Item 1. Business - ---------------- (a) General
First Mutual Bancshares, Inc. (the "Company") is a Washington corporation, which was formed for the purpose of becoming the bank holding company for First Mutual Bank ("First Mutual" or the "Bank"). The Bank's reorganization was completed on October 26, 1999, on which date the Bank became the wholly-owned subsidiary of the Company, and the stockholders of the Bank became stockholders of the Company. Prior to completion of the reorganization, the Company had no material assets or liabilities and engaged in no business activities. Subsequent to the reorganization, the Company has engaged in no significant activity other than holding the stock of the Bank and engaging in certain passive investment activities. Accordingly, the information set forth in this report, including financial statements and related data, relates primarily to the Bank.
First Mutual was incorporated as a Washington state-chartered mutual savings bank in 1968 known as First Mutual Savings Bank and was the successor to Eastside Savings and Loan Association, which was organized in 1952 and commenced operations in 1953. The Bank converted from mutual to stock form through the sale and issuance of 966,000 shares of Common Stock in December 1985. In connection with the holding company reorganization, the Bank changed its name to First Mutual Bank. The Bank is subject to regulation by the State of Washington Department of Financial Institutions and the Federal Deposit Insurance Corporation ("FDIC"). The Company is subject to regulation by the Federal Reserve Board.
The business of the Bank consists of attracting deposits from the general public as well as wholesale funding sources and investing those funds primarily in commercial and residential real estate loans, mid-sized business loans, loans secured by savings accounts, and consumer loans. The Bank also invests in federal government and agency obligations; structured notes; real estate mortgage investment conduits ("REMICs"); mortgage-backed securities; and corporate and municipal securities. In addition to portfolio lending, the Bank conducts a significant mortgage banking operation, which encompasses the selling of primarily fixed-rate loans into the secondary mortgage market. The Bank generally sells the right to service the loans sold (i.e., collection of principal and interest payments) for which it receives a fee.
The principal sources of funds for the Bank's lending and investment activities are deposits, repayment of loans, loan sales and Federal Home Loan Bank ("FHLB") of Seattle advances. The Bank's primary sources of income are interest on loans, gains on sales of loans and loan servicing rights, servicing fees on loans, service-charge income on deposit accounts and interest and dividends on investment securities. Its principal expenses are interest paid on deposits and borrowings, and general and administrative costs.
The Bank's savings and lending operations are conducted through nine full service facilities located in Bellevue(3), Redmond, Seattle(2), Issaquah, Bellingham, and Monroe, Washington, and two income property loan production offices located in Salem, Oregon, and Tacoma, Washington. The Bank's main office is currently located at 400 108th Avenue N.E., Bellevue, Washington. See "Item 2.
Item 2. Properties - ------------------
The following table provides the location of the Bank's offices, as well as certain information relating to these offices.
The Bank reviews the utilization of its properties on a regular basis and believes that it has adequate facilities for current operations.
The Bank regularly analyzes demographic and geographic data as well as information regarding the Bank's competitors and its current loan and deposit customers in order to locate potential future bank sites. Specific criteria is gathered for each potential geographic area identified. The criteria is then weighted as to importance to the Bank, its customers and its target market and a ranking is made of the various locations under analysis.
The Bank may open new branches from time-to-time, and on a selective basis, depending on the availability of capital resources, the locations potential for growth and profitability, and if the business model for the branch is favorable. The Bank intends to open an office in Kirkland, Washington in mid-year 2000.
Item 3.
Item 3. Legal Proceedings - --------------------------
At December 31, 1999, First Mutual was not engaged in any litigation which in the opinion of management, after consultation with its counsel, would exceed 10% of the equity capital accounts of the Bank.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1999.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters - ------------------------------------------------------------------------------
The information contained under the caption "Stock Information" in the Annual Report is incorporated herein by reference.
The following table provides the cash dividends declared by the Company (and the Bank as its predecessor) during the last three fiscal years. All amounts have been adjusted for stock dividends and the dilutive effect of stock options.
Fiscal Fiscal Fiscal Fiscal Fiscal Quarter Ending 1999 1998 1997 1996 1995 - -------------- ---- ---- ---- ---- ---- Fiscal year $.200 $.600 $.501 $.105 $.198 March 31 .050 .450 .029 .027 .021 June 30 .050 .050 .034 .026 .021 September 30 .050 .050 .034 .026 .021 December 31 .050 .050 .404 .026 .135
Item 6.
Item 6. Selected Financial Data - --------------------------------
The information contained in the section captioned "Selected Financial Data" in the Annual Report is incorporated herein by reference.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - -----------------------------------------------------------------------------
The information contained under the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Annual Report is incorporated herein by reference.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk - --------------------------------------------------------------------
The information contained in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Market Risk Sensitive Instruments" in the Annual Report is incorporated herein by reference.
Item 8.
Item 8. Financial Statements and Supplementary Data - ---------------------------------------------------
The financial statements contained in the Annual Report, which are listed under Item 14 herein, are incorporated herein by reference.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure - -----------------------------------------------------------------------------
Not applicable.
Part III
Item 10.
Item 10. Directors and Executive Officers of the Registrant - -----------------------------------------------------------
The information contained under the section captioned "Proposal 1. Election of Directors" in the Company's Proxy Statement is incorporated herein by reference. Reference is made to the cover page of this report for information regarding compliance with Section 16(a) of the Exchange Act.
The following table sets forth certain information with respect to the executive officers of the Company and the Bank.
Age at December Position ------------------------------------------- Name 31, 1999 Company Bank - ---- -------- ------- ---- John R. Valaas 55 President and Chief President and Executive Officer Chief Executive Officer
Roger A. Mandery 57 Executive Vice President Executive Vice and Treasurer President - Chief Financial Officer, Treasurer and Assistant Secretary
James R. Boudreau 52 Senior Vice President - Chief Credit Officer
Kenneth J. Walkky 51 Vice President - Income Property Production Manager
Kari Stenslie 35 Vice President - Vice President - Controller Controller
Robin R. Carey 42 Vice President - Operations and Administration
Scott Harlan 38 Vice President - Residential and Con- sumer Lending
Ronald P. Werth 52 Vice President - Business Banking Manager
The following is a description of the principal occupation and employment of the executive officers of the Bank during at least the past five years:
JOHN R. VALAAS is the President and Chief Executive Officer for First Mutual Bank and First Mutual Bancshares, Inc. Prior to his appointment as President of the Bank, Mr. Valaas was Senior Vice President and manager of the Commercial Financial Services Division at Seafirst Bank where he was employed from 1983 to 1992. Mr. Valaas has over 28 years of experience in commercial banking.
ROGER A. MANDERY, CPA, is Executive Vice President for First Mutual Bank and First Mutual Bancshares, Inc. Prior to serving in that capacity, from March 1984 to 1989, he was Senior Vice President of Finance.
Mr. Mandery serves as the Bank's Chief Financial Officer and in this capacity is responsible for the Bank's treasury, accounting, internal audit, asset/ liability, and consumer and retail banking functions.
JAMES R. BOUDREAU is First Mutual's Senior Vice President and Chief Credit Officer; he has been employed by the Bank since 1975. He is responsible for overseeing lending policies for all lending areas of the Bank. He chairs the Bank's Loan Committee and supervises the asset management and residential underwriting departments.
KENNETH J. WALKKY, CPA, joined First Mutual in September 1990 as Vice President and Manager of Income Property Lending. He is responsible for income property and construction lending production. Prior to joining the Bank, he served as Vice President and Northern Regional Manager of Commercial Real Estate Lending, Puget Sound National Bank, where he was employed from 1983 to 1990. He was a Vice President at Seafirst Bank from 1980 to 1983. Mr Walkky is also a Washington State certified general appraiser.
KARI STENSLIE, CPA, CMA, is the Vice President and Controller for First Mutual Bank and First Mutual Bancshares, Inc. and has been employed by the Bank since 1988. She is responsible for the Bank's accounting systems financial reporting, tax accounting, and operational analysis functions.
ROBIN R. CAREY is First Mutual's Vice President of Operations and Administration and has been employed by the Bank since 1979. She is responsible for overseeing central banking operations, facilities, loan servicing, income property operations, and human resources.
SCOTT HARLAN is the Bank's Vice President of Residential and Consumer Lending and has been employed by the Bank since 1985. He is responsible for the home equity, consumer, wholesale residential lending, secondary marketing, and the information systems departments.
RONALD P. WERTH joined First Mutual in February 1996 as Vice President and Manager of Business Banking. He is responsible for all aspects of Business Banking including business development and administration. From 1988 to 1995 he served as Vice President - Finance for two privately owned companies. Prior to that, he served as Vice President for the Corporate Banking Division at Seafirst Bank where he was employed from 1973 to 1988.
Item 11.
Item 11. Executive Compensation - --------------------------------
The information required by this item is incorporated by reference to the section captioned - "Proposal I -Executive Compensation" in the Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------
The information required by this item is incorporated herein by reference to the sections captioned "Proposal 1. Election of Directors" and "Principal Shareholders" in the Company's definitive proxy statement for the Company's 2000 Annual Meeting of Shareholders.
Item 13.
Item 13. Certain Relationships and Related Transactions - --------------------------------------------------------
The information required by this item is incorporated by reference to the section captioned - "Proposal I -Meetings, Compensation, Relationships and Certain Committees of the Board of Directors" in the Proxy Statement.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K - -------------------------------------------------------------------------- (a)(1) Consolidated Financial Statements (*) ------------------------------------- Independent Auditors' Report Consolidated Statements of Financial Condition at December 31, 1999 and Consolidated Statements of Income for the three years ended December 31, 1999 Consolidated Statements of Stockholders' Equity for the three years ended December 31, 1999 Consolidated Statements of Cash Flows for the three years ended December 31, 1999 Notes to Consolidated Financial Statements
(2) All required financial statement schedules are included in the Notes to Consolidated Financial Statements.
(b) A Form 8-K was filed on November 10, 1999 in connection with the holding company reorganization.
(c) Exhibits -------- (3) a. Articles of Incorporation (a) b. Bylaws (a) (11) Statement regarding computation of per share earnings. Reference is made to the Company's Consolidated Statements of Income attached hereto as part of Exhibit 13, which are incorporated herein by reference. (13) 1999 Annual Report to Shareholders. (21) Subsidiaries - ------------------- (*) Incorporated by reference from 1999 Annual Report to Shareholders attached hereto as Exhibit 13. (a) Incorporated by reference to the Current Report on Form 8-K filed with the SEC on November 10, 1999.
SIGNATURES
Pursuant to the requirements of Section 13 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.
FIRST MUTUAL BANCSHARES, INC.
DATE: March 29, 2000 BY: /s/John R. Valaas ----------------------------------- John R. Valaas, President and Chief Executive Officer and Duly Authorized Representative
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
By: /s/Roger A. Mandery By:/s/Victor E. Parker ------------------------------ ---------------------------- Roger A. Mandery Victor E. Parker Principal Financial Officer Director
Date: March 29, 2000 Date: March 28, 2000
By: /s/Kari A. Stenslie By:/s/George W. Rowley, Jr. ------------------------------ ---------------------------- Kari A. Stenslie George W. Rowley, Jr. Principal Accounting Officer Director
Date: March 29, 2000 Date: March 28, 2000
By: /s/F. Kemper Freeman, Jr. By:/s/Richard S. Sprague ------------------------------ ---------------------------- F. Kemper Freeman, Jr. Richard S. Sprague Chairman of the Board Director
Date: March 27, 2000 Date: March 27, 2000
By: /s/James J. Doud, Jr. By: /s/John R. Valaas ------------------------------ --------------------------- James J. Doud, Jr. John R. Valaas Director Director
Date: March 27, 2000 Date: March 29, 2000
By: By: ---------------------------- --------------------------- Mary Case Dunnam H. Scott Wallace Director Director
Date: March , 2000 Date: March , 2000 -- -- By: By: /s/Robert C. Wallace ------------------------------ -------------------------- Janine Florence Robert C. Wallace Director Director
Date: March , 2000 Date: March , 2000 -- --
EXHIBIT 13
1999 Annual Report to Shareholders
FIRST MUTUAL BANCSHARES INCORPORATED
ANNUAL REPORT
Corporate Profile
First Mutual Bancshares, Inc. (the "Company") is based on the Eastside, the area immediately east of Seattle and Lake Washington that includes parts of King and Snohomish counties. It is the holding company for First Mutual Bank, its principal subsidiary. First Mutual Bank's primary lending market serves citizens of the Eastside and the I-5 corridor, which stretches from Bellingham, Washington, on the north to Salem, Oregon, on the south. The nine branches of this state-chartered, FDIC-insured bank are located in Bellevue (three), Ballard, Bellingham, Redmond, Issaquah, Monroe and West Seattle. In addition, commercial real estate loan production offices are located in Tacoma, Washington, and Salem, Oregon.
Operating income is derived primarily from real estate lending activities. First Mutual Bank also makes consumer and small business loans and sells a range of depository and other financial services.
First Mutual Bank converted to an FDIC-insured mutual savings bank in 1968. It originally was chartered as a savings and loan association when it opened in 1953. In December 1985 the Bank converted to a stock FDIC savings bank and completed its initial public offering of common stock. The holding company, First Mutual Bancshares, Inc., was formed in October 1999.
In 1999 the Company's net income increased 15.2 percent to $6.0 million, or $1.26 diluted earnings per share, up from $5.2 million, or $1.09 diluted earnings per share, in 1998. Net interest income for 1999 was $19.0 million, while deposits totaled $400 million, and total assets were $581 million at year-end 1999.
The Company's common stock trades on The Nasdaq Stock Market under the symbol FMSB.
Letter to Shareholders
Dear Fellow Shareholder:
First Mutual Bancshares, Inc. includes the results of First Mutual Bank, which ended 1999 with record earnings and notably high performance ratios. The final quarter of the year marked our 29th consecutive quarter of record year- over-year earnings gains. Net income for 1999 increased 15 percent to $6.0 million, and diluted earnings per share rose 16 percent to $1.26, compared with $1.09 for 1998.
Total assets also reached record levels, rising to $581 million from $489 million at the end of 1998. We are less interested in the absolute level of assets, however, than we are in their earning power and their quality. With regard to the latter, we once again are pleased to report that non-performing assets were only $352,000 at the end of 1999, or .06 percent of total assets.
One of the primary measures of earning power by which we judge ourselves is return on equity, a measure of how efficiently shareholder funds are used. For 1999 our return on equity was a record 16.22 percent.
A full discussion of First Mutual's financial performance may be found in the Management's Discussion and Analysis section, beginning on page 5.
Strategies for Change
Over the past several years we have discussed the strategic evolution of First Mutual's balance sheet. It may be useful to review that evolution in this communication.
