions (6,519) -- Other (116) (41) --------- --------- Net cash used by investing activities (59,853) (52,137) --------- --------- FINANCING ACTIVITIES Increase (decrease) in deposits 97,578 67,288 Proceeds from FHLB advances 156,501 106,464 Repayment of FHLB advances (227,300) (109,480) Proceeds from issuance of trust preferred securities 25,000 -- Proceeds from repurchase agreement borrowings 1,226 -- Repayments of repurchase agreement borrowings (6,754) (9,628) Increase (decrease) in other borrowings (3,165) 84 Cash dividends paid (3,369) (3,321) Repurchases of stock, net of forfeitures (738) (5,429) Other 1,144 1,384 --------- --------- Net cash provided by financing activities 40,123 47,362 --------- --------- NET INCREASE (DECREASE) IN CASH AND DUE FROM BANK 25,548 (17,040) CASH AND DUE FROM BANKS, BEGINNING OF PERIOD 67,728 67,356 --------- --------- CASH AND DUE FROM BANKS, END OF PERIOD $ 93,276 $ 50,316 ========= ========= (Continued on next page) 8 BANNER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (in thousands) For the Six Months Ended June 30, 2002 and 2001 (Continued from prior page) 2002 2001* --------- --------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest paid in cash $ 33,958 $ 45,332 Taxes paid in cash $ 2,500 $ 5,607 Non-cash transactions: Loans, net of discounts, specific loss allowances and unearned income, transferred to real estate owned $ 4,004 $ 2,422 Net change in accrued dividends payable $ 117 $ 23 Other assets/liabilities $ 45 $ -- The following summarizes the non-cash activities relating to acquisitions: Fair value of assets and intangibles acquired, including goodwill $ (44,544) $ -- Fair value of liabilities assumed 34,453 -- Fair value of stock issued and options assumed to acquisitions' shareholders -- - --------- --------- Cash paid out in acquisition (10,091) -- Less cash acquired 3,572 - --------- --------- Net cash acquired (used) $ (6,519) - ========= ========= See selected notes to consolidated financial statements 9 BANNER CORPORATION AND SUBSIDIARIES SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1: Basis of Presentation Banner Corporation (BANR or the Company) is a bank holding company incorporated in the State of Washington. The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly-owned subsidiary, Banner Bank (BB or the Bank). BB is a Washington-chartered commercial bank the deposits of which are insured by the Federal Deposit Insurance Corporation (FDIC) under both the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF). BB conducts business from its main office in Walla Walla, Washington, and its 41 branch offices and six loan production offices located in Washington, Oregon and Idaho, including two new branch offices in Washington state opened in August 2002. The Company is subject to regulation by the Federal Reserve Board (FRB). The Bank is subject to regulation by the State of Washington Department of Financial Institutions' Division of Banks and the FDIC. In the opinion of management, the accompanying consolidated statements of financial condition and related interim consolidated statements of income, comprehensive income, changes in stockholders' equity and cash flows reflect all adjustments (which include reclassifications and normal recurring adjustments) that are necessary for a fair presentation in conformity with generally accepted accounting principles ("GAAP"). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements. Actual results could differ from these estimates and may have a material impact on the financial statements. Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, we have identified several accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of our financial statements. These policies relate to the methodology for the determination of our allowance for loan and lease losses, the valuation of goodwill, and the valuation of real estate held for sale. These policies and the judgments, estimates and assumptions are described in greater detail in subsequent sections of Management's Discussion and Analysis and in Note 1 of the Notes to the Consolidated Financial Statements which is part of Banner Corporation's 2001 Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC). We believe that the judgments, estimates and assumptions used in the preparation of our financial statements are appropriate given the factual circumstances at the time. However, given the sensitivity of our financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition. Certain reclassifications have been made to the 2001 financial statements and/or schedules to conform to the 2002 presentation. These reclassifications may have affected certain ratios for the prior periods. The effect of such reclassifications is considered immaterial. All significant intercompany transactions and balances have been eliminated. The information included in this Form 10-Q should be read in conjunction with Banner Corporation's 2001 Annual Report on Form 10-K filed with the SEC. Interim results are not necessarily indicative of results for a full year. Note 2: Recent Developments and Significant Events Mergers and Acquisitions: On January 1, 2002, the Company completed the acquisition of Oregon Business Bank (OBB), which was headquartered in Lake Oswego, Oregon. BB paid $10.1 million in cash for all the outstanding common shares of OBB. OBB was merged with and into BB and operates as a division of BB. The acquisition was accounted for as a purchase and resulted in the recording of approximately $4.8 million of costs in excess of the fair value of OBB's net assets acquired (goodwill). In addition, an estimated $714,000 of core deposit intangibles were recorded and will be amortized on an accelerated basis over a five-year period resulting in a first-year charge to earnings of $286,000. Opened in 1999, OBB was an Oregon state-chartered community bank which had, before recording of purchase accounting adjustments, approximately $38.9 million in total assets, $33.1 million in loans, $33.2 million in deposits and $4.7 million in shareholders' equity at December 31, 2001. OBB operates one full service branch in Lake Oswego, Oregon. Sale of $25 Million of Trust Preferred Securities: On April 10, 2002, the Company completed the issuance of $25 million of trust preferred securities (TPS) in a private placement. The TPS were issued by a special purpose business trust owned by the Company and sold to a pooled investment vehicle sponsored by Sandler O'Neill & Partners and Salomon Smith Barney. The TPS have been recorded as a liability on the statement of financial condition but qualify as Tier 1 capital for regulatory capital purposes. The proceeds from this offering are expected to be used primarily to fund growth, including acquisitions, or may also be used to fund the Company's stock repurchase program and other general corporate purposes as necessary. Under the terms of the transaction, the TPS have a maturity of 30 years and are redeemable after five years with certain exceptions. The holders of the TPS will be entitled to receive cumulative cash distributions at a variable annual rate, with a current interest rate of 6.0154%, reset semi-annually equal to six month LIBOR plus 3.70%. 10 Accounting Standards Recently Adopted: In January 2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, which applies to all acquired intangible assets whether acquired singly, as part of a group, or in a business combination. This statement requires that goodwill not be amortized; however, goodwill for each reporting unit must be evaluated for impairment on at least an annual basis using a two-step approach. The first step used to identify potential impairment compares the estimated fair value of a reporting unit to its carrying amount, including goodwill. If the fair value of a reporting unit is less than its carrying amount, the second step of the impairment evaluation, which compares the implied fair value of goodwill to its carrying amount, must be performed to determine the amount of the impairment loss, if any. This statement also provides standards for financial statement disclosures of goodwill and other intangible assets and related impairment losses. The adoption of this statement has had a material impact on the Company's results of operation. Goodwill is no longer being amortized, reducing other current period operating expenses by an estimated $795,000 per quarter, or $3.2 million a year, with a corresponding increase in net income. The Company has performed its initial assessment of goodwill impairment during the second quarter of 2002 and has determined that its goodwill is not impaired. In August 2001, SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, was issued. The statement supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, but retains the requirements relating to recognition and measurement of an impairment loss and resolves certain implementation issues resulting from SFAS No. 121. The statement was adopted by the Company on January 1, 2002 and did not have a material impact on the results of operations or financial condition of the Bank. Note 3: Adoption of SFAS No. 141 and 142 Goodwill, Intangible Assets and Acquisitions The following table shows the pro forma effects of SFAS No. 142 applied to the prior comparative period (in thousands except per share amounts): Quarters Ended Six Months Ended June 30 June 30 ------------------- --------------------- 2002 2001 2002 2001 -------- -------- -------- -------- Reported Net Income $ 3,527 $ 1,619 $ 7,436 $ 3,928 Add back: Goodwill amortization -- 795 -- 1,590 -------- -------- -------- -------- Adjusted Net Income $ 3,527 $ 2,414 $ 7,436 $ 5,518 ======== ======== ======== ======== Basic earnings per share as reported: $ 0.32 $ 0.14 $ 0.67 $ 0.35 Goodwill amortization -- .08 -- 0.14 -------- -------- -------- -------- Adjusted basic earnings per share $ 0.32 $ 0.22 $ 0.67 $ 0.49 ======== ======== ======== ======== Diluted earnings per share as reported: $ 0.30 $ 0.14 $ 0.65 $ 0.34 Goodwill amortization -- .07 -- 0.13 -------- -------- -------- -------- Adjusted diluted earnings per share $ 0.30 $ 0.21 $ 0.65 $ 0.47 ======== ======== ======== ======== Acquisition of OBB: The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. January 1, 2002 --------- (in thousands) Cash $ 3,572 Securities 1,531 Loans receivable 33,648 Property and equipment 237 Other assets 49 Core deposit intangible (CDI) 714 Goodwill 4,793 --------- Total Assets Acquired 44,544 --------- Deposits (33,499) Borrowings (701) Other liabilities (253) --------- Total Liabilities Assumed (34,453) --------- Net Assets Acquired $ 10,091 ========= The $714,000 of acquired intangible assets was assigned to core deposit intangible and is being amortized on an accelerated basis over a five-year useful life. Loans receivable and deposits were assigned fair market valuation premiums of $534,000 (three-year average life) and $347,000 (two- year average life), respectively. The premiums are being amortized using a level yield method. The $4.8 million of goodwill was assigned to OBB's ongoing business relationships. None of the goodwill is expected to be deductible for income tax purposes. 