Several years ago the Board made a strategic commitment to fundamentally alter First Mutual's balance sheet by reducing the portfolio's reliance on single-family home loans. In 1990 single-family home loans were 73 percent of the loan portfolio. At the end of 1999 they were approximately 21 percent of the portfolio.
The goal was to develop strong, multiple lines of business that would provide superior levels of earnings and portfolio diversification. This process had already begun in the mid-1980s when a department was formed to underwrite small commercial real estate loans. Substantial resources have been devoted to our Income Property Department and, today, small commercial real estate loans represent 64 percent of our loan portfolio.
In 1996 we established our Business Banking Department, which targets companies with credit needs in excess of $100,000. Business loans now are 6.2 percent of our portfolio. To complement the customer set targeted by Business Banking, we formed the Small Business Department this year. It will provide credit solutions to those smaller enterprises whose needs are less than $100,000. We are confident that the extensive relationships established
between our branch teams and the businesses in their communities provide a strong foundation on which to grow our Small Business product line.
As noted in last year's letter, our Consumer Lending Department has added basic product lines aimed at the individual with borrowing needs, beginning with home equity loans. We also provide direct consumer loans as well as indirect consumer financing. Indirect consumer loans are granted through a select set of home improvement dealers located in Washington and Oregon.
Finally, in 1999 we established our Private Banking Department, which focuses on higher-income, higher-net-worth individuals who are seeking extraordinary levels of personalized service from their financial institution. We have piloted this program successfully in our primary market region east of Lake Washington and have been gratified by its early success.
To provide better access to our financial services, we began offering on-line banking to our customers in 1999. Interest in this product has been high, as it adds another level of convenience for many customers to do their banking with us. In that capacity it serves as an adjunct to the high levels of service we provide in person in our branches.
In recent years First Mutual has evolved from being primarily a transactional provider of home mortgage loans to being a relationship-oriented institution that can provide any individual or company with all the financial products they need. As we have discussed consistently, over the years, we believe strong, responsive relationships with our customers are the key to profitable expansion of First Mutual. It is what differentiates us. Over time very large financial institutions will provide a range of products that, in effect, will be offered in a mass production fashion. The success of community financial institutions like First Mutual will be based on competitively priced products provided with a very high level of personal service.
First Mutual Bancshares, Inc.
During 1999 we took the important step of establishing a holding company. At the same time we changed the name of the bank subsidiary from First Mutual Savings Bank to First Mutual Bank. First Mutual Bancshares owns all of First Mutual Bank. The holding company structure provides us with more flexibility to take advantage of growth opportunities that continue to become available to us in our robust Pacific Northwest marketplace.
Dynamic Regional Economy
First Mutual Bank, with its headquarters in Bellevue, Washington, is situated in a market that has experienced some of the most dynamic growth of any area in the United States. While growth may slow somewhat in 2000, we continue to expect significant job creation and growth in income levels. Our market is home to the world's largest and most successful software company, the world's largest on-line retailer, and the world's largest airplane manufacturer. These entities, their spin-offs, and all the associated wealth created by them are exceptionally strong engines for economic growth. We believe First Mutual Bank is well situated to take advantage of the opportunities that lie ahead.
/s/F. Kemper Freeman, Jr. F. Kemper Freeman, Jr. Chairman of the Board
/s/John R. Valaas John R. Valaas President/CEO
February 1, 2000
In this Annual Report to Shareholders, First Mutual Bancshares, Inc. (the "Company") has included certain forward-looking statements concerning its future operations. It is the Company's desire to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. This statement is 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 Annual Report to Shareholders. Sentences containing words such as "may," "will," "expect," "anticipate," "believe," "estimate," "optimistic," "hopeful," "should," "projected," or similar words may constitute forward-looking statements. Although the Company believes that the expectations expressed in these forward-looking statements are based on reasonable assumptions within the bounds of its knowledge of its business and operations, risks and uncertainties may cause actual results to differ materially from these expectations. Factors which could affect actual results include interest rate trends, the general state of the economy in the Company's market area and the country as a whole, the impact of competitive products, services and pricing, the ability of the Company to control costs and expenses, loan delinquency rates, and legislative, regulatory and accounting changes affecting the banking and financial services industry. These risks and uncertainties should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. Also, there are other risks and uncertainties discussed from time to time in the Company's SEC securities filings. The Company and the Bank disclaim any obligation publicly to announce future events or developments which affect the forward-looking statements herein.
Management's Discussion and Analysis of Financial Condition and Results of Operations
The information contained in this section should be read in conjunction with the Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements.
Formation of the Bank Holding Company
First Mutual Bancshares, Inc. (the "Company"), a Washington corporation, is a holding company primarily engaged in the business of planning, directing, and coordinating the activities of its wholly-owned subsidiary, First Mutual Bank (formerly First Mutual Savings Bank). On October 26, 1999, First Mutual Savings Bank converted into the holding company form of ownership in a tax-free reorganization. In the reorganization, First Mutual Savings Bank changed its name to First Mutual Bank and became the wholly-owned subsidiary of the Company. First Mutual Bank is also referred to as the "Bank" in this report.
Financial Highlights
First Mutual Bank's performance in 1999 reflects another year of record earnings, solid asset growth, and excellent credit quality.
Net income was up 15.2%, totaling $6,000,000, or $1.26 per diluted share, which compares to $5,208,000, $1.09 per diluted share, in 1998, and $4,519,000, $0.97 per diluted share, in 1997. Net income in 1999 was influenced by a favorable increase in net interest income, which was partially offset by a decline in other operating income. Net interest income in 1999 improved to $19.0 million from $17.4 million in 1998, an increase of 9.4%, compared to an increase of $1.6 million, or 10.1%, from 1997 to 1998. Net interest income in 1997 totaled $15.8 million, up 16.6% from the previous year. Other operating income fell 8.7%, from $3,230,000 in 1998 to $2,949,000 in 1999. In prior years other operating income has experienced gains, jumping 89.3% in 1998 and a more modest 3.9% increase in 1997.
Contributing to record earnings for 1999 was the successful growth in assets, which increased $92 million, or 18.8%. By comparison, the growth in assets in 1998 was $43 million, or 9.8%. Those figures compare to the national average for asset growth for FDIC-insured savings institutions of 6.1% for 1998 and an increase of 8.8% for the 12 months ending September 1999. The growth in assets occurred in both the investment securities and loan portfolios. Investment securities increased 28.4%, from $82,101,000 in 1998 to $105,406,000 in 1999. The growth in securities from
[Bar graph]:
1997 $4,519 1998 $5,208 1999 $6,000
Net Income/Dollars in Thousands
1997 to 1998 was also significant, rising $17 million, or 25.4%. Portfolio loans (loans receivable) increased dramatically in 1999 to $457,981,000, a growth of 25.4% from 1998's balance of $365,104,000. The comparative increase the prior year was 2.3%, or $8.3 million. Partially offsetting the rise in portfolio loans was a decrease in loans held for sale, which are loans pending delivery into the mortgage-backed secondary market. Loans held for sale fell 90.1%, from $27,371,000 in 1998 to $2,710,000 in 1999. In contrast to 1999, loans held for sale in 1998 rose dramatically, from $8,422,000 in 1997 to $27,371,000 in 1998. The rapid growth and contraction in loans held for sale reflects the "refinance boom" experienced in the mortgage market.
The Bank's non-performing assets continued to remain at exceptionally low levels. Non-performing assets increased slightly to $352,000, from $336,000 in 1998. As a percent of assets, non-performing assets totaled .06% in 1999 versus .07% the previous year.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income, which increased 9.4% from the prior year, is influenced by changes in the volume and mix of earning assets and funding sources and the market rate of interest.
Earning assets rose $93 million, or 19.6%, in 1999, following increases of 10.1% and 6.3% in 1998 and 1997, respectively. The contribution to net interest income from the growth in assets totaled $2,520,000 in 1999. Offsetting that contribution was a decrease of $892,000, resulting from an unfavorable change in interest rates. In 1998 the growth in earning assets increased net interest income by $2,591,000, which also was in part offset by an adverse change in rates amounting to $1,001,000. Net interest income in 1997 was increased by both a growth in earning assets, which added $1,712,000, and a positive trend in interest rates, which contributed $543,000.
The net interest margin declined in 1999 to 3.66%, from 3.85% the previous year, and 3.78% in 1997. The drop in the net interest margin in 1999 is attributable to a greater decline in the interest income ratio than the corresponding figure for the interest expense ratio. The interest income ratio (interest income/average-earning assets) fell from 8.67% in 1998 to 8.13% in 1999, a decrease of .54%. During the same period the interest expense ratio (interest expense/average deposits and borrowings) only declined .37%. One of the factors that contributed to the decrease in the net interest margin was the Bank's 28.4% increase in investment securities. The yield from the investment securities portfolio is significantly less than that received from the loan portfolio; for example, investment securities at year-end 1999 had an average return of 6.15% as compared to 8.29% for the loan portfolio.
Also contributing to the decline in the net interest margin in 1999 was the rise in short-term interest rates. The one-year Treasury rate, for example, increased from 4.59% on December 31, 1998, to 6.11% at year-end 1999. Because the Bank was negatively gapped (which is more liabilities repricing within a one-year period than assets) at year-end 1998 by .84%, and further negatively gapped by 15.3% at December 1999, the
rise in short-term interest rates worked to the Bank's disadvantage.
In 1998 the net interest margin increased to 3.85% from 3.78% the previous year. The net interest margin rose that year even though the Bank was negatively gapped and the impact from the change in interest rates was adverse. The cause of that anomaly was a change in the mix between the loan and securities portfolios. The securities portfolio's average quarterly balance declined 2.4%, while the same measure for loans rose 12.5%. The combination of these changes created a condition in which the net interest margin increased on a year-to-year comparison, while the overall effect from interest rates was negative.
The outlook for 2000 is influenced by the effect of trends in interest rates and the Bank's ability to successfully increase earning assets. Although 84% of the Bank's loan portfolio is comprised of adjustable-rate loans, the balance of the portfolio is invested in fixed-rate instruments. In addition, most of the securities portfolio is comprised of fixed-rate instruments. During periods of rising rates, as we experienced in 1999, the net interest margin is compressed as funding costs rise faster than yields on assets.
If interest rates continue to rise, it is likely that the net interest margin will further decline. Management, however, is cautiously optimistic that some or all of that decline could be offset through the growth in assets. Although future results cannot be predicted based upon past performance, the Bank has increased its assets by 13.7%, compounded per year, for the past five years. The comparative national average for FDIC-insured institutions is 6.76%, compound growth, for the five years ended in 1998.
Other Operating Income
Other operating income fell in 1999 to $2,949,000, from $3,230,000 the previous year. The comparable figure for 1997 was $1,706,000. The disappointment in 1999 was primarily due to a decline in mortgage banking activities and the resulting decrease in gain on sales of loans. Adversely affecting all three years was the decline in net service fee income, which has decreased from $805,000 in 1997 to $469,000 in 1999.
Gain on Sales of Loans. Gain on sales of loans fell 17.2% to $1,452,000 in 1999, after rising sharply in 1998 to $1,753,000, from $140,000 in 1997. Gain on sales of loans is heavily influenced by residential loan volume, which in turn benefited from the "refinance boom" experienced in 1998 and the first half of 1999. Gain on sales of loans is composed of three elements: sale of mortgage servicing rights, secondary market fees, and capitalization of mortgage servicing rights.
The net gain on sale of servicing rights amounted to $1,530,000 in 1999, down $452,000, or 22.8%, from $1,982,000 the previous year. There were no sales of a similar nature in 1997. The sale of servicing rights totaled $110 million in 1999, as compared to $178 million the previous year. In addition, the sale of servicing rights in 1999 declined substantially on a quarterly sequential basis. In the first quarter of 1999 the sale of servicing rights totaled $32 million, with the sale in the second quarter rising to $40 million, falling to $28 million in the third quarter, and further dropping to $10 million in the fourth quarter. The projected sale for the first quarter of 2000 is $7 million.
The amount and profit of sales executed in 2000 will depend on residential loans originated, both in terms of amount and mix of loans. The total number of loans closed and type of loans originated is heavily influenced by the nature of the interest rate yield curve and whether or not long-term rates are generally rising or falling. Rising rates, as we experienced in 1999, usually have an adverse affect upon the amount of residential loans originated.
Although it is the Bank's intent to sell servicing rights in 2000, sales in subsequent years could be materially reduced or eliminated if the Bank believes that it is in the best interest of the institution to retain the servicing rights and the annuity-like fee income attendant with those rights.
Secondary market fees are the cash gains or losses from the sale of loans into the secondary market. Cash losses in 1999 totaled $351,000 on loan sales of $110 million. In 1998 the cash losses amounted to $426,000 on sales of $198 million. The comparable figure for 1997 was a loss of $5,000 on sales of $98 million. The more favorable results achieved in 1999 and 1997 are attributable to fewer loan sales than in 1998. Nineteen-ninety-seven also benefited from the sale of $4 million in income property loans. The margin for income property loans is significantly greater than that for residential loans.
Beginning in 1996 the Bank adopted a new accounting procedure that requires the capitalization of mortgage servicing rights. The amount recognized as income in 1999 totaled $273,000, which compares to $197,000 in 1998, and $145,000 in 1997. The rise in 1999 is largely the result of an increase in valuations of servicing rights as compared to previous years.
Servicing Fees, Net of Amortization. Servicing fee revenue is sensitive to amortization expense, the
[Bar graph]
1997 $213 1998 $380 1999 $310
Loan Production/Dollars in Millions
spread realized on the servicing portfolio and, of course, the size of the portfolio.
In 1999 gross fee income (net of guarantor fees) received from the mortgage servicing portfolio totaled $622,000. Deducted from those gross fees was amortization expense of $153,000. In 1998 gross fees totaled $742,000, and amortization expense amounted to $268,000. The comparable figures for 1997 were $1,055,000 and $250,000, respectively.
Amortization expense is largely impacted by the early prepayment of loans. In 1999 principal prepayments totaled $51 million, or 17% of the year-end 1998 servicing portfolio balance. The prepayment rate was greater in 1998, with $78 million in loan principal repaid, an amount equal to 21% of the 1997 year-end servicing balance. The results for 1997 were better than either of the two subsequent years principal prepayments totaled $50 million and represented 13% of the 1996 year-end servicing portfolio.
Also impacting servicing fee income is the spread realized from the servicing portfolio. The spread is the difference between the total loan interest received from the borrower and the amount remitted to the investor. The Bank retains the spread as compensation for servicing the loan on behalf of the investor. In 1999 the spread on the $231 million average servicing portfolio equaled .27%. In contrast, the servicing portfolio averaged $324 million in 1998 and carried a spread of .23%. The comparable figures for 1997 were $375 million for the servicing portfolio and .28% for the servicing spread.
The drop in the servicing portfolio in 1999 contributed to the decline in service fee income. As was noted earlier, it is the Bank's current position to sell mortgage servicing rights as they are originated. This practice will most likely lead to a continued decline in the mortgage servicing portfolio, and a further decrease in service fee income.
Whether or not the Bank will change its position in the future regarding the retention of servicing rights will be dependent on interest rate trends, the borrowers' propensity to prepay loans, management's expectations for future interest rate directions, and the estimated lives of loans in the servicing portfolio.
Fees on Deposit Services and Other Income. Deposit fee income has risen 88.62% in the last three years, from $167,000 in 1997, to $208,000 in 1998, and $315,000 this year. The increase in all three years is largely attributable to fee income from checking accounts. Revenue from checking accounts amounted to $85,000 in 1997, increasing to $95,000 last year, and further rising to $155,000 in 1999.
Other income is composed of a variety of fee sources of which loan fees, late payment assessments
(late charges), rental income and limited partnership fee income constitute the most significant items. Loan fees, those that were not deferred, increased from $240,000 in 1997 to $385,000 last year. There was a slight decrease to $383,000 in 1999. The jump in fee income in 1998 was principally the result of increased sales to investors where the Bank functioned as a broker. In 1999, with the decline in mortgage banking lending from $217 million in 1998 to $85 million this year, brokered loan revenues dropped $50,000, or 19.8%. That loss of fee income was partially offset by loan fees from other sources.
Late charges have declined for the past three years, from $118,000 in 1997 to $77,000 this year. This trend is a reflection of both a fall in total loans serviced and the emphasis that the Bank places on asset management. Total loans serviced in 1997 included $365 million of portfolio loans and $379 million in loans serviced for others for a total of $744 million. At year-end 1999 total loans serviced had decreased 12% from 1997 levels to $655 million, of which loans serviced for others had fallen to $194 million.
Fee income from rental income and limited part-nership dropped from $130,000 in 1998 to $85,000 this year. While rental income rose modestly, fee income from the Bank's limited partnership fell $47,000, or 73%. The Bank's percentage of ownership in the partnership is de minimus; thus, its influence on dividends declared is not significant. The Bank is hopeful that fee income in the year 2000 will be comparable to the dividends received in 1998. Revenues from rental fees and limited-partnership dividends totaled $96,000 in 1997.
Other Operating Expenses
Salaries and Employee Benefits. Salaries and employee benefits expense essentially leveled off in 1999, after having grown rapidly in the previous two years. Employee costs in 1999 fell a modest $199,000, or 2.7%, as compared to increases of $1,541,000, or 25.9%, from 1997 to 1998, and $1,356,000, or 29.4%, from 1996 to 1997. Salaries and employee benefits expense was affected by a change in loan officer commission expense, a decline in discretionary bonuses paid to directors and senior management, and a drop in the benefit of deferred loan origination expense. Salaries and benefits costs were not materially affected by an increase in staff. The full-time equivalent (FTE) count was 135 at December 31, 1999, up just a fraction from 133 in 1998. The FTE staff in 1997 was 125.
Loan officer commission expense fell $307,000, or 33%, from $929,000 in 1998, to $622,000 this year. Commission expense amounted to $339,000 in 1997. Loans originated in 1999 totaled $310 million as compared to $380 million the year before. Loan volume
in 1997 amounted to $213 million.
Employee compensation expense also benefited from a substantial reduction of discretionary bonuses to directors and senior management. Certain discretionary bonuses awarded to directors and senior management in 1997 and 1998 were not awarded in 1999. These discontinued bonuses totaled $465,000 in 1997 and $808,000 in 1998.
Offsetting compensation costs is the deferral of loan origination expense. In accordance with the current accounting literature, standard loan origination costs are deferred and amortized over the life of the loan. The standard loan costs, which are determined for common loan types, are then deducted from operating expense, with the net figures reported in the financial statements. As was noted earlier, loan originations have ranged from $213 million in 1997 to $310 million this year. The accounting benefit (see Note 14 to the financial statements) has also varied, from $1,093,000 in 1997, to $1,622,000 last year, to $1,495,000 in 1999.
Occupancy Expense. Occupancy expense of $1,480,000 in 1999 was up 7.3%, from $1,379,000 the previous year. The comparative figure for 1997 was $1,165,000. The increases in all three years are principally due to opening new offices and corporate expan-sion at the Bellevue headquarters. In 1999 the Bank opened a loan production office in Salem, Oregon, and incurred a full year's operating expense from the Bellingham Branch. The previous year the Bank had opened its ninth full-service branch. In 1997 occupancy expense increased as a result of the opening of a second branch in Bellevue and additional leased space at the Corporate Headquarters to accommodate the residential lending department.
Other Expenses. Other expenses rose 6.4%, from $3,108,000 in 1998, to $3,307,000 in 1999. The in-crease from 1997 to 1998 was $542,000, or 21.1%. A number of items contributed to the change in other operating expenses, including legal expenses, outside services, and audit and accounting services.
The Bank's legal fees were up sharply in the last two years, jumping 101.3% in 1999, to $298,000, from $148,000 the previous year. Legal costs in 1998 had risen 82.7%, from 1997's figure of $81,000. The in-crease in 1999 was due primarily to the formation of the Bank's holding company; thus, legal expenses for year 2000 should drop accordingly. In 1998 the Bank encountered several issues related to residential construction lending that were difficult to litigate. Those
[Bar graph]
1997 .15% 1998 .07% 1999 .06%
Non-performing Assets/Percentage of Total Assets
issues have since been settled and the Bank does not anticipate any further legal expenses regarding those particular matters.
Outside services expense dropped from $379,000 in 1998 to $180,000 in 1999. In July of 1998 the Bank engaged independent consultants to review the operating procedures of the Bank and to implement improvements as needed. The project was concluded by late spring 1999. The comparable level of costs for outside services expense in 1997 was $80,000.
Audit and accounting services and bank examination costs increased from $90,000 in 1997 to $147,000 this year. The 63.3% rise in expenses reflects both a growth in assets and the increased complexity of the Bank over the past three years. Assets have grown $164 million, or 39.4%, since December 1996, and the Bank has added two full-service offices, a loan production facility in Salem, Oregon, and three new consumer lending departments.
Reserve and Provision for Loan Losses
The provision for loan losses reflects the amount deemed appropriate to produce an adequate reserve for estimated losses that exist based on the inherent risk characteristics of the Bank's loan portfolio. In determining the appropriate reserve balance, the Bank takes into consideration the profile of the loan portfolio, the local and national economic outlook, and the current and historical performance of the loan portfolio.
The determination of the level of reserves, and thus any additional provision, is arrived at through a process that begins with the Asset Management Department. That department analyzes the loan portfolio from a historical credit perspective and a composition and geographic concentration viewpoint. The Asset Management Department then prepares an economic analysis of the Puget Sound region to include employment forecasts, housing sales, vacancy rates, commercial real estate analysis, and comments on the area's major employers. That information is then reviewed by the Bank's Senior Loan Committee, which further evaluates national and international trends and establishes the appropriate level of reserve.
An $805,000 provision for loan losses was charged to operations in 1999. The Bank's reserve balance was $6,309,000 at December 31, 1999. At year-end 1998 the reserve balance was $5,569,000, which in turn was an increase of $711,000 over 1997's balance of $4,858,000.
A key factor in determining the appropriate level of loan loss reserves is the mix of the Bank's loan portfolio. Currently 20.8% of the portfolio is residential loans, while the remaining 79.2% is composed of commercial, construction, and consumer loans. The residen-
tial figure of 20.8% compares, per third-quarter 1999 FDIC Quarterly Banking Profile (latest available data), to 71.4% for FDIC-insured thrift institutions and 23.4% for FDIC-insured commercial banks. Management's view is that its loan portfolio is closely related to that of a commercial bank.
The Bank's loan loss reserves to total loans ratio was 1.37% at December 31, 1999. The comparable ratios for FDIC-insured savings institutions and commercial banks, as of September 30, 1999, were .92% and 1.73%, respectively. Although the Bank's loan mix is similar to that of a commercial bank, and therefore arguably its ratio of loan loss reserves to total loans should correspond to the national average, management believes that the Bank's current ratio of non-performing loans to assets warrants favorable consideration. As of year-end 1999 the Bank's non-performing assets to total assets ratio was .06%. That number compares to the national ratios of .66% for savings institutions and .61% for commercial banks as of September 30, 1999.
Although the Bank uses neither local nor national ratios to determine its appropriate provision or level of reserves, its ratio of 1.37% reserves to total loans would appear to be reasonable in light of those national norms and the nature of the Bank's loan portfolio, and its favorable non-performing asset status.
REVIEW OF FINANCIAL CONDITION
Investment Securities
Investment securities increased from $82 million at year-end 1998 to $105 million as of December 31, 1999, a growth of 28.4% in year-end balances.
In the fourth quarter of 1998, and again in the first quarter of 1999, the Bank substantially increased its investment in securities. Management perceived this period to be opportune for security purchases because of the source of the Bank's funding and the then current status of the institution's various capital components.
Loans
The loan portfolio is segregated into two components, loans held for sale and loans receivable. Loans held for sale is that portion of the loan portfolio which is pending sale and delivery into the secondary market. Loans receivable are loans held in the Bank's portfolio of which the largest component is commercial real estate.
Loans held for sale totaled $3 million at December 31, 1999, a decline of $24 million from the previous year-end. At December 31, 1998, loans held for sale had risen to $27 million, reflecting the sudden increase in mortgage banking activity in 1998. It is not unusual for the balance in loans held for sale to change dramatically from year to year. At year-end 1993, another year of vigorous mortgage-banking activity, the year-end
balance for loans held for sale totaled $24 million; the following year, 1994, the loan totals fell to $4 million. The normal balance for loans held for sale is in the range of $4 to $12 million, but will vary with refinancing activity.
Portfolio loans increased substantially, 25.4%, in 1999, from $365 million at December 31, 1998, to $458 million at year-end 1999. The growth in the loan portfolio is the result of record loan portfolio originations and a drop in the prepayment of loans. Loans closed for the Bank's portfolio totaled $225 million in 1999, up 38.2% from $163 million in 1998. Loan prepayments, which were a strong $138 million in 1998, declined to $124 million this year. Contributing to 1999's success was the "slope" of the interest rate yield curve. A "steepening" of the yield curve in 1999 made the Bank's adjustable-rate commercial loans more attractive as compared to fixed-rate commercial instruments. At the same time as the yield curve was adjusting to a more favorable position, rising interest rates discouraged current borrowers from prepaying their loans.
The future shape of the yield curve is difficult to predict, and, consequently, so is the prospect of whether loans will continue to prepay. Nevertheless, management is guardedly optimistic that it can continue to grow assets under the current conditions. Nineteen-ninety-nine was a year of record portfolio lending, and the Bank is reasonably hopeful that 2000 will be a successful year.
Deposits
Deposits declined $11,077,000, or 2.7%, in 1999. That figure compares to a growth of 10.3% in 1998, and an average increase of 4.8% in the first nine months of 1999 for all FDIC-insured institutions. Management is concerned about the erosion of the Bank's deposit base, which could eventually degrade its ability to fund the growth of earning assets. Actions taken in 1999 to address this problem include new leadership and branch incentive programs. Management is guardedly hopeful that the steps taken in 1999 will bear positive results in year 2000.
Market Risk Sensitive Instruments
Market risk is the risk of loss from adverse changes in market prices and rates. A significant market risk for the Bank arises from interest rate risk inherent in its lending, deposit, and mortgage banking activities. To that end, management actively monitors and man-ages its interest rate risk exposure.
[Bar graph]
1997 $373 1998 $411 1999 $400
Deposits/Dollars in Millions
1999 Percentage Change 1998 Percentage Change Immediate Change --------------------------- --------------------------- in Interest Rates Net Interest Net Portfolio Net Interest Net Portfolio (in basis points) Income Value Income Value - ------------------------------------------------------------------------------ +400......... -15% -49% 7% -11% +300......... -11 -38 7 -6 +200......... -8 -26 6 -1 +100......... -4 -14 4 0 -100......... 1 5 -5 -2 -200......... 0 8 -10 -8 -300......... -2 6 -15 -13 -400......... -4 2 -20 -18
The Bank's profitability is affected by fluctuations in interest rates. An immediate and substantial increase in interest rates may adversely impact the Bank's earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis. Increases in the level of interest also may adversely affect the fair value of the Bank's securities and other earning assets. Generally, the fair value of fixed-rate instruments fluctuates inversely with changes in interest rates. As a result, increases in interest rates could result in decreases in the fair value of the Bank's interest-earning assets, which could adversely affect the Bank's results of operations if such assets were sold. In the case of interest-earning securities classified as available for sale, the Bank's stockholders' equity could sustain significant unrealized losses if such assets were retained.
The Bank uses a number of measures to monitor and manage interest rate risks, including income simulation and interest "gap" analysis (further discussed under the subhead Asset and Liability Management). An income simulation model is primarily used to assess the possible direction and magnitude of changes in interest rates. Key assumptions in the model include prepayment speeds on mortgage-related assets, cash flows and maturities of financial instruments held for purposes other than trading, changes in market conditions, loan volumes and pricing, deposit sensitivity, customer preferences, and management's financial capital plans. These assumptions are inherently uncertain; therefore, the model cannot precisely estimate net interest in-come or precisely predict the impact of higher or lower interest rates on net interest income. Actual results may significantly differ from simulated results due to the timing, magnitude, and frequency of interest rate changes, and changes in market conditions and management strategies, among other factors.
Based solely on the results of simulated calculations as of December 31, 1999 and 1998, the estimated impact of immediate changes in interest rates is as
[Bar graph]
1997 $446 1998 $489 1999 $581
Assets/Dollars in Millions
shown in the table to the left. The percentages shown represent changes over a 12-month period in the Bank's net interest income and net portfolio value under a stable interest rate environment compared to the various rate scenarios. Net portfolio value is defined as the net market value of the Bank's assets and liabilities, which has been estimated by calculating the present value of their cash flows. The cash flows have been adjusted to account for projected amortization, pre-payments, core deposit decay rates, and other factors.
The percentage changes in net interest income and in net portfolio value moved adversely in 1999, as compared to the prior year. Interest rates increased significantly in 1999, from 4.59% at year-end 1998 for the one-year Treasury bill to 6.11% in 1999, and from 4.66% to 6.68% for the 10-year Treasury security. The addition of $31 million of securities and $22 million of loans with intermediate-term repricing characteristics is reflected in the simulation as an increase in the Bank's sensitivity to interest rate fluctuations.