11 Intangible Assets: The gross carrying amount and accumulated amortization of the Company's intangible assets other than goodwill as of June 30, 2002 is as follows (in thousands): June 30, 2002 ---------------------------------- Gross Net Carrying Accumulated Carrying Amount Amortization Amount ------- ------------ ------- Core Deposit Intangible (CDI) $ 714 $ (127) $ 587 Mortgage Servicing Rights (MSR)* $ 1,530 $ (70) $ 1,460 ------- ------- ------- $ 2,244 $ (197) $ 2,047 ======= ======= ======= * Amortization of mortgage servicing rights is recorded as a reduction of loan servicing income. Mortgage servicing rights are recorded on an individual loan basis with the gross carrying amount and accumulated amortization fully written off if the loan repays in full. Amortization expense for the quarter and six months ended June 30, 2002 includes $53,000 and $127,000, respectively, of expense related to the CDI amortization and $191,000 and $288,000 for the quarter and six months, respectively, of expense related to the MSR amortization. Estimated amortization expense in future years with respect to existing intangibles (in thousands): Year Ended CDI MSR TOTAL ----------------- ------ ------ ----- December 31, 2002 $ 255 $ 267 $ 522 December 31, 2003 200 219 419 December 31, 2004 143 183 326 December 31, 2005 86 152 238 December 31, 2006 30 127 157 Note 4: Business Segments BB is a community oriented commercial bank chartered in the State of Washington. BB's primary business is that of a traditional banking institution, gathering deposits and originating loans for portfolio in its primary market area. BB offers a wide variety of deposit products to its consumers and commercial customers. Lending activities include the origination of real estate, commercial/agriculture business and consumer loans. BB is also an active participant in the secondary market, originating residential loans for sale on both a servicing released and servicing retained basis. In addition to interest income on loans and investment securities, BB receives other income from deposit servicing charges, loan servicing fees and from the sale of loans and investments. BB also has a mortgage lending subsidiary, Community Financial Corporation (CFC), located in the Lake Oswego area of Portland, Oregon, that was established in fiscal 2000. CFC's primary lending activities are in the area of construction and permanent financing for one- to four-family residential dwellings. Generally accepted accounting principles establish standards to report information about operating segments in annual financial statements and require reporting of selected information about operating segments in interim reports to stockholders. They also establish standards for related disclosures about products and services, geographic areas and major customers. The Company has determined that its current business and operations consist of a single business segment. Note 5: Additional Information Regarding Interest-Bearing Deposits and Securities Encumbered Securities: Securities labeled "Encumbered" are pledged securities that are subject to certain agreements which may allow the secured party to either sell and replace them with similar but not the exact same security or otherwise pledge the securities. In accordance with SFAS No. 140, the amounts have been separately identified in the Consolidated Statements of Financial Condition as "Encumbered." The following table sets forth additional detail on BANR's interest-bearing deposits and securities at the dates indicated (at carrying value) (in thousands): June 30 December 31 June 30 2002 2001 2001 --------- --------- --------- Interest-bearing deposits included in cash and due from banks $ 24,378 $ 12,408 $ 9,001 Mortgage-backed securities 206,726 207,185 183,617 Other securities-taxable 144,323 82,259 83,754 Other securities-tax exempt 22,136 23,673 27,465 Other stocks with dividends 2,854 3,558 3,954 --------- --------- --------- Total securities 376,039 316,675 298,790 Federal Home Loan Bank (FHLB) stock 31,800 30,840 29,780 --------- --------- --------- $ 432,217 $ 359,923 $ 337,571 ========= ========= ========= 12 The following table provides additional detail on income from deposits and securities for the periods indicated (in thousands): Quarters Ended Six Months Ended June 30 June 30 ------------------ ------------------ 2002 2001 2002 2001 ------- ------- ------- ------- Mortgage-backed securities- interest $ 2,886 $ 3,005 $ 5,442 $ 6,277 Taxable interest and dividends 1,888 1,554 3,310 3,320 Tax-exempt interest 330 412 662 828 Federal Home Loan Bank stock- dividends 470 511 927 973 ------- ------- ------- ------- 2,688 2,477 4,899 5,121 ------- ------- ------- ------- $ 5,574 $ 5,482 $10,341 $11,398 ======= ======= ======= ======= Note 6: Calculation of Weighted Average Shares Outstanding for Earnings Per Share (EPS) The following table reconciles total shares originally issued to weighted shares outstanding used to calculate earnings per share data (in thousands): Quarters Ended Six Months Ended June 30 June 30 ----------------- ------------------ 2002 2001 2002 2001 ------ ------ ------ ------ Total shares originally issued 13,201 13,201 13,201 13,201 Less retired shares and treasury stock plus unvested shares allocated to MRP (1,554) (1,391) (1,572) (1,348) Less unallocated shares held by the ESOP (577) (633) (577) (633) ------ ------ ------ ------ Basic weighted average shares outstanding 11,070 11,177 11,052 11,220 Plus unvested MRP and stock option incremental shares considered outstanding for diluted EPS calculations 512 506 463 433 ------ ------ ------ ------ Diluted weighted average shares outstanding 11,582 11,683 11,515 11,653 ====== ====== ====== ====== Note 7: Restatement of Financial Statements Restatement of Financial Statements: On September 17, 2001, the Company announced that it had become aware of irregularities associated with a former senior lending officer. The irregularities included a check kiting scheme of a single commercial loan customer, as well as activities designed to conceal credit weaknesses of several loan customers. Upon further review, the Company determined that it would be necessary to file amended quarterly reports on Form 10-Q/A for each of the quarters ended March 31, 2001 and June 30, 2001, to recognize charges in those periods which appropriately reflect the timing of losses incurred as a result of the check kiting and credit manipulation activities. For the restated quarter ended March 31, 2001, the Company recorded an expense of $3.6 million ($2.3 million after tax) as a result of the check kiting scheme. During the restated quarter ended June 30, 2001, the Company recorded $2.6 million ($1.7 after tax) of expense related to the check kiting scheme and an additional $2.0 million ($1.3 million after tax) was added to the provision for loan losses. The Company recorded an additional expense of $1.9 million in the quarter ended September 30, 2001, with respect to the check kiting scheme and also recognized $4.2 million and $4.0 million, respectively, of additional provision for loan losses associated with the credit manipulation in the quarters ended September 30, 2001 and December 31, 2001. The changes in the consolidated financial statements resulted in restated net income of $2.3 million for the quarter ended March 31, 2001 and $1.6 million for the quarter ended June 30, 2001, compared to $4.6 million and $4.6 million, respectively, as previously reported. For the six months ended June 30, 2001, restated net income was $3.9 million compared to $9.2 million as previously reported. 13 ITEM 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations Special Note Regarding Forward-Looking Statements Management's Discussion and Analysis (MD&A) and other portions of this report contain certain "forward-looking statements" concerning the future operations of Banner Corporation. Management desires to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 and is including this statement for the express purpose of availing the Company of the protections of such safe harbor with respect to all "forward-looking statements" contained in this report and our Annual Report. We have used "forward-looking statements" to describe future plans and strategies, including our expectations of the Company's future financial results. Management's ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors which could affect actual results include interest rate trends, the general economic climate in the Company's market area and the country as a whole, the ability of the Company to control costs and expenses, the ability of the Company to efficiently incorporate acquisitions into its operations, the Company's ability to successfully complete consolidation and conversion activities, successfully resolve outstanding credit issues and/or recover check kiting losses, competitive products and pricing, loan delinquency rates, and changes in federal and state regulation. These factors should be considered in evaluating the "forward-looking statements," and undue reliance should not be placed on such statements. General Banner Corporation (the Company or BANR), a Washington corporation, is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly owned subsidiary, Banner Bank (BB). BB is a Washington-chartered commercial bank the deposits of which are insured by the FDIC under both the BIF and the SAIF. BB conducts business from its main office in Walla Walla, Washington, and its 41 branch offices and six loan production offices located in 19 counties in Washington, Idaho and Oregon. The operating results of BANR depend primarily on its net interest income, which is the difference between interest income on interest-earning assets, consisting of loans and investment securities, and interest expense on interest-bearing liabilities, composed primarily of savings deposits and Federal Home Loan Bank (FHLB) advances. Net interest income is primarily a function of BANR's interest rate spread, which is the difference between the yield earned on interest-earning assets and the rate paid on interest-bearing liabilities, as well as a function of the average balance of interest-earning assets as compared to the average balance of interest-bearing liabilities. As more fully explained below, BANR's net interest income increased for the quarter ended June 30, 2002 compared to the same period a year earlier, reflecting a 39 basis point increase in the interest rate spread and growth in interest bearing assets and liabilities. The net interest margin also increased, expanding 26 and 19 basis points for the quarter and six months ended June 30, 2002, respectively, when compared to the same period one year prior. BANR's net income also is affected by provisions for loan losses and the level of its other income, including deposit service charges, loan origination and servicing fees, and gains and losses on the sale of loans and securities, as well as its non-interest operating expenses and income tax provisions. The provision for loan losses increased significantly for the quarter and six months ended June 30, 2002, compared to the same periods ended June 30, 2001. As explained more fully below and in Note 7 of the Selected Notes to the Consolidated Financial Statements, much of this increase reflects impaired loans associated with a former senior commercial loan officer that had been manipulated to conceal credit weaknesses. Continued weak economic conditions, particularly in some of the Puget Sound market areas serviced by the Company were also a factor with respect to the higher level of provision for loan losses. Other operating income remained relatively flat for both the quarter and six months ended June 30, 2002. Other operating expenses decreased for the quarter and six months ended June 30, 2002, compared to the same periods ended June 30, 2001. As explained below and in Note 7 of the Selected Notes to the Consolidated Financial Statements, non-interest expenses for the quarter and six months ended June 30, 2001, included check kiting losses of $2.6 million and $6.2 million, respectively, which were not a factor in 2002. In addition the Company's amortization expense for goodwill and other intangibles decreased $795,000, for the current quarter, with the adoption of SFAS No. 142 which no longer requires amortization of goodwill. Excluding the check kiting losses and adoption of SFAS No. 142, other operating expenses increased compared to the year earlier amounts reflecting the continued growth of the Company. The MD&A is intended to assist in understanding the financial condition and results of operations of the Company. The information contained in this section should be read in conjunction with the Consolidated Financial Statements and accompanying Selected Notes to the Consolidated Financial Statements. 14 Recent Developments and Significant Events See Notes 2 and 7 of the Selected Notes to the Consolidated Financial Statements Comparison of Financial Condition at June 30, 2002 and December 31, 2001 Total assets increased $77.6 million, or 3.7%, from $2.087 billion at December 31, 2001, to $2.165 billion at June 30, 2002. The growth of $77.6 million largely reflects the acquisition of OBB on January 1, 2002, and strong deposit growth. Securities investments increased $59.4 million from $316.7 million to $376.0 million. The OBB acquisition provided $1.5 million of this increase. The increase in securities resulted primarily from the purchase of taxable notes and bonds issued by various federally sponsored agencies many containing provisions for the issuer to call the securities. Net loans receivable (gross loans less loans in process, deferred fees and discounts, and allowance for loan losses) decreased $23.4 million, or 1.5%, from $1.575 billion at December 31, 2001, to $1.552 billion at June 30, 2002. This loan decrease occurred due to a decrease of $32.8 million in loans held for sale to $10.5 million at June 30, 2002, reflecting the sale of residential mortgage loan inventory that had built up at December 31, 2001. These balances also reflect the acquisition of OBB on January 1, 2002, which provided $33.6 million of gross loans consisting of $14.3 million of commercial and multi-family mortgages, $9.0 million of construction and land loans, $839,000 of residential mortgages and $9.5 million of commercial and consumer loans. Changes in the loan portfolio mix reflect the Company's continuing effort to increase the portion of its assets invested in loans and more specifically the portion of loans invested in commercial real estate, construction and land development, and non-mortgage loans. While these loans are of inherently higher risk than residential mortgages, management believes they can produce higher credit-adjusted returns to the Company and provide better opportunities to develop comprehensive banking relationships with the borrowers than most residential mortgages. The majority of the increase in securities was funded by a net increase of $131.1 million in deposits offset by a $53.8 million decrease in borrowings. Net income from operations also helped to fund asset growth. Deposits grew $131.1 million, or 10.1%, from $1.296 billion at December 31, 2001, to $1.427 billion at June 30, 2002. Non-interest bearing deposits grew 8.5% to $196.2 million from $180.8 million ate December 31, 2001. FHLB advances decreased $70.8 million from $502.0 million at December 31, 2001, to $431.2 million at June 30, 2002. Additional funding came from the issuance of $25.0 million of TPS in April of this year. Other borrowings, primarily the reverse repurchase agreements with securities dealers, decreased $8.0 million, from $76.7 million at December 31, 2001, to $68.0 million at June 30, 2002. Comparison of Results of Operations for the Quarters and Six Months Ended June 30, 2002 and 2001 (restated), General. For the quarter ended June 30, 2002, the Company had net income of $3.5 million, or $.30 per share (diluted), compared to net income of $1.6 million, or $.14 per share (diluted), for the quarter ended June 30, 2001, an increase of $1.9 million. Net income for the first six months of the current year was $7.4 million, an increase of $3.5 million from $3.9 million for the six months ended June 30, 2001. The prior period contained expenses associated with the check kiting scheme and additional loan loss provision described in Note 7 of the Selected Notes to the Consolidated Financial Statements. BANR's operating results (excluding the check kiting charges) reflect significant growth of assets and liabilities and an improved net interest margin which were offset by a higher level of loan loss provision and other operating expenses. As explained below, provision for loan losses increased not only as a result of the credit manipulation activities but also as a result of an increased level of non-performing loans and net charge-offs. Compared to levels a year ago, total assets increased 6.3%, to $2.165 billion, at June 30, 2002, net loans declined slightly by 0.8%, to $1.552 billion, deposits grew 13.2%, to $1.427 billion, and borrowings decreased 7.8%, to $524.9 million. Average equity was 9.23% of average assets for the quarter ended June 30, 2002, compared to 9.83% of average assets for the quarter ended June 30, 2001. Net interest margin increased 26 basis points for the quarter reflecting a 39 basis point increase in net interest rate spread, which was partially offset by the increased use of interest-bearing liabilities relative to interest-earning assets and lower yields on assets funded by non-interest-bearing liabilities and stockholders equity. The changes in net interest spread and net interest margin are notable in light of the significant volatility and changes in the level of market interest rates over the past two years. Changes in the level of interest rates during this period initially reduced the Company's net interest margin, however, largely as a result of declining funding costs, net interest margin has increased over the past twelve months. 