The Bank's primary objective in managing in-terest rate risk is to minimize the adverse impact of changes in interest rates on the Bank's net interest income and capital, while structuring the Bank's asset and liability components to obtain the maximum net interest margin. The Bank relies primarily on its asset and liability structure to control interest rate risk.
Asset and Liability Management
Asset and liability management is the responsibility of the Asset/Liability Committee, which acts within policy directives established by the Board of Directors. The Asset/Liability Committee meets regularly to monitor the composition of the balance sheet, to assess projected earnings trends, and to formulate strategies consistent with the objectives for liquidity, interest rate risk, and capital adequacy. The objective of asset/liability management is to maximize long-term shareholder returns by optimizing net interest income within the constraints of credit quality, interest rate risk policies, levels of capital leverage, and adequate liquidity.
The Bank manages assets and liabilities by matching maturities and repricing in a systematic manner. In addition to the simulation model, an interest "gap" analysis is issued to measure the effect interest rate changes have on net interest income. The interest gap is the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing in that same time period. A gap is considered positive when the amount of interest-rate-sensitive assets exceed the amount of interest-rate-sensitive liabilities. A gap is considered negative in the reverse situation.
The following table shows the Bank's one-year interest-rate-sensitive gap at December 31:
1999 1998 - ------------------------------------------------------------------------------ One-year repricing assets $ 333,124,176 $ 311,261,831 One-year repricing liabilities 422,095,639 315,375,840 ------------- ------------- One-year gap $ (88,971,463) $ (4,114,009) ============= ============= Total assets $ 581,116,306 $ 489,230,139 ============= ============= Interest rate sensitivity gap as a percent of assets (15.3)% (.84)%
During a period of rising interest rates, the net earnings of an institution with a negative gap may be adversely affected due to its interest-bearing liabilities repricing to a greater extent than its interest-earning assets. Conversely, during a period of falling interest rates, net earnings may increase. At December 31, 1999 and 1998, the Bank had a matched one-year gap posi-tion of minus 15.3% and minus .84%, respectively.
The change in the Bank's negative gap from ..84% to 15.3% is in large measure due to the Bank's acquisition of intermediate securities and loans. At year-end 1998, assets in the one-to-five-year range totaled $106 million. The amount of assets in the same time range at December 31, 1999, was $158 million. Securities increased $32 million and loans rose by $20 million. The majority of those loans were commercial real estate projects.
Although interest rates have risen substantially in the last 12 months, and a number of economists predict further increases in interest rates, the Bank remains optimistic that its strategy of investing in intermediate-term instruments will be successful. Interest rates have, in general, declined from their highs in 1982, with periodic reversals such as occurred in 1987 and 1994. Management believes that the long-term trend for interest rates is still downward.
The Bank's focus in managing its interest rate risk is through the marketing and funding of adjustable-rate loans. As of December 31, 1999, 84% of the Bank's loan portfolio had adjustable rates. The Bank also originates and sells long-term, fixed-rate mortgage loans, which have been underwritten to specifications of the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association.
The Bank's management reviews, on a monthly basis, interest rate trends. Where appropriate, hedging techniques are employed. These techniques may include financial futures, options on financial futures, and extended commitments on future lending activities and interest rate exchange agreements. During 1999, 1998, and 1997, the Bank did not choose to enter into any off-balance-sheet derivative agreements, nor were any agreements held at December 31, 1999, 1998, and 1997.
Liquidity
The Bank's primary sources of funds are: (1) deposits, (2) principal repayments of both loans and investment securities, (3) loan sales, and (4) borrowings from the Federal Home Loan Bank (FHLB) of Seattle. The principal use of funds is to invest in securities and loans. Security purchases amounted to $41 million in 1999, down 39.7% from $68 million in purchases in 1998. The comparative figure for 1997 was $29 million. Loan originations, including loans held for sale, totaled $310 million, $380 million, and $213 million during 1999, 1998, and 1997, respectively. Principal repayments on portfolio loans totaled $124 million, $138 million, and $84 million, for the same periods. Funds obtained from loan sales amounted to $110 million in 1999, $198 million in 1998, and $98 million in 1997.
The Bank's line of credit with the FHLB, for the year 2000, has been established at 40% of assets. Borrowings totaled $134 million, $32 million, and $34 million, at December 31, 1999, 1998, and 1997, respectively. These borrowings represented 23.1% of the year-end assets in 1999, 6.5% in 1998, and 7.7% in 1997.
FHLB borrowings increased dramatically in 1999 due to a decline of 2.7% in deposits at the same time that assets grew 18.8%. It is the Bank's intent to continue to fund asset growth with FHLB borrowings until such time as deposits are able to contribute as the main element of the Bank's funding sources.
Capital Requirements
The Company is regulated by the Federal Reserve Board. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve. The Bank, as a state-chartered, federally insured institution, is subject to the capital requirements established by the FDIC. The Federal Reserve requires the Company to maintain capital adequacy that generally parallels the FDIC requirements.
At December 31, 1999, the Company, and its bank subsidiary, exceeded all current regulatory capital requirements as presented in the following table:
The Well-Capitalized Capital Ratios Company FMB Minimum - ------------------------------------------------------------------------------ Total capital to risk-weighted assets 11.08% 11.10% 10.00%
Tier 1 capital to risk-weighted assets 9.83% 9.85% 6.00%
Tier 1 leverage capital to average assets 7.02% 7.03% 5.00%
BUSINESS SEGMENTS
The Bank has identified three distinct segments of business for the purposes of management reporting (see Note 21 to the financial statements). Segment results are determined based on the Bank's management accounting process, which assigns balance sheet and income statement items to each responsible business unit. This process is dynamic and somewhat subjective. Unlike financial accounting, there is no body of guidance for management accounting equivalent to generally accepted accounting principles.
The management accounting process measures the performance of the business segments based on the management structure of the Bank and is not necessarily comparable with similar information for any other financial institution. Changes in management structure and/or the allocation process may result in changes in allocations, transfers, and assignments.
Consumer Banking
This segment provides depositor banking services, and offers consumer loans on automobiles, boats, individual lines of credit, loans for home improvements, etc.
Income before tax has fallen sharply for the last few years, from $2,114,000 in 1997, to $1,566,000 last year, to $877,000 in 1999. Although net interest income has risen modestly, from $6,235,000 in 1997 to$6,418,000 in 1999, the operating expenses have more than offset the benefits of increased interest revenues.
Operating expenses rose $843,000, or 18.3%, from $4,605,000 in 1997 to $5,448,000 last year, and a further $617,000, or 11.3%, in 1999. Expenses for this segment have increased as a result of adding new offices and consumer lending departments. In the last three years the Bank has opened two full-service branch offices, a Private Banking Department, and three consumer loan departments Sales Finance Department, Direct Consumer Loan Department, and the Small Business Banking Department. The addition of these support departments now provides the branch offices with a full line of consumer lending products. Management is hopeful that the increase in operating costs will be less aggressive in 2000. There is no planned expansion of branch-support departments and only the addition of one full-service office in Kirkland.
Residential Lending
Residential lending is a segment encompassing the mortgage banking operations, permanent single-family loans, and construction residential lending.
Income before taxes dropped, from $2,017,000 in 1998 to $1,537,000 in 1999. Income before taxes was $1,094,000 in 1997. The favorable results in 1998 were largely the effect from a rise in mortgage banking
activity. Loan originations related to the mortgage banking operation more than doubled, from $94 million in 1997 to $217 million in 1998, an increase of 132.3%. Mortgage banking originations then declined in 1999 to $85 million, a decrease of 60.7% from the 1998 level. Loan sales, which are highly correlated with loan originations, also fell in 1999, to $110 million from $198 million the previous year. Loan sales in 1997 totaled $98 million.
Although mortgage banking loan originations and sales declined in 1999, operating costs rose $59,000, or 2.8%, from $2,098,000 in 1998 to $2,157,000 this year. Most of the increase in operating costs is related to non-direct overhead, such as accounting, human resources, etc. Operating expenses for this business segment were $1,642,000 in 1997.
The Bank anticipates that loan originations and sales for year 2000 will either equal or decline from the 1999 levels.
Commercial Lending
Commercial lending activities include multi-family housing, commercial real estate properties, and business banking loans.
Commercial lending is the most profitable segment, contributing 74.8% of the Bank's income before federal income taxes. Earnings before income taxes in 1999 were $7,174,000, an increase of $1,149,000, or 19.1%, from 1998. Pretax income was also up sharply in 1998, by $988,000, or 19.6%, compared to $5,038,000 in 1997.
The improvement in both years is principally the result of increased assets, which rose from $235 million in 1997, to $274 million in 1998, to $338 million this year.
Particularly encouraging was the increase in business banking assets, which rose from less than $4 million in 1997, to over $16 million in 1998, with a further increase to $25 million in 1999.
Year 2000 Issues
As was true for the country as a whole, the Bank went through the date change into 2000 without any disruptions to its systems or services to customers. The Bank relies on third-party vendors for almost all of its data processing and telecommunications systems. These vendors made all the necessary changes to their systems to ensure a smooth changeover.
While the Bank has not experienced any problems related to year 2000 to date, there are still some impor-
[Bar graph]
1997 15.6% 1998 16.0% 1999 16.2%
Return on Average Equity/Percentages
tant dates ahead as defined by the Federal Financial Institutions Examination Council. These dates include the end of the first quarter and the end of the year. The Bank will continue to monitor its systems to ensure they properly handle these dates.
While the Bank currently believes that these dates will not pose significant operational problems, there can be no assurance that any significant failures will not have a material impact on the operations of the Bank.
Inflation and Changing Prices
Generally accepted accounting principles require the measurement of financial position and operating results in terms of historical dollars, without consideration for change in relative purchasing power, over time, due to inflation. Virtually all assets and liabilities of a financial institution are monetary in nature; therefore, interest rates generally have a more significant impact on a bank's performance than does the effect of inflation. Over short periods of time, interest rates may not necessarily move in the same direction or in the same magnitude as inflation.
First Mutual Bancshares, Inc. and Subsidiaries Consolidated Statements of Financial Condition
December 31, ------------------------- Assets 1999 1998 - ------------------------------------------------------------------------------ Cash and cash equivalents: Interest-earning deposits with banks $ 14,993 $ 216,953 Noninterest-earning demand deposits and cash on hand 3,850,002 5,312,192 ------------ ------------ 3,864,995 5,529,145
Mortgage-backed and other securities available for sale 17,350,034 20,336,611
Loans receivable held for sale, fair value of $2,709,750 and $27,578,835 2,709,750 27,370,815 Mortgage-backed and other securities held to maturity, fair value of $85,439,652 and $62,467,023 88,056,338 61,764,431
Loans receivable, net: Loans receivable 457,980,649 365,104,245 Reserve for loan losses (6,309,268) (5,569,431) ------------ ------------ 451,671,381 359,534,814 Accrued interest receivable 3,840,911 3,311,122 Mortgage servicing rights 110,341 356,585 Land, buildings, and equipment, net 5,527,024 5,536,748 Federal Home Loan Bank (FHLB) stock, at cost 7,020,400 4,876,500 Other assets 965,132 613,368 ------------ ------------ TOTAL $581,116,306 $489,230,139 ============ ============ Liabilities and Stockholders' Equity - ------------------------------------------------------------------------------ Liabilities: Deposits: Investor custodial checking $ 3,216,280 $ 8,146,226 Money market deposit and checking accounts 96,623,844 90,773,090 Regular savings 11,018,069 12,247,457 Time deposits 289,315,897 300,084,375 ------------ ------------ Total deposits 400,174,090 411,251,148
Drafts payable 1,381,374 4,382,611 Accounts payable and other liabilities 4,147,946 5,465,700 Advance payments by borrowers for taxes and insurance 1,589,312 1,517,253 FHLB advances 134,236,925 31,765,000 Other advances 250,000 Federal income taxes 186,474 ------------ ------------ Total liabilities 541,779,647 454,568,186
Stockholders' equity:
Common stock, $1 par value Authorized, 10,000,000 shares; issued and outstanding, 4,672,636 and 4,247,275 shares 4,672,636 4,247,275 Additional paid-in capital 31,116,359 25,848,681 Employee Stock Ownership Plan debt (310,739) (603,738) Retained earnings 4,527,356 5,181,720 Accumulated other comprehensive loss: Unrealized loss on securities available for sale, net of federal income tax (668,953) (11,985) ------------ ------------ Total stockholders' equity 39,336,659 34,661,953 ------------ ------------ TOTAL $581,116,306 $489,230,139 ============ ============
See notes to consolidated financial statements.
First Mutual Bancshares, Inc. and Subsidiaries Consolidated Statements of Income
Years ended December 31, ----------------------------------------- 1999 1998 1997 - ------------------------------------------------------------------------------ INTEREST INCOME: Loans receivable $35,480,694 $34,518,508 $31,201,837 Mortgage-backed and related securities 3,677,457 1,651,771 2,069,627 U.S. Treasury, government agency, and other securities 2,737,325 2,624,756 2,322,780 Interest-earning deposits with banks 37,245 62,476 470,254 FHLB stock dividends 385,337 357,525 331,460 ----------- ----------- ----------- 42,318,058 39,215,036 36,395,958
INTEREST EXPENSE: Deposits 18,601,358 19,879,653 17,779,162
FHLB advances and other 4,692,006 1,939,021 2,810,800 ----------- ----------- ----------- 23,293,364 21,818,674 20,589,962 ----------- ----------- ----------- Net interest income 19,024,694 17,396,362 15,805,996 PROVISION FOR LOAN LOSSES 805,000 750,000 976,000 ----------- ----------- ----------- Net interest income after provision for loan losses 18,219,694 16,646,362 14,829,996 OTHER OPERATING INCOME: Servicing fees, net of amortization 469,040 473,678 805,049
Gain on sales of loans 1,452,267 1,753,397 140,161 Fees on deposit services 314,539 207,948 167,107
Other 712,766 794,983 594,065 ----------- ----------- ----------- Total other operating income 2,948,612 3,230,006 1,706,382 OTHER OPERATING EXPENSES: Salaries and employee benefits 7,300,890 7,500,148 5,958,712 Occupancy 1,479,618 1,378,519 1,164,847 Other 3,306,643 3,108,471 2,566,197 ----------- ----------- ----------- Total other operating expenses 12,087,151 11,987,138 9,689,756 ----------- ----------- -----------
Income before federal income taxes 9,081,155 7,889,230 6,846,622
FEDERAL INCOME TAXES: Current 3,730,157 3,206,350 2,602,726 Deferred (649,350) (524,816) (274,784) ----------- ----------- ----------- 3,080,807 2,681,534 2,327,942 ----------- ----------- -----------
NET INCOME $ 6,000,348 $ 5,207,696 $ 4,518,680 =========== =========== =========== PER SHARE DATA Basic earnings per common share $1.28 $1.12 $1.01 ===== ===== ===== Earnings per common share assuming dilution $1.26 $1.09 $0.97 ===== ===== ===== WEIGHTED AVERAGE SHARES OUTSTANDING 4,675,654 4,637,340 4,469,106 ========= ========= =========
WEIGHTED AVERAGE SHARES OUTSTANDING INCLUDING DILUTIVE STOCK OPTIONS 4,759,276 4,760,115 4,658,144 ========= ========= =========
See notes to consolidated financial statements.
See notes to consolidated financial statements.
First Mutual Bancshares, Inc. and Subsidiaries Consolidated Statements of Cash Flows Years ended December 31, --------------------------------------------- Operating Activities: 1999 1998 1997 - ------------------------------------------------------------------------------
Net income $ 6,000,348 $ 5,207,696 $ 4,518,680 Adjustments to reconcile net income to net cash provided (used) by operating activities: Provision for loan losses 805,000 750,000 976,000 Depreciation and amortization 691,064 545,020 428,075 Deferred loan origination fees, net of accretion 1,144 171,310 (173,756) Amortization of mortgage servicing rights 152,996 268,257 250,270 Gain on sales of loans (1,527,473) (1,938,900) (140,161) Gain on securities available for sale (753) Gain on sale of repossessed real estate (17,029) (46,332) FHLB stock dividends (385,337) (357,300) (331,300) Deferred federal income tax benefit (649,350) (524,816) (274,784) Cash provided (used) by changes in operating assets and liabilities: Loans receivable held for sale 24,661,065 (18,949,102) 4,023,464 Accrued interest receivable (529,789) (162,709) (315,268) Other assets 177,848 (302,839) 24,512 Drafts payable (3,001,237) 2,518,867 (397,925) Accounts payable and other liabilities 359,462 659,679 170,088 Advance payments by borrowers for taxes and insurance 72,059 (70,025) 71,858 Federal income taxes (186,474) 547,954 (26,634) ------------- ------------- ------------- Net cash provided (used) by operating activities 26,624,297 (11,683,240) 8,802,366
Investing Activities: - ------------------------------------------------------------------------------ Loan originations (225,070,857) (162,849,964) (119,652,687) Loan principal repayments 123,909,771 137,747,107 84,331,634 Increase in undisbursed loan proceeds 8,193,950 6,830,982 2,650,908 Principal repayments on mortgage- backed and other securities 16,471,568 61,066,514 22,491,981 Purchase of mortgage-backed and other securities held to maturity (40,764,092) (50,178,401) (28,644,099) Purchase of mortgage-backed securities available for sale (17,881,548) Purchase of premises and equipment (647,999) (675,318) (3,031,631) Purchase of FHLB stock (1,758,563) Proceeds from sale of loans 1,972,098 2,341,219 Proceeds from sale of securities available for sale 6,090 Proceeds from sale of real estate held for sale 119,738 418,743 59,130 ------------- ------------- ------------- BALANCE, net cash used by investing activities, (117,574,386) (23,180,666) (41,788,674) carried forward
Footnotes for Stockholders' Equity (see page 26): (1)The amount of common stock issued and outstanding for 1997 has been adjusted to show the effect of the three-for-two stock split paid November 5, 1997. (2)Cash dividends declared divided by weighted average shares outstanding of 4,675,654 in 1999, 4,215,764 in 1998, and 4,062,824 in 1997. (3)Income tax benefit netted against accumulated comprehensive losses were $344,612, $6,174, and $2,462 for the years ended December 31, 1999, 1998, and 1997, respectively. (4)There were no reclassification adjustments to other comprehensive income (loss).
See notes to consolidated financial statements.
First Mutual Bancshares, Inc. and Subsidiaries Consolidated Statements of Cash Flows (continued) Years ended December 31, --------------------------------------------- 1999 1998 1997
Net cash used by investing activities, brought forward $(117,574,386) $ (23,180,666) $ (41,788,674)
Financing Activities: - ------------------------------------------------------------------------------ Net increase (decrease) in deposit accounts (29,847,370) 18,620,774 26,635,899 Interest credited to deposit accounts 18,770,312 19,801,820 17,797,160 Proceeds from advances 456,003,925 212,647,000 40,693,000 Repayment of advances (353,282,000) (215,112,000) (60,643,000) Dividends paid (2,594,437) (2,283,821) (520,655) Proceeds from exercise of stock options 45,041 542,281 629,497 Repurchase of common stock (102,531) Repayment of Employee Stock Ownership Plan debt 292,999 267,832 152,541 ------------- ------------- ------------- Net cash provided by financing activities 89,285,939 34,483,886 24,744,442 NET DECREASE IN CASH AND CASH EQUIVALENTS (1,664,150) (380,020) (8,241,866)
CASH AND CASH EQUIVALENTS: Beginning of year 5,529,145 5,909,165 14,151,031 ------------- ------------- ------------- End of year $ 3,864,995 $ 5,529,145 $ 5,909,165 ============= ============= ============= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Loans originated for mortgage banking activities $ 85,327,840 $ 217,334,219 $ 93,553,864 Loans originated for investment activities 225,070,857 162,849,964 119,652,687 ------------- ------------- ------------- Total loans originated for mortgage banking activities and investment activities $ 310,398,697 $ 380,184,183 $ 213,206,551 ============= ============= ============= Proceeds from sales of loans held for sale $ 109,988,905 $ 198,385,117 $ 97,577,328 Cash paid during the year for: Interest $ 22,962,500 $ 21,712,686 $ 20,673,000 Income taxes $ 3,565,155 $ 2,110,000 $ 2,305,030
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING ACTIVITIES: Loans transferred to (from) real estate held for sale, net $ (21,827) $ 21,922 Loans securitized into securities held to maturity and available for sale $ 9,574,060
See notes to consolidated financial statements.
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Years ended December 31, 1999, 1998, and 1997
Note 1: Summary of Significant Accounting Policies
Formation of the bank holding company: First Mutual Bancshares, Inc. and subsidiaries (the Company), a Washington corporation, is a holding company primarily engaged in the business of planning, directing, and coordinating the activities of its wholly-owned subsidiary, First Mutual Bank (formerly First Mutual Savings Bank). On October 26, 1999, First Mutual Savings Bank converted into the holding company form of ownership in a tax-free reorganization. In the reorganization, First Mutual Savings Bank changed its name to First Mutual Bank and became the wholly-owned subsidiary of the Company. First Mutual Bank is also referred to as the Bank in this report.
Principles of consolidation and basis of presentation: The consolidated financial statements include the accounts of First Mutual Bancshares, Inc. and its wholly owned subsidiaries, First Mutual Bank and First Mutual Services, Inc. (collectively, the Bank). All significant intercompany transactions have been eliminated. Certain reclassifications have been made to the 1998 and 1997 financial statements to conform to the 1999 presentation.
Use of estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Changes in these estimates and assumptions are considered reasonably possible and may have a material impact on the financial statements.
Nature of business: The Bank is a community-oriented savings bank offering a variety of savings products to retail customers while concentrating its lending activities on housing and commercial real estate loans. The Bank conducts business from its main office in Bellevue, Washington and its nine branches in the greater Puget Sound area. The Bank accepts deposits from the general public and provides lending services to citizens of the Eastside and the I-5 corridor stretching from Bellingham, Washington to Salem, Oregon. In addition to portfolio lending, the Bank operates a mortgage banking operation.
Cash and cash equivalents: For purposes of the consolidated statements of cash flows, all deposits and investment securities with an original term to maturity of three months or less are considered to be cash equivalents.
Securities: Securities are classified at acquisition into three categories: held to maturity, available for sale, and held for trading. Securities are classified as held to maturity when the Company has the ability and positive intent to hold them to maturity. Securities classified as available for sale are maintained for future liquidity requirements and may be sold prior to maturity. There were no securities classified as held for trading during 1999, 1998, and 1997.
Securities held to maturity are carried at cost, adjusted for amortization of premiums and accretion of discounts to maturity. Unrealized losses on securities held to maturity caused by fluctuations in fair value are recognized when it is determined that an other-than-temporary decline in value has occurred. Unrealized gains and losses on securities available for sale are excluded from earnings and are reported net of tax as a separate component of comprehensive income until realized. Realized gains and losses on sale are computed on the specific identification method and are included in operations on the date sold.
Loans receivable, loans receivable held for sale, and reserve for loan losses: Loans receivable are stated at unpaid principal balances less the reserve for loan losses and deferred loan origination fees. Mortgage loans securitized and transferred into the security portfolio are transferred at amortized cost.
Nonaccrual loans are those for which management has discontinued accrual of interest because there exists significant uncertainty as to the full and timely collection of either principal or interest or such loans have become contractually past due 90 days with respect to principal or interest.
The reserve for loan losses is maintained at a level that is sufficient to provide for estimated losses based on evaluating known and inherent risks in the loan portfolio. This reserve is provided for based upon management's continuing analysis of the factors underlying the quality of the loan portfolio.
For income property and business loans, loan quality is evaluated on an individual basis and an appropriate grade is assigned. The grades range from three-or-better, for the better quality loans, to grades four, five, and six for loans with potential problems. Loss reserves are then computed on the loan balance for each grade using ratios developed from historical loss experience. For the residential and consumer loans, management computes loss reserves on a portfolio-wide basis, but provides higher reserves for specific loans that are delinquent or are known to have problems.
Management then considers other factors in evaluating the adequacy of the reserve for loan losses. 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. The reserve is based upon factors and trends identified by management at the time financial statements are prepared. The ultimate recovery of loans is susceptible to future market factors beyond management's control, which may result in losses or recoveries differing significantly from those provided in the financial statements.
Management also evaluates income property and business loans for impairment on an individual basis. A loan is considered impaired when it is probable that a creditor will not collect all amounts due (principal and interest) under the terms of a loan agreement. The valuation of impaired loans is based on the present value of expected future cash flows using the loan's effective interest rate or the loan's observable market price or fair value of the collateral, if the loan is collateral dependent. The amount by which the recorded investment in the loan exceeds market price or the fair value of the collateral is included in the allocated reserve for loan losses. Any portion of an impaired loan classified as loss under regulatory guidelines is charged off. The remaining groups of smaller-balance homogeneous loans are evaluated collectively for impairment.
Mortgage loans originated and held for sale are carried at the lower of aggregate cost or estimated fair value. Net unrealized losses on loans receivable held for sale are recognized in a valuation allowance by charges to operations. Note 1 continued on next page.
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Note 1: Summary of Significant Accounting Policies (continued)
Real estate held for sale (included in other assets): Real estate held for sale includes properties acquired through foreclosure. These properties are initially recorded at the lower of cost or fair value and are subsequently evaluated to determine that the carrying value does not exceed the then current fair value of the property. Losses that result from ongoing periodic valuation of these properties are charged to operations in the period in which they are identified. The amounts that will ultimately be recovered from real estate held for sale may differ substantially from the carrying value of the assets because of future market factors beyond management's control.
Land, buildings, and equipment: Premises and equipment are stated at cost, less accumulated depreciation. Depreciation is computed on the straight-line method over the estimated useful lives as follows:
Buildings and improvements 15 to 40 years Leasehold improvements 5 to 20 years Furniture, fixtures, and equipment 1 to 20 years
The Company follows the policy of capitalizing expenditures for betterments and major renewals, and expenses ordinary maintenance and repairs as incurred.
Mortgage servicing rights: Originated servicing rights are recorded when mortgage loans are originated and subsequently sold or securitized (and held as available-for-sale securities) with the servicing rights retained. The total cost of the mortgage loans is allocated between servicing rights and the loans (without the servicing rights) based on their relative fair values. The cost relating to the mortgage servicing rights is capitalized and amortized in proportion to, and over the period of, estimated future net servicing income. Amounts capitalized are recorded at cost, net of accumulated amortization and valuation allowance.
In order to determine the fair value of servicing rights, management uses a valuation model that calculates the present value of future cash flows. Assumptions used in the valuation model include market discount rates and anticipated prepayment speeds. The prepayment speeds are based on loan prepayment forecasts derived from the consensus of investment banking firms as reported by on-line, fixed-income quotation systems. In addition, estimates of the cost of servicing per loan, an inflation rate, ancillary income per loan, and default rates are used.
Management assesses impairment of the capitalized mortgage servicing rights based on recalculations of the present value of remaining future cash flows using updated market discount rates and prepayment speeds. Subsequent loan prepayments and changes in prepayment assumptions in excess of those forecasted can adversely impact the carrying value of the servicing rights. Impairment is assessed on a stratum-by-stratum basis with any impairment recognized through a valuation allowance for each impaired stratum. The servicing rights are stratified based on the predominant risk characteristics of the underlying loans: fixed-rate loans and adjustable-rate loans.
Employee Stock Ownership Plan: The Company sponsors a leveraged Employee Stock Ownership Plan (ESOP). Statement of Position (SOP) No. 93-6, Employers' Accounting for Employee Stock Ownership Plans, was effective as of January 1994. As is allowed under SOP No. 93-6, the Company continues to account for ESOP transactions for shares purchased by the ESOP prior to 1994 under SOP No. 76-3. Accordingly, the Company records compensation expense based on the amounts contributed by the Company to the ESOP and includes unallocated ESOP shares as outstanding for purposes of its earnings-per-share calculation.
ESOP stock purchases have been insignificant since January 1994. At such time that the ESOP purchases material amounts of stock in future periods, such transactions will be accounted for in accordance with the provisions of SOP No. 93-6 as described below.
Under SOP No. 93-6, as shares are released from collateral, compensation expense is recorded equal to the then current market price of the shares, and the shares become outstanding for purposes of earnings-per-share calculations. Stock and cash dividends on allocated shares are recorded as a reduction of retained earnings and paid directly to plan participants or distributed directly to participants' accounts. Cash dividends on unallocated shares are recorded as a reduction of debt and accrued interest. Stock dividends on unallocated shares are recorded as an increase to the unearned shares issued to the employee stock ownership trust contra-equity account and distributed to participants over the remaining debt service period.
Income taxes: The Company files a consolidated tax return which includes income earned by its subsidiaries. The Company accounts for income taxes on the liability method. The liability method recognizes the amount of tax currently payable and deferred at the date of the financial statements as a result of all events that have been recognized in the financial statements, as measured by the provisions of current enacted tax laws and rates.
Loan fee income and interest income on loans receivable: Loan origination fees and certain direct loan origination costs related to loan origination activities are deferred. Net deferred fees are amortized into income over the contractual or actual life of the loan as an adjustment to the loan yield. Net deferred fees related to loans sold are recognized in income at the time the loans are sold.
Interest income is accrued on loans receivable until management doubts the collectibility of the loan or the unpaid interest, at which time a reserve for any accrued interest is established.