15 Interest Income. Interest income for the quarter ended June 30, 2002, was $36.3 million compared to $39.7 million for the quarter ended June 30, 2001, a decrease of $3.5 million, or 8.7%. The decrease in interest income occurred despite a $104.2 million, or 5.5%, growth in average balances of interest- earning assets as a result of a 113 basis point decrease in the average yield on those assets. The yield on average interest-earning assets decreased to 7.28% for the quarter ended June 30, 2002, compared to 8.41% for the same period a year earlier. Average loans receivable for the quarter ended June 30, 2002, increased by $34.6 million ($33.1 million from the acquisition of OBB), or 2.2%, when compared to the quarter ended June 30, 2001, reflecting modest internal growth as well as the acquisition of OBB. Interest income on loans decreased by $3.6 million, or 10.4%, compared to $34.3 million for the prior year, as the impact of the increase in average loan balances was offset by a 109 basis point decrease in the average yield. The decrease in average loan yield reflects the significant decline in the level of market interest rates, particularly the prime rate, compared to prior year levels, which offset continued changes in the mix of the loan portfolio. The loan mix continued to change as the portion of the portfolio invested in lower yielding one- to four-family residential loans declined, while the portion invested in higher yielding construction, land development and commercial loans increased. Loans yielded 7.76% for the quarter ended June 30, 2002, compared to 8.85% for the quarter ended June 30, 2001. While the level of market interest rates was significantly lower than a year earlier, loan yields were supported to a degree by certain loans with rate floors and by changes in the portfolio mix. The average balance of mortgage-backed securities, investment securities, daily interest-bearing deposits and FHLB stock increased by $69.6 million for the quarter ended June 30, 2002, and the interest and dividend income from those investments increased $92,000, compared to the quarter ended June 30, 2001. The average yield on mortgage-backed securities decreased from 6.23% for the quarter ended June 30, 2001, to 5.54% for the comparable period in 2002. Yields on mortgage-backed securities were lower in the 2002 period reflecting the effect of lower market rates on the interest rates paid on the significant portion of those securities that have adjustable rates and prepayments on certain higher-yielding portions of the portfolio. The average yield on investment securities and short-term cash investments decreased from 6.54% for the quarter ended June 30, 2001, to 5.15% for the comparable quarter in 2002, also reflecting the lower level of market rates. Earnings on FHLB stock decreased by $41,000 to $470,000 in the quarter ended June 30, 2002 from $511,000 in the comparable quarter in 2001. This resulted from a 99 basis point decrease in the yield received on FHLB stock offset by an increase of $2.1 million in the average balance of FHLB stock for the quarter ended June 30, 2002. The dividend yield on FHLB stock was 6.01% for the quarter ended June 30, 2002, compared to 7.00% for the quarter ended June 30, 2001. Dividends on FHLB stock are established on a quarterly basis by vote of the Directors of the FHLB. Interest income for the six months ended June 30, 2002 decreased by $8.0 million, or 10.0%, to $72.3 million from $80.3 million for the comparable period in 2001. Interest income from loans decreased $7.0 million, or 10.1%, from the comparable period in 2001. The decrease in loan interest income reflects the impact of a 124 basis point decrease in the yield on the loan balances and occurred despite a $62.9 million growth in average loans receivable balances. Interest income from mortgage-backed and investment securities and FHLB stock for the six months ended June 30, 2002, decreased $1.1 million, from $11.4 million in 2001 to $10.3 million in the current period, reflecting a $34.4 million increase in average balances offset by a 114 basis point decrease in yield. Interest Expense. Interest expense for the quarter ended June 30, 2002, was $16.8 million compared to $22.5 million for the comparable period in 2001, a decrease of $5.7 million, or 25.3%. The decrease in interest expense was due to a decrease in the average cost of all interest-bearing liabilities from 5.02% to 3.50%. The $128.2 million increase ($33.2 million from the OBB acquisition) in average interest-bearing deposits for the quarter ended June 30, 2002, compared to June 30, 2001, reflects the solid deposit growth throughout the Company over the past twelve months. Deposit interest expense decreased $4.1 million for the quarter ended June 30, 2002, compared to the same quarter a year ago. Average deposit balances increased from $1.226 billion for the quarter ended June 30, 2001, to $1.386 billion for the quarter ended June 30, 2002, while, at the same time, the average rate paid on deposit balances decreased 172 basis points. To a significant degree, deposit costs for a quarter reflect market interest rates and pricing decisions made three to twelve months prior to the end of that quarter. Generally, market interest rates for deposits were declining and lower for the nine months preceding the quarter ended June 30, 2002, than for the same period preceding the June 30, 2001 quarter. The reduction in deposit costs, which tends to lag declines in market rates, continued in the most recent quarter as a result of the cumulative effect of declining rates in the four preceding quarters as well as sharply low rates in the current quarter. Average FHLB advances totaled $450.0 million during the quarter ended June 30, 2002, compared to $504.6 million during the quarter ended June 30, 2001, a decrease of $54.6 million that, combined with a 56 basis point decrease in the average cost of advances, resulted in a $1.5 million decrease in related interest expense. The average rate paid on those advances decreased to 5.55% for the quarter ended June 30, 2002, from 6.11% for the quarter ended June 30, 2001. FHLB advances are generally fixed rate, fixed term borrowings. For the past two quarters, a significant portion of maturing FHLB advances have been repaid as a result of strong deposit growth. In the current quarter additional funding was also provided by the issuance of $25 million of TPS. The average balance of TPS was $22.3 million and the average rate paid was 6.09% (including amortizing prepaid loan underwriting costs) for the quarter ended June 30, 2002. Other borrowings consist of retail repurchase agreements with customers and reverse repurchase agreements with investment banking firms secured by certain investment securities. The average balance for other borrowings increased $985,000 from $69.1 million for the quarter ended June 30, 2001, to $70.1 million for the same period in 2002, while the related interest expense decreased $477,000 from $867,000 to $390,000 for the respective periods. The average rate paid on other borrowings was 2.29% in the quarter ended June 30, 2002 compared to 5.03% for the same quarter in 2001. The Company's other borrowings generally have relatively short terms and therefore reprice to current market levels more quickly than FHLB advances which generally lag current market rates. A comparison of total interest expense for the six months ended June 30, 2002, shows a decrease of $11.7 million, or 25.6% from the comparable period in June 2001. The interest expense reflects an increase in average deposits of $152.4 million combined with a $43.6 million decrease in FHLB advances and other borrowings. The effect on interest expense of the $122.9 million increase in average interest-bearing liabilities was offset by a 157 basis point decrease in the interest rate paid on those liabilities. 16 The following tables provide additional comparative data on the Company's operating performance: Quarters Ended Six Months Ended Average Balances June 30 June 30 ---------------- --------------------- --------------------- *Restated (See Note 7) 2002 2001* 2002 2001* (in thousands) ---------- ---------- ---------- ---------- Investment securities and deposits $ 172,660 $ 120,662 150,393 $ 126,187 Mortgage-backed obligations 209,030 193,511 203,695 195,573 Loans 1,586,389 1,551,811 1,596,968 1,534,087 FHLB stock 31,348 29,280 31,120 29,049 ---------- ---------- ---------- ---------- Total average interest-earning asset 1,999,427 1,895,264 1,982,176 1,884,896 Non-interest-earning assets 139,813 117,462 137,061 115,751 ---------- ---------- ---------- ---------- Total average assets $2,139,240 $2,012,726 $2,119,237 $2,000,647 ========== ========== ========== ========== Deposits 1,386,332 1,226,077 1,361,457 1,209,093 Advances from FHLB 450,018 504,614 463,056 506,700 Trust preferred securities 22,253 -- 11,188 -- Other borrowings 70,068 69,083 75,036 71,894 ---------- ---------- ---------- ---------- Total average interest-bearing liabilities 1,928,671 1,799,774 1,910,737 1,787,887 Non-interest-bearing liabilities 13,191 15,179 11,716 15,190 ---------- ---------- ---------- ---------- Total average liabilities 1,941,862 1,814,953 1,922,453 1,803,077 Equity 197,378 197,773 196,784 197,570 ---------- ---------- ---------- ---------- Total average liabilities and equity $2,139,240 $2,012,726 $2,119,237 $2,000,647 ========== ========== ========== ========== Interest Rate Yield/Expense (rates are annualized) ------------------------------------------------- Interest Rate Yield: Investment securities and deposits 5.15% 6.54% 5.33% 6.63% Mortgage-backed obligations 5.54% 6.23% 5.39% 6.47% Loans 7.76% 8.85% 7.82% 9.06% FHLB stock 6.01% 7.00% 6.00% 6.75% ---------- ---------- ---------- ---------- Total interest rate yield on interest-earning assets 7.28% 8.41% 7.35% 8.59% ---------- ---------- ---------- ---------- Interest Rate Expense: Deposits 2.86% 4.58% 2.97% 4.70% Advances from FHLB 5.55% 6.11% 5.53% 6.17% Trust preferred securities 6.09% -- 6.09% -- Other borrowings 2.29% 5.03% 2.40% 5.43% ---------- ---------- ---------- ---------- Total interest rate expense on interest-bearing liabilities 3.50% 5.02% 3.58% 5.15% ---------- ---------- ---------- ---------- Interest spread 3.78% 3.39% 3.77% 3.44% ========== ========== ========== ========== Net interest margin on interest- earning assets 3.90% 3.64% 3.90% 3.71% ========== ========== ========== ========== Additional Key Financial Ratios (ratios