Interest rate risk management: Management may hedge certain mortgage banking transactions with purchased option contracts and forward sales commitments. Net gains or losses on these options are considered in the calculation of the lower of cost or fair value for loan receivables held for sale.
Earnings per share (EPS) data: The Company displays basic and diluted EPS in the income statement. Basic EPS is computed by dividing net income by the weighted average number of shares outstanding during the year. Diluted EPS reflects the potential dilutive effect of stock options and is computed by dividing net income by the weighted-average number of shares outstanding during the year, plus the dilutive common shares that would have been outstanding had the stock options been exercised. A reconciliation of the numerator and denominator used for the basic EPS to the numerator and denominator used for the diluted EPS is provided in Note 13.
Note 1 continued on next page.
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Note 1: Summary of Significant Accounting Policies (continued) New accounting standards:
Recently issued and adopted:
Accounting for mortgage-backed securities: Statement of Financial Accounting Standards (SFAS) No. 65, Accounting for Certain Mortgage Banking Activities, as amended by SFAS No. 115 and 125, required that after the securitization of a mortgage loan held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed security as a trading security. In October 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 134, Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise. SFAS No. 134 further amends SFAS No. 65 to require that after the securitization of a mortgage loan held for sale, an entity engaged in mortgage banking activities should classify the resulting retained mortgage-backed securities using the classification criteria in SFAS No. 115 (i.e., held-to-maturity, available-for-sale, or trading). However, a mortgage banking entity must classify as trading any retained mortgage-backed securities described above that it has committed to sell before or during the securitization process. The adoption of this standard did not have a material impact on the results of operations or financial condition of the Company.
Recently issued and not yet adopted:
Accounting for derivative instruments and hedging activities: In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities. It requires that an entity should recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. The accounting for changes in the fair value of a derivative (gains and losses) depends on the intended use of the derivative and the resulting designation.
As allowed by SFAS No. 137, which defers the effective date of SFAS No. 133 by one year, the Company will implement this statement on January 1, 2001. The impact of the adoption of the provision of this statement on the results of operations or financial condition of the Company has not been determined.
Note 2: Reserve Balances
The Bank is required to maintain an average reserve balance of $25,000 in its account with the Federal Reserve. For the years ended December 31, 1999, 1998, and 1997, the Bank complied with this requirement.
Note 3: Mortgage-Backed and Other Securities Available for Sale
The amortized cost and estimated fair value of securities available for sale at December 31, 1999 and 1998, are summarized as follows:
Gross Gross Amortized unrealized unrealized Estimated cost gains losses fair value - ------------------------------------------------------------------------------ 1999: FHLMC securities $ 427,499 $ 7,216 $ $ 434,715 FNMA securities 16,073,769 22,354 933,028 15,163,095 GNMA securities 1,869,018 116,794 1,752,224 ----------- ----------- ----------- ----------- $18,370,286 $ 29,570 $ 1,049,822 $17,350,034 =========== =========== =========== ===========
1998: FHLMC securities $ 648,646 $ 17,941 $ $ 666,587 FNMA securities 17,679,888 35,825 41,675 17,674,038 GNMA securities 1,996,385 399 1,995,986 ----------- ----------- ----------- ----------- $20,324,919 $ 53,766 $ 42,074 $20,336,611 =========== =========== =========== ===========
Proceeds from the sale of securities available for sale during 1999, 1998, and 1997, were $-0-, $-0-, and $6,090, respectively. Gross gains on those sales were $-0-, $-0-, and $753, respectively. No gross losses were realized on sales during 1999, 1998, and 1997.
The securities available for sale at December 31, 1999, have contractual maturities of over 10 years. Expected maturity may differ from contractual maturity because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Note 4: Mortgage-Backed and Other Securities Held to Maturity
The amortized cost and estimated fair value of mortgage-backed and other securities are summarized as follows:
Gross Gross Amortized unrealized unrealized Estimated cost gains losses fair value - ------------------------------------------------------------------------------ December 31, 1999: FNMA certificates $39,827,759 $ 149,563 $ 1,389,648 $38,587,674 FHLMC certificates 1,792,23 18,780 1,811,017 U.S. government agency securities 42,652,659 44,178 1,250,503 41,446,334 Merrill Lynch corporate bond 2,534,010 111,285 2,422,725 Municipal bonds 625,395 84,965 540,430 REMICs 624,278 7,194 631,472 ----------- ----------- ----------- ----------- $88,056,338 $ 219,715 $ 2,836,401 $85,439,652 =========== =========== =========== =========== December 31, 1998: FNMA certificates $14,241,885 $ 238,948 $ 14,235 $14,466,598 FHLMC certificates 3,555,875 14,470 4,180 3,566,165 U.S. government agency securities 38,643,616 656,784 151,235 39,149,165 Merrill Lynch corporate bond 2,544,950 33,450 2,511,500 Municipal bonds 627,083 36,313 590,770 REMICs 1,151,194 31,631 1,182,825 U.S. Treasury securities 999,828 172 1,000,000 ----------- ----------- ----------- ----------- $61,764,431 $ 942,005 $ 239,413 $62,467,023 =========== =========== =========== ===========
The amortized cost and estimated fair value of mortgage-backed and other securities held to maturity at December 31, 1999, by contractual maturity, are shown below. Expected maturity may differ from contractual maturity because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties: Amortized Estimated cost fair value - ------------------------------------------------------------------------------ Due after one year through five years $42,753,848 $41,612,287 Due after five years through ten years 34,831,242 33,283,523 Due after ten years 10,471,248 10,543,842 ----------- ----------- $88,056,338 $85,439,652 =========== ===========
There were no sales out of the held-to-maturity portfolio during 1999 or 1998.
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Note 5: Loans Receivable, Net and Loans Receivable Held for Sale
Loans receivable consisted of the following as of December 31:
1999 1998 - ------------------------------------------------------------------------------ Real estate: Single-family residential $ 96,417,980 $ 95,807,396 Single-family construction 41,261,540 38,640,163 Income property: Commercial construction 10,920,400 12,740,000 Commercial real estate 146,764,503 121,257,209 Multifamily construction 20,723,753 9,260,369 Multifamily residential 148,354,325 118,014,727 Consumer and other loans 24,435,217 17,464,747 Business loans 3,347,265 2,629,590 ------------ ------------ 492,224,983 415,814,201 Less: Deferred loan origination fees (1,575,966) (1,574,473) Undisbursed loan proceeds (29,958,618) (21,764,668) Reserve for loan losses (6,309,268) (5,569,431) ------------ ------------ 454,381,131 386,905,629 Loans receivable held for sale (2,709,750) (27,370,815) ------------ ------------ Loans receivable, net $451,671,381 $359,534,814 ============ ============
A substantial portion of the Company's revenues is derived from the origination of loans in the Puget Sound region of Washington State. The customers' ability to honor their commitments to repay such loans is dependent upon the region's economy and, to a certain extent, the dominant industries in that region such as aerospace, international trade, and high technology.
Single-family residential, permanent, and construction loans are primarily secured by collateral located in Western Washington. Income property loans, by county or state in which the property resides, are as follows at December 31, 1999:
The Bank originates both adjustable and fixed interest rate loans. At December 31, 1999, the composition of those loans was as follows:
Term to maturity Adjustable or rate adjustment Fixed rate rate Total - ------------------------------------------------------------------------------ Due within one year $ 8,712,231 $271,090,893 $279,803,124 After one but within three years 1,818,639 57,935,795 59,754,434 After three but within five years 3,633,037 44,134,840 47,767,877 After five but within ten years 13,025,800 9,390,926 22,416,726 After ten years 44,439,609 199,361 44,638,970 ------------ ------------ ------------ $ 71,629,316 $382,751,815 $454,381,131 ============ ============ ============
Single-family adjustable-rate loans have both period and lifetime adjustment limitations. Income property adjustable-rate loans typically only have lifetime adjustment limitations. Both types of adjustable-rate loans are generally indexed to either the one-, three-, or five-year Treasury constant maturity or the Federal Home Loan Bank's 11th District cost of funds. Future market factors may affect the correlation of the interest rate adjustment with the rates the Bank pays on the short-term deposits that have been primarily utilized to fund these loans.
Note 5 continued on next page.
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Note 5: Loans Receivable, Net and Loans Receivable Held for Sale (continued)
An analysis of the changes in the reserve for loan losses is as follows for the years ended December 31: 1999 1998 1997 - ------------------------------------------------------------------------------ Balance, beginning of year $5,569,431 $4,858,376 $3,882,376 Provision for loan losses 805,000 750,000 976,000 Writeoffs (68,123) (38,945) Recoveries 2,960 ---------- ---------- ---------- Balance, end of year $6,309,268 $5,569,431 $4,858,376 ========== ========== ==========
The Bank had the following non-performing loans (loans over 90 days delinquent) as of December 31: 1999 1998 - ------------------------------------------------------------------------------ Non-performing loans $ 342,579 $ 298,503 Percentage of total loans 0.07% 0.08%
The Bank had no impaired loans during the years and at year-end 1999, 1998, and 1997.
The Bank serviced loans owned by other investors with aggregate principal balances of $193,923,146 and $268,246,425 as of December 31, 1999 and 1998, respectively.
Outstanding commitments to borrowers for loans totalled $74,307,000 and $65,071,000 at December 31, 1999 and 1998, respectively. Outstanding commitments to sell loans to investors, which totalled $2,000,000 and $34,811,000 at December 31, 1999 and 1998, respectively, hedge against interest rate fluctuations from the time of loan commitment until the date at which loans are sold, which is generally within 60 days.
Commitments to extend credit generally have fixed expiration dates. Since portions of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Prior to extending commitments, the Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management's credit evaluation of the borrower. Collateral held includes residential and income-producing properties.
Note 6: Accrued Interest Receivable
Accrued interest receivable at December 31 is summarized as follows:
1999 1998 - ------------------------------------------------------------------------------ Loans receivable $2,726,936 $2,359,489 Mortgage-backed securities available for sale 100,322 113,668 Mortgage-backed and other securities held to maturity 1,013,653 837,965 ---------- ---------- $3,840,911 $3,311,122 ========== ==========
Note 7: Mortgage Servicing Rights and Servicing Fees
Changes in the mortgage servicing rights balance for the years ended December 31 are as follows: 1999 1998 - ------------------------------------------------------------------------------ Balance, beginning of year $ 356,585 $ 601,435 Additions 273,391 197,054 Sales (366,639) (173,647) Amortization (152,996) (185,759) Provision for impairment (82,498) ---------- ---------- Balance, end of year $ 110,341 $ 356,585 ========== ==========
Changes in the valuation for impairment of mortgage servicing rights for the years ended December 31:
1999 1998 1997 - ------------------------------------------------------------------------------ Balance, beginning of year $ 120,226 $ 37,728 $ Additions 82,498 37,728 --------- --------- --------- Balance, end of year $ 120,226 $ 120,226 $ 37,728 ========= ========= =========
Note 7 continued on next page.
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Note 7: Mortgage Servicing Rights and Servicing Fees (continued)
Servicing fee income, net of amortization, consisted of the following for the years ended December 31:
1999 1998 1997 - ------------------------------------------------------------------------------ Servicing fees $ 622,036 $ 741,935 $ 1,055,319 Amortization and provision for impairment of mortgage servicing rights (152,996) (268,257) (250,270) ----------- ----------- ----------- Loan servicing fees, net $ 469,040 $ 473,678 $ 805,049 =========== =========== ===========
Note 8: Land, Buildings, and Equipment
The following is a summary of land, buildings, and equipment at December 31:
1999 1998 - ------------------------------------------------------------------------------ Land $ 1,930,130 $ 1,921,349 Buildings 3,645,059 3,580,105 Furniture, fixtures, and equipment 2,849,775 2,390,291 Leasehold improvements 576,329 527,449 9,001,293 8,419,194 Less accumulated depreciation and amortization 3,474,269 2,882,446 ----------- ----------- $ 5,527,024 $ 5,536,748 =========== ===========
The Bank leases six of its office locations under operating leases. Total lease obligations are as follows:
2000 $ 436,003 2001 472,631 2002 440,424 2003 445,865 2004 446,598 ----------- $ 2,241,521 ===========
Total lease expenses were $367,216, $338,871, and $307,349, for the years ended December 31, 1999, 1998, and 1997, respectively.
Note 9: Deposits Deposits consisted of the following at December 31:
Note 9 continued on next page.
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Note 9: Deposits (continued)
Deposits at December 31, 1999 and 1998, included public funds of $5,509,152 and $7,134,255, respectively. Mortgage-backed securities with a book value of $913,032 and $1,255,260 were pledged as collateral on these deposits at December 31, 1999 and 1998, respectively, which exceeds the minimum collateral requirements established by the Washington Public Deposit Protection Commission.
As of December 31, 1999, scheduled maturities of time deposits were as follows:
Year ending December 31, ------------------------ 2000 $240,063,226 2001 35,331,191 2002 5,930,735 2003 4,773,943 2004 2,270,526 Thereafter 946,276 ------------ $289,315,897 ============
Included in deposits are time deposits greater than or equal to $100,000 of $96,931,913 and $98,656,486 at December 31, 1999 and 1998, respectively. Interest on time deposits greater than or equal to $100,000 totalled $5,300,446, $5,229,314, and $4,506,761 for the years ended December 31, 1999, 1998, and 1997, respectively.
Deposit interest expense by type for the years ended December 31 was as follows: 1999 1998 1997 - ------------------------------------------------------------------------------ Time deposits $14,955,529 $16,672,427 $15,065,475 Money market deposit and checking 3,331,616 2,802,074 2,187,329 Regular savings 314,213 405,152 526,358 ----------- ----------- ----------- $18,601,358 $19,879,653 $17,779,162 =========== =========== ===========
Note 10: FHLB and Other Advances
The Company's borrowings consisted of the following at December 31:
1999 1998 - ------------------------------------------------------------------------------ FHLB advances $134,236,925 $31,765,000 ============ =========== FHLB advances: Maximum outstanding at any month end $134,236,925 $39,755,000 Average outstanding 88,470,615 33,441,310 Weighted average interest rates: Annual 5.288% 5.798% End of year 5.513 5.236
Other advances $ 250,000 ============
Under the terms of the FHLB advances, in addition to FHLB stock held, the Bank must maintain unencumbered collateral of at least 120% of outstanding advances if the collateral is one to four family permanent mortgages, 125% if the collateral is rated first-lien residential privately issued mortgage-backed securities and collateralized mortgage obligations, and 105% if the collateral is U.S. Treasury and agency securities. At December 31, 1999, the minimum book value of eligible collateral pledged for these borrowings was $161,411,131. The Bank has an available line of credit with the FHLB in the amount equal to 35% of total assets.