are annualized) ------------------------------------------------------ Return on average assets 0.66% 0.32% 0.71% 0.40% Return on average equity 7.17% 3.28% 7.62% 4.01% Average equity / average assets 9.23% 9.83% 9.29% 9.88% Average interest-earning assets/ interest-bearing liabilities 103.67% 105.31% 103.74% 105.43% Non-interest [other operating] expenses/average assets Excluding amortization of costs in excess of net assets acquired (goodwill) 2.59% 2.92% 2.58% 3.01% Including amortization of costs in excess of net assets acquired (goodwill) 2.59% 3.03% 2.58% 3.12% Efficiency ratio [non-interest (other operating) expenses/revenues] Excluding amortization of costs in excess of net assets acquired (goodwill) 60.22% 69.16% 60.22% 71.23% Including amortization of costs in excess of net assets acquired (goodwill) 60.22% 72.98% 60.22% 75.09% 17 Provision and Allowance for Loan Losses. During the quarter ended June 30, 2002, the provision for loan losses was $4.0 million, compared to $3.0 million for the quarter ended June 30, 2001, an increase of $1.0 million. A comparison of the provision for loan losses for the six-month periods ended June 30, 2001 and 2002 shows an increase of $3.1 million from $3.9 million to $7.0 million. The increase in the provision for loan losses reflects the amount required to maintain the allowance for losses at an appropriate level based upon management's evaluation of the adequacy of general and specific loss reserves as more fully explained in the following paragraphs. The higher provisions in the current periods reflect changes in the portfolio mix, higher levels of non-performing loans and net charge-offs, and concerns about the current economic environment. The provision for loan losses for the quarter and six months ended June 30, 2002, includes $3.9 million and $5.8 million, respectively, of loan charge-offs as a result of further deterioration in the quality of five of the problem loans associated with the former senior lending officer as referenced in Note 7 of the Selected Notes to the Consolidated Financial Statements. Non-performing loans increased to $19.9 million at June 30, 2002, compared to $8.1 million at June 30, 2001. Non-performing loans are primarily concentrated in the Seattle metropolitan area where continued economic weakness has diminished certain borrowers' ability to meet loan obligations, and largely, although not exclusively, reflect loans associated with the former senior loan officer noted above. Net charge-offs were $6.3 million for the current quarter compared to $2.2 million for the same quarter a year earlier. Net charge-offs were $8.4 million for the six months ended June 30, 2002, compared to $2.5 million for the six months ended June 30, 2001. A comparison of the allowance for loan losses at June 30, 2002 and 2001, shows a decrease of $129,000 from $16.8 million at June 30, 2001, to $16.6 million at June 30, 2002. The allowance for loan losses as a percentage of net loans (loans receivable excluding allowance for losses) was 1.06% at both June 30, 2002, and at June 30, 2001. In recent months, the Company has hired additional credit administration and special assets personnel and is directing significant efforts at identifying problem loans and managing non-performing assets. In originating loans, the Company recognizes that losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the credit worthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the security for the loan. As a result, the Company maintains an allowance for loan losses consistent with the generally accepted accounting principles (GAAP) guidelines outlined in SFAS No. 5, Accounting for Contingencies. The Company has established systematic methodologies for the determination of the adequacy of its allowance for loan losses. The methodologies are set forth in a formal policy and take into consideration the need for an overall general valuation allowance as well as specific allowances that are tied to individual problem loans. The Company increases its allowance for loan losses by charging provisions for possible loan losses against the Company's income and values impaired loans consistent with the guidelines in SFAS No. 114, Accounting by Creditors for Impairment of a Loan, and SFAS No. 118, Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosure. The allowance for losses on loans is maintained at a level sufficient to provide for estimated losses based on evaluating known and inherent risks in the loan portfolio and upon management's continuing analysis of the factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, actual loan loss experience, current and anticipated economic conditions, detailed analysis of individual loans for which full collectibility may not be assured, and determination of the existence and realizable value of the collateral and guarantees securing the loans. Losses that are related to specific assets are usually applied as a reduction of the carrying value of the assets and charged immediately against the allowance for loan loss reserve. Recoveries on previously charged off loans are credited to the allowance. The reserve is based upon factors and trends identified by management at the time financial statements are prepared. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such agencies may require additions to the allowance based upon judgments different from management. Although management uses the best information available, future adjustments to the allowance may be necessary due to economic, operating, regulatory and other conditions beyond the Company's control. The adequacy of general and specific reserves is based on management's continuing evaluation of the pertinent factors underlying the quality of the loan portfolio, including changes in the size and composition of the loan portfolio, delinquency rates, actual loan loss experience and current economic conditions. Large groups of smaller-balance homogeneous loans are collectively evaluated for impairment. Loans that are collectively evaluated for impairment include residential real estate and consumer loans. Smaller balance non-homogeneous loans also may be evaluated collectively for impairment. Larger balance non-homogeneous residential construction and land, commercial real estate, commercial business loans and unsecured loans are individually evaluated for impairment. Loans are considered impaired when, based on current information and events, management determines that it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. Factors involved in determining impairment include, but are not limited to, the financial condition of the borrower, value of the underlying collateral and current status of the economy. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of collateral if the loan is collateral dependent. Subsequent changes in the value of impaired loans are included within the provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the provision that would otherwise be reported The Company's methodology for assessing the appropriateness of the allowance consists of several key elements, which include specific allowances, an allocated formula allowance, and an unallocated allowance. Losses on specific loans are provided for when the losses are probable and estimable. General loan loss reserves are established to provide for inherent loan portfolio risks not specifically provided for. The level of general reserves is based on analysis of potential exposures existing in the Bank's loan portfolio including evaluation of historical trends, current market conditions and other relevant factors identified by management at the time the financial statements are prepared. The formula allowance is calculated by applying loss factors to outstanding loans, excluding loans with specific allowances. Loss factors are based on the Company's historical loss experience adjusted for significant factors including the experience of other banking organizations that, in management's judgment, affect the collectibility of the portfolio as of the evaluation date. During the current quarter the Company reduced the loss factors associated with one- to four-family loans while at the same time it increased the factors associated with non-residential loans. The unallocated allowance is based upon management's evaluation of various factors that are not directly measured in the determination of the formula and specific allowances. This methodology may result in losses or recoveries differing significantly from those provided in the financial statements. 