FHLB advances at December 31, 1999, mature as follows:
Interest rates Amount - ------------------------------------------------------------------------------ 2000 4.94 - 6.45% $113,586,925 2002 5.3% 4,650,000 2004 4.83 - 4.97% 15,000,000 2006 6.25% 1,000,000 ------------ $134,236,925 ============
The other advances mature on November 30, 2000, with an interest rate of 7.84%.
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Note 11: Federal Taxes on Income
For tax years beginning prior to January 1, 1996, a qualified thrift institution was allowed a bad debt deduction based on a percentage of taxable income or on actual experience. Accordingly, the Bank used the percentage of taxable income method prior to 1996.
The Small Business Job Protection Act of 1996 (the Act) required qualified thrift institutions, such as the Bank, to recapture their post-1987 additions to their bad debt reserves. Such recaptured amounts are to be taken into taxable income ratably over a six-year period, which began with the year ended December 31, 1998.
As of December 31, 1997, these additions were $1,973,380, of which $328,897 was recaptured in taxable income for both 1999 and 1998. The Act also repealed the reserve method of accounting for tax bad debt deductions and required thrifts to calculate the tax bad debt deduction based on actual current loan losses. The recapture of the post-1987 additions to tax basis bad debt reserves does not result in a charge to earnings as these amounts have been provided for in the deferred tax liability.
If bad debt deductions taken for federal income tax purposes before 1987 are later used for purposes other than bad debt losses, they will be subject to federal income taxes at the prevailing corporate rates. Retained earnings at December 31, 1999, 1998, and 1997, includes $640,000, for which no federal taxes had been provided in the financial statements. The Bank does not anticipate that retained earnings will be used in any way which would result in payment of taxes.
Deferred federal income taxes constitute the differences in the reporting of income and expense for financial statement and income tax purposes. The components of deferred income tax benefit are as follows for the years ended December 31:
1999 1998 - ------------------------------------------------------------------------------ Mortgage servicing rights $ (218,140) $ (120,856) Loan origination fees and costs (75,332) (14,115) FHLB stock dividends 131,015 121,558 Reserve for loan losses (385,735) (375,948) Other, net (101,158) (135,455) ----------- ----------- $ (649,350) $ (524,816) =========== ===========
At December 31, the significant components of the Company's net deferred tax asset were as follows:
1999 1998 - ------------------------------------------------------------------------------ Deferred tax assets: Reserve for loan losses $ 1,742,582 $ 1,356,847 Other, net 202,253 101,095 Mortgage servicing rights 196,367 ----------- ----------- 2,141,202 1,457,942 Deferred tax liabilities: Mortgage servicing rights 21,773 Loan origination fees and costs 385,509 460,841 FHLB stock dividends 956,668 825,653 ----------- ----------- 1,342,177 1,308,267 Unrealized loss on available-for- sale securities 346,885 ----------- ----------- Net deferred tax asset $ 1,145,910 $ 149,675 =========== ===========
Note 12: Stockholders' Equity and Regulatory Capital Requirements
Stock dividends and stock splits: The Company's Board of Directors declared a 10% stock dividend in March 1999, a 10% stock dividend in May 1997, and a three-for-two stock split in September 1997.
Restricted retained earnings: Under Washington State law, preconversion retained earnings are restricted for the protection of preconversion depositors. Restricted retained earnings at December 31, 1999, totalled $161,411.
Regulatory capital requirements: The Company and the Bank are subject to various regulatory capital requirements administered by the Federal Deposit Insurance Corporation (FDIC), Washington State Department of Financial Institutions, and the Federal Reserve Board. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary action by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's and the Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk-weightings, and other factors.
Note 12 continued on next page.
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Note 12: Stockholders' Equity and Regulatory Capital Requirements (continued)
Quantitative measures established by regulators to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets. Management believes, as of December 31, 1999, that the Company and the Bank met all capital adequacy requirements to which they are subject.
As of December 31, 1999 and 1998, the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank's category.
Actual capital amounts and ratios for the Company and the Bank are presented in the table below:
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Note 13: Earnings Per Share
The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations:
Income Shares(1) Per share(1) (numerator) (denominator) amount - ------------------------------------------------------------------------------ Year ended December 31, 1999: Basic EPS: Income available to common shareholders $ 6,000,348 4,675,654 $1.28 ===== Effect of dilutive stock options 83,622 ----------- --------- Diluted EPS: Income available to common shareholders plus assumed stock options exercise $ 6,000,348 4,759,276 $1.26 =========== ========= ===== Year ended December 31, 1998: Basic EPS: Income available to common shareholders $ 5,207,696 4,637,340 $1.12 ===== Effect of dilutive stock options 122,775 ----------- --------- Diluted EPS: Income available to common shareholders plus assumed stock options exercise $ 5,207,696 4,760,115 $1.09 =========== ========= ===== Year ended December 31, 1997: Basic EPS: Income available to common shareholders $ 4,518,680 4,469,106 $1.01 ===== Effect of dilutive stock options 189,038 ----------- --------- Diluted EPS: Income available to common shareholders plus assumed stock options exercise $ 4,518,680 4,658,144 $0.97 =========== ========= =====
(1)Shares and EPS have been adjusted for a 10% stock dividend paid May 5, 1999, a 10% stock dividend paid July 2, 1997, and a three-for-two stock split paid November 5, 1997.
Note 14: Other Operating Expenses
Salaries and employee benefits consisted of the following for the years ended December 31: 1999 1998 1997 - ------------------------------------------------------------------------------ Salaries and employee benefits incurred $ 8,795,576 $ 9,122,196 $ 7,051,486 Amounts deferred with loan origination fees (1,494,686) (1,622,048) (1,092,774) ----------- ----------- ----------- $ 7,300,890 $ 7,500,148 $ 5,958,712 =========== =========== ===========
Direct costs of originating loans are deferred and capitalized with the related loan origination fees collected. Deferral of costs varies directly with the volume of loan originations.
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Note 15: Retirement Plan and Trust
The Bank has a 401(k) retirement plan and trust for employees. All employees who have completed one year of service and meet the minimum hours-worked requirement are eligible for the plan. The Bank funds the annual cost of the plan as accrued. Employees may contribute up to 12% of their salaries to the plan. The Bank matches 75% of the employees' contributions up to 6% of the employees' compensation. At plan year-end, the Bank contributes an additional 3% of the employees' compensation. Participants are fully vested in employer contributions to the plan upon six years of employment.
The Bank's contributions to the 401(k) retirement plan and trust were $356,087, $320,971, and $255,658 for the years ended December 31, 1999, 1998, and 1997, respectively. There were no significant changes in the rate of contributions to the plan between those years.
Note 16: Employee Stock Ownership Plan
In 1985, the Company established an ESOP to provide benefits to all employees who have completed one year of service and meet the minimum hours-worked requirement. The plan is noncontributory on the part of the participants and provides for full vesting upon completion of five years of service. The plan provides for the distribution of accumulated benefits to the employees or their beneficiaries upon death, termination, or retirement. The Company loaned the ESOP's trustee $200,000 for purchase of the Company's common stock at the initial offering price in 1985. During 1990, the Company's Board of Directors authorized the trustee to borrow an additional $1,464,375 from the Company to purchase 139,600 more shares (unadjusted for subsequent stock dividends and stock splits) of the Company's common stock in the open market. Shares of stock are allocated to employees as the loans are repaid. The outstanding loan balance at December 31, 1999, was $310,739. During 1999, the ESOP sold 15,409 shares in the open market.
Shares held by the ESOP at December 31, 1999, were as follows: Average Number Price range price of shares per share per share - ------------------------------------------------------------------------------ Allocated: Vested 288,723 Nonvested 11,075 ------- 299,798 $1.20 - $4.63 $ 2.84 Nonallocated 64,866 ------- 364,664 =======
Contributions to the ESOP during the years ended December 31, 1999, 1998, and 1997, were $77,312, $65,109, and $-0-, respectively.
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Note 17: Stock Option Plan
The Company has a stock option plan for directors and employees. Options have a term of six or 10 years and are granted at fair market value on the grant date. The Company's Board of Directors determines vesting of the options. Options generally become exercisable in one or more installments during their term, and the right to exercise may be cumulative. At December 31, 1999, 80,682 shares of common stock, adjusted for stock dividends, were available for grant under the plan. A total of 200,708 shares are currently exercisable at December 31, 1999. All schedules presented in this footnote are adjusted for stock dividends and stock splits.
A summary of the Company's stock option plan as of December 31, 1999, 1998, and 1997, and changes during the years ended on those dates is presented below: Weighted Weighted Range of average average exercise exercise fair Shares price* price* value* - ------------------------------------------------------------------------------ BALANCE, January 1, 1997 401,823 $3.38-$7.16 $ 4.36 Exercisable at year-end: 201,623 shares 3.65 Options granted 47,355 10.98 10.98 $ 3.94 Options exercised (85,087) 3.38-4.44 3.57 Options terminated (7,174) 4.44-10.98 5.30 -------- BALANCE, December 31, 1997 356,917 3.38-10.98 5.42 Exercisable at year-end: 167,906 shares 3.95 Options granted 114,664 15.85-15.91 15.89 4.97 Options exercised (134,252) 3.38-7.16 4.05 Options terminated (1,096) 7.16-15.85 10.06 -------- BALANCE, December 31, 1998 336,233 3.38-15.91 9.52 Exercisable at year-end: 96,259 shares 4.53 Options granted 62,300 12.38 12.38 5.34 Options exercised (9,378) 4.43-10.98 4.80 Options terminated (3,333) 7.16-15.85 12.20 -------- BALANCE, December 31, 1999 385,822 10.07 Exercisable at year-end: ======== 200,708 shares 7.13 *per share
The following table summarizes information about stock options outstanding at December 31, 1999:
Options outstanding Options exercisable - ----------------------------------------------------- ----------------------- Weighted Weighted Weighted Number average average Number average Range of of shares exercise remaining of shares exercise exercise price outstanding price* life exercisable price* - ------------------------------------------------------------------------------ $3.00-$6.00 123,503 $ 4.23 5.3 years 123,503 $ 4.23 6.01- 9.00 42,354 7.16 6.5 years 28,620 7.16 9.01-12.00 45,045 10.98 7.5 years 14,135 10.98 12.01-15.00 61,250 12.38 9.5 years 15.01-18.00 113,670 15.89 6.0 years 34,450 15.91 ------- ------- 385,822 $10.07 6.5 years 200,708 $ 7.13 ======= ======= * per share
The Company applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its stock option plan. Accordingly, no compensation cost has been recognized for its stock option plan for the years ended December 31, 1999, 1998, and 1997. Had compensation cost for the Company's stock option plan been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123, the Company's net income and earnings per share for the years ended December 31, 1999, 1998, and 1997, would have been reduced to the pro forma amounts indicated below:
1999 1998 1997 - ------------------------------------------------------------------------------ Net income: As reported $ 6,000,348 $ 5,207,696 $ 4,518,680 Pro forma 5,781,149 5,038,625 4,419,924 Basic earnings per common share: As reported $1.28 $1.12 $1.01 Pro forma 1.24 1.09 0.99 Earnings per common share - assuming dilution: As reported $1.26 $1.09 $0.97 Pro forma 1.22 1.06 0.95
Note 17 continued on next page.
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Note 17: Stock Option Plan (continued)
The compensation expense included in the pro forma net income and net income per share figures on the previous page are not likely to be representative of the effect on reported net income for future years because options vest over several years and additional awards generally are made each year.
The fair value of options granted under the Company's stock option plan was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used: Annual dividend yield of 1.62% for 1999, 3.14% for 1998, and 1.10% for 1997; expected volatility of 35% for 1999, 33% for 1998, and 33% for 1997; and expected lives of 8.1 years for 1999, 6.5 years for 1998, and 5.0 years for 1997. The risk-free interest rate assumptions used were 6.00%, 5.79%, and 6.19%, for 1999, 1998, and 1997, respectively.
Note 18: Contingencies
In the normal course of business, the Company has various legal claims and other contingent matters outstanding. Management believes that any ultimate liability arising from these actions will not have a material adverse effect on the Company's financial condition or results of operations.
Note 19: Fair Value of Financial Instruments
The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, Disclosures about Fair Value of Financial Instruments. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessary to interpret market data in the development of the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The estimated fair value of financial instruments is as follows at December 31, 1999 and 1998 (in thousands):
1999 1998 ----------------------------- ---------------------------- Esti- Favorable Esti- Favorable mated (unfavor- mated (unfavor- Carrying fair able) Carrying fair able) value value variance value value variance - ------------------------------------------------------------------------------ Assets: Cash and cash equivalents $ 3,865 $ 3,865 $ $ 5,529 $ 5,529 $(4,456) Securities held for sale 17,350 17,350 20,337 20,337 Loans held for sale 2,710 2,710 27,371 27,579 208 Mortgage-backed and other securities 88,056 85,440 (2,616) 61,764 62,467 703 Loans receivable 451,671 452,358 687 359,535 361,849 2,314 Accrued interest receivable 3,841 3,841 3,311 3,311 Mortgage servicing portfolio 110 393 283 357 2,076 1,719 FHLB stock 7,020 7,020 4,877 4,877 ------- ------- Favorable (unfavorable) variance (1,646) 4,944
Liabilities: Demand, savings, and money market deposits 110,858 110,858 111,167 111,167 Time deposits 289,316 289,114 202 300,084 301,427 (1,343) Drafts payable 1,381 1,381 4,383 4,383 Advance payments by borrowers for taxes and insurance 1,589 1,589 1,517 1,517 Short-term FHLB advances 113,587 112,390 1,197 23,265 23,296 (31) Long-term FHLB advances 20,650 20,433 217 8,500 8,550 (50) Other advances 250 250 ------- ------- Favorable (unfavorable) variance 1,616 (1,424)
Off-balance-sheet financial instruments: Commitments to sell loans 7 7 (25) (25) ------- ------- Favorable (unfavorable) variance 7 (25) ------- ------- Net favorable (unfavorable) variance $ (23) $ 3,495 ======= =======
Note 19 continued on next page.
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Note 19: Fair Value of Financial Instruments (continued)
Fair value estimates, methods, and assumptions are set forth below for the Company's financial and off-balance-sheet instruments.
Securities, loans held for sale, and commitments to sell loans: The fair value of securities and loans receivable held for sale, and forward commitments, are based on quoted market rates and dealer quotes.
Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair value of the loans that have fixed interest rates or a variable rate which do not reprice frequently is estimated using discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers or similar credit quality. The fair value of non-performing loans is estimated using discounted cash flow analysis, using applicable risk adjusted spreads to the contractual interest rates applicable to each category of loan.