18 The following tables are provided to disclose additional detail on the Company's loans and allowance for loan losses (in thousands): *Restated (See Note 7) June 30 December 31 June 30 2002 2001 2001* Loans (including loans held for sale): ---------- ---------- ---------- Secured by real estate: One- to four-family $ 378,566 $ 422,456 $ 404,314 Commercial 367,166 363,560 396,017 Multifamily 81,942 79,035 83,853 Construction and land 340,117 335,798 327,261 Commercial business 263,796 270,022 252,308 Agricultural business 95,375 76,501 73,053 Consumer 41,705 45,605 45,084 ---------- ---------- ---------- Total Loans 1,568,667 1,592,977 1,581,890 Less allowance for loan losses 16,646 17,552 16,775 ---------- ---------- ---------- Total net loans at end of period $1,522,021 $1,575,425 $1,565,115 ========== ========== ========== Allowance for loan losses as a percentage of net loans outstanding 1.06% 1.10% 1.06% Quarters Ended Six Months Ended June 30 June 30 ----------------- ----------------- 2002 2001* 2002 2001* ------- ------- ------- ------- Balance, beginning of the period $18,899 $15,980 $17,552 $15,314 Acquisitions -- 460 Provision 4,000 2,950 7,000 3,900 Recoveries of loans previously charged off: Secured by real estate: One- to four-family -- 1 -- 1 Commercial (9) -- -- -- Multifamily -- -- -- -- Construction and land -- -- -- -- Commercial business 13 21 13 27 Agricultural business 1 -- 2 -- Consumer 46 -- 55 5 ------- ------- ------- ------- 51 22 70 33 Loans charged off: Secured by real estate: One- to four-family (5) (65) (11) (97) Commercial -- -- -- -- Multifamily -- -- -- -- Construction and land (487) (14) (487) (14) Commercial business (5,703) (1,940) (7,289) (2,042) Agricultural business -- -- (141) (100) Consumer (109) (158) (508) (219) ------- ------- ------- ------- (6,304) (2,177) (8,436) (2,472) ------- ------- ------- ------- Net charge-offs (6,253) (2,155) (8,366) (2,439) ------- ------- ------- ------- Balance, end of period $16,646 $16,775 $16,646 $16,775 ======= ======= ======= ======= Net charge offs as a percentage of average net book value of loans outstanding for the period 0.39% 0.14% 0.52% 0.16% ------- ------- ------- ------- 19 The following is a schedule of the Company's allocation of the allowance for loan losses: June 30 December 31 June 30 2002 2001 2001 Specific or allocated loss allowances: ------- ------- ------- Secured by real estate: One- to four-family $ 670 $ 2,366 $ 2,229 Commercial 1,988 3,967 4,032 Multifamily 410 593 682 Construction and land 3,651 3,431 3,663 Commercial business 7,231 4,660 3,835 Agricultural business 1,173 990 890 Consumer 637 774 948 ------- ------- ------- Total allocated 15,770 16,781 16,279 Unallocated 876 771 496 ------- ------- ------- Total allowance for loan losses $16,646 $17,552 $16,775 ======= ======= ======= Allowance for loan losses as a percent of net loans (loans receivable excluding allowance for loan losses) 1.06% 1.10% 1.06% Other Operating Income. Other operating income was $3.5 million for the quarter ended June 30, 2002, a decrease of $86,000 from the quarter ended June 30, 2001. This included a $348,000 decrease in the gain on sale of securities for the current quarter. Loan sales for the quarter ended June 30, 2002 totaled $68.5 million, including $16.8 million of loans sold by CFC, compared to $87.4 million for the quarter ended June 30, 2001. Gain on sale of loans for BANR included $156,000 of fees on $13.4 million of loans brokered by CFC, which are not reflected in the volume of loans sold. Other fee and service charge income for BANR increased by $80,000 to $1.5 million for the quarter ended June 30, 2002, compared to $1.5 million for the quarter ended June 30, 2001. Miscellaneous income increased by $148,000, largely reflecting the Company's increased investment in bank owned life insurance and the resulting increase in cash surrender value. Other operating income for the six months ended June 30, 2002, increased $267,000 from the comparable period in 2001. This includes a $336,000 increase in the gain on sale of loans, $343,000 decrease in gain on sale of securities and a $237,000 increase in miscellaneous income. Loan sales increased from $134.4 million for the six months ended June 30, 2001 to $160.7 million for the six months ended June 30, 2002. Other Operating Expenses. Other operating expenses decreased $1.4 million from $15.2 million for the quarter ended June 30, 2001, to $13.8 million for the quarter ended June 30, 2002. As noted above, other operating expenses for the quarter ended June 30, 2001, included a charge of $2.6 million associated with a check kiting scheme that had been concealed by a former senior lending officer of BB. In addition, the amortization of goodwill and intangibles decreased $742,000 for the quarter ended June 30, 2002 as a result of the adoption of SFAS No. 142. Excluding the check kiting charge and change in goodwill amortization, other operating expenses increased $2.0 million compared to the same quarter a year earlier. Increases in other operating expenses, excluding the check kiting charge and change in goodwill amortization, reflect the overall growth in assets and liabilities, customer relationships and complexity of operations as BANR continues to expand. The higher level of operating expenses in the current quarter includes significant increases in compensation for credit examination and special assets personnel as well as additional executive management and production staff hired to re-position the Company for future growth. The increase in expenses includes operating costs associated with OBB, which was acquired on January 1, 2002. The increase also reflects expenses associated with the expanding operations at BB's mortgage lending subsidiary, CFC. The higher operating expenses associated with BANR's transition to more of a commercial bank profile caused BANR's efficiency ratio, excluding the amortization of goodwill and check kiting loss, to increase to 60.22% for the quarter ended June 30, 2002, from 56.68% (72.98% including goodwill and the check kiting loss) for the comparable period ended June 30, 2001. Other operating expenses as a percentage of average assets increased to 2.59% for the quarter ended June 30, 2002, compared to 2.35% (3.03% including goodwill and the check kiting loss) for the quarter ended June 30, 2001. Other operating expenses for the six months ended June 30, 2002 decreased $3.7 million from $30.9 million for the first six months of 2001 to $27.2 million in the current period. As explained earlier, the decrease is largely due to the previously noted check kiting loss ($6.2 million) and discontinued amortization ($1.6 million) of goodwill offset by growth in BANR's operations for the current six-month period. Income Taxes. Income tax expense was $1.6 million for the quarter ended June 30, 2002, compared to $1.1 million for the comparable period in 2001. The Company's effective tax rates for the quarters ended June 30, 2002 and 2001 were 31% and 39%, respectively. The lower effective tax rate in the current quarter is primarily a result of a decrease in the relative effect of the non-deductible intangible amortization expense compared to the prior quarter reflecting the discontinuance of the amortization of goodwill. Income tax expense for the six months ended June 30, 2002 increased to $3.5 million, compared to $2.4 million in the comparable period in 2001. The Company's effective tax rates for the six months ended June 30, 2002 and 2001 were 32% and 38%, respectively. Similar to the quarterly results, the lower effective tax rate in the current period is primarily a result of a decrease in the relative effect of the non-deductible intangible amortization expense compared to the prior quarter reflecting the discontinuance of the amortization of goodwill. 20 Asset Quality The Bank's asset classification committee meets at least monthly to review all classified assets, to approve action plans developed to resolve the problems associated with the assets and to review recommendations for new classifications, any changes in classifications and recommendations for reserves. The committee reports to the Board of Directors quarterly as to the current status of classified assets and action taken in the preceding quarter. State and federal regulations require that the Bank review and classify its problem assets on a regular basis. In addition, in connection with examinations of insured institutions, state and federal examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. If an asset or portion thereof is classified loss, the insured institution establishes specific allowances for loan losses for the full amount of the portion of the asset classified loss. A portion of general loan loss allowances established to cover possible losses related to assets classified substandard or doubtful may be included in determining an institution's regulatory capital, while specific valuation allowances for loan losses generally do not qualify as regulatory capital. At June 30, 2002 and December 31, 2001, the aggregate amounts of the Bank's classified assets were as follows (in thousands): June 30 December 31 2002 2001 ------- ----------- Loss $ -- $ -- Doubtful 232 171 Substandard assets 36,206 32,658 Special mention 34,670 34,140 The following tables are provided to disclose additional details on asset quality (in thousands): June 30 December 31 2002 2001 Non-performing assets at end of the period: ------- ----------- Nonaccrual Loans: Secured by real estate: One- to four-family $ 757 $ 1,006 Commercial 859 415 Multifamily -- -- Construction and land 7,102 6,827 Commercial business 10,140 8,884 Agricultural business 429 86 Consumer 275 291 ------- ------- 19,562 17,509 Loans more than 90 days delinquent, still on accrual: Secured by real estate: One- to four-family 21 18 Commercial -- 325 Multifamily -- -- Construction and land -- -- Commercial business -- 39 Agricultural business 290 -- Consumer 3 152 ------- ------- 314 534 ------- ------- Total non-performing loans 19,876 18,043 Real estate owned, held for sale, net (REO), and other repossessed assets 6,253 3,011 ------- ------- Total non-performing assets at the end of the period $26,129 $21,054 ======= ======= Non-performing loans as a percentage of total net loans before allowance for loan losses at end of the period 1.27% 1.13% Non-performing assets as a percentage of total assets at end of the period 1.21% 1.01% Troubled debt restructuring [TDRs] at end of the period $ 598 $ 302 ======= ======= 21 Liquidity and Capital Resources The Company's primary sources of funds are deposits, borrowings, proceeds from loan principal and interest payments and sales of loans, and the maturity of and interest income on mortgage-backed and investment securities. While maturities and scheduled repayments of loans and mortgage-backed securities are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by market interest rates, economic conditions and competition. The primary investing activity of the Company, through its subsidiaries, is the origination and purchase of loans. In addition the Company maintains a securities portfolio which management may increase or decrease in response to changes in loan and deposit activity or market condition. During the six months ended June 30, 2002, the Company purchased loans in the amount of $3.9 million while loan originations, net of repayments, totaled $140.9 million. During this same six month period the securities investments increased $59.4 million. This activity was funded primarily by sales of loans and deposit growth. During the six months ended June 30, 2002, the Company sold $160.4 million of loans. Net deposit growth was $131.1 million (including $33.2 million from acquisitions) for the six months ended June 30, 2002. FHLB advances decreased $70.8 million for the six months ended June 30, 2002. Other borrowings and TPS increased $17.0 million for the six months ended June 30, 2002. The Bank must maintain an adequate level of liquidity to ensure the availability of sufficient funds to accommodate deposit withdrawals, to support loan growth, to satisfy financial commitments and to take advantage of investment opportunities. During the six months ended June 30, 2002, the Bank used its source of funds primarily to fund loan commitments, to purchase securities, to repay FHLB advances and other borrowings, and to pay maturing savings certificates and deposit withdrawals. At June 30, 2002, BB had outstanding loan commitments totaling $367.2 million including undisbursed loans in process totaling $308.4 million. BB generally maintains sufficient cash and readily marketable securities to meet short-term liquidity needs. BB maintains a credit facility with the FHLB-Seattle, which provides for advances which, in aggregate, may equal the lesser of 40% of BB's assets or unencumbered qualifying collateral, up to a total possible credit line of $865 million. Advances under this credit facility totaled $431.2 million, or 20% of BB's assets at June 30, 2002. At June 30, 2002, savings certificates amounted to $915.0 million, or 64%, of the Bank's total deposits, including $707.2 million which were scheduled to mature within one year. Historically, the Bank has been able to retain a significant amount of its deposits as they mature. Management believes it has adequate resources to fund all loan commitments from savings deposits, FHLB-Seattle advances, other borrowings and sale of mortgage loans and that it can adjust the offering rates for savings certificates to retain deposits in changing interest rate environments. Capital Requirements Federally-insured state-chartered banks are required to maintain minimum levels of regulatory capital. Under current FDIC regulations, insured state-chartered banks generally must maintain (i) a ratio of Tier 1 leverage capital to total assets of at least 3.0% (4.0% to 5.0% for all but the most highly rated banks), (ii) a ratio of Tier 1 capital to risk-weighted assets of at least 4.0% and (iii) a ratio of total capital to risk-weighted assets of at least 8.0%. At June 30, 2002, BANR's banking subsidiary exceeded all current regulatory capital requirements to be classified as a well capitalized institution, the highest regulatory standard. In order to be categorized as a well capitalized institution, the FDIC requires banks it regulates to maintain a leverage ratio, defined as Tier 1 capital divided by total regulatory assets, of at least 5.00%; Tier 1 (or core) capital of at least 6.00% of risk-weighted assets; and total capital of at least 10.00% of risk-weighted assets. BANR, as a bank holding company, is regulated by the Federal Reserve Board (FRB). The FRB has established capital requirements for bank holding companies that generally parallel the capital requirements of the FDIC for banks with $150 million or more in total consolidated assets. BANR's total regulatory capital must equal 8% of risk-weighted assets and one half of the 8% (4%) must consist of Tier 1 (core) capital. The actual regulatory capital ratios calculated for BANR along with the minimum capital amounts and ratios for capital adequacy purposes were as follows (dollars in thousands): Minimum for capital Actual adequacy purposes ----------------- ----------------- Amount Ratio Amount Ratio June 30, 2002: ------ ----- ------ ------ BANR-consolidated Total capital to risk- weighted assets $ 199,940 12.84% $ 124,601 8.00% Tier 1 capital to risk- weighted assets 182,486 11.72 62,301 4.00 Tier 1 leverage capital average assets 182,486 8.69 83,990 4.00 22 Item 3 - Quantitative and Qualitative Disclosures About Market Risk Market Risk and Asset/Liability Management The financial condition and operation of the Company are influenced significantly by general economic conditions, including the absolute level of interest rates as well as changes in interest rates and the slope of the yield curve. The Company's profitability is dependent to a large extent on its net interest income, which is the difference between the interest received from its interest-earning assets and the interest expense incurred on its interest-bearing liabilities. The activities of the Company, like all financial institutions, inherently involve the assumption of interest rate risk. Interest rate risk is the risk that changes in market interest rates will have an adverse impact on the institution's earnings and underlying economic value. Interest rate risk is determined by the maturity and repricing characteristics of an institution's assets, liabilities, and off-balance-sheet contracts. Interest rate risk is measured by the variability of financial performance and economic value resulting from changes in interest rates. Interest rate risk is the primary market risk affecting the Company's financial performance. The greatest source of interest rate risk to the Company results from the mismatch of maturities or repricing intervals for rate sensitive assets, liabilities and off-balance-sheet contracts. This mismatch or gap is generally characterized by a substantially shorter maturity structure for interest-bearing liabilities than interest-earning assets. Additional interest rate risk results from mismatched repricing indices and formulae (basis risk and yield curve risk), and product caps and floors and early repayment or withdrawal provisions (option risk), which may be contractual or market driven, that are generally more favorable to customers than to the Company. The principal objectives of asset/liability management are to evaluate the interest-rate risk exposure of the Company; to determine the level of risk appropriate given the Company's operating environment, business plan strategies, performance objectives, capital and liquidity constraints, and asset and liability allocation alternatives; and to manage the Company's interest rate risk consistent with regulatory guidelines and approved policies of the Board of Directors. Through such management, the Company seeks to reduce the vulnerability of its earnings and capital position to changes in the level of interest rates. The Company's actions in this regard are taken under the guidance of the Asset/Liability Management Committee, which is comprised of members of the Company's senior management. The committee closely monitors the Company's interest sensitivity exposure, asset and liability allocation decisions, liquidity and capital positions, and local and national economic conditions and attempts to structure the loan and investment portfolios and funding sources of the Company to maximize earnings within acceptable risk tolerances. The Company's primary monitoring tool for assessing interest rate risk is asset/liability simulation modeling which is designed to capture the dynamics of balance sheet, interest rate and spread movements and to quantify variations in net interest income resulting from those movements under different rate environments. The sensitivity of net interest income to changes in the modeled interest rate environments provides a measurement of interest rate risk. The Company also utilizes market value analysis, which addresses changes in estimated net market value of equity arising from changes in the level of interest rates. The net market value of equity is estimated by separately valuing the Company's assets and liabilities under varying interest rate environments. The extent to which assets gain or lose value in relation to the gains or losses of liability values under the various interest rate assumptions determines the sensitivity of net equity value to changes in interest rates and provides an additional measure of interest rate risk. The interest rate sensitivity analysis performed by the Company incorporates beginning of the period rate, balance and maturity data, using various levels of aggregation of that data, as well as certain assumptions concerning the maturity, repricing, amortization and prepayment characteristics of loans and other interest-earning assets and the repricing and withdrawal of deposits and other interest-bearing liabilities into an asset/liability computer simulation model. The Company updates and prepares simulation modeling at least quarterly for review by senior management and the directors. The Company believes the data and assumptions are realistic representations of its portfolio and possible outcomes under the various interest rate scenarios. Nonetheless, the interest rate sensitivity of the Company's net interest income and net market value of equity could vary substantially if different assumptions were used or if actual experience differs from the assumptions used. 23 Sensitivity Analysis The table of Interest Rate Risk Indicators sets forth, as of June 30, 2002, the estimated changes in the Company's net interest income over a one-year time horizon and the estimated changes in market value of equity based on the indicated interest rate environments. Table of Interest Rate Risk Indicators Estimated Change in ---------------------------------------- Change (In Basis Points) Net Interest Income in Interest Rates (1) Next 12 Months Net Market Value ----------------------- ------------------- ---------------- (dollars in thousands) +400 $(3,216) (3.8%) $(79,016) (40.2%) +300 (2,810) (3.4%) (49,836) (25.3%) +200 (3,419) (4.1%) (28,623) (14.5%) +100 (3,559) (4.2%) (11,839) (6.0%) 0 0 0 0 0 -100 1,126 1.3% 1,245 0.6% -200 (481) (0.6%) 8,963 4.6% -300 $ N/A N/A $ N/A N/A - ---------- (1) Assumes an instantaneous and sustained uniform change in market interest rates at all maturities. Another although less reliable monitoring tool for assessing interest rate risk is "gap analysis." The matching of the repricing characteristics of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest sensitive" and by monitoring an institution's interest sensitivity "gap." An asset or liability is said to be interest sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets anticipated, based upon certain assumptions, to mature or reprice within a specific time period and the amount of interest-bearing liabilities anticipated to mature or reprice, based upon certain assumptions, within that same time period. A gap is considered positive when the amount of interest sensitive assets exceeds the amount of interest sensitive liabilities. A gap is considered negative when the amount of interest sensitive liabilities exceeds the amount of interest sensitive assets. Generally, during a period of rising rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to adversely affect net interest income. Certain shortcomings are inherent in gap analysis. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as ARM loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Finally, the ability of some borrowers to service their debt may decrease in the event of a severe interest rate increase. The table of Interest Sensitivity Gap presents the Company's interest sensitivity gap between interest-earning assets and interest-bearing liabilities at June 30, 2002. The table sets forth the amounts of interest-earning assets and interest-bearing liabilities which are anticipated by the Company, based upon certain assumptions, to reprice or mature in each of the future periods shown. At June 30, 2002, total interest-earning assets maturing or repricing within one year exceeded total interest-bearing liabilities maturing or repricing in the same time period by $111.3 million, representing a one-year gap to total assets ratio of 5.14%. 24 Table of Interest Sensitivity Gap As of June 30, 2002 Within 6 Months 1-3 3-5 5-10 Over 10 6 Months to One Year Years Years Years Years Total -------- -------- -------- -------- -------- -------- ---------- (dollars in thousands) Interest-earning assets(1): Construction loans $233,366 $ 1,423 $ 2,190 $ 797 $ -- $ -- $ 237,776 Fixed-rate mortgage loans 84,592 57,498 140,291 109,561 37,460 49,785 579,187 Adjustable-rate mortgage loans 209,880 60,919 65,639 15,936 3,743 -- 356,117 Fixed-rate mortgage-backed securities 18,658 5,045 20,074 15,378 32,090 63,857 155,102 Adjustable-rate mortgage-backed securities 53,273 -- -- -- -- -- 53,273 Fixed-rate commercial /agriculture loans 26,501 26,488 31,479 13,261 6,553 225 104,507 Adjustable-rate commercial/ agriculture loans 226,984 5,574 1,203 1,659 311 -- 235,731 Consumer and other loans 28,657 6,735 14,509 6,997 1,832 342 59,072 Investment securities and interest-bearing deposits 98,478 47,600 10,935 3,330 13,538 49,091 222,972 -------- -------- -------- -------- -------- -------- ---------- Total rate-sensitive assets 980,389 211,282 286,320 166,919 195,527 163,300 2,003,737 -------- -------- -------- -------- -------- -------- ---------- Interest-bearing liabilities(2): Regular savings and NOW accounts 21,377 21,377 49,879 49,879 -- -- 142,512 Money market deposit accounts 86,819 52,091 34,727 -- -- -- 173,637 Certificates of deposit 548,444 156,588 156,244 49,436 4,167 90 914,969 FHLB advances 82,370 44,790 106,494 75,600 121,079 849 431,182 Other borrowings 54,692 -- -- -- -- -- 54,692 Retail repurchase agreements 11,037 743 1,477 -- -- -- 13,257 -------- -------- -------- -------- -------- -------- ---------- Total rate-sensitive liabilities 804,739 275,589 348,821 174,915 125,246 939 1,730,249 -------- -------- -------- -------- -------- -------- ---------- Excess (deficiency) of interest- sensitive assets over interest- sensitive liabilities $175,650 $(64,307) $(62,501) $ (7,996) $ 70,281 $162,361 $ 273,488 ======== ======== ======== ======== ======== ======== ========== Cumulative excess (deficiency) of interest-sensitive assets $175,650 $111,343 $ 48,842 $ 40,846 $111,127 $273,488 $ 273,488 ======== ======== ======== ======== ======== ======== ========== Cumulative ratio of interest- earning assets to interest- bearing liabilities 121.83% 110.31% 103.42% 102.55% 106.43% 115.81% 115.81% ======== ======== ======== ======== ======== ======== ========== Interest sensitivity gap to total assets 8.11% (2.97%) (2.89%) (0.37%) 3.25% 7.50% 12.63% ======== ======== ======== ======== ======== ======== ========== Ratio of cumulative gap to total assets 8.11% 5.14% 2.26% 1.89% 5.13% 12.63% 12.63% ======== ======== ======== ======== ======== ======== ========== (footnotes on following page)
25 Footnotes for Table of Interest Sensitivity Gap - ----------------------------------------------- (1) Adjustable-rate assets are included in the period in which interest rates are next scheduled to adjust rather than in the period in which they are due to mature, and fixed-rate assets are included in the periods in which they are scheduled to be repaid based upon scheduled amortization, in each case adjusted to take into account estimated prepayments. Mortgage loans and other loans are not reduced for allowances for loan losses and non-performing loans. Mortgage loans, mortgage-backed securities, other loans, and investment securities are not adjusted for deferred fees and unamortized acquisition premiums and discounts. (2) Adjustable- and variable-rate liabilities are included in the period in which interest rates are next scheduled to adjust rather than in the period they are due to mature. Although the Bank's regular savings, NOW, and money market deposit accounts are subject to immediate withdrawal, management considers a substantial amount of such accounts to be core deposits having significantly longer maturities. For the purpose of the gap analysis, these accounts have been assigned decay rates to reflect their longer effective maturities. If all of these accounts had been assumed to be short-term, the one year cumulative gap of interest-sensitive assets would have been negative $23.1 million or (1.07%) of total assets. Interest-bearing liabilities for this table exclude certain non-interest-bearing deposits which are presented in the average balance calculations in the table included in Item 2, Management's Discussion and Analysis of Financial Conditions and Results of Operations, and Comparison of Results of Operations for the Quarters and Six Months Ended June 30, 2002 and 2001 (restated). 26 PART II - OTHER INFORMATION Item 1. Legal Proceedings From time to time BANR or its subsidiaries are engaged in legal proceedings in the ordinary course of business, none of which is considered to have a material impact on the BANR's financial position or results of operations. Item 2. Changes in Securities Not Applicable Item 3. Defaults Upon Senior Securities Not Applicable Item 4. Submission of Matters to a Vote of Stockholders The annual meeting of stockholders of the Company (meeting) was held on April19, 2002. At the meeting there were a total number of 11,598,103 shares eligible to vote of which 10,362,022 were received or cast at the meeting. The result of the vote on the election of directors, the first proposal presented at the meeting, is as follows: The following individuals were elected as directors: FOR WITHHELD ------------------------- ------------------------- # of votes percentage of # of votes percentage of shares voted shares voted ---------- ------------- ---------- ------------- Jesse G. Foster 10,265,310 99.07% 96,712 0.93% Dean W. Mitchell 10,249,424 98.91% 112,598 1.09% Brent A. Orrico 10,186,003 98.30% 176,019 1.70% D. Michael Jones 10,269,330 99.11% 92,692 0.89% The terms of Directors Robert D. Adams, David B. Casper, Margaret C. Langlie, Wilbur Pribilsky, Gary Sirmon and Steve Sundquist continued. Director S. Rick Meikle resigned effective January 3, 2002. The result of the vote on the approval of the appointment of Deloitte & Touche LLP as independent auditors for the fiscal year ending December 31, 2002, the second proposal at the meeting, is as follows: # of votes percentage of shares voted ---------- -------------------------- FOR 10,284,959 99.26% AGAINST 44,657 0.43% ABSTAIN 32,406 0.31% Item 5. Other Information Not Applicable Item 6. Exhibits and Reports on Form 8K Report(s) on Form 8-K filed during the quarter ended June 30, 2002, are as follows: Date Filed Purpose ---------- ------- None 27 SIGNATURES - ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Banner Corporation August 14, 2002 /s/D. Michael Jones ------------------------------------- D. Michael Jones President and Chief Executive Officer (Principal Executive Officer) August 14, 2002 /s/ Lloyd W. Baker ------------------------------------- Lloyd W. Baker Treasurer and Executive Vice President (Principal Financial and Accounting Officer) 28 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER OF BANNER CORPORATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The undersigned hereby certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and in connection with this Quarterly Report on Form 10-Q, that: - the report fully complies with the requirements of Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, and - the information contained in the report fairly presents, in all material respects, the company's financial condition and results of operations. August 14, 2002 /s/D. Michael Jones ------------------------ D. Michael Jones Chief Executive Officer August 14, 2002 /s/Lloyd W. Baker ------------------------ Lloyd W. Baker Chief Financial Officer 29 -----END PRIVACY-ENHANCED MESSAGE-----