No adjustment was made to the market interest rates for changes in credit of performing loans for which there are no known credit concerns. Management believes that the risk factor embedded in the market interest rates along with the general reserves applicable to the loan portfolio for which there are not known credit concerns results in a fair valuation of such loans.
Deposit liabilities: Under SFAS No. 107, the fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, NOW accounts, and money market and checking accounts, is equal to the amount payable on demand. The fair value of time deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using market rates for deposits of similar maturity of the top 25 local deposit-ranked institutions.
FHLB and other advances: The fair value of FHLB advances and other borrowings is estimated based on discounting the estimated future cash flows using rates currently available to the Company for debt with similar remaining maturity.
Other: The carrying value of other financial instruments has been determined to be a reasonable estimate of their fair value.
Mortgage servicing portfolio: The carrying value of the mortgage servicing portfolio is mortgage servicing rights as defined by SFAS No. 125. The fair value of the mortgage servicing portfolio represents the fair value of the total servicing portfolio, and is based upon an independent appraisal and a valuation model that calculates the present value of future cash flows.
Commitments to originate loans: Based on the short terms of these instruments, the unrealized gains or losses are expected to be insignificant.
Limitations: The fair value estimates presented herein are based on pertinent information available to management as of December 31, 1999 and 1998. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date, and therefore, current estimates of fair value may differ significantly from the amounts presented herein.
Note 20: Selected Quarterly Financial Data (unaudited)
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Note 20: Selected Quarterly Financial Data (unaudited) (continued)
Note 21: Segments
The Company is organized based on the products and services that it offers. Under this organizational structure, the Company has three reportable segments: consumer banking, residential lending, and commercial lending.
- -- Residential lending offers conventional or government-insured loans to Borrowers to purchase, refinance, or build homes, secured by one-to- four- unit family dwellings. Embedded within the residential lending segment is a mortgage banking operation, which sells loans in the secondary mortgage market. The mortgage banking operation may choose to retain or sell the right to service the loans sold (i.e., collection of principal and interest payments) depending upon market conditions.
- -- Commercial lending offers permanent and interim (construction) loans for multifamily housing (over four units), commercial real estate properties, and loans to small- and medium-sized businesses for financing inventory, accounts receivables, and equipment, among other things. The underlying real estate collateral or business asset being financed typically secures these loans.
- -- Consumer banking offers depositor banking services, home equity lending, direct consumer loans, and consumer dealer financing contracts.
These segments are managed separately because each business requires different processes and different marketing strategies to reach the customer base that buys those products and services. All three segments derive a majority of their revenue from interest, and management relies primarily on net interest revenue in managing these segments. No single customer provides more than 10% of the Company's revenues.
Basis of accounting for reportable segments: Starting in 1997, the Company adopted business unit profitability reporting, which measures the performance of segments as self-standing business entities. As self- standing entities, the segments have fully income-allocated and cost- burdened profit and loss statements. Except for the allocations and the funds transfer-pricing mechanism described below, the accounting policies for the segments are the same as those described in the Summary of Significant Accounting Policies.
Allocations and funds transfer-pricing mechanism:
- -- Operating income and expenses are allocated to segments whenever they can be directly attributed to their activities. Indirect income and overhead costs are credited or charged to the segments whenever they are specifically identified as providers or users of the ancillary internal service, or are allocated based on some common denominator. For certain services, intersegment user fees are assessed at agreed-upon prices.
- -- A funds transfer-pricing method has been utilized to allocate interest income for the deposits held in the branch banks. The deposit-gathering activities contribute to the profitability by reducing borrowing costs. The deposits are therefore presumed to generate revenues for consumer banking through reinvestments in low-risk securities (inferred interest- earning assets). The interest earnings are calculated using an internal, proxy-market interest rate. The loan-producing units in the residential, commercial, and consumer segments are also presumed to borrow money to fund their loans using an internal, proxy-market interest rate.
- -- Equity capital commensurate with the risk weight of segment assets has been allocated to simulate the operating capital level required by the Bank's regulators. The allocated capital provides the segments with interest-free funding.
Note 21 continued on next page.
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Note 21: Segments
Financial information for the Company's segments is shown below for the:
Years ended December 31, ------------------------ Consumer Residential Commercial Banking Lending Lending Totals - ------------------------------------------------------------------------------ Revenues from external customers 1999 $ 9,087,676 $ 8,462,124 $ 26,782,327 $ 44,332,127 1998 6,521,653 10,718,074 24,156,802 41,396,529 1997 6,326,339 10,068,321 20,810,023 37,204,683 Revenues from other segments 1999 17,373,355 303,320 1,634,108 19,310,783 1998 21,051,822 428,300 1,482,378 22,962,500 1997 18,505,479 467,586 1,303,662 20,276,727
Total revenues 1999 26,461,031 8,765,444 28,416,435 63,642,910 1998 27,573,475 11,146,374 25,639,180 64,359,029 1997 24,831,818 10,535,907 22,113,685 57,481,410
Net interest revenue 1999 6,418,249 1,739,501 10,155,577 18,313,327 1998 6,446,931 1,967,849 8,838,699 17,253,479 1997 6,235,391 2,098,386 7,254,032 15,587,809
Income before federal income taxes 1999 877,327 1,537,276 7,173,600 9,588,203 1998 1,565,589 2,017,212 6,025,083 9,607,884 1997 2,113,629 1,093,807 5,037,563 8,244,999
Total assets 1999 413,124,784 106,367,487 337,945,234 857,437,505 1998 414,809,598 107,019,912 274,234,989 796,064,499 1997 373,687,398 124,405,900 235,318,964 733,412,262
Revenues from external customers is comprised of interest income and other operating income. Revenues from other segments include the interest-free benefit of allocated equity capital, the interest revenue from the inferred earning assets on branch deposits, and intersegment user fees and charges.
Note 21 continued on next page.
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Note 21: Segments (continued)
Reconciliations of segment data to the Company consolidated financial statements are shown in the table below. The amounts for the segments differ from the actual consolidated financial statements due to the use of internal, proxy-market interest rates, and various methods for allocating costs. The provision for loan losses and the reserve for loan losses have not been allocated to the segments. Total segment assets include inferred interest-earning assets on branch deposits, which are essentially the same assets from the lending segments, but credited with a proportionate interest yield.
Years ended December 31, ------------------------ 1999 1998 1997 - ------------------------------------------------------------------------------ Total revenues for year ended December 31: Segment total revenues $ 63,642,910 $ 64,359,029 $ 57,481,410 Back out or add back: Revenues from other segments (19,310,783) (22,962,500) (20,276,727) Revenues of administrative departments netted against overhead costs and reallocated as net costs 934,543 1,048,513 897,657 ------------ ------------ ------------ Consolidated total revenues $ 45,266,670 $ 42,445,042 $ 38,102,340 ============ ============ ============ Net interest revenue for year ended December 31: Segment net interest revenue $ 18,313,327 $ 17,253,479 $ 15,587,809 Back out or add back: Difference between actual interest expense and intersegment funding allocation 51,974 (653,030) (291,096) Interest revenues of administrative departments netted against overhead costs and reallocated as net costs 659,393 795,913 509,283 ------------ ------------ ------------ Consolidated net interest income $ 19,024,694 $ 17,396,362 $ 15,805,996 ============ ============ ============ Income before federal income taxes for year ended December 31: Segment pre-tax income $ 9,588,203 $ 9,607,884 $ 8,244,999 Back out or add back: Unallocated loan loss provision (762,475) (750,000) (976,000) Difference between actual total funding cost and total intersegment funding allocation 426,795 (81,573) 66,053 Unallocated net expenses of administrative departments (171,368) (887,081) (488,430) ------------ ------------ ------------ Consolidated pretax income $ 9,081,155 $ 7,889,230 $ 6,846,622 ============ ============ ============ Total assets as of December 31: Segment total assets $857,437,505 $796,064,499 $733,412,262 Back out or add back: Inferred intersegment interest- earning assets on branch deposits (274,549,327) (308,525,629) (290,256,005) Unallocated reserve for loan loss (6,309,268) (5,569,431) (4,858,376) Unallocated nonearning assets of administrative departments 4,537,396 7,260,700 7,464,559 ------------ ------------ ------------ Consolidated total assets $581,116,306 $489,230,139 $445,762,440 ============ ============ ============
First Mutual Bancshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements
Note 22: Parent Company Only Financial Statements
Summary of condensed parent company financial information for First Mutual Bancshares, Inc. for December 31, 1999 (in thousands):
Statement of Financial Condition
Assets - ------------------------------------------------------------------------------ Cash $ 533 Investment in subsidiaries 39,397
Other assets 64 --------- Total $ 39,994 =========
Liabilities and Stockholders' Equity - ------------------------------------------------------------------------------ Liabilities: Borrowings $ 250 Other liabilities 408 ---------
Stockholders' equity 39,336 --------- TOTAL $ 39,994 =========
Statement of Income
INCOME: Equity in undistributed net income from subsidiaries $ 6,124
OTHER EXPENSE:
Compensation and employee benefits 3 Other operating expense 185 --------- Total expenses 188 --------- Income before federal income taxes 5,936
FEDERAL INCOME TAX BENEFIT 64 --------- NET INCOME $ 6,000 =========
Independent Auditors' Report
Board of Directors First Mutual Bancshares, Inc. Bellevue, Washington
We have audited the accompanying consolidated statements of financial condition of First Mutual Bancshares, Inc. and subsidiaries (the Company) as of December 31, 1999 and 1998, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial condition of the Company as of December 31, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles.
/s/Deloitte & Touche LLP
January 28, 2000 Deloitte & Touche LLP Seattle, Washington
Stock Information
The Company sold 966,000 shares of common stock in its initial public offering on December 23, 1985. As of December 31, 1999, there were 4,672,636 shares outstanding. The shares are held by approximately 1,200 shareholders of record and persons or entities who hold their stock in nominee or "street" name through various brokerage firms or other depositories.
First Mutual Bancshares, Inc.'s common stock trades on The Nasdaq Stock Market under the symbol FMSB. The following data are based on the reported sale prices on the Nasdaq National Market System for the quarters indicated, as reported by the National Association of Securities Dealers.
Quarter Ending High* Low* --------------------------------------------------------- March 31, 1998 $ 17.73 $ 15.91 June 30, 1998 16.59 15.00 September 30, 1998 16.08 10.80 December 31, 1998 13.75 11.19 March 31, 1999 12.73 11.36 June 30, 1999 13.06 11.25 September 30, 1999 13.00 9.00 December 31, 1999 12.88 10.00
*Adjusted to reflect the 10% stock dividend paid May 5, 1999.
General Information
BOARD OF DIRECTORS F. Kemper Freeman, Jr. Chairman H. Scott Wallace Vice Chairman John R. Valaas President, CEO James J. Doud, Jr. Mary Case Dunnam Janine Florence Victor E. Parker George W. Rowley, Jr. Richard S. Sprague Robert C. Wallace
BANCSHARES OFFICERS President John R. Valaas Chief Executive Officer Executive Vice President Roger A. Mandery Chief Financial Officer Vice President Kari A. Stenslie Controller Corporate Secretary Phyllis A. Easterlin
BANK EXECUTIVE OFFICERS President John R. Valaas Chief Executive Officer Executive Vice President Roger A. Mandery Chief Financial Officer Senior Vice President James R. Boudreau Chief Credit Officer Vice Presidents Robin R. Carey Operations and Administration Scott B. Harlan Residential and Consumer Lending Kari A. Stenslie Controller Corporate Secretary Phyllis A. Easterlin
FIRST MUTUAL BANCSHARES, INC., AND FIRST MUTUAL BANK CORPORATE HEADQUARTERS AND MAIN OFFICE 400 - 108th Avenue NE Bellevue, Washington 98004 (425) 455-7300 (425) 453-5302 Fax www.firstmutual.com
ANNUAL MEETING The annual meeting is scheduled to be held April 27, 2000, 3 p.m., at the Hyatt Regency Bellevue, 900 Bellevue Way NE, Bellevue, Washington.
TRANSFER AGENT AND REGISTRAR ChaseMellon Shareholder Services, L.L.C. Shareholder Relations P.O. Box 3315 South Hackensack, NJ 07606 (800) 522-6645 www.chasemellon.com
INDEPENDENT CERTIFIED PUBLIC Accountants Deloitte & Touche LLP
LEGAL COUNSEL Preston Gates Ellis LLP
INVESTOR RELATIONS COUNSEL Len Cereghino & Co. 2605 Western Avenue Seattle, Washington 98121 (206) 448-1996
FORM 10-K A copy of the Form 10-K as filed with the Securities and Exchange Commission will be furnished to shareholders upon written request to the Secretary, First Mutual Bancshares, Inc., P.O. Box 1647, Bellevue, WA 98009-1647.
You may also contact us through our Web site: www.firstmutual.com.
FIRST MUTUAL BANK OFFICES Ballard 2038 NW Market Street Seattle, Washington 98107 (206) 706-0894
Bellevue Financial Center 400 - 108th Avenue NE Bellevue, Washington 98004 (425) 453-2801
Bellevue West 10001 NE 8th Street Bellevue, Washington 98004 (425) 453-9434
Bellingham 1100 Harris Street Bellingham, Washington 98225 (360) 714-0433
Crossroads 15635 NE 8th Street Bellevue, Washington 98008 (425) 644-4214
Issaquah 855 Rainier Boulevard N Issaquah, Washington 98027 (425) 392-2673
Monroe 19265 State Route 2 Monroe, Washington 98272 (360) 794-8686
Redmond 16900 Redmond Way Redmond, Washington 98052 (425) 883-4700
West Seattle 4520 California Avenue SW Seattle, Washington 98116 (206) 932-6299
LOAN PRODUCTION OFFICES Salem 401 Ratcliff Drive SE, Suite 170 Salem, Oregon 97302 (503) 363-4726
Tacoma 2323 N 31st Street, Suite 200 Tacoma, Washington 98403 (253) 759-3559
----------------------- FIRST MUTUAL BANCSHARES ----------------------- INCORPORATED
460 -108th Avenue NE Bellevue, Washington 98004 (425) 455-7300
Exhibit 21
Subsidiaries of the Registrant
Parent - ------ First Mutual Bancshares, Inc.
Percentage Jurisdiction or Subsidiaries of Ownership State of Incorporation - ------------ ------------ ---------------------- First Mutual Bank 100% Washington
First Mutual Services (1) 100% Washington
- ---------------- (1) This corporation is a wholly owned subsidiary of First Mutual Bank. First Mutual Services (FMS) engages in the sale of mutual funds and annuities. PRIMEVEST Financial Services functions as the broker dealer and is responsible for the sale and delivery of securities. As of December 1999, the company has decided to discontinue directly offering investment products to its customers. The Bank's investment in First Mutual Services at December 31, 1999, was